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Being stuck in a financial bind is stressful, and having bad credit can make the situation feel even worse.
Whether you need money fast to keep the lights on, pay for doctor visits or buy groceries, you might think your only option to stay afloat is to take out a payday loan.
A payday loan may be able to help you keep the lights on as a last resort — but it’s a tradeoff. Payday loans typically have high fees and difficult repayment terms. Taking out a payday loan today could make it harder to get out of debt down the road.
Before you commit to a payday loan, let’s look at how they work, the possible consequences of using payday loans to bridge money gaps and some alternatives to payday borrowing.
What is a payday loan?
A payday loan is a small, short-term loan that’s due by your next payday. It’s typically marketed to people for those times when there’s more month than money. And depending on your state, it’s common for payday loan amounts to be around $500 or less.
A payday loan typically works like this: If approved, you either write a post-dated check or sign an automatic withdrawal authorization form that lets the lender take the money due (principal, interest and fees) from your bank account after the date of your next expected paycheck. Even though you may be required to leave a post-dated check at the store, many payday loan lenders will require you to return on your payday to pay the balance off.
But if you can’t repay the loan after your next paycheck, the lender might offer to let you roll your current loan over into a new one. This includes the existing loan and fees — on top of the new loan amount and fees — so that now you have an even larger loan to pay off on your next payday.
This rollover practice is how you can end up owing far more than you originally borrowed. In fact, 60% of payday loan borrowers end up owing more in fees than they originally took out, and 80% either roll over their loans when they’re due or default within a year, according to the Consumer Financial Protection Bureau. Very few people actually pay them off on the due date after they first take them out.
Should I get a payday loan with bad credit?
The decision to take out a payday loan is ultimately up to you. But it’s important to have all the facts about how these short-term, high-interest loans work.
Pros of payday loans
The biggest advantage of payday loans is that they’re relatively quick and easy to get. Payday lenders typically don’t check your credit when they decide whether to lend money to you, so bad credit probably won’t stop you from getting a payday loan. If approved, you may be able to get cash on the same business day you apply for a payday loan (even within the same visit), especially if you apply in person at a payday loan store.
Cons of payday loans
The biggest strike against payday loans is their high fees. The fees on a typical payday loan can be so high that they hit an equivalent APR of around 400%, the CFPB says. Compare that to credit cards, which have a national average APR of around 15%, and you can see why payday loans are so much more expensive.
For example, if you take out a two-week payday loan for $500 with a $15 fee per $100 (adding up to an APR of nearly 400%), by the end of one year you’d have paid $1,565.43 in interest. That same $500 borrowed on a credit card with a 15% APR and repaid in 12 monthly increments would cost you $41.55 in interest.
And while it may seem helpful to roll one payday loan into another when you can’t afford to repay the original loan amount, that’s actually how many people get trapped in a cycle of debt which can last for months or even years.
What are some alternatives to payday loans?
Luckily, payday loans may not be your only option if you need money. Even with bad credit, you may qualify for other types of loans instead.
Asking for an extension
There’s no shame in asking for help when you need it due to a financial emergency, and requesting an extension on your bills might signal to your creditors that you’re sincerely trying to pay them. Creditors may be open to working with you to create a more manageable payment arrangement rather than see you default on your bills altogether.
Payday alternative loan
If you’ve been a member of a federal credit union for at least one month, you may qualify for a payday alternative loan. Some federal credit unions offer these small, short-term loans — and they come with more-reasonable fees. You also can’t borrow more than three payday alternative loans within a six-month period.
Small personal loan
Finally, consider a small personal loan for bad credit. You may not qualify for the best interest rates if your credit needs some work. But even if you qualify for a personal loan with a high interest rate, it will likely still be cheaper than a payday loan. And while some lenders may process your application in time for same- or next-day financing, others may take a while to review your loan application.
Although the laws governing personal loans vary from state to state, one thing most people can agree on is that high interest rates and fees and difficult repayment terms mean payday loans should only be considered as a last resort. If you do decide to take out a payday loan, it’s best to plan your repayment strategy in advance so that you don’t get caught in a debt trap.
You can do this by planning a way to pay off the payday loan when it’s due. Then, take steps to improve your credit and build an emergency fund. Good credit and a rainy-day fund can help ensure you won’t have to resort to a payday loan the next time you find yourself in a financial jam.