How Do Payday Loans Work?

Payday loans are short-term, high-cost loans that can help you get the money you need for an immediate expense between paychecks. Sometimes referred to as cash advance loans, they’re typically used by people facing short term financial emergencies but are usually more expensive than they’re worth. Before you use a payday loan, it’s important to understand exactly what you’re taking on.

Payday Loans Expalined

The Application Process

Depending on the lender and where you live, you’ll apply for a payday loan at a physical branch location or through the lender’s website. Some states don’t allow payday loans at all, and others have strict laws regarding fees and maximum amounts, so it’s a good idea to search for payday loans on your state’s government website to find out what’s allowed in your area.

There typically aren’t many requirements for approval. Lenders don’t usually run credit checks, so there’s no need to have a high score or even a credit history. This makes them particularly appealing to people facing tough financial circumstances. To apply, you’ll usually need a valid ID, a bank account in good standing, and a paystub.

Payday loans aren’t usually for any more than a few hundred dollars, but amounts can range between $50 – $1,000 depending on the lender and the state you live in.

How Much Do Payday Loans Cost?

Payday loans are typically much more expensive than other types of loans. Specific costs are regulated by state laws, but fees are usually between $10 – $30 per $100 borrowed.

Payday loan APRs can easily reach triple digits. And according to a report published by the Consumer Federation of America, they’re usually 400% or higher. Compare that to the 12% -30% APR that is typical of credit cards, and you can see just how expensive payday loans really are.

Regardless of where you live, lenders must inform you of the APR before you accept the loan.

Repayment

Repayment methods may vary by lender, but you’ll usually have a few different options available. These include:

  • Paying by check
  • Direct transfer from your bank account
  • Through the lender’s website

Some payday loans also have an automatic repayment requirement. You’ll often be required to give the lender a signed, postdated check when you agree to the loan, which gives them permission to take funds out of your account if you fail to make your payment by the due date.

The due date will usually be within 14 days of your next paycheck. You’ll typically find that lenders require payments covering the loan amount and any fees are due in full – installment payments aren’t allowed.

Is There Any Repayment Assistance Available?

If you’ve taken out a payday loan and are struggling to repay it, debt consolidation may be able to help. Companies that offer debt consolidation will usually charge interest rates that are much lower than those of payday loans and offer longer repayment periods, which can help you better manage your immediate finances.

What Are Rollover Loans?

If you can’t pay your loan by the due date, many lenders will allow you to roll it over into a new loan. The CFPB reported that over 80% of all payday loan borrowers rolled their loans over within 30 days of borrowing. This extends the life of your loan, but you’ll be paying even more in fees and interest. Many states regulate how many times you can roll it over, and some prohibit rollovers altogether, so it’s important to check the specific laws in your state.

If you live in a state that doesn’t allow rollovers, you’ll find that many lenders get around this by allowing you to use a second loan to cover the amount you owed on the initial one.

Do Payday Loans Affect My Credit Score?

Payday lenders don’t usually run credit checks, so there’s no inquiry that will appear on your credit report or affect your score. They also don’t show up after you’ve accepted the loan since the lender isn’t reporting to the credit bureaus.

However, if you fail to repay your loan, your lender can send the amount owed to collections. Because collection agencies often report to the credit bureaus after they’ve purchased an account, those delinquent payments can begin appearing on your credit report.

What Are the Pitfalls of Payday Loans?

The biggest pitfall of payday loans is that the high cost can lead you into a cycle of debt. If you’re struggling to make ends meet already, the expensive fees can make your situation even worse by pulling you deeper into debt and preventing you from building up any savings. As a result, you’ll constantly be paying “catch up” on your bills. To illustrate this point, the Pew Charitable Trusts reported that payday loan borrowers often take out as many as eight payday loans a year.

Payday loans can also land you in trouble with your bank if you’re unable to pay. If a lender attempts to cash a check and you don’t have enough money in your account to cover the payment, you can be fined by your bank and accumulate overdraft fees. If you’re then unable to pay the bank the amount you owe, they can close your account and send you to collections. Closed accounts and consistent bad checks can also appear on your file in ChexSystems. Negative remarks in this system will make it difficult to open new bank accounts.

Lenders can also opt to send your unpaid loan to collections, which will appear on your credit report. Or they can decide to sue you for the amount due.

Are Payday Loans Offered by My Bank Any Different?

Payday loans from a bank are nearly identical to the payday loans you can get from other lenders. But if you choose to get a payday loan from your bank, you’ll want to be aware of any terms and conditions they might have. Many banks that offer payday loans require you to allow the bank to pull funds directly from your checking account to repay. While you’ll need to repay the loan regardless of where you get it, using a private lender may give you more control.

Are There Any Payday Loan Alternatives?

Getting money quickly to cover unexpected expenses can be tough, but you might have some alternatives available. Before you use a payday loan, consider these options:

  • Keep an Emergency Credit Card: Consider keeping a credit card open only to cover emergency expenses. While you’ll still pay interest on the amount you’ve spent if you can’t pay it off before the due date, it will likely be much less expensive than a payday loan, and you’ll be able to break it up into smaller monthly payments.
  • Get a Loan From a Bank or Mainstream Lender: While personal loans are usually for larger amounts than payday loans, and may be for more than you initially need, you can still save money with lower interest rates. Start by talking with your bank and then compare to other mainstream lenders. Even if you don’t have a strong credit history, there are many lenders who may be able to help.
  • Ask Your Family or Friends: Asking the people you’re closest to for a loan can be difficult, but it’s often worth it if you’re facing a serious financial emergency. Draw up a written contract that stipulates your repayment, and stick to the plan.
  • Generate Extra Income: If you’re able, consider getting a part-time job or taking up a freelance side-gig. The extra hours of work might be daunting, but if some extra cash can help you avoid using a payday loan, it might be well worth your time in the long run.
  • Save an Emergency Fund: To avoid finding yourself in a tight situation again, build a savings account for emergency purposes. Even adding a small amount every week can add up over time.

The Bottom Line

While payday loans can be useful in emergency situations, the high APR and loan fees can lead to a cycle of debt that isn’t usually worth the risk. Because of this, it’s important to consider all of your other options before you agree to a payday loan.

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