When to use payday loans – and when to avoid them

As costs of living keep rising and wages yet to outpace inflation, a broken-down car, urgent medical emergency, or sudden interstate or international travel could deplete your savings in one fell swoop – or push you to breaking point if you haven’t much savings to go on. Some people turn to quick cash loans or “payday” loans to get them out of a sudden financial jam. Though they are relatively easy to access, there are drawbacks you should consider before applying for them. So what are payday loans, when should you use them, and when should you avoid them?

What a payday loan is

A payday loan, also called a quick cash loan, payday advance loan, or small cash loan, is a loan amount from as little as $100-$200 to about $500 though some lenders may approve slightly higher amounts, such as $1,000 – but these are usually capped at this point.

The “payday” aspect of the loan refers to the loan term. A payday loan is “designed” to help people cover sudden or unexpected expenses to tide them over until payday – usually every fortnight or month. The advantage is you do not need to put up collateral or an asset as a security against the loan (this is known as an unsecured loan.)

Since the loan terms are shorter than consumer personal loans and the amounts are under $1,000, lenders will charge significantly higher interest rates than other credit products – including that of credit cards. Some payday loans may have equivalent annualised percentage rates (APRs) of 400% or more. That means if you borrow $1,000, you’ll end up paying $5,000 – $4,000 of which is interest.

Some states and jurisdictions may place limits on what lenders may charge in fees or interest.

What you need to apply

You should learn the requirements of a payday loan before applying. Though you will not need any collateral, you will need to have access to a savings or checking account into which the lender can deposit your funds. You’ll also need to provide government issued ID and proof of income – if your income is consistent, a lender will consider it eligible. Most payday lenders will not conduct a credit check as part of their due diligence.

When should you use payday loans?

Payday loans should only be used in emergency situations when substantial sums of money are required – an urgent medical bill; fixing a car that gets you and your family around; or whitegoods that need immediate replacement. These are one-off, discrete expenses – not recurring expenses. Payday loans may be suitable for your circumstances as payday loans have fixed repayments allowing you to budget around the costs unlike credit cards, where your interest may compound if you don’t pay off your balance.

When should you avoid payday loans?

Payday loans should be avoided for recurring costs, liabilities, or leisure items. These may include rent or mortgage repayments, utility bills, memberships or insurance renewals and the like. Though you may find it hard, buying a broken TV or entertainment appliance on a payday loan should also be avoided – it should be for replacing something you need or paying a bill you otherwise cannot avoid or defer until later.

Using payday loans for non-urgent or recurring expenses can lead to a “debt spiral” where you incur more debt to keep up with repayments on existing debt.

If you need extensions on loan repayments or rent, you should talk to your bank or landlord to arrange an alternative payment plan first. Utility companies can also help in times of financial hardship. You may also want to take advantage of financial counselling services in your area or low-interest loans offered by the government.

If you’re ever unsure about taking on a debt, talk to a financial adviser before applying for a credit product.

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