Payday loans may seem like a good idea when you are desperate for money. There are offices on most corners, approval is relatively easy, plus they do not ask a lot of questions. If you walk into a location prepared with information, you can usually walk out with cash within 15-30 minutes.
How payday loans work
Let’s say something happens to your car and it will cost $500 to fix it. Since you need it for work, you need it fixed immediately. What happens if you do not have $500 in your savings account and you have no one to ask to borrow the funds? To make matters worse, your credit cards are maxed out or you may not even have credits cards. Most likely you wouldn’t be able to get a loan from a bank.
In this type of situation, many people will opt for a payday loan. In order to get a loan, all you usually need to take is a bank statement, recent paystub and tell them you need $500. You sign a few papers; write a post-dated check a month from now for a little more than the amount you are borrowing, we will use $510 as an example. When you leave, you will have $500 and the ability to pay for your car repair. On the due date of the loan, you bring the amount of your post-dated check in cash and they will return your post-dated check to you. Seems easy enough right? Not really.
When you make the payment of $510, it could prevent you from paying your other bills. So in order to be able to pay for your bills, you immediately take out another payday loan. Since this is your second payday loan, you have a shorter repayment period, possibly only two weeks and this time you owe $550 instead of $510. You may think to yourself, it’s only an extra $40; I will just eliminate an expense like eating out. The problem is that in another two more weeks, you are repeating the cycle.
What happens if another emergency happens? You get sick and you do not have any insurance. The doctor visit plus medication costs $250. Now you go to a different payday loan place to borrow more money to pay for your medicine. So each payday you are now running between two payday loan offices handing over your paycheck, or more, then signing up for another loan to get more money, minus additional fees, to pay your bills.
How can you get out of this hole you’ve dug for yourself?
How to get out
There are basically two approaches a person can take to get out of the cycle of payday loans. The first involves receiving a lump sum of money. For example overtime at work, a second job, a tax return, a gift from family or friends, or money from selling something of value. Once you received that lump sum, you would then use that money to pay off your loan and hopefully move on. Since this is never a given, most people will need to try option two.
Using the same $500 example from above, the next time you go to pay off your current loan and borrow more money, borrow a smaller amount like $475 instead of $500. This will force you to make adjustments to get through to the next pay period, but it can be done.
Now you are borrowing $475 and you will have to pay back $532 instead of $550. The next time, borrow $450 instead and you will pay back $504. If you notice, each time you are borrowing $25 less but the payoff amount decreases by a lesser amount. That’s another way they keep you stuck.
If you keep dropping by only $25 increments, it will take you years to pay off the loan entirely. It is a good start, but will not be enough. This is where you will need to get creative. Do you have anything you can sell for extra money? Could you get a temporary second job such as cleaning houses or mowing lawns? If you can make any extra money, it should be saved for the next pay period. If you’re at $450 and you make $150 extra, only borrow $300 next time. Using this approach will take a lot of discipline but is better than being stuck in a payday loan forever.
How to prevent future payday loans
You are finally finished paying off that payday loan, now what?
Remember that $50 you were paying toward your payday loan every two weeks? Just keep in mind that you were able to survive without that money somehow. As long as missing that $50 doesn’t affect your health by say eating less, you can continue to survive without it. First thing is open a savings account and deposit that $50 each pay period into the account and try to forget about it. Pretend it is gone like it was before when you had a payday loan. Do not pull from it to go to the movies or hang out with friends. If you are able to withstand the urge to withdraw from that account, in a few months you will be prepared for a small emergency. Continue doing this and in a year you will have accumulated more than $1,000.
Saving is not easy
Saving money is never an easy thing to do, especially when do not have extra money. If you can stop wasting money on payday loans, you will be able to make other changes in your personal finance. For instance, create a budget, or think about ways to escape debt and better your financial position.
Payday loans are evil as they prey on people in bad situations and then make things even worse. The interest rates they charge are obscene which is designed to keep people trapped for years and years. If you want to avoid this situation, or stop yourself from getting back into the situation, plan for emergencies by setting aside a small portion of your pay into a savings account.