Just as you’ve made ends meet this month, catastrophe strikes. Pipes burst in your house — and while you always wanted a swimming pool, you definitely didn’t want it in your basement. Or for it to smell like that. Then someone in your family texts you: The car’s totaled.
For You: Dave Ramsey Says This Is the Best Way To Pay Off Debt
Learn More: 3 Advanced Investing Moves Experts Use to Minimize Taxes and Help Boost Returns
Life happens, sometimes all at once. And even the most robust emergency fund might not cover it all. As you’re pacing in the muddy basement water, you start searching for fast solutions — and up pops an ad for a payday loan.
In a few simple clicks, you could have enough money to cover the costs. The relief washes over you, momentarily distracting you from the fine print about interest rates and rollover fees.
Slow your roll. That short-term relief could come with long-term financial consequences.
For experts like Michelle Kruger, a practicing financial planner, teacher and author, payday loans can be a “dangerous financial trap disguised as a helpful opportunity.” We spoke with her as part of GOBankingRates’ Top 100 Money Experts series to understand why payday loans so often backfire and what safer alternatives exist.
High Interest, High Risk, Relatively Low Reward
According to Kruger, the biggest pitfall of payday loans is built into their very structure. “Payday loans are short-term, high-interest loans,” she explained. “They typically have a repayment term of two weeks with a repayment date coinciding with the borrower’s next pay date.”
Just how high can those interest rates get?
The District of Columbia Department of Insurance, Securities, and Banking reports that payday loan interest rates can exceed a whopping 400% APR. The agency has advised consumers to avoid payday loans despite their increased visibility and availability online, primarily because many payday lending operations take advantage of people in crisis by using deceptive, or even illegal lending practices.
Even if you meet your immediate financial needs with the initial loan, your next paycheck might not stretch far enough to repay it. That’s when rollover fees and penalties kick in, quickly turning a modest loan into a crushing financial burden.
Read Next: 4 Moves To Make if You Can’t Pay All Your Bills this Month
Financial Death by a Thousand Fees
Those fees add up fast.
Kruger notes that payday lenders typically charge 15% to 20% in finance fees for each two-week loan. “On an annualized basis, that can equal an APR of 300% to 500%,” she said. By comparison, credit card interest rates, which are already considered high, tend to fall between 20% and 30% APR.
A 15% finance charge on a $300 loan might not seem catastrophic — that’s $45 in interest. But if you can’t repay the loan by your next paycheck, well, that $45 becomes $90. Miss another payment, and you’re paying $135 — and you haven’t even touched the principal.
“Most payday loan borrowers find themselves taking out a new payday loan on their next pay date,” said Kruger. “Now a portion of their paycheck is needed to repay the loan and is no longer available to pay their other obligations. It becomes a repeating, expensive cycle that can be difficult to end.”
Quick Fixes Don’t Teach Long-Term Skills
One of the most overlooked downsides of payday loans is that by going for the quick fix — and locking yourself into a hamster wheel of ongoing financial crisis — you miss the opportunity to develop smarter ways to handle unexpected costs, like creating an emergency fund, improving credit or learning budgeting strategies.
Talking to a financial advisor or credit counselor can help you build those skills. In fact, you might be surprised by how helpful your creditors can be.
“You can call credit card companies and ask for a more affordable payment plan,” said Kruger. “Just be respectful and clear about your situation. Many companies are willing to work with you.”
There are also nonprofit credit counseling programs that can help you organize your debts and create a manageable repayment plan — often for free or at a low cost.
But Kruger says your best first stop should be your local credit union.
“If you find yourself in need of a small, short-term loan, consider contacting your local credit union,” she said. “Credit unions are owned by their members, so they sometimes offer financial products like short-term loans that other financial institutions wouldn’t find profitable.”
Bottom Line
Payday loans may seem like a quick fix, but they’re often a fast track to a cycle of high fees, steep interest and deeper debt. You’re better off exploring safer alternatives that won’t sabotage your future.
“Money is a tool,” Kruger said. “People expect to know how to use money well without practicing. Intentionally practice your money skills daily, and you’ll be amazed to see how your skill and confidence with money grow.”
This article is part of GOBankingRates’ Top 100 Money Experts series, where we spotlight expert answers to the biggest financial questions Americans are asking. Have a question of your own? Share it on our hub — and you’ll be entered for a chance to win $500.
More From GoBankingRates
- Dave Ramsey Says This is the Best Way to Pay Off Debt
- The One Number That Reveals Your True Financial Health, According to Experts
- Are Memberships Worth It? This One Comes with More Than $1K in Annual Benefits
- 3 Advanced Investing Moves Experts Use to Minimize Taxes and Help Boost Returns
This article originally appeared on GOBankingRates.com: The One Loan That’s Almost Guaranteed To Deliver Financial Disaster
