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Payday loans: What you need to know

Payday lenders offer small loans designed to help tide you over to the next paycheck but watch out for these potential pitfalls.

Video Transcript

- Payday lenders offer small loans designed to help tide you over to the next paycheck. Payday loans have very high interest rates, as much as 400% on an average APR. The lender may also charge administrative and loan fees, adding to the cost of the payday loan. The average payday loan borrower ends up in debt for more than six months, with an average of nine payday loan transactions.

More than 12 million Americans every year take out at least one payday loan. The high interest rates on a payday loan make it very difficult for borrowers to repay the loan when it comes due, usually at the next paycheck, so they end up borrowing more money and getting deeper into debt, setting up a cycle of debt that's very difficult to break. For a low-income borrower, it can be very difficult to not only repay the loan and the fees from the loan, but also to have enough money to pay the upcoming bills that would be covered by the next paycheck, which now has to be used to repay the payday loan. That's why many borrowers end up having to take out another loan, and pay even more in interest and fees.

There are alternatives to payday loans if you're in a financial crunch. Many credit unions offer small emergency loans at interest rates much lower than payday lenders. Some banks also have similar programs. You may be able to get a cash advance from a credit card. While those interest rates may be high, they're not as high as that of a payday loan. Another potential option is to borrow money from a family member or friend.

If you're in too much debt or overwhelmed by bills, credit counseling can help. An accredited nonprofit credit counselor can help you work out a payment plan with your creditors to get you on a sustainable financial footing. Stay financially fit, friends.