Payday Loan: What Is It And How Does It Work?

A payday loan, also known as a cash advance, is a short-term loan that lends a small amount of money to the borrower on the agreement that it is paid at the borrower’s next paycheck. This type of loan can get approved as quickly as within a few hours, making it suitable for paying an unexpected payment or for buying something you need but don’t necessarily have the cash for at the time. Because it is so easy and convenient to obtain, payday loans are quite popular, and as much as 12 million Americans take out this loan every year. Let’s take a closer look at payday loans and how they work.

Payday Loans in a Nutshell

Payday loans are short-term loans that come with high interest and are paid back by the borrower within 15 to 30 days, generally at the arrival of the borrower’s next paycheck. This type of loan tends to be small-dollar in amount with interest rates coming up as high as 500% depending on state laws, and the terms agreed between lender and owner. Because this loan is for small amounts, many states set a limit on payday loan size. The limit depends on which state you take out the loan from, but the common loan limit is $500.

How Do Payday Loans Work?

A payday loan is easy to obtain and the cash borrowed can be received within three business days at most. Unlike typical bank loans, the requirements needed for a payday loan are not as strict. A credit check may not even be required to avail of one. In most case, you are eligible to take out a cash advance if you meet the following criteria:

  • 18 years old and above
  • An open and active checking or savings account
  • Proof of steady income
  • A valid address and phone number

The process of obtaining a payday loan is usually straightforward. Many people these days opt to take out payday loans online. You will need to fill out and submit a form and wait for your approval. Once your loan is approved, you can expect for the money to be delivered straight to your bank account.

If you opt to take out a payday loan from a physical vendor, you will typically have to write a check for the amount you are borrowing, along with a lender’s fee. The lender then keeps this check, which they will cash out on the date of your next payday.

Although a payday loan is a small-dollar loan, if you take a closer look, it is quite expensive. Depending on the agreed annual percentage rate (APR), you may end up paying several hundred percents. For example, if you borrow $200, you may have to pay a $20 fee for a two-week term. This is much higher than the average APR a credit card charges.

Assuming you don’t have enough money to pay back the loan, you are given the option to “roll it over” to extend the loan. However, this means that you will have to keep paying the interest and even some overdue fees. This is one of the reasons why many people consider payday loans as predatory. If you are not careful, a wholesome loan of a few hundred bucks may become thousands if you fail to give your payments.

The Takeaway

Payday loans are very popular and for arguably the wrong reasons. However, if done right and with good intention, payday loans can be quite useful to someone who is in dire need of a quick buck. The advantages are significant, but the disadvantages can get you in trouble. Before you go ahead and take out a payday loan, make sure to think it over and consider your other options. A payday loan should only be your last resort.

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