What Is a Payday Loan?
People that need a quick infusion of cash may be able to get what they need through the use of a payday loan. While this type of borrowing is expensive, it may be your only option when you need money you’re planning on getting paid sooner. Before you head out and sign up for a payday loan, make sure to understand the who, what, when, where, and why of these types of fast money.
What is a payday loan?
Payday loans are short term loans that act as advances on the money you will be getting with your next paycheck. Typically, the loans are rather expensive and are offered for smaller dollar amounts, usually $500 and under. Unlike installment loans, most payday loans are set for repayment in a single payment, usually in line with when you’re expecting to get your next paycheck.
How do payday loans work?
In most states, borrowers can get access to payday loans through a storefront lender or online lending company. You’ll answer a few questions, provide some employment verification information, and submit your application. If you’re approved, you’ll get the money instantly or under 24 hours in cash, check, or directly into your bank account.
For repayment, you’ll be expected to pay the loan after your next paycheck. Sometimes lenders will have you write a post-dated check (a check for a later date) for the amount that you owe. They will hold onto the check and cash it on the date it is written for. The other popular form of repayment is you give the lender authorization to debit funds electronically from your bank account. Usually, this is set to pull the funds after you’ve had time to deposit your paycheck or if you get direct deposits from work.
The most important thing to realize about payday loans is they are incredibly expensive. Usually, you’ll pay a fee between $10 and $30 for every $100 you need.
According to the Consumer Financial Protection Bureau, “a typical two-week payday loan with a $15 per $100 fee equates to an annual percentage rate of (APR) of almost 400 percent.”
For a two- to four-week loan, this is astronomically high. Even if these were a year-long loan, the rates would be high.
In many states, the fees and interest rates associated with payday loans are capped to offer some protection to consumers. Even with the caps, though, they are expensive.
Because of this, payday loans should be your absolute last resort. Only after you have exhausted all other options should you look into using a payday loan. Even then, you may want to ensure you 100% need to get the funds and can’t wait until you get your paycheck.
Advantages of payday loans
While payday loans should be your last resort for borrowing, they can be appealing to some borrowers.
Easier approval process
Getting approved for a payday loan is not hard. As long as you can prove employment and banking information, your chances of approval are high. Even if you have bad credit or a bad history of financial mistakes, you may still get approved for a payday loan.
Quick access to funds
Once approved, you’ll get access to your funds almost immediately. Typically, funds are provided in cash, check, direct deposit, or put onto a prepaid debit card. Most applicants approved in brick and mortar payday loan locations will walk out the door with money in-hand. Those that apply online should have access to funds in their account within a few hours or one business day at most.
Drawbacks of payday loans
There are several reasons you should look to other lending options before settling on payday loans. While there are some situations where they would be necessary, they should be your last resort.
It’s very expensive
The cost of a payday loan is astronomically high. With rates in the triple digits for a short-term loan, the total cost should be a deterrent. Additionally, some payday loan establishments have extra fees tacked on top of the interest you are paying. When you couple the high interest rates and the fees together, you’re looking at one of the most expensive forms of lending in the world.
Only a short-term fix
The repayment period for most payday loans is only around two weeks to four weeks. Some payday loans give you longer to pay back, but most of the time, terms are short. This means that the funding is only going to be able to bridge your financial needs for a short period.
What happens in two or four weeks when you have to pay back the loan? What happens if your financial needs are not fully met by then? Many people find themselves falling into payday loan traps where they are always a paycheck or several paychecks behind.
Many people who take out payday loans do so without thinking through their plan fully. If you don’t have a good plan to make good on your loan, you could end up ruining your credit for a long time. Even if you have poor credit already, you could end up making it much worse, which could exclude you from many other types of lending in the future.
Payday loans may appear as attractive options when money is in short supply, and you need a fast fix. While these funding sources may temporarily fix your problem, it could just be a band-aid that does not correct the underlying problem. Payday loans expose you to risk that should be avoided at all costs. Yes, there are some unique and rare situations where a payday loan might be the right financial move, but again, those situations are few and far between.
If you are considering moving forward with a payday loan, ensure you take the time to read all of the terms you agree to before you sign. Make sure you have a complete and plausible plan to repay the loan on time and avoid falling into a payday loan trap or cycle.