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Payday Loans - What is the True Cost?

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When you need quick cash, what could be more convenient than taking out a same-day payday loan that is deposited directly into your bank account? On your next payday - a week or two later - the loan is automatically repaid because the creditor has your bank information. Sure, there is a fee, but there's no credit check, no collateral, and no lengthy application process like there is for a personal loan. You just walk into the payday loan office or go online, fill out a few forms proving that you have a steady job and a checking account, and you get up to $2,000 the same day.

It sounds easy, but it may not be such a good deal. Payday loans are defined as short-term loans with an interest rate above 36%. That sounds like a high rate, doesn't it? After all, you see new car loans advertised for zero percent, and home mortgages for 6%. Personal loans from banks are generally between 10% and 15%. Even credit card cash advances can be cheaper. A $300 cash advance on the average credit card, repaid in one month, would incur a finance charge of $13.99 at an APR of 57%.

To make it sound less expensive, payday loan providers don't advertise their annual percentage rate (APR) the same way credit card and personal loan providers do. They state the interest in terms of a fee per $100 loaned. Here's a typical example.

Payday Loans: How the Fee Translates to APR

You walk into the payday loan office or apply online. You need to borrow $500 until your next payday, which is in seven days. The fee for your loan is $15 per $100 borrowed. You think, "That's not so bad, it's 15%, isn't it"? You agree to the loan terms and you give the lender a check in the amount of $575, dated in seven days.

When your loan is due to be repaid in seven days the creditor will cash the check or debit your checking account. If you have $575 in your account, then you are finished and the transaction is completed.

You will have paid $75 for your loan. That translates into an annual percentage rate (APR) of 780%. It's very high, but that's because calculating the APR is complex and involves not only the loan amount and the fee, but the period of the loan-how long until you pay it back.

The big danger to payday loans is that many customers can't pay back the loan on time. Think about it - a customer who does not have $500 in his or her bank account this week is unlikely to have $575 in their account next week. Many customers "roll over" their loans. They cannot pay on the due date, so the creditor charges the $75 fee and agrees to collect on the next payday.

Are You the Average Payday Loan Customer?

According to the Consumer Federation of America, from a single lender each year the average payday loan customer takes eight to thirteen payday loans or loan renewals. So if you are the average customer, let's say you roll over or renew your $500 loan 10 times in one year. To borrow $500 for 10 weeks, you will pay a total of $750 in finance charges plus repay the amount borrowed. Your $500 payday loan will end up costing you $1,250.

There are additional risks and fees. To get a payday loan you are required to give the creditor a personal check as repayment. If your check bounces, your bank will charge you a fee - often as high as $40. You can lose your bank account or have difficulty opening a new bank account if you develop a record of bouncing checks used to get payday loans.

Before you take out a payday loan, carefully consider the real cost - and ask yourself if it's worth it.