How Do Payday Loans Work?

What is a payday loan?

A payday loan is a type of short-term loan available to those who may have bad credit and need a little cash quickly to make ends meet or cover an emergency.

Many payday loans have a 14-day duration, although the due date of the loan may be adjusted to match the borrower’s payday—hence the name “payday” loan.

The amount borrowed is generally smaller than conventional personal loans.

How do payday loans work?

Payday loans are centered on income. When you apply for a payday loan, you’ll typically be asked to provide proof of your income and your checking account information.

Depending on whether you're applying in person at a brick-and-mortar storefront lender or online with an online lender, if you’re approved for a loan, you can pick up your money in person or have it automatically deposited in your bank account as soon as the next business day.

In turn, you’ll be asked to approve the date that the lender can withdraw the amount you borrowed (plus any fees and interest) from your checking account.

You may also have the option to write a check to the payday lender that they will cash on the date you specify.

Payday loans and credit scores

With payday lenders, your credit score isn’t usually an obstacle.

While your credit score is still considered in the lending decision, most payday lenders will look at many factors outside of your credit history to determine whether or not they think you can repay the loan.

Some of the things they may look at are your other outstanding loans, prior wage garnishments, bad checks, or any history of bankruptcy.

Getting a payday loan

Payday loans are typically offered via a brick-and-mortar storefront or online.

To apply for a payday loan at a storefront, you’ll need to visit one in your state of residence.

To apply for a payday loan with an online lender, you can do so from home using a computer or mobile phone.

Which type of lender to choose is a personal preference, as long as the lender is certified and licensed in your state.

Benefits of payday loans

Payday loans have historically been one of the only options for people with bad credit who have needed money quickly to cover an unexpected expense.

Dangers of payday loans

There are many potential downsides to payday loans.

Payday loans are often criticized for the way they’re structured. The single, lump-sum repayment of the full loan amount plus the added interest and fees is often difficult to manage.

When you turn to payday loans, you’re already likely to be dealing with strained finances. When your repayment date rolls around, you may find you’re unable to make the payment.

Further, traditional payday loans can be debt traps. Many lenders will give you money knowing full well that you won't be able to pay the loan back. The lender may charge extra fees for late repayment which may further increase the cost.

Often, you’ll be forced to roll your loans into a new one if you miss a payment. This starts a cycle that is almost impossible to break. It is so bad that many states have banned payday loans altogether.

Payday loan controversy

Payday loans are controversial. As of today, payday loans have been banned in 18 states. Even amongst the states that do allow payday loans, all but four of them cap the highest amount you can borrow.

Most states put the cap at $500, although some go as low as $300 and others as high as $1,000. However, the limit could be lower if your gross income is too low.

Payday loan APRs

Payday loans are often criticized for having high annual percentage rates (APRs). Not only is the APR on a payday loan often much higher than that of a traditional credit card, you’re also expected to repay the loan in just one payment.

Problems arise when you aren’t able to repay your loan by the due date and are required to roll over the loan. If that happens, the principle of the loan will go even higher and the high APR becomes a significant financial burden.

To avoid this, you need to be sure you can afford to repay a payday loan by the time it is due, which is typically between 14 and 30 days depending on the lender.

How much do payday loans cost?

According to the Consumer Financial Protection Bureau, the average payday loan has a mean APR of 339 percent, but it varies depending on how you get your payday loan. That means that the typical cost of a payday loan from a storefront lender is $15 for every $100 borrowed.

So, if you are taking a $350 payday loan - which is the median amount taken by payday loan customers - it will cost you $52.50. In two weeks, when it's time to repay your loan, you will owe a total of $402.50.

Payday loan alternatives

Luckily, there’s a better alternative to payday loans—LendUp.

Where available, we offer short-term personal loans when you need them and they are worlds apart from predatory payday loans.

When you choose LendUp, there are no hidden fees, and all of our pricing is clearly spelled out. You’ll be able to see your exact finance charge and your repayment date.

Plus, the average LendUp APR is 12 percent lower than the average payday loan APR—and that’s just the beginning. For borrowers in eligible states, the LendUp Ladder could help reduce your APR even further. Ladder availability varies by state.

Recommended further reading: The 6 Most Common Pitfalls of Payday Loans, and How to Avoid Them

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