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Friendly looking people proclaiming the benefits.  Smiling representatives, extending a hand.  The ads for payday loans and check cashing services are appealing and perhaps you've been tempted to check them out.

What is a payday loan?
Payday loans are usually small, short-term, high-rate loans intended to get you cash before payday.  The idea is that once you receive your paycheck, you'll pay off the loan.  These loans may also be called cash advance loans, check advance loans or post-dated check loans.

Here's how it works:

  • With payday loans you don't need to have a credit history as you would with other types of loans. 
  • You write a personal check payable to the lender for the amount of the loan plus a fee.
  • The fee is typically a big chunk of the loan amount. So even if you pay back the loan on time, you've paid a high price for a short-term loan.
  • If you can't repay the loan when it becomes due, you can extend or "roll-over" the loan until the next payday but you'll pay additional fees every time.

...this is the most expensive type of credit available. This is the most expensive type of credit available. Here's an example - you write a check for $345 and receive $300 cash. Perhaps you think that's not bad in exchange for getting cash quickly.  But what happens if you're still strapped for cash two weeks later?  Sure, you can roll the loan over and pay an additional $45 each time. If you continued this each payday for a year, you would have paid over a thousand dollars to borrow $300! 

It's important to note that payday lenders don't allow you to pay down the loan, so it's all or nothing:  in our example, pay off the $300 or pay $45 to keep the interest flowing to the lender at a rate of 400%!!  If you don't roll the loan over (and pay another fee), the lender will try to cash your check - generating hefty fees for non-sufficient funds, as well as bounced check charges from the lender. And, you subject yourself to possible criminal penalties for writing bad checks.

According to a study by the Center for Responsible Lending the payday lending industry now accounts for $28 billion in loans each year. And over 90% of these borrowers roll over the loans, keeping them trapped in a never-ending cycle. The cost to American families is over $5 billion a year.

Repeated renewals of the loan can end up costing more than 400% interest.Often people take out a payday loan as a last resort, but know that there are other options.  While these options may not be great financial planning moves, any of these might make a better source of cash than a payday loan:

  • Reducing the tax withholding from your paycheck
  • Retirement plan loan
  • IRA withdrawal
  • Credit card cash advance
  • Cash-value life insurance loan
  • Pawning a personal asset
  • Salary advance (if your employer offers it)