As you read negative commentary about the interest rates charged on pay day loans, keep in mind that the comments typically focus on two factors. These are the annual percentage rate (APR) for the loan and the borrowers who renew pay day loans several times or consistently take out new ones. If you pay the loan back within the two-week time frame it's intended for and only rarely use this type of credit, you avoid paying a large amount of interest over several months or a year.
The One-Time Fee vs. APR
When you look into getting a pay day loan, you'll see that the lending company urges you to pay the loan back as soon as possible. Loans are generally issued for two weeks, but you should have the option to pay it back sooner without any penalties.
The state where you live may regulate pay day lenders and cap the APR they can charge. That cap tends to be quite high. Depending on where you live and the loan company you borrow from, your loan might have an APR of 391 percent, 782 percent, a number in between those rates or one that's even higher. Naturally, this looks alarming when you consider that the average credit card APR is between 13 and 16 percent as of March 2015.
However, the concept of an APR is primarily to determine what the money will cost the borrower over the course of a year. If you borrow $200 at 391 percent annual interest and pay it back within two weeks, it only costs you $30. That's the finance charge the pay day lender informs you about when you apply for the loan.
The Pay Day Loan as Emergency Funding
When you approach the loan as a one-time emergency funding instrument, it can be an advantageous way of solving a financial emergency and does not have the negative issues commonly mentioned.
Taking out a $200 short-term loan with a $30 fee can help you make emergency repairs on your vehicle, for example. Not taking out this loan with the $30 fee could lead to worse financial issues. You might feel forced to write a check for the repair work and then have to deal with the fallout if the check is an overdraft. That can lead to bank fees as well as a fee from the repair shop. An automatic $35 bank fee can lead to other checks going into overdraft and more fees.
In addition, you may risk losing your job if you can't get your car fixed and have no way to get to work.
The Importance of Avoiding Ongoing Loans
The information provided at pay day lending websites and at the brick-and-mortar stores instruct borrowers not to rely on these loans as ongoing financial support. In fact, some of these lenders will be glad to refer you to credit counselors if you are having serious financial problems.
States generally allow borrowers to renew pay day loans a certain number of times. Borrowers also can typically apply for a new loan as soon as they pay back the current one. These choices can lead people into actually having to pay a very high dollar amount of interest because they aren't managing the credit properly.
If you take out a pay day loan and find yourself having to renew it more than once, or continuing to take out new loans after paying back previous ones, it's time to take a hard look at your financial situation. You'll need to start earning more or spending less -- or both -- to avoid your problems getting worse.
When managed effectively, pay day loans can be a valuable tool as a short-term source of emergency funds. If you do borrow money from one of these companies, pay it back quickly and only use this funding option on rare occasion.