Cards and Loans

What Are Payday Loans, And How Do They Work?

Credit companies offer different types of loans based on borrower’s needs. A payday loan is one such loan that caters to the needs of employed persons that might be bogged down with emergencies that cannot wait until the next paycheck.

A payday loan is a short term loan accorded to people who need immediate cash while awaiting their next paycheck. While a small dollar loan, it tends to cost a lot, given the high annual percentage rate, that can rise to triple digits.

The loan is usually given to people with a paycheck as it must be paid within two weeks or less upon issuance. While a life savior in times of financial distress, payday loans can plunge one into more distress given the high APR.

How They Work

Payday loans are slightly different from other loans as they depend on one’s paycheck as well as where one lives. The loans can be applied for via online or through a physical branch of a payday lender. The application process is pretty simple compared to other types of loans.

Given that payday loans are designed to cover emergencies, they are usually approved within hours of application. The money is usually deposited in the bank account or paid in cash or check. In return, the applicant must pay the loan in full plus the charge within two weeks.

The APRs on a payday loan can be 400% more than what people pay in other loans. However, that has not stopped people from turning to these lifesavers, as most people resort to them when there is no other financing option. People with poor credit scores who cannot get loans with better terms often resort to payday loans in times of emergencies.

Payday loans Fees

Payday loans fees vary from one lender to another and depend on a number of factors. In the U.S, the costs are set by state laws and can range from $10 to $30 for every $100 borrowed. In the U.K, the t charge for payday loans is £24 for every £100 borrowed.

If you borrow a $100 payday loan, and the lender charges $15 for every $100 borrow, then this translates to an APR of 15%. Considering an average APR of 4% a month for other loans, the 15% APR would essentially translate to an APR of about 400%.

How much can you borrow with payday loans?

The amount of payday loan that one can borrow depends a great deal on the paycheck. However, most of them range between $50 and $1,000 as such amounts are designed to cater to short-term emergencies awaiting a paycheck at the end of the month.

In the U.S, some states have maximum caps on the amount of payday loans that companies can issue. The highest cap is usually $1000, with some states going for low caps of about $300. On the other hand, some states limit payday loans to 25% of the applicant’s monthly income.

States that don’t have caps on the amount of payday loans that lenders can issue have caps on the fees that the company can charge.

Paying Payday Loans

A borrower is required to refinance their payday loans after two weeks or less. The payment must come in single payment by the next payday. Depending on the lender, one can pay off the debt using a postdated check or a check on the next day. Similarly, some lenders accept online payments through their websites or payments through debit cards.

In some cases, failure to pay a payday loan on time can result in a lender withdrawing money from the account electronically.

Do Payday loans affect credit scores?

In instances where payday loan lenders don’t run a credit check, it is unlikely that the loan will affect credit scores or appear in the credit report, for that matter. Likewise, the loans may never appear on the credit score report, even on one accepting the loan.

However, a payday loan can appear on one’s credit report on the loan becoming delinquent and the lender selling one’s account to a collection agency. Collection agencies are required to report such loans as collection account to credit reporting bureaus, something that could affect one’s scores.

Alternatives to payday loans

While payday loans can feel like lifesavers when bogged with emergencies, there are often better alternatives. Current account overdrafts are some of the best options for people waiting for their next paychecks. Such loans are much cheaper for short term borrowing.

Local credit union loans are other alternatives given their low charges; such loans come with a maximum APR of about 40%, which is much lower, compared to the 400% applicable on payday loans. Credit cards can be ideal alternatives as they come with low APRs compared to payday loans.

Ruchi Gupta

Ruchi Gupta covers various beats from finance to technology and from lifestyle to hobbies. She has an MBA in Finance. Ruchi enjoys writing on celebrities and political news. She likes traveling and exploring places.
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