Let me set the scene: You reach Thursday and have decided a weekend of fun is in order. You check your account and discover that you only have $5 of your budget spare. The horror! Netflix and noodles look to be in your future... then, suddenly you hear a maniacal laugh from the TV. “Money fast? I can help!” Queue terrifying music.
But as promised, next day, you have a full week's wage or more in your account and your weekend is going to be as fab as you want.
Don’t get me wrong - sometimes, sudden bills will come in and leave you strapped for cash, and not everyone has emergency funds or a credit card. I get the temptation. In fact, I have bowed to the maniacal laugh and the easy cash before. Short term... great for you and problem solved! But what is the catch, because yes, you know there is always a catch.
Let's start with the most obvious...
The Cost
Say Fred Smith needs to borrow at least a couple of weeks wages to sort bills that have all become due at the same time. So he asks for a loan of say $1500. He finds a payday lender that offers the following:
- Establishment fee – 20% of the loan amount
- Monthly fee – 4% per month
Sitting down, he works out that once he takes into account his weekly bills and expenses, he will be able to pay this off at about $200 a week. At this rate, it will take him roughly 2 months to pay it off. Now here is the kicker: he would have paid an additional $480 in that two months.
Now let's make it even worse for Fred Smith. He has a lot of bills coming in the next few months, so he has decided he can really only afford $100 a week. Well guess what that means? It is now going to take him over 4 months to pay back and with an additional $600 paid in fees.
So, while at the time the money is great, in the long run cost is not so great. Sadly, in most cases, the borrower is going to have the funds to only make the minimum repayment and therefore suffer the maximum cost for this type of loan.
How does it effect my Credit Rating?
"Pay-day" loans affect your credit rating in one of two ways. First, they can surprisingly have a positive impact. Say you only have the pay-day loan on record and it was paid perfectly, never late, no late fees ever charged. This situation may actually increase your credit rating as it will show that you can handle debt. However, the bank will still likely ask why you needed it. As I've advised in previous musings, they need everything but the kitchen sink.
More often though, it will impact your credit rating negatively. Statistics on pay-day loans suggest that those who use pay-day loan services do this regularly. Here is where the real evil comes in. It can effectively lead the borrower to an endless cycle of borrowing and owing just to cover the borrowing already in place. When there are too many of these on your credit file, your credit rating will drop and will result in struggles to get a lender to approve you. Big banks giving big loans, as part of their due diligence, will want to see that you can live on what you earn and pay off big repayments without needing this sort of help.
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So next time you hear that maniacal laugh and offer of easy cash, weigh up what it is really going to be worth in the long run. If you are already a victim of the evil pay-day loan, take a step and approach your finances in a different way.