What is a payday loan?
Payday loans are small, unsecured short-term cash loans that people borrow to get through the month until their next salary kicks in. It is thus, a small principal being lent out, often at a very high-interest rate (up to the order of 30-50%).
Payday loans are meant for the working class who have difficulty in making ends meet, and are often broke at the end of the month. These loans need to be repaid within 7 to 60 days, depending on the loan provider. This short tenure, urgent nature of loan and repayment risk makes the loan very costly. But people are willing to take it just because of the convenience it offers in the case of an emergency. Payday loans in India are used for life events such as loans for weddings, medical emergencies and payment of school fees.
How does a payday loan work?
Let’s understand how payday loans work with an example.
Let’s assume that you have a terrible toothache and your dentist says you need a root canal and an implant done. The pain is unbearable. Your dentist quotes ₹ 30,000. But you are still seven days away from payday, and your bank account is sadly on the verge of being empty.
You go to one of the several online payday lenders who offer you convenient payday loans.
As you expect your salary within seven days, you apply for a loan for a tenure of seven days and for a principal amount of ₹ 30,000 at 1% interest per day.
So, ₹ 30,000 (Amount borrowed) + ₹ 2100 (Interest) = ₹ 32,100 to be repaid within 7 days.
Essentially, if you have to take a 30-day loan, you are paying 30% interest. If you take a 60-day loan, you are paying 60% interest. And in case you are late, you are likely to pay penalties on a per day basis.
Advantages of Payday Loans
Payday loans can be a saviour for those who live month to month and find it difficult to cater to sudden expenses.
- Quick and Easy: It is a fast loan, i.e. often approved and disbursed within minutes, thereby no hassle of lengthy waits.
- Minimum Documentation and Formalities: In most cases, the main requirement is to have a bank account and share some minimum personal and financial details. It does not require any extensive documentation like other loans.
- No Credit Check: Since these loans are availed often by the working poor, no credit checks or collaterals are involved. Anyone can avail this loan irrespective of financial background.
Disadvantages of Payday Loans
The very reason that makes the payday loans attractive can suck the borrower in a vicious cycle of debt.
- Very High-Interest Rates: While the interest rate per day may seem manageable, when annualised, they turn out to be 400% annual interest (APR) or even more. The APR can even go up to 9000%, for very short loans. Let’s put that in perspective— credit cards have an APR of 9-30%, generally! So, now you can imagine how costly payday loans can be!
- Debt Trap: If you are unable to repay the loan in the next month itself, the spiralling over often incurs huge penalties and additional costs. This often makes it impossible to repay going ahead, making the probability of a debt trap very real.
What are payday loan alternatives to consider?
The following could be better options than payday loans:
- Reduce expenses
- Borrow from family and friends
- Get a personal loan
- Use a credit card and pay it back when you get your next salary
- Borrow from employer
- Keep a personal line of credit ready for emergencies
With faster loan application process, low-interest rate, and flexible repayment options, MoneyTap’s small personal loan is a better and cheaper alternative to payday loans. Get MoneyTap!