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700% - The Outrageous Cost of Payday Loans

fan of 100 U.S. dollar banknotes

With as many locations as Starbucks, and even more locations than Mcdonald's, you're never too far from a payday loan.

Payday lenders are a staple of shady neighbourhood corners and rundown strip malls. You'll recognize one by the many "get money fast" signs plastered all over their windows.

Storefronts are often bleak, rundown, and unwelcoming. As someone who've never step foot in one, they've always been a mystery to me. Why do they exist? Why are there so many of them?

Payday Loans

Payday loans are short-term loans offered by alternative lenders (non-banks). These loans usually range from $100 - $1,500.

Loans last typically 1 - 4 weeks (depending on the borrower's pay schedule). Payday loans are due on your payday, hence the name. They're designed for people can't access funds through traditional lenders, could be due to low credit scores, low assets, high debt, etc.

Payday loans don't require a credit check or a deposit. You simply provide proof of income, an address, and access to your bank account. When payment comes due, the lender will automatically withdraw the amount due from your account.

Easy money, right? Well this comes at a price (a really high one).

The Costs

Payday loans are typically priced per $100 borrowed. Most lenders charge between $15 - $25 per $100. 

This might sound okay at first, but when you calculate the interest, you realize how absurdly expensive this actually is. 

The formula to calculate interest rate, also know as the Annual Percentage Rate (APR) is:

APR= [(Interest/Loan Amount) x 365]/Loan Period

For a 1-week loan of $100, a fee of $15 equals to an annual interest rate of:
[($15/$100) x 365]/7 = 782%

This is an atrocious amount of interest. To put this in perspective, the average credit card (which are already considered to have high interest) charge only 17%. A bargain by comparison.

If a payday loan cost $15 per $100, how much does $100 cost on a credit card? We can rearrange the above formula to help us calculate this.

Interest = [APR/(365/Loan Period)] x Loan Amount

Plugging in the numbers, we get an interest payment/fee of:

[0.17/(365/7)] x $100 = $0.33

Big difference! Payday loans make a lot of money with their hefty fees. It's a $90 billion industry and growing. That's why you see them everywhere. 

Avoid, Avoid, Avoid

If you have access to traditional banking services, payday loans should never be an option. These loans are the absolute last resort. Almost anything else would be better.

Their high fees often lead borrowers towards a cycle of debt - taking out new payday loans to pay off previous ones, again and again. Compounding more and more interest. Snowballing debt that becomes near-impossible to get out of. 

If you're in an emergency, look to other options. Work with banks, credit unions or government programs. Stay as far away as you can from payday loans. Nothing is worth 700% interest.


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