Payday loans explained: Real benefits, major risks, and smarter alternatives

For Indian working professionals who need money quickly, payday loans can be one of the easier solutions. This short-term loan offers immediate availability for liquid funds until your next paycheck. Therefore, it is essential to understand what a payday loan is, how it works, and what to be cautious about before applying for one.

What is a payday loan?

A payday loan is a short-term, unsecured loan to address urgent money requirements until your next payday. It is an advance on wages, and the loan amount can be proportional to your wages. Payday loans are characterised by their shortness, i.e., between two weeks and a month or until your next payday.

How do payday loans work in India?

You can obtain a payday loan from a lender's branch or online. You are given instant approval with less documentation, provided your salary information is readily available. Upon approval, money is disbursed in the form of a cheque or credited to your bank account. The repayment, together with charges and interest, is usually collected before the next payday.

For example, Kotak Mahindra Bank provides this loan. This is a term loan, offered for one month, pre-approved at 50% of your net salary, and offered to salary account holders of Kotak. No paperwork required and instant disbursal. Currently, the interest rate on this loan is 10% per annum.

What are the different types of payday loans?

There are numerous types of payday loans that exist. They are designed to cater to the different needs of borrowers. Some are secured, requiring collateral such as a car title or a landlord's security deposit, while others are unsecured, relying entirely on the borrower's promise to repay.

What are the advantages of payday loans?

Payday loans have a few wonderful aspects:

• Speed: Disbursal on the spot for urgent expenditure.
• Less documentation: Straightforward application.
• No credit verification: A loan can be availed even if you have a bad credit history.
• Flexibility: Money can be repaid on flexible terms.

Note: For complete clarity on these aspects, reach out to your bank's customer support team.

What are the disadvantages?

Given their convenience, payday loans are enormously risky as well:

• High interest rates: Payday loans typically have higher interest rates than most short-term loans. Kotak Mahindra Bank, for example, offers payday loans at an annual interest rate of 10%.
• Debt trap: Short tenor i.e., short term and high rate of interest can make it a debt trap.
• Impact on credit score: Your credit score is affected if you are not prompt in making repayments.
• Not regulated by the RBI: The Reserve Bank of India does not regulate most payday lenders.
• Complicated hidden charges: Many payday lenders use complicated terms and hidden charges that are difficult for ordinary people to understand.

What are the documents required and the eligibility criteria?

The usual eligibility criteria are:

• Indian nationality.
• Older than 18.
• Full-time job with fixed income.
• Required documents include proof of income, age, employment, address, and identity.

What are the alternatives?

Credit card advances, loans from family members or friends, or personal loans prior to a payday loan can be fair alternatives that a borrower should consider before going for a payday loan.

Important questions to consider before applying for any payday loan

• Can you truly afford it?: This is an important question to ponder on before applying for any payday loan. It is essential to have a proper repayment plan even before applying for any new loan and a clear understanding of whether you can afford such a loan or not?
• What is the applicable interest rate?: This is another important point to consider. Do keep in mind, it is not only the applicable interest rates but the processing charges, associated fees and hidden expenses that matter holistically.
• Is it a true emergency?: Now, the third point that you should definitely consider is whether it is a true emergency you are dealing with that makes applying for a payday loan indispensable?

Hence, payday loans may provide an instant solution to an urgent need for cash, but their expense and their repayment implications necessitate that all the other alternatives be considered seriously. Use them with care and place a high premium on prudent financial management.

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