The payday loan cycle is when a borrower takes a payday loan and isn’t able to repay it on the scheduled due date. As a result, the borrower either has to default on the payday loan and incur fees, or take out a second payday loan, to cover the first payday loan, and continue to pay high interest rates.
If you’re not familiar with payday loans then there’s a few things you need to know before possibly being caught in the payday loan cycle.
Payday loans are very short-term loans, usually they’re only for two-weeks. A borrower wanting to obtain one has to write the payday loan company a two-week post-dated check. Two weeks later, the payday loan company cashes the check. If the borrower doesn’t have enough money in his or her checking account to cover the check they’re likely to incur bounced check fees, in addition to having to pay the payday loan company’s interest, which can be as high as 40% for the two-week loan.
Example: On June 1, a borrower writes a payday loan company a $400 check that the payday loan company will cash on June 15. In exchange for the $400 check the payday loan company will give the borrower $335 on June 1.
The best way to avoid being caught in the payday loan cycle is to utilize alternative financing, such as a personal loan, to meet your short or mid-term financial obligations.