As I promised before that I’m gonna write about disadvantages of Payday loans on my earlier post about Should you take any payday loans?, and here we are! So what are the disadvantages? The most obvious one — high costs. A payday loan can cost you say, $15 per two weeks. If you’re borrowing only for two weeks, that doesn’t sound like much. However, if you calculate the Annual Percentage Rate (APR), you’ll see it comes to 391%! If you don’t think that’s too much, let me ask you this question. If you invested money in the stock market, what would you consider a good annual rate of return? 20%? Maybe 30%? If you made a 20% return (on average) in stocks year after year, you’d be doing very well indeed. And this is for an investment that’s generally considered high risk. Now compare that with what the payday loan companies charge. You are providing them with a return on their money they likely won’t get anywhere else on the planet!

There is another, less obvious reason why payday loans are dangerous. According to some estimates, over 60% of borrowers roll over a payday loan. Many take loans repeatedly, too.

Let’s put in some numbers so that you can clearly see what rollovers imply.

Assume you borrow $400 for two weeks at a cost of $15 per $100 per two weeks. At the end of two weeks, you owe them a total of $460.

Let’s say you don’t repay the $400 at the end of two weeks. Instead, you request a rollover. So you pay them the lending fee of $60 and they agree to roll over the loan for another two weeks. The total cost of the loan at the end of 4 weeks may be as follows:

Original loan amount: $400
Fresh lending fees payable: $60
Late fees payable: $60 (assuming late fees apply at the same rate as lending fees)
Lending fees already paid: $60
Total: $580

At the end of this period (which is 4 weeks from the day you originally took the loan), you decide that you don’t have $580 available and so request them to roll the loan over for another two weeks. Then this is what it can cost you in total at the end of 6 weeks:

Original loan amount: $400
Fresh lending fees payable: $60
Late fees payable: $60
Lending fees already paid: $120
Late fees already paid: $60
Total: $700

If you continue this process for six months (more specifically, for 24 weeks), this is what it may cost you in total:

Original loan amount: $400
Fresh lending fees payable: $60
Late fees payable: $60
Lending fees already paid: $660
Late fees already paid: $600
Total: $1780

For an original loan of $400, in a mere 6 months, the payday loan company will collect fees and charges of $1380 from you. That’s 3.45 times the amount you borrowed. In APR terms that’s 749.5%! If over 60% of borrowers roll over their loans, no wonder many payday loan companies are wildly profitable!

Snowballing costs can easily lead you into a debt trap if you get addicted to payday loans.

So what are the key points to keep in mind when dealing with payday loan companies? Two things:

First, avoid them if at all possible. The best way is, of course, to get your finances fully under control so that you always have cash and / or credit available to meet emergencies.

Second, if you do choose to borrow from payday loan companies, borrow only an amount you’re 100% sure you can repay on the due date. If that amount is too low to meet your needs, get additional funding from other sources. Because rolling over cash advances is one of the worst things you can do to yourself.