With some loans, you can save money by paying them off ahead of schedule—but paying off a cash advance loan early might leave you disappointed!
If you’ve taken out a cash advance loan to cover emergency expenses and you’re in a position to pay it off early, congratulations! You’re getting ahead of the game. But will paying that cash advance loan off ahead of schedule actually save you money? Here’s what you need to know.
Also, before we start, cash advances are technically loans taken out with a credit card, but the term is also often applied to what are essentially payday loans, and those are the loans we’ll be discussing in this article.
How do cash advance loans work?
If you’re familiar with payday loans, then you can skip to the next section. That’s because payday loans and these cash advances are essentially interchangeable. In fact, cash advances are sometimes referred to as “payday cash advances.”
Cash advance loans are small-dollar, short-term no credit check loans that are aimed at people with poor credit, the kind whose scores lock them out from borrowing money with traditional lenders. They have an average principal loan amount of a few hundred dollars and an average repayment term of only two weeks.
These loans are very easy to apply for—oftentimes all you need is a bank account in order to qualify for one— and they’re repaid in a single lump-sum balloon payment with the due date set for the borrower’s next payday. Lenders usually “secure” the loan through a post-dated check or an automatic debit agreement for the amount owed.
The average interest rate for cash advance loans is $15 per $100, which seems fairly reasonable … at least at first. When measured against regular personal loans, however, that cost is extremely high. A 15% interest rate for a two-week online loan adds up to an annual percentage rate (APR) of almost 400%!
It all depends on how interest is being charged.
Any loan you borrow is going to come with some kind of interest. But there are two ways that interest can be charged, and that is what determines whether or not early repayment will save you money.
The standard way to charge interest is as an ongoing rate. A loan with a 10% APR, for example, would accumulate 10% of the loan principal in interest every year. That means that interest on this loan accumulates at the rate of .027% every day.
However, when interest is charged this way, every payment made on the loan lowers the outstanding principal, which means that less money accumulates in interest. To return to the previous example: A one-year $1,000 loan with a 10% APR would actually only accumulate $56 in interest.
The other way to charge interest is as a simple flat fee. A $500 cash advance loan with a 15 per $100 interest charge, for instance, would charge the borrower $75 in interest right off the bat, to be repaid when the loan is due.
If interest is being charged as a flat fee, then paying off your loan early won’t save you a dime. That interest fee is the same on the day the loan issued as it is on the day it’s due. So in answer to the question posed in the title of this post: No, paying off a cash advance loan early won’t save you money.
With amortizing installment loans, on the other hand, paying your loan off early will save you money. (Here’s a quick primer on how amortization works.) The quicker the loan is paid off, the less time there is for interest to accumulate, and the less money you’ll pay on the loan overall.
The one exception for installment loans can be prepayment penalties. These are extra fees levied against the borrower if a loan is paid off early. If you’re looking to take out a personal installment loan, do your best to find one that doesn’t charge prepayment penalties.
With cash advances, watch out for loan rollover.
Even though paying off a payday cash advance loan early might not save you money, they can still seem like a pretty good proposition. Two weeks and you’re out of debt!
But the truth of how these short-term bad credit loans work looks a little different. According to data collected by the Consumer Financial Protection Bureau (CFPB), the average payday loan user takes out 10 loans annually and spends almost 200 days per year in debt.
And when interest is charged as a flat fee, the costs can add up quickly. Many borrowers have trouble affording those lump sum payments, which leads to them either reborrowing a loan or rolling to over—at least if they live somewhere that hasn’t banned loan rollover outright.
Reborrowing a loan simply means taking out a new loan immediately after you’ve paid off your old one. Rolling a loan over, on the other hand, means extending the original loan’s due date in return for a new interest charge. Oftentimes, all borrowers have to do to roll over a loan is pay off the original interest charge.
Every time someone does this, their cost of borrowing increases. If the first interest charge is 15%t, then the second charge brings their total interest rate to 30%. The next rollover brings them to 45%, then 60%, etc.
When somebody is rolling a loan over, they’re paying extra money in interest, but they aren’t borrowing any extra money. Any payment they make to roll over their loan increases their cost of borrowing, but it doesn’t pay down their principal, which means it doesn’t bring them any closer to being out of debt.
There’s a name for this: It’s called a “debt cycle.” Actually, there are two names for it, as it’s also referred to as a “debt trap.” And while paying off a cash advance loan ahead of schedule won’t save you money, the dangers of one snaring you in a high-interest debt trap could end up costing you hundreds (or even thousands!) of dollars in extra fees and interest. It’s a bit of a lose-lose proposition.
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