What is a Payday Loan?

Credit: thebalance.com

A payday loan is a cash advance from your next paycheck, designed to help you make it to your next payday. Unfortunately, it is one of the most expensive types of loans available.

Once you start taking out payday loans, it is easy to become dependent on them. Learn more about how these loans work and why you should avoid them unless it is necessary.

Definition and Example of a Payday Loan

A payday loan is a cash advance of a portion of your next paycheck. Once approved, the company will lend you a small amount—usually no more than $500—and charge you fees for using its services.

For example, suppose you’re short on funds one month and can’t pay your rent, so you go to a payday lender and apply for enough to help you make the payment. The lender approves your loan and charges you $15 for every $100 it gives you. You get $400 to help you pay your rent, so you owe the lender $460.

Warning: Fees for payday loans are quite steep—they can range from $10 to $30 for every $100 you borrow. That translates to an APR of 400% or more, compared to credit cards, which usually have an APR of around 20% on the high end.

How Does a Payday Loan Work? 

Payday loans have a simple application process and very few requirements. They will typically look to see that you have an active account with a bank or credit union, a prepaid card account, and a job or other verifiable source of income.

You provide your identification, banking, and other details. Once you’re approved, you usually receive your loan funds within 24 hours.

Payday loan companies operate under a wide variety of titles, and each one’s system for loaning and collecting money may be unique. They all make money through upfront loan fees and interest charges on existing loans. They may take postdated checks as collateral to deposit on your next payday (or another agreed-upon date).

Payday lenders often offer the option to roll your loan over for an additional fee. If you pay $30 for a $200 loan and then roll that loan over when it’s due, you’d have an additional $30 fee, meaning you’d owe $260.