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Payday Loans: Be Cautious With Short-Term Credit

Cash advance or payday loans are very simple loans. They are based on the understanding that upon receiving your next paycheck, you will have the funds to pay the loan off. They are easy to apply for and quickly disbursed. For this reason, such a loan is both a useful tool and something it is quite easy to get into trouble with.

Another definition of this type of loan is “short-term credit.” This is because it has a very short repayment term, usually no more than two weeks (i.e. until your next paycheck.)

Due to the short term and the generally small amounts these loans are not generally provided by traditional banks, but rather by businesses largely dedicated to cash-advance loans. The lender does not have the long-term potential of earning $170,000 interest on a $150,000 loan over thirty years; therefore the profit must be obtained in another fashion.

This translates into a high interest rate. A second reason for the high interest rate is that this type of loan is a risky proposition for the lender. The borrower does not go through the intensive vetting process that exists at a traditional bank. All that is required for a cash-advance is proof of employment and ID. Because these documents can easily be falsified and even the honest borrower probably has a less than stellar (read “bad”) credit history, there is a high risk of default. To offset such risk, the lender has to charge concomitantly higher rates to all borrowers.

Thus, while this can be a handy source of cash in an emergency situation between paychecks, payday loans should also be approached with caution. The most important aspect is to make sure you are dealing with a legitimate lender, as the oftimes desperate needs of the borrowers can lend itself to shay practices on the lenders’ part.

Once the lender’s bonafides have been established, it is up to the borrower to not get herself into trouble with a cash-advance. The repayment period is as short as the interest rate is high.

This means that if the borrower is taking out more than she can pay back in the time laid out by the loan terms, or using such loans on a too-frequent basis, she can find herself borrowing ever-larger amounts to pay off the monies she has previously borrowed. This leads to a cyclical downward spiral of debt from which it may be impossible to recover. All borrowing must be approached cautiously.