Basics

Bad Credit and Payday Loans

Cory

July 21, 2023

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4

min read

Bad Credit and Payday Loans 

When meeting financial ends seem impossible, the prospects of a quick fix loan can be incredibly appealing, especially to the unbanked or underbanked. It's in such scenarios that payday loans frequently come to attention. But despite their convenience, these loans may not always be the best solution to financial tribulations. 

Understanding Payday Loans

Payday loans are short-term, high-interest loans that were originally designed to be repaid on the borrower's next payday (hence the name). They provide an attractive solution for individuals with bad credit and immediate cash needs. However, according to the Federal Trade Commission[1], these loans can often lead borrowers into a vicious cycle of debt. 

How Payday Loans Work

To get a payday loan, borrowers need to show proof of income and a checking account. Once approved, the borrower receives the loan amount either in cash or by electronic transfer. The understanding is that the loan, coupled with extreme rates of interest, will be repaid by the borrower’s upcoming payday, hence no credit score is typically needed (Consumer Financial Protection Bureau [2]).

Why You Might Not Want a Payday Loan

Despite the immediate relief that payday loans can offer, they come with a host of detrimental potentials. Firstly, they're often characterized by remarkably high annual percentage rates (APRs). As detailed by the Center for Responsible Lending [3], the national average APR for a payday loan is astonishingly high at 391%. 

Moreover, many times, due to the high interest and fees, borrowers are unable to repay the entire loan and fee, causing a need for a new loan, and as such, commencing a cycle of debt (Federal Reserve Bank of St. Louis [4]). This cycle can lead to higher borrowing costs, negatively impacting a borrower's financial health further.

Alternatives to Payday Loans

As a credit card company serving the unbanked and underbanked, we believe there are various alternatives to payday loans:

  1. Credit Counseling: Nonprofit organizations like the National Foundation for Credit Counseling can provide free or low-cost credit counseling services and help construct a debt management plan [5].
  2. Credit Union Loans: Credit unions often offer small, short-term loans at far more affordable rates than payday loans [6].
  3. Payment Plan With Creditors: Creditors may be willing to negotiate payment plans with a reduced interest rate or longer payback periods, providing relief without the potential for a debt spiral [7].
  4. Emergency Assistance Programs: There are numerous local social service agencies, churches and charities that offer emergency help either directly or through social services programs [8].

Conclusion

While payday loans seem like an attractive quick fix for urgent money needs, the heavy interest rates and the likelihood of falling into a debt trap outweigh their initial convenience. Exploring alternatives and becoming financially literate can lead to better financial health and a satisfactory credit record.   

Citations

[1] Payday Loans | FTC Consumer Information - 

https://www.consumer.ftc.gov/articles/0097-payday-loans

[2] What is a payday loan? | Consumer Financial Protection Bureau -

https://www.consumerfinance.gov/ask-cfpb/what-is-a-payday-loan-en-1567/

[3] Payday Loan Facts and the CFPB’s Impact | Center for Responsible Lending - 

https://www.responsiblelending.org/sites/default/files/nodes/files/research-publication/crl_payday_loan_facts_oct2017.pdf

[4] Payday Loans | Federal Reserve Bank of St. Louis - 

https://www.stlouisfed.org/publications/inside-the-vault/fall-2007/payday-loans

[5] National Foundation for Credit Counseling

https://nfcc.org

[8] Income Support | Office of Community Services | ACF - 

https://www.acf.hhs.gov/ocs/programs/csbg/about/faq/income-support