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Payday loans are small, unsecured short-term cash loans that people borrow to get through the month until their next salary kicks in. It is thus, a small principal being lent out, often at a very high-interest rate (up to the order of 30-50%).
Payday loan is a prompt and unsecured financing option that allows individuals to mitigate any monetary crisis. The loan quantum here depends on the next paycheque of an applicant and is usually a portion of his/her total income.
Let’s understand how payday loans work with an example. Let’s assume that you are in need of ₹ 40,000 which is for an emergency, but you are still thirty days away from payday, and your bank account is sadly on the verge of being empty.
You go to one of the several online payday lenders who offer you convenient payday loans. As you expect your salary within seven days, you apply for a loan for tenure of seven days and for a principal amount of ₹ 40,000 at 9 % interest per month.
So, ₹ 40,000 (Amount borrowed) + ₹ 3600 (Interest) = ₹ 43,600 to be repaid within 7 days.
Essentially, if you have to take a 30-day loan, you are paying 108 % interest. If you take a 60-day loan, you are paying 108% interest. And in case you are late, you are likely to pay penalties on a per day basis.
Payday loans are convenient but that convenience comes at a cost. Finance charges can range from 15% to 30% of the amount being borrowed, which can easily make the effective annual percentage rate (APR) on the loan in the triple-digit range.
Even if you only have the loan for a few weeks, you’re likely to pay much more in interest with a payday loan than you would for a personal loan or even a credit card cash advance. Payday loans are often problematic for the people who use them because they tend to be favored by borrowers who may not have cash or other financing options readily available.
One of the biggest pitfalls that can happen with payday loans is when a borrower falls into a cycle of repeatedly extending their loan. They find themselves unable to repay the loan on payday, so they extend the loan for another pay period. They continue spending borrowed money and in the meantime, the fees continue piling up. It’s a vicious cycle and it’s one that can continue indefinitely since there is no limit on how many times a person can get this type of loan.
1. Borrow from Family or Friends
If you’re in a financial bind, a family and friends loan may be a great way to dodge a high-interest payday loan. In fact, you may even be able to borrow money with no interest.
Regardless of the interest rate you decide on, put your loan agreement in writing. This contract should include the amount of money you’re borrowing, the interest being charged or the collateral being used, the payoff period, and the payment amounts and due dates.
Failure to repay a loan of this type won’t hurt your credit, but it can result in legal action and a severed friendship or strained family relationship.
2. Seek Help from a Credit Counselor
A nonprofit credit counseling agency may be the way to go if you feel like you’re swimming in debt. A certified credit counselor can help you pay off your debt faster, lower your interest rates, work with you on a household budget and improve your financial situation. Depending on which services you utilize, nonprofit credit counseling agencies may provide their services at little to no cost.
3. Develop a Budget
Create a balance sheet with cash inflows and outflows. Knowing how much you have coming in and where you’re spending it is crucial to managing personal finances. Next, consider eliminating any expenses that aren’t crucial. For instance, cable is a good place to start eliminating expenses. Look for another provider or drop to a cheaper package. Keep in mind that it is a serious mistake to borrow at high interest rates to pay regular monthly expenses. If you can’t pay the rent without a loan, move to a cheaper place.
4. Peer-to-Peer Lending
Peer-to-peer lending (P2P) platforms would be treated as non-banking financial companies (NBFCs) and regulated by the Reserve Bank of India (RBI).Peer-to-peer lending is a form of crowd-funding used to raise loans for people who need to borrow, from people who want to invest. It enables individuals to borrow and lend money without any financial institution as an intermediary, and extends credit to borrowers who are unable to get it through traditional financial institutions.
1. Very High-Interest Rates
While the interest rate per day may seem manageable, when annualized, they turn out to be 400% annual interest (APR) or even more. The APR can even go up to 9000%, for very short loans. Let’s put that in perspective credit cards have an APR of 9-30%, generally! So, now you can imagine how costly payday loans can be.
2. Debt Trap
If you are unable to repay the loan in the next month itself, the spiralling over often incurs huge penalties and additional costs. This often makes it impossible to repay going ahead, making the probability of a debt trap very real.
3. Hidden Fees
Before taking out a loan, it is smart to ask your lender about any potential fees you have to pay in addition to the principal and interest of your loan. Below are the most common hidden fees to watch out for:
4. Not Considering Cheaper Alternatives
Some borrowing options that may be cheaper than a payday loan:
5. Difficulty to Repay
If you’re having difficulty making ends fulfill, it could be difficult to appear aided by the cash you will need to repay your loan. It may roll the loan over if you can’t pay. You then need to pay more charges along with your financial obligation gets larger and tougher to cover straight right back. In reality, an average of, pay day loan borrowers simply take over fifty percent at 12 months to cover back once again their loans.