Finance Roll

A new craze is sweeping across the Australian continent - on face value, there are numerous lenders changing the traditional way money has been lent. They advertise slogans like - 24 hour approval, on the spot approval, easy money, very low interest rates, etc. These lenders seem to advertise rates which are as low as half the bank's standard variable rates. If you recall the old adage of 'if it's too good to be true - it usually is'

There are various terms used to describe this style of lending and they extend to car loans as well as personal loans. If you're lucky, you might not be familiar with the term "payday loan". This is a loan which is supplied by a third-party lender and it is supposed to help consumers get out of last-minute financial jams by offering a cash advance on an upcoming paycheck. While getting out of a tough spot is certainly a good thing, the interest charged by payday lenders usually exceeds 100%, which could make a tough spot even tougher. In my opinion, payday loans are examples of loan shark companies preying on peoples' desperation under new marketing campaigns.

The way they work:

A payday loan works like this: You're short on cash and can't wait until your next paycheck comes around, so you head off to your local payday lender (many are online these days), and ask to set up a payday loan -- usually somewhere between $50 and $1,000, although the higher limits are usually harder to qualify for. You write a post-dated check for that amount plus the fees you now owe to the lender. You get your money right then and there and, when payday rolls around, the lender will cash your check and collect its profit. Typically, people who use payday loans find themselves in situations where they are presented with few other financial alternatives. In their eyes, a payday loan is a way of staying afloat for a short period of time without having to ask for handouts. People with low credit or no credit are ideal customers for payday lenders.

One step forward, two steps back

In most cases, these loans are not attractive options for short-term financial problems. Exorbitant interest charges, sub-par lender reliability, small loan size, future dependency and the possible negative effects that borrowing from these lenders can have on your credit rating are all valid reasons to avoid a payday loan if at all possible. The amount of interest charged by payday lenders is no joke. Annualized interest rates of between 200% and 500% are the industry standard. Payday lenders are often able to get around usury laws (government limits on the amount of interest a lender can charge) by calling their interest charges "service fees", which aren't subject to the same regulations as interest fees are in many places. The other way is to advertise monthly interest rates instead of the standard annual rates. E.g. the current standard bank variable rate is 8.07% which is significantly cheaper than a monthly interest rate of 3%. A 3% interest rate equals to a 36%pa.

Paltry sums

With all the detractors from these loans, the size of most of these loans seems of little consequence. But when you consider the fact that most of these lenders won't typically authorize anything more than a maximum of a few thousand dollars, their usefulness -- particularly if someone is concerned about keeping up car or mortgage payments -- really comes into question. The small loans act in the lenders' favors in more ways than one: Smaller loans mean more borrower diversification because spreading money over more customers means less risk. Also, limiting loans to small amounts can often disguise just how extreme the interest rates are.

Learning to live without

Another major risk that goes along with these loans is the risk of dependency. While a payday loan might get you through the end of the month, will the interest charged on the loan make things even more difficult for you the following month? A cycle of dependency like this can cripple a person's financial health. As these types of loans become more commonplace and are being handled by more established companies, some of these lenders are starting to report to credit bureaus. Given the precarious nature of most payday borrowers' finances, defaulting on your payday loan could mean a lasting scar on an already weak credit rating.

Better alternatives

Such loans are not the only solution to short-term liquidity problems. If you need money and you find that collateral and credit aren't major problems, a conventional loan is the best-case scenario. Don't make the decision yourself as to whether you qualify for personal loans or other types of emergency funds - go to a reputable finance broker and let them advise you. If taking out a personal loan isn't a realistic possibility, asking your employer for a pay advance is a much better option. Despite the old adage that warns against borrowing from friends and family, you might want to consider it over resorting to taking out a payday or similar loan -especially considering the payback options put you in a deeper hole. The final option is to approach the bank you have your home or car loan with, and advise them of the financial difficulty you are facing. In most cases, they will work with you to get over the hardship period by putting in place a payment arrangement. Contrary to popular belief, finance lenders are not in the business of 'kicking people out of their homes' and selling them for a profit. In fact, they do everything they can to avoid this scenario. If your loans are for personal use (instead of business purpose), you are covered under the Uniform Credit Consumer Code which extends many protections to consumers - especially for their primary place of residence.

Conclusion

Resorting to a payday loan must be your last resort and your only option. If this is the case, it's important to weigh your options and reflect on all your facts before you enter into a financial agreement that's 'stacked in the house's favor'. Ensure you have approached a few reputable mainstream finance brokers which deal with 'non conforming personal loans' before committing to these last resort loans. If your past shows you have had periods of financial pressure, be proactive about planning for the next 'unforeseen' financial pressure by organizing access to emergency funds when you DON'T need them. Ensure these funds are not costing you anything to have them and also ensure you do not use these funds for any other purpose except emergencies. Again, finance brokers are the best way to organize these funds but ensure you speak to a financial advisor and / or accountant who can advise you on the best strategies to 'stay afloat' financially and how to get ahead.