What Is a Payday Loan?

Posted on December 6, 2022 in Loans

Payday loans are short-term, high-interest loans that you must clear in a lump sum within your next paycheck. They’re a form of unsecured personal financing (you don’t need to offer collateral to get them).

You can get a payday loan for whatever reason; maybe you’re late on receiving payment from your employer, you’re short on your expenses, or you need to cover an impromptu emergency.

Qualifying for a payday loan is fast and easy. However, before you do so, remember that the average American spends five months in debt each year because of getting a payday loan.

This article will give you all you need for insights on payday loans. So, how do they work?

How Do Payday Loans Work?

Payday loan lenders don’t check your credit history when applying for a payday loan, making them convenient if you’ve got a poor credit score. To secure your loan, you must show proof of consistent income. Some lenders will decide on the amount to front you based on your income, while others won’t, leading you to a debt trap because of the high-interest rates they charge.

You can visit lenders’ stores or apply online through payday loaning platforms. Once approved for a payday loan amount, you’ll be required to write a post-dated check or give digital access to your checking account to the payday loan lender.

To repay your payday loan, the lender will deposit the check or electronically withdraw money from your checking account on the due date. You can also settle the loan physically on the agreed due date.

How to Qualify for a Payday Loan

To qualify for a payday loan, lenders consider if you have the following;

  • If you have a stable income- you’ll be asked to show proof by providing pay stubs or payments from your social fund.
  • You’re 18+ years old and must present an Identification Card for verification and be a U.S. citizen.
  • You own an active bank account to facilitate easy transactions.

The approval or rejection time for a payday loan is around 15 minutes. Once you’ve presented all the necessary documentation, it shouldn’t take long to know if you’ve qualified.

Cost of Payday Loans

Payday loans charge very high rates because lenders risk lending you money without considering your credit history or collateral. These interest rates vary from state to state, with the average one being an APR (Annual Percentage Rate) of 400%, which could go as high as 700%. This makes it extremely easy to get in over your head with payday loans.

Some lenders within the states that allow payday loan lending charge a flat fee of $15 for every $100 borrowed. It’s advisable to be on the lookout to avoid being charged non-sufficient fees. These fees are caused by insufficient funds in your checking account when the lender opts to cash in the check or withdraw cash electronically.

Laws Governing Payday Loans

You may be wondering why payday loans are so dangerous. It’s because payday loans are predatory, and they take advantage of your financial desperation. As such, the CFPB and FTC have established federal laws under the Truth in Lending Act to protect consumers from unfair debt practices by payday lenders. These regulations include the following;

  • The lender should confirm your ability to repay the loan while meeting your basic and financial requirements. This move seeks to reduce the debt rollover and borrowing rate since 34% of Americans borrow 11 to 19 payday loans per year.
  • Lenders should provide you with written notice when they want to withdraw a different amount of cash or make withdrawals on a different date. It will reduce the chances of being overcharged on the interest earned.
  • Lenders shouldn’t make an excess of two debit attempts on your account to avoid non-sufficient and overdraft fees.

Since these are federal regulations, statutory laws vary depending on your residence. The consumer financial protection bureau can be a great resource for state specific info, but at a high level the regulations include the following;

  • Capping of fees charged– It includes limiting interest rates, acquisition fees, maintenance fees, and deferred deposit charges.
  • Limiting the maximum amount to be borrowed– In California, the maximum is $300. In Alaska is $500 and in Delaware $1,000.
  • Limiting the maximum loan term– It’s the number of days you should take to repay the loan entirely. For Alaska, it’s 14 days; for Delaware, it’s less than 60 days.
  • Some states forbid payday loan lending, including New York, New Mexico, Arizona, and other states.

To avoid being ripped off by payday loan lenders, you should ensure you’re familiar with your state’s regulations. If you face unfair practices, report your payday lender to your attorney general’s office or CFPB.

Payday Loan Alternatives

Other means of personal financing are much more affordable and easier to manage than payday loans when you need that extra dollar. It’s always advisable to consider them before you decide to take a payday loan. They include the following;

  1. Borrow money from friends or family. They can front you the cash at zero interest.
  2. Visit your community organization to cater to your basic needs. They offer free services.
  3. Apply for a personal loan at a credit union. They’ll offer you a low-interest rate even if you’ve got a bad credit rating.
  4. Ask for a personal installment loan from your bank. You can pay it over some months, making it flexible and easy to plan for your future spending.
  5. Request for a pay advance from your employer. You should budget carefully to avoid repeated cycles of pay advances.
  6. Look for a side hustle to make that extra dollar, for example, driving for Uber.

FAQ’s Regarding What is a payday loan

What happens if I can’t pay my payday loans?

When you notice that you can’t pay your payday loan, notify your lender in advance to reach a sensible agreement that they receive partial payments. If you don’t, the matter will escalate to debt collecting which is annoying, and you might be sued in a civil court.

You can also reach out for debt counseling options, alternative payday loans options, or debt consolidation to avoid further interest rates

How do payday loans affect my credit score?

Since payday lenders don’t consider your credit history, payday loans won’t affect your credit score as long as you make timely payments. But when you default on your loan and debt collectors start handling it, your credit score will be negatively affected as they report to a credit reporting bureau. Note that these reports can stay in your credit history for 7 to 10 years, thus, affecting your future loan applications.

Can I roll over my payday loans?

Yes, you can renew or roll over your payday loans to a later date as long as you agree with your payday lender. The downside to rolling over is that you’ll have to pay a rollover fee on top of the principal and interest fees accumulated.

How are service members protected from payday loans?

The Military Lending Act protects active service members by capping the APR to 36%, among other rights. You can always visit your local Judge Advocate General’s office for more information on consumer financing regulations.

Final Thoughts on What a Payday Loan is

A payday loan is a type of short-term borrowing where a lender will extend high-interest credit based on your income in the form of unsecured loans typically around $500 or less.

Yes, it’s no doubt that payday loans are a quick fix to your cash-stripped pockets. But they aren’t the only choice and certainly not the cheapest option for personal financing. Consider alternatives to payday loans such as cash advance apps, or credit cards to avoid high costs or falling into a never-ending debt cycle. They are much more affordable, and some are interest-free.

I hope you’ve gotten a deeper understanding of payday loans and can make better choices for personal financing.

Other Top Resources, and Questions About Payday Loans to Read about:

Related blog posts

Need expert financial advice?

Let TurboFinance connect you with the best consulting services and resources to help you take control of your finances and find a path to build wealth.

Get A Free Consultation Today!