From the perspective of sheer numbers, it would appear that most American citizens are addicted to debt. Credit cards, home equity loans, second mortgages and payday loans all contribute to the amount of money that the average American citizen owes.
Extra expenses and unexpected bills almost always wind up stored on plastic, accumulating interest and growing each month, and payday loans are used to tide you over until that next paycheck arrives.
But how beneficial are payday loans and credit cards, and how does your financial situation benefit the financial institutions who extend these lines of credit?
The largest factor influencing the application for credit cards and payday loans are the interest rates that are applied to them. When you apply for any type of loan – rather on a credit card or in the form of cash – you must be cognizant of the interest rate, how often it is compounded and the consequences of not paying.
A credit card is an ongoing line of credit. You can charge any amount up to your credit card limit, and pay it back monthly however you desire. Many people choose to pay only the minimum payment, which allows the credit card companies to continue making money off the interest you accrue.
A payday loan is a much shorter loan that is typically given as cash or direct deposit, and is due on the date of your next paycheck from your place of employment. It is also commonly called “deferred deposit”. The financial institution – or loan center – charges a large fee for the loan, which must be paid as well as the loan amount. If you are unable to pay the amount when it is due, you continue to accrue the original fee every two weeks until you are able to satisfy the debt in full.
So what should consumers do when they are low on cash?
There have been tragedies in both types of credit – credit cards and payday loans – but which is the lesser of the two evils? It really depends on how well you are able to manage your money, and how well you can guarantee that you’ll be able to satisfy a debt when it is due.
Bankrate.com sites a specific example of a woman who borrowed $150.00 from a payday loan center. Six months after the fact, she was still suffering from the same set of problems that brought her to the loan center in the first place, but by then she owed more than one thousand dollars and the payday loan center was threatening to throw her in jail.
This is not as uncommon as you might think.
On the other hand, in 2005, the combined credit card debt in America totaled more than seven-and-a-half billion dollars. About one in every twenty American household owes more than $10,000 to credit card companies, and 60% of Americans pay only their minimum payment each month.
There are a few discrepancies, however, that separate payday loans from credit card debt.
- Interest – Only about 1/3 of payday loan companies (including those that are found only online) actually disclose the interest rate for payday loans to potential customers. Credit card companies display the interest rate no matter the medium, which typically falls between 12% and 18%. Many payday loan companies have been known to wind up charging customers up to 1800% interest.
- Precedence – Payday loan companies in Kentucky and Tennessee are currently undergoing legislation from previous customers who are now filing for a Chapter 13 bankruptcy due solely to their payday loan debt. Because the interest – or fee, whichever they charge – is compounded every week, it is easy to sink into thousands of dollars in debt.
- Time To Pay – With payday loans, you must pay the debt back when your next paycheck arrives, or you pay a significant price. Credit cards – however easy they make it to sink into debt – can be paid off over an extended period of time.
- Disclosure – Credit card companies are typically reputable and follow the guidelines of disclosure to potential customers. They give you the interest rate, the annual fee and the grace periods up front – in writing – so that the customer can make an informed decision. Payday loan companies, however, rarely disclose everything, and many consumers have fallen victim to scams.
The advice from the consumer advocates who have researched this at length?
Most experts recommend staying away from all lines of credit and managing finances within one’s means. Everyone comes to difficult times, and the best way to handle it is the budget more carefully.
- Savings Accounts – Keep at least $1,000 in a savings account – where it can accrue interest – for emergencies. Don’t touch this money unless absolutely necessary, and replenish the funds as soon as possible.
- Avoid Payday Loans – Because you never know what might happen in the future, you cannot always guarantee the ability to pay back the loans when they are due. If you must use a payday loan center, choose a reputable company such as Ace or Cash Advance.
- Pay Credit Cards Off – Only charge to credit cards what you will be able to cover when the bill arrives. Paying the minimum monthly payment can rack up debt faster than large purchases.
Payday loans have an exponentially higher interest rate than credit cards, and it is important to carefully research a company before soliciting a payday loan.