One out of fifty American households (around 2.5 million) takes out a payday loan every year. Many people who use them don’t just take out one; they rely on them over the course of the year to make ends meet.
These financial instruments are known for high interest rates and fees, but the price comes with a convenience not found with any other banking transaction. They’re simple, small, and cover emergencies – all without a credit check.
How do payday loans work? We’ll show you what they are, who they’re for, and how to pay them back.
What Are Payday Loans?
Payday loans are a type of short-term unsecured bad credit loan given out by lenders focused on sub-prime customers, usually payday loan specialists.
The name comes from the type of asset historically used to secure the loan: your paycheck.
When you agree to a payday loan, you give the lender the authority to debit your checking account on the day you get paid. Securing the loan requires turning over a postdated check that the lender can deposit on the day your salary enters your bank account.
Payday Loans Are For You If…
You need a small amount of cash right now – and you can say with 100% certainty that you’ll pay it back when it’s due.
You don’t have access to a credit card or any other type of emergency credit with a lower interest rate, or you don’t trust yourself with a credit card.
You don’t want your credit score pulled, and are looking for a no credit check loan.
You’re fully aware of the costs of a payday loan – even if you pay it back on time.
There’s no one – including your employer, family member, or community service – willing to lend you a small, short-term loan.
Payday Loans Aren’t For You If…
You’re already stretched thin and can’t afford to pay back double the money borrowed.
You have a credit card or line of credit to use.
You haven’t exhausted your other options, including calling creditors, asking for a pay advance from your employer, using emergency services like food banks, LIHEAP, or a local agency to take care of impending bills.
How Do Payday Loans Work: Fees and Interest Rates
All loans come with fees and interest rates, but payday loans are known for assessing high fees and interest rates to all loans.
With a traditional loan, interest rates tend to come down as principal balances go up. A mortgage comes with a lower interest rate than does a personal loan because you’re borrowing hundreds of thousands of dollars.
No one could afford to pay 17% interest on $350,000. The housing market would crash. Plus, lenders make money on interest over 15 or 30 years, so despite low rates, they’re not getting a raw deal.
A payday loan is a short-term loan with a small principal. Lenders only have a few weeks to make money on their investment.
As a result, these loans come with a set fee per $100 borrowed; the cost depends on your state of residence and the lender. The average charge per $100 borrowed is $10, but it may be as high as $30.
An APR is also assessed: it’s not uncommon to receive an interest rate of over 100% or even 400% for the 14-day loan. All states set the maximum interest rate a payday lender charges.
Now, the 400% fee isn’t assessed over years or even months. The basic premise of a payday loan is to get money today and pay it back on your next payday – one or two weeks later.
Still, a payday loan isn’t like borrowing money from a relative. It’s not unheard of to pay back two to three times more than you received plus the lender’s fee. If you aren’t able to repay the loan, the lender’s fee is assessed again and again until the loan is repaid.
Repaying a Payday Loan
Payday loans feature different rules than personal loans. Payments on a personal loan are due monthly over the course of the term. You’re allowed to pay more than the minimum amount, and you’re allowed to make your payment early. You might even choose to pay off the whole loan before the term is up.
None of these options are typically possible with a payday loan.
Payday loans are repaid in full on your next payday.
You’re not usually allowed to pay them off early to save on interest. If you can’t pay the loan on your next payday, the balance is rolled over to the next payday. More interest and fees will accrue and create an even higher balance.
What Happens If I Don’t Repay My Loan?
The problem with payday loans for many people lies in that our paychecks are gone before we get them. When you’re paid at the beginning of the month, your money goes towards rent and utilities. Your second paycheck goes towards daily essentials and other bills.
If you can’t pay your loan, your lender rolls over the balance to the next payday. Again, it’s unlikely you’ll be able to pay it off earlier even if you come up with the cash.
Some unscrupulous payday lenders are mortally offended when the loan isn’t paid back on agreed upon date. Because payday loans aren’t regulated in the same manner as larger financial institutions, some try unsavory tactics like suggesting you might go to jail for failing to pay back the loan.
Failing to pay back a payday loan isn’t a crime. Criminal charges and a jail sentence can’t be brought. However, if you are unable to pay back the principal, the creditor is allowed to pursue collection efforts, including suing you for the money in civil court.
Payday Loan Alternatives
Payday loans are inevitable for some people, but there are many alternatives that you can choose from even if you have bad credit. In fact, you can also use these alternatives to build credit so that you’re able to borrow money even more favorably in the future.
Credit cards are your best option when you need money fast, and your checking account is empty.
While you shouldn’t use credit cards to spend money you don’t have, they’re more forgiving than a payday loan because you won’t pay interest on the balance until it rolls over to the next month. The law mandates that credit card lenders give you a minimum of 21 days to pay the money back – in installments or all at once – before charging interest to the balance.
Even when they assess interest, it’s still significantly lower than the APR found on the average payday loan.
Need cash quick? Credit cards offer a cash advance option that allows cardholders to withdraw money from an ATM or transfer it to their checking account.
You aren’t able to withdraw your whole balance. Banks often limit cash advances to 10% of your available credit. However, it is a quick solution for cold, hard cash when nothing else will do.
Cash advances come with a higher interest rate than credit card purchases. It will
Personal loans are your best option if you need to borrow a larger amount, up to $15,000. If you have a long-term relationship with your bank and a good credit score, it’s an excellent place to start. However, banks often take their time processing an application, and if you need money today, it might not be a good option.
Online lenders offer secured and unsecured personal loans with balances as low as $1,000 to keep you going when your paycheck runs out. Their APR may be higher than a conventional loan from a bank, but it will almost certainly be lower than a payday loan.
The terms are also likely to be more favorable; you will be allowed to pay in installments rather than a lump sum payment.
Remember, debt isn’t always mandatory. You may be able to cover an expense by asking around. Ask your company’s HR if they’re able to pay early or even provide a loan.
If the bill you’re worried about is to pay rent or heating, there may be a community assistance group able to help.
Debt should help you learn to manage your finances, not hurt them even more. Taking on avoidable, unaffordable debt may cause you to become reliant on payday loans or another lending option, which will cost you significantly over time.
Are Payday Loans Right for You?
Statistics show that the use of payday loans is shrinking, but people who use them often don’t just use one: they come back over and over again. Even with the unfavorable fees and terms, they offer fast cash with a simplicity that big banks can’t beat – as long as you’re able to pay them back on time.
Do you need cash fast and don’t know where to turn? Still asking “how do payday loans work”? Bonsai Finance can help you find the best option for your needs now and your financial future.
Contact Bonsai Finance today to learn more about lending options and what’s available to you.