3 things to consider before taking out a payday loan

The past two years have been difficult for many people. Along with the Covid lockdowns, many have had to deal with sudden job loss, pay cut, working from home, depleted finances, and more. In times like this, many cash-strapped employees resorted to payday loans or payday loans. Many of us often face a cash crunch, especially at the end of the month, and want a small loan to stretch over a few days until the next paycheck is credited. To take advantage of this demand, a number of companies offer quick short-term online loans at interest rates of 24-36% per annum. (Read more about how to manage your finances here: https://www.outlookindia.com/website/story/business-news-five-personal-finance-thumb-rules-to-follow/401955)

Short of money

Lack of cash at the end of the month is often due to overspending at the beginning of the month, or it could be due to a medical emergency, a sudden occasion in the family where a gift needs to be given, a sudden travel plan , home renovation, among other reasons. Situations like this put us in dire need of cash, while the next salary is still a few days away.

You can borrow from friends (although they may be in the same situation as you) or family (perhaps you don’t want to go that route). You can ask your employer for a salary advance, but the company may not have such a policy in place. This gap of a few days is what many new-age fintech companies are trying to bridge with a loan product called a payday advance. Most of these companies partner with Non-Banking Financial Companies (NBFCs) registered with the Reserve Bank of India (RBI) to offer such loans. (Read more about getting out of a debt trap here: https://www.outlookindia.com/business/-india-in-a-debt-trap-here-are-four-ways-to-get -out-of-a-debt-trap-news-37974)

EarlySalary, LoanTap, PayMeIndia, Cashkumar, Quick Credit, Flex Salary, and CreditBazaar are just some of the companies that offer instant business loans for a short term. Fintech companies see this as an opportunity, as banks don’t lend that fast.

What to keep in mind when using such loans

There are three specific things to keep in mind. The first is frequency. If you only take such a loan once or twice a year, there is nothing to worry about, but if the frequency is higher, it may indicate that you are making a habit of it. “Second, don’t use more than 40% of your credit limit. This will ensure that you don’t misuse it (the credit). Third, repay as soon as possible because the interest rate is high and a perfect debt trap,” says Anant Ladha, founder of Invest Aaj For Kal, a financial planning company.

Risks and costs

There are mainly two costs involved: the interest rate and the processing fee. The interest rate is quite high at 24-36 percent per annum. Also, they are not “good” loans, such as a home loan or an education loan, where you get an asset and income tax deductions are available. So, the smart way to use payday loans is to use them only when unavoidable.

Besides the high interest rate, there are also risks. “The biggest risk is that you could hurt your financial plan, which a lot of people don’t see as a risk,” Ladha says. Relying on payday loans often means you’re not saving or investing enough, which is detrimental to both short- and long-term goals. Moreover, you have to pay more interest on the salary loan.

“Other visible risks are those of data security and (these products) are not fully governed by detailed RBI guidelines,” adds Ladha.

A word of warning

A loan, whatever it is, remains a loan. It is advisable to take payday loans only after careful consideration. Anyone looking for a payday loan should ask themselves why their expenses exceed their income. If the reason is a temporary emergency, borrowing may be justified, although an emergency fund should be available for such situations. A conscious budgeting exercise can help avoid these expensive loans.

While opting for a payday loan, also think about how your credit score will be affected not only by the loan but also by a situation where you are unable to repay on time. Here’s how you can build a strong credit profile: https://www.outlookindia.com/business/how-to-maintain-a-healthy-credit-profile–news-30908

So, weigh the pros and cons before deciding to offer yourself a “starting salary”.

About Janet Young

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