Need a Payday Loan? Why This Wall Street Expert Says You Should Think Again

If you're in a tight spot financially, a payday loan may sound like the solution to your problems. The trouble is that they charge huge fees and can quickly become extremely expensive. Here's why Your Rich BFF warns her followers to think again.

Why Your Rich BFF hates payday loans

In a recent video about common financial scams, Vivian Tu (aka Your Rich BFF) zeroed in on payday loans. "I absolutely hate these because they prey on lower income folks who don't have a lot of options and need cash in a hurry," she said.

Payday loans are usually very short-term loans of around $500 or less, though the amount could be as much as $1,000. As the name suggests, the idea is that the cash will tide you over until your next payday. The problem is that the interest rates and fees are so exorbitantly high that borrowers can quickly be trapped in a cycle of debt.

According to 2013 research from Pew Charitable Trusts, the average payday loan size is $375. The research says it takes the average borrower five months to repay the loan at a cost of a whopping $520 in interest and fees.

How payday loans add up

Let's say your car breaks down tomorrow and you don't have cash to cover it. You borrow $500 from a payday lender for two weeks. According to the CFPB, payday loans usually charge around $10 to $30 in fees for every $100 borrowed. That works out at an APR of around 400%. To put that in context, the average APR for a credit card is around 20%, per the Federal Reserve.

Back to that $500 loan. If you get charged $15 for every $100 you borrowed, you'd owe $75 in fees come payday. That's already a lot to pay for a two-week loan. But for many payday borrowers, it is only the start. All too often, people can't pay back the initial loan and can get stuck taking a second, third, or fourth payday loan -- all with sky-high fees.

If you didn't have $500 for the initial car repair, it may be difficult to come up with $575 two weeks later. This is where things get even harder. In some states, your lender may give you a rollover. This means, you'd pay the $75 you owe in fees and then extend the original loan and pay more fees. When it comes due, you'd owe another $75 in fees as well as the original $500. That's $150 in fees -- and more if you roll it over a third or fourth time.

Alternatives to payday loans

If you're struggling to keep your head above water financially, it can feel like a payday loan is the only option. Unfortunately, while a payday loan may solve your immediate issue, the high fees can mean you'll face more financial stress further down the road.

Here are some alternatives that won't come with such a high price tag:

• Personal loan: Depending on your credit score, you may be able to qualify for a top personal loan with an APR of 7% to 35%. Pay attention to the fees, loan term, and total interest you will pay.
• Borrow from friends or family: Borrowing from loved ones can be fraught with difficulties, particularly if you don't repay the money. However, if someone is willing and able to help you out, it could help you avoid the vicious cycle of payday loans.
• Get an advance from your employer: If you have been in your job for a while, you might be able to get an advance on your paycheck from your boss. Find out whether your company has a policy in place about salary advances, and think about the best way to frame your request.
• Credit card: Many financial gurus will warn you of the evils of carrying a balance on your credit card. It can cost a lot in interest and damage your credit score if your credit utilization gets too high. However, sometimes it's about choosing the lesser of two evils. Credit card debt is less costly and harmful for your financial stability than a payday loan.
• Emergency fund: If you have any cash in a savings account, use this rather than a payday loan. Emergency savings are designed for exactly this type of situation.
• Talk to your creditors: If you can't pay certain bills, it's worth talking to your creditors to see if you can work out a payment plan to reduce your monthly payments for an agreed period of time.
• Find additional cash: Do you have unwanted items at home you might sell? Or can you take on extra hours at work? If you have a side hustle, could you put in some more time in the coming weeks?

Bottom line

Truth be told, payday loans are not actually scams. They are still legal in many U.S. states. That said, some states have banned them outright and others have put restrictions on the fees they can charge and how many times people can roll their loans over.

Scam or not, payday loans can quickly make a bad financial situation even worse. If you don't have an emergency fund and need cash urgently, try to find another way. If you can borrow from a more trustworthy lender at a lower rate or find another way to get the cash, you could save yourself a world of pain further down the road.