What To Consider Before Applying For An Instant Loan

Posted on January 3, 2021 in Loans

When life moves as quickly as it does in these modern times, it can be pretty easy to fall behind financially. Taking out a loan can do a lot to help stabilize the situation and get your finances back on track, but there can be quite a few hurdles involved when taking out a standard personal loan from a bank or credit union. 

An alternative to these more traditional options is an instant loan. Another term for this style is a payday loan, and while they can be advantageous for getting money fast, there are quite a few factors to consider before jumping in and taking one out.

What is a Payday Loan?

The first thing we’ll cover is what exactly a payday loan is and some of the perks of taking one out as opposed to traditional personal loans. In a payday loan, an individual will apply either at a physical branch or online payday lender just like they would at a traditional bank or credit union. 

Now, the key difference is the speed in which the application is approved or denied and how fast the cash hits the borrower’s hands. Banks and credit unions can take days or sometimes even weeks hammering out the details of a loan while instant or payday loans often take mere minutes to resolve. 

Another additional benefit is that the applicant’s credit score is not factored into the loan so they are much easier to get as opposed to traditional loans. Also, the life span of the loan is typically two weeks or until the next paycheck arrives for the borrower, so instead of the burden of a loan that will take months or years, the entire process is complete within a week or two. 

As a result of the ease and convenience of these loans, it is estimated that roughly 2.5 million Americans take out a payday loan every year, and in 2015 alone there were more payday lender stores in the 36 states where they are legal than there were McDonald’s in all 50 states. 

Needless to say, payday loans are quite popular, for better or worse, but they do come with some pretty significant consequences that should be seriously considered before applying for one. For example, you don’t want to end up asking yourself, “how can I block payday loans from debiting my account?

Qualifications For a Payday Loan

So, now that we know what a payday loan is we can get into the details of them. 

The first thing that needs to be covered is that these types of loans are not available in all 50 states, so anyone living in the following states will have to find another option for instant cash: Arizona, Arkansas, Connecticut, Georgia, Maryland, Massachusetts, New Jersey, North Carolina, Pennsylvania, Vermont, West Virginia and the District of Columbia. 

In the case the applicant lives in a state where payday loans are legal, there are a few more qualifications required before the application can begin:

  • The applicant must be at least 18 years old with valid identification
  • The applicant must have an active checking account
  • The applicant must provide proof of income

Maximum Amount of a Payday Loan

The laws for payday loans can vary wildly from state to state which makes sense since several states have made them illegal. However, the average payday loan is about $350, though they can range from $50 to $1,000 depending on the state. 

Of the states where payday loans are legal 32 of them have a capped maximum amount but Maine, Utah, Wisconsin and Wyoming have no cap whatsoever. Delaware, Idaho and Illinois have caps at $1000 but California and Montana have set the cap at $300. 

So, it’s important to know exactly what the legal limits are for the particular state the borrower resides in. 

Costs of a Payday Loan

The fees and interest rates on payday loans can change from lender to lender and also depend on the legalities allowed in each state. 

A good idea of the amount expected to be added on to the loan is between $10 and $30 for every $100 borrowed. 

Now, here is where people can get themselves into trouble when taking on payday loans as opposed to other types of loans or credit cards. If someone takes out a $100 loan that is to be paid back in two weeks and the lender is charging $20 for every $100 borrowed, then that interest rate would be 20%, which is a little high for some types of loan but nothing too extraordinary. However, since the loan is only 14 days then the daily interest cost would be the interest rate (20%) divided by the days to repay (14) for a total of $1.42 interest cost per day. Now, the loan is only to last 14 days, but in order to find the Annual Percentage Rate (APR) the daily interest rate of $1.42 is multiple by 365 (days in a year) where it would end up being over $521. That means that, in reality, the APR on this loan is over 500% and not 20% like the loan would have implied. 

Sometimes APRs for payday loans can reach as high as 1,900%, although rare. The reason this matters is a standard APR for a credit card is around 12% to 30%, and the average APR for a personal loan is less than 10%. 

Depending on the situation it is very possible to end up in a cycle of debt where a borrower would take out a loan, and in order to repay it, would need to roll over the debt in the form of another loan and so on and so forth. Some states have laws in order to prevent this, but again, it varies from state to state.

Repaying a Payday Loan

If the qualifications are made, the interest rate and fees are acceptable, and the loan is granted, then the clock on repayment has begun ticking. Most payday loans last for two weeks or less and the loan is preferred to be repaid in one single payment with fees and interest rates included. 

Here is yet another potential pitfall when taking on a payday loan: if the loan is not repaid by the time the date agreed upon passes, then the lender can electronically withdraw the money from the borrower’s bank account. This is why one of the standard qualifications is a functioning bank account. 

The potential ramifications for this happening could result in the borrower’s bank account being overdrafted by pledging funds the account does not have. 

Overdraft fees vary from bank to bank but are usually somewhere around $35 on top of the amount that is overdrawn. Now, on top of this fee the bank will usually charge interest on the overdrawn amount which is normally well over 20% starting out and can increase from there. To make matters even worse than that most banks charge a daily fee for every day the account remains overdrawn and these fees are usually in the $5 to $10 range. 

So, if a payday loan is not repaid and the account is overdrawn by $50, then after one day, it will be $85 plus say 25% interest to get back settled. That would be a total of $106.25 to stop the overdraft from continuing. By day two the total would be up to $118.75 and after a week up to $193.75. 

This amount of money for someone that needed a $100 loan with a 500% APR in the first place could be absolutely devastating so it is very important to have a firm plan in place to pay back the loan on time. 

The Takeaway: While instant loans can get people in need the money to get them out of a jam and back on their feet, these types of loans can also create an entire new set of problems that are much harder to eliminate than the original issue.

While the majority of people that take out payday loans are desperately in need of money, they actually often end up hurting their personal finances even more in the long run with payday loans. 

Now, of course, sometimes the situation may call for the risk of taking on a loan, but there are plenty of other debt relief options to consider before taking on the serious gamble and risk on a payday loan.

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