Payday loans are small loans made by check cashers or similar businesses at extremely high interest rates. Typically, payday loans are short term (two weeks) and for a few hundred dollars. To get a loan, you write a personal check for the amount that you are borrowing, plus a fee. The lender agrees to hold onto the check until you are ready to repay. In return, you get cash immediately.
David took out a payday loan for $500. He plans on repaying his loan in two weeks. The payday lender says he will charge David $20 interest for every $100 that he borrows during this time period. This means that David will owe $600 when he repays his loan in two weeks. Why?
$20 interest for every $100 borrowed. David is borrowing $500.
$20 x 5 ($100) = $100 interest
$500 borrowed + $100 interest = $600
Unfortunately, David didn’t have the $600 he needed in two weeks, so he extended the loan for another two weeks. Suddenly, he owed $700 because the interest kept piling up! If David kept extending the loan for a year, it would cost him $2,600 in interest just so he could borrow $500.
The main reason to avoid payday loans is that they don’t help you solve the real problem. If you’re having financial difficulties, payday loans can only make the problem worse. You’re paying a really high rate of interest which means that your expenses are just going up.