Short Term Loans: Making Them Work

How to Calculate Whether a Payday Loan Makes Financial Sense for You

The fee structure of a short-term loan is much different than your credit card or other loans you may have dealt with before. Because of this, it can be difficult to determine whether the loan is actually a good financial decision or not. Also, the annual percentage rate—a great tool when determining the cost of a traditional long-term loan—isn't really applicable since these loans are designed to be repaid in a 7-30 day term.

That means you'll have to make some calculations on your own in order to determine the value of a payday loan in your unique situation. Fortunately, if you follow a simple set of instructions, the calculations aren't that difficult.

Step 1: Determine the Cost of Not Taking the Loan

Quite a few payday loans are used in the event of an unavoidable expense or an emergency. However, one of the most effective uses of a payday loan is to avoid incurring overdraft or late payment fees from your bank or other creditors. That's why the first thing you should consider is the cost of not taking the loan out at all--often, there is a very real financial impact if you choose to avoid taking the loan.

Consider all of the possible fees and penalties associated with late payment on your financial obligations. This is the immediate cost that you should compare your payday loan fees with when making your decision. However, you should also consider things that don't have a specific dollar amount tied to them, such as:

  • Your continued job security
  • The emotional cost of borrowing from family
  • Maintaining your family's quality of life

Step 2: Calculate the Actual Cost of the Loan

Calculating the initial cost of your payday loan is actually quite simple: all you need to do is look at the fee schedule available at your lender. Unlike a mortgage or credit card, the fees associated with a payday loan are completely transparent. You're told what you'll need to repay at the end of the loan, and any amount over the money you borrow is your net cost.

However, there is one major element that people often misunderstand with short-term loans: the annual percentage rate. The Truth in Lending Act requires all credit suppliers to produce the APR for a loan at the time of lending. This is perfectly suited for loans of one year or more. When this is applied to short-term loans, though, the result is astronomically high APRs of 300% or more.

To determine your actual APR, divide the published figure by the fraction of a year you're planning to hold the loan. For example, a one month loan would simply divide the APR by 12. This will give you a better figure to use in your comparison. That said, the best figure is simply the amount of money over your principal that you're required to repay.

Step 3: Estimate Your Likelihood of Timely Repayment

It's a simple truth that many folks who use payday loans aren't in the best situation to repay their loan. Also, the same type of life events that cause you to need a payday loan can still happen while you're borrowing. So, you'll want to know what happens if you can't make your payment and honestly determine whether you'll be able to pay on time or not.

To do this, look at your next month's income and expenses. Is it possible to create enough excess in your budget to guarantee repayment in a timely fashion? If the answer is no, you'll need to add late payment penalties into your cost assessment of the loan. This allows you to have an honest outlook regarding the cost of your payday loan. Try to calculate, given your possible budget, how long repayment will take and adjust your loan cost accordingly.

If, after performing these steps, the cost of the loan is less than the cost of not taking the loan, you can proceed with confidence. You'll know that you're making a responsible decision for you and your loved ones by utilizing this type of financial product. Learn more about your options by visiting resources like

About Me

Short Term Loans: Making Them Work

People warned me about taking out short-term loans, especially payday loans. What I found is that if I manage them responsibly, they come in very handy. On more than one occasion, these simple loans have helped me out of difficult situations. They took care of emergency car repairs, and provided the cash I needed to pay bills and avoid incurring late fees. I always repaid them on time, and the lender rewarded me by increasing the limit on how much I can borrow. If you are thinking of securing a payday loan, let me tell you what to look for in a lender. I'll also help you understand the commitment that you are assuming. With responsible use, I know you will find these loans as helpful for you as they've been for me.


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