Finance Roll

Payday lending has been the subject of much debate, leading to a great deal of understandable confusion amongst the general public. Needless to say, confusion and important financial transactions are not a good mix. To a potential borrower, there is nothing more important than a clear mind in terms of knowing exactly what his/her borrowing options are and finding the kind of loan that best fits the borrower's needs and financial circumstances. So how do payday loans fit within this scenario?

The first thing to remember is that payday lending is simply a tool. Like any tool, it can be used constructively or destructively. If used correctly and appropriately, it can be a borrower's best option. If used in the wrong circumstance or by an uneducated borrower, then problems can arise. The purpose of this article is to educate the reader so that he/she can make the right borrowing decisions.

Payday lending exists because it provides the kind of tool that can't be found elsewhere. In these days of foreclosures, bad economic times and shrinking credit (even to "good credit" customers), there is sometimes a need for a very quick emergency borrowing option that doesn't entail the high fees charged by banks and credit cards. An article published in the April 14, 2009 Wall Street Journal described how consumers who took out payday loans "avoided expensive checking account overdraft fees". The article went on to state that "nearly 90% said they were either very or somewhat satisfied with the (payday loan) transaction" and concluded that "compared to (bank) overdraft practices, payday loans are transparent".

To see if a payday loan is the best option for you, give yourself the following test:

(a) Do you need money very quickly?
(b) Is it an amount in the $100-$1,500 range?
(c) Are you considering using a credit card advance, pawn shop transaction, or bank account overdraft to get the money?
(d) Can you pay it back in a short timeframe?

If the answer to all these questions is yes, then a payday loan just might be the smartest and most legitimate option for you. On the other hand, if the answer to one or more of them (especially (d)) is no, then this type of loan could lead to trouble. Consider the following scenarios:

Scenario 1: You had a medical emergency that required you to write a $275 check. However, you don't have enough funds in your bank account to cover both this check and your other bills.

Fees from payday lenders range from $15 to $30 per $100. Taking the average of that range, we can estimate that borrowing $300 from a payday lender would typically cost you $67.50 for the two week period. Now let's take a look at what it might cost you if you didn't borrow the money.

Your current bank account has $250 in it. You have already written checks to pay your utility bill ($50) and groceries ($77) but neither check has cleared yet. You also wrote a check for $27 to cover some car parts and another ($19) for school supplies just yesterday. You also have a $50 credit card bill due this week. You can never be sure of the order in which the bank will process the checks, but let's assume a worst case scenario: i.e., the $275 check is processed first. This would cost you approximately $143.75 in overdraft charges for the five bounced checks (based on current estimates of typical bank overdraft fees) Also since you didn't pay your credit card on time, you will incur an approximate $34.35 late fee (based on an average credit card late fee as noted by Index Credit Cards). Total cost of not taking the loan would be $178.10!

$67.50 is a lot cheaper than $178. Under this scenario, taking the loan is clearly the smart choice.

Scenario 2: Same as 1, except instead of paying the loan in two weeks, you let it roll over a second two weeks and then another two weeks beyond that. Now instead of $67.50, your debt becomes $202.50. At this point, taking the loan would no longer be the smarter choice.

Moral of the story: Payday loans can be very useful, but also dangerous if you let them roll over multiple times!

Payday loans are intended as short term credit loans. If used as intended, they can be the best way to fix a temporary financial hardship. However they can also be easily abused. Payday lending should be properly viewed as a beneficial tool to an educated consumer who is able to recognize its value and knows how to use it wisely, appropriately, and legitimately.