When it comes to money, expecting the unexpected is easier said than done. That’s why troubling headlines like these should come as no surprise:
- 27% of Americans have no emergency savings.
- 56% don’t have enough saved for an emergency expense of $1,000 or more.
- 59% aren’t comfortable with their level of emergency savings.
Bankrate’s 2024 annual survey reveals these statistics, and the findings are even more dire for younger generations. However we look at it, the message is clear: many of us are unprepared or underprepared for unexpected expenses, which can hit at any time and derail our finances. This bleak outlook is echoed by MarketWatch, which found that 66% of Americans are living paycheck to paycheck.
When faced with an unexpected bill—whether medical, vehicle-related, or something else—some may dip into savings, borrow from family, or use credit cards. But for those without these options, payday loans might seem like the only choice, despite their risky nature.
What Are Payday Loans?
A payday loan allows us to borrow money against our next paycheck to cover urgent financial needs. These loans are typically short-term, with repayment due in two to four weeks, and the loan amounts are usually small, often around $500.
To apply for a payday loan, whether in-person or online, we need to show proof of income. Payday lenders typically don’t care about our credit history, which can be appealing if we have bad or no credit. But this convenience comes at a steep cost.
To truly understand how costly payday loans can be, let’s imagine we take out a 14-day payday loan for $500 with a $75 fee.
At first glance, the cost seems straightforward: $75 on a $500 loan, or 15%. “Not so bad,” we may think. However, that’s where we’re mistaken. To grasp the full impact of the cost, we need to calculate the Annual Percentage Rate (APR).
APR gives us a clear picture of the total loan cost over a period of one year. Even though this hypothetical loan is just for 14 days, knowing the APR helps us understand how expensive it truly is, allowing us to compare it to other options.
Here’s how the calculation works:
- The loan costs $75 for 14 days, or $5.36 per day.
- Multiply $5.36 by 365 days, and the annualized cost is $1,956.40.
- Divide $1,956.40 by the loan amount of $500, and we get an APR of 391%.
This 391% APR is the best case scenario, assuming we repay the loan right after we receive our wages. If we’re unable to do so, additional fees will pile up quickly. What begins as a short-term loan can spiral out of control, trapping us in a cycle of debt, making it increasingly difficult to break free.
A Few Words on Regulations
Each year, about 12 million Americans turn to payday loans, often out of desperation for quick cash. Their shared blight makes them vulnerable to persuasion and, worse still, exploitation.
To protect consumers, many states, including the District of Columbia, have imposed limits on APRs. Since payday loan APRs can easily reach triple digits, as shown in the earlier example, these caps effectively render the industry illegal in those areas.
If we ever consider taking out a payday loan, it’s crucial to first check whether they are legal in our state. If they are, our next priority should be to repay the loan as quickly as possible. While not all payday lenders are unscrupulous, it’s important to be cautious. Should we ever find ourselves slipping into debt collections, remember this: abusive, unfair, and deceptive practices are prohibited by both federal and state law. In such cases, we should file complaints with the Federal Trade Commission (FTC), the Consumer Financial Protection Bureau (CFPB), and our state’s Attorney General.
The Big Picture
It’s wise to hope for the best, but even wiser to prepare for the unexpected. Payday loans may seem like a quick fix in desperate times, but they often do more harm than good. By understanding the risks and exploring safer, cheaper alternatives, we can protect ourselves from falling into a payday loan sinkhole.
Ideally, we want to avoid needing these loans altogether. After all, it’s reassuring to be among the 41% of Americans who feel secure in their emergency savings.
To be part of that group, a decent salary helps, but it’s not enough on its own. Oftentimes, despite having a good income, we overspend because we anticipate it will flow and grow unabated. Before we know it, we’re living paycheck to paycheck. It’s essential to take a close, honest look at our spending and saving habits. If we’ve been spending too freely, it might be time to pump the brakes and slow down to avoid a train wreck. This challenge is aptly captured by a Chinese proverb: shifting from living modestly to lavishly is easy; reversing that shift is much more difficult.
Because life can feel long, we might grow complacent about saving. Instead of focusing solely on immediate pleasures, it’s crucial to keep sight of the bigger picture: building a solid financial foundation that can withstand any storm. Achieving financial stability is possible—it won’t be easy, but nothing worth doing ever is. So, stop procrastinating and start making positive changes today!
