If you required a small amount of money and I told you that I would lend you money at 360 per cent to 540 per cent per year, will you take such a loan?
I am sure your response will be some version of ‘are you nuts?’
But such lending is happening. And it is gaining popularity.
India has been introduced to the concept of payday loans in recent years. These are ultra short-term, unsecured and (very) high-interest loans of small ticket sizes that fill the temporary gap in your cash flows. And these loans are multipurpose in nature. Like personal loans, you can use them for any purpose.
Small loans, high interest
The loan amount can range between Rs 500 and a few lakh rupees. Most payday lenders customize the interest rate according to the borrower’s profile, credit history, amount being borrowed, etc. But, in general, the rates charged range between 0.5 per cent and 1.5 per cent a day. In most cases, it is around 1 per cent a day. And this translates to 365 per cent a year! Now compare this with the so-called high-cost personal loans and credit card debts.
But most borrowers don’t realize the exorbitant rates they pay because most loan tenures are limited to a month or so. Borrowers don’t annualize the rates. They buy the simple idea that it’s a small amount that they are borrowing, which they would clear by the next or the subsequent salary day. Another reason is that, many times, these lenders don’t mention interest rates but express it in rupee terms. So, if you borrow Rs 1000, you need to pay back Rs 1250 next month.
You may ask as to how such high interest rates are even allowed? And is it even fair?
It is best not to get into whether it’s fair or not. Nobody is forcing anyone to borrow from these payday loan lenders!
Should you go for them?
But all said and done, are these loans that bad?
I would say that it’s a tool for solving temporary liquidity crunches for those who have no other option. And of course, it comes at an extremely high cost. So ideally, these loans should be taken (only after exploring all other options) just for dire emergencies. Many youngsters use them for regular purchases and discretionary spends, which is not right.
I am pretty sure that once someone takes these loans and repays them, he/ she will be tempted to use this line of credit again very soon if he/she isn’t very disciplined.
Payday loans do seem like access to easy credit. But they are not sources of secondary income. These are high-cost loans and it have to be repaid.
And if you have to take these frequently, then the problem may lie elsewhere. Since emergencies don’t come every month, it’s clear that you are living beyond your means. This payday loan will not solve this actual problem.
If borrowers aren’t careful, this line of high-cost credit can easily push them into a debt trap. Such loans should be avoided for discretionary spends. And even in case of emergencies, these payday loans should be used as the last resort when no other option works out.
When it comes to emergencies, have a small contingency fund in place. This way, there will be no need to take any payday loans or depend on any other source. It is generally said that having at least 3-6 months’ worth of expenses as emergency funds is a good buffer. But depending on individual circumstances, the right emergency fund amount may differ.
Payday loans should be treated as the last resort and not as the go-to option due to their convenient availability. These are exorbitantly costly and can do more harm than good to your finances.(The writer is the founder of StableInvestor.com)