When Should I Use Short Term Loans?
November 6th, 2008
Millions of people across America use payday loans and other emergency cash products to cover bills, avoid bounced checks, or pay for car repair, medical expenses, or other unexpected expenses. At ThinkCash, we receive letters every day from customers thanking us for helping them get through a financial pinch. We’ve shared some of our customers’ stories on this web site.
Yet short term loans are often criticized by the media and politicians for charging high interest rates. It’s hard to know what to believe. Are short term loans a good idea or not? The truth is that short term loans can be a great way to handle cash emergencies and even save money by avoiding more expensive fees. But it’s also true that short term loans are expensive and aren’t always the best option.
This is the first in a series of blog posts that will provide tips on when (and when not) to use short term loans. We’ll look at real-world situations faced by Americans every day and suggest ways to get the most for your hard earned money.
Short Term Loans vs. Bank Overdraft Protection
One of the most common uses of short term loans is to avoid bank overdraft fees or NSF charges. In 2007, U.S. Banks collected $17.5 billion in overdraft fees. This equates to over 500 million overdraft transactions, or more than two for every adult!
Overdraft protection is a form of credit with a flat fee, averaging about $34 per transaction. Bank overdraft loans are almost always more expensive than payday loans or other short term loans*. Let’s look at an example:
Consider a consumer that needs to pay two bills totaling $100. Their checking and savings accounts are almost empty and payday is still a week away. If this consumer were to use overdraft protection, they would incur, on average, $68 in fees (two overdraft charges at $34.00 each) to cover the two bills. Furthermore, any additional debit or check transaction, no matter how small, would incur another $34 fee.
By comparison, if this same customer were to take a $100 payday loan from PayDay One, they would pay on average $22.50† in fees for a 14 day loan, saving more than $40.
Based on data from an independent study*, Americans could save over $10 billion annually if they used short term loans instead of bank overdraft protection
Despite this, it’s important for consumers to remember that it’s always best to avoid high interest loans (including overdraft protection, payday loans, and other short term credit product) if possible. There are often lower cost alternatives such as borrowing money from a friend or family, requesting a payment extension from the company that send the bill, or seeking lower interest credit from a bank or credit card provider.
In the next post in this series, we’ll look at when NOT to use short term loans.
*Cost of bank overdraft loans is based on an average overdraft fee of $34, average overdraft loan amount of $25, and an average term of 4 days (Source: A consumer panel tracked by Lightspeed Research and Forrester Research and published by the Center for Responsible Lending). Payday loan cost based on a fee range of $10 to $30 per $100 borrowed for a 14 day loan (source: PayDay One internal data).
†For a 14 day loan from PayDay One, the finance charge would be $22.50 which is equivalent to an Annual Percentage Rate of 586.61%. Rates and renewal options vary by state, please see Loan Cost & Terms by visiting www.paydayone.com.
