Erin asked us the following question:
“I know that if I take out a 700 dollar payday loan I’m not getting seven hundred bucks. Rather, I’ll be charged with a high interest and other fees. So my question is, how much does it really cost to pay for a 700 dollar payday loan?” – Erin, Chicago, IL
The number in 700 dollar payday loan and other loans for that matter is the principal amount, not the actual cash you’re getting. It is a peg where the interest and all other applicable fees will be based on. The nonprofit, nonpartisan Center for Responsible Lending admitted that loan terms are often complicated with various fees attached to the principal so seeing the actual costs is difficult.
To simplify the computation and for easy comparison with other loans, including those in the UK and Canada, let’s see how much a 700 dollar payday loan actually costs if you pay it at once, in 3 months and 8 months, the last being the average length of time that borrowers are able to repay payday loans, according to a Pew Charitable Trusts 2013 study.
The first cost, obviously, is the interest. Let’s use 15%, which is the median cap in many states (some states limit the rate at 10% but it’s a ploy to put payday lenders out of business, instead of declaring the industry illegal). If you’re paying your 700 dollar payday loan on your next paycheck, you’ll be charged with $105 on interest, so the total amount is $805. Add to this around $20 for processing fee and other administrative fees that the direct lender may charge. So the loan costs you about $125. Not bad had you truly needed $700 for an emergency. It’s also possibly the best big amount you can borrow next to a 1000 loan.
If you roll over the 700 dollar payday loan for three months, you’ll be charged six times on interest. That’s because payday loans are repaid on the next immediate paycheck, often after two weeks. At 15% interest every payday, you’ll be jacking up the loan to $1,330 exclusive of administrative charges and other late payment fees! That’s nearly a 100% additional cost to the principal. At this stage, it’s easy to see how a 700 dollar payday loan can easily trap you in a debt spiral. The sad thing is, remember the average length of time that most payday borrowers repay their loan? Let’s take a look at 8 months.
Using still our 700 dollar payday loan and 15% rate, at eight months the interest alone will be at a staggering $1,680. You’re actually paying twice the amount in interest alone than the cash that you’ve actually spent for this loan. And remember, we haven’t included yet late payment fees. Other lenders charge around 1.5% to 3% for late payments every payday.
In both our 3-month and 8-month examples, there’s a silver lining that can benefit a particular set of borrowers: entrepreneurs or small business owners who expect to generate an extra income off the loan higher than the total interests. For instance, borrowing to pay for an extra supply of raw materials for a new project, then using the cash flow to pay off the interest in gradual terms.
Getting payday loans may be fast now with the influx of various online and bad credit loan packages. But they may put you in a difficult situation rather than solve your financial woes. The obvious way to prevent falling into the debt trap is to pay the loan at once. If you decide to roll over this loan for the next few paydays, at least don’t let it linger for 3 months when it’s harder to repay it.
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