Understanding Payday Loans: What You Need to Know

A payday loan is a short-term financial solution designed to help you cover immediate cash needs until your next paycheck. While they may seem like a quick fix, payday loans often exacerbate financial problems for borrowers. Before you consider applying for a payday loan, it’s crucial to understand what they entail and the potential risks involved.

What Is a Payday Loan?

Payday loans are small-dollar, high-cost loans available online or at physical branches of payday lenders. These loans typically come with exorbitant fees, translating to triple-digit annual percentage rates (APRs). Repayment is usually due within two weeks or by your next payday. State laws vary regarding payday loans, with some states imposing strict regulations or outright prohibiting them.

How Do Payday Loans Work?

Upon approval for a payday loan, you may receive cash, a check, or a direct deposit into your bank account. In return, the lender may require you to write a check for the loan amount plus the finance charge, which is based on your loan amount. The lender will cash the check on the repayment date, typically within 14 days. Alternatively, you may authorize the lender to withdraw the lump-sum payment from your bank account.

If you cannot repay the loan on time, you may have the option to renew or roll it over into a new payday loan. However, this compounds your finance charges and can lead to a cycle of debt that is difficult to escape.

How Much Do Payday Loans Cost?

Payday loan costs are regulated by state laws, with fees ranging from $10 to $30 for every $100 borrowed. A typical two-week payday loan costs $15 per $100 borrowed. Due to their short repayment terms, payday loan APRs often exceed 400%, according to the Consumer Federation of America.

For example, borrowing $100 for a two-week payday loan with a $15 fee results in a simple interest rate of 15%. However, because the loan term is only 14 days, the APR is nearly 400%. In comparison, credit card APRs usually max out at 30%, and personal loans typically have a maximum APR of 36%.

How Much Can I Borrow With a Payday Loan?

State laws dictate the maximum amount you can borrow with a payday loan, with $500 being the most common limit. Some states, like Idaho, Illinois, Nevada, Washington, and Wisconsin, set limits based on the borrower’s income. Other states, such as Utah and Wyoming, have no set limit.

It’s important to note that 29 states have specific statutes allowing payday lending with few limitations. Eighteen states and the District of Columbia protect consumers by setting interest rate caps of 36% or lower. In some states, payday lenders have found ways to circumvent these protections by structuring their loans differently.

Why Are Payday Loans Bad?

While payday loans can provide quick cash in emergencies, they often do more harm than good. Here are some reasons to avoid payday loans:

• They’re expensive: With an average APR of 400% or more, payday loans are among the most expensive types of loans available. Rolling over or renewing the loan compounds these costs.
• They’re difficult to repay: Payday loans are typically small, but repayment is due within a couple of weeks, giving you little time to resolve your financial issues. Most payday loan borrowers roll over or renew their loans within 14 days, according to the Consumer Financial Protection Bureau (CFPB).
• They don’t help your credit: Payday lenders may not require a credit check, but they also don’t report your payments to credit bureaus. If you fail to repay the loan, the lender may send it to collections, which can damage your credit.

What Do You Need for a Payday Loan?

Payday lenders have minimal requirements for approval. Most don’t run a credit check or require proof of your ability to repay the loan. Typically, you’ll need:

• A photo ID
• A bank account in good standing
• A steady paycheck

Do Payday Lenders Check Credit?

Payday lenders typically don’t conduct credit checks, making these loans appear less risky than other financing options. However, payday loans are among the riskiest financial choices, especially if you’re already facing financial hardship.

Do Payday Loans Affect Your Credit?

Generally, payday loans do not affect your credit. There’s no hard inquiry when you apply, and payday lenders usually don’t report on-time payments to credit bureaus. However, if you can’t repay the loan and the lender sells your debt to a collection agency, the agency will report the unpaid debt to credit bureaus, significantly damaging your credit scores.

Alternatives to Payday Loans

Many people turn to payday loans due to a lack of knowledge about or fear of alternatives. While you may not have access to all these options, it’s essential to research them to minimize your costs. Here are some alternatives to consider:

Bad-Credit Personal Loans

Some personal lenders specialize in working with individuals with poor credit. Whether you need to cover basic expenses, pay for an emergency, or consolidate debt, you can usually get the cash you need. Some credit unions offer payday alternative loans (PALs) with more reasonable interest rates and repayment terms, though eligibility depends on the type of PAL and the credit union’s membership requirements. While bad-credit personal loans have higher interest rates than other personal loans, they are still much lower than payday loan rates.

Family or Friends

Asking loved ones for financial assistance can be uncomfortable, but it may be worth it to avoid deeper debt. Create an official agreement and stick to it to prevent damaging your relationship.

Bad-Credit Credit Cards

Most credit cards for people with bad credit require a security deposit, which won’t help your cash shortage. However, some issuers offer unsecured credit cards with low credit requirements. Retail credit cards, for instance, are often accessible to people with bad credit and can be used outside the store, though they typically have low credit limits.

How to Get a Payday Loan

If payday loans are legal in your state, you can apply by searching for lenders that offer loans in your area. Options may include online lenders and physical stores that also provide check cashing, money transfer, and other services. However, consider a payday loan only as a last resort. Research and compare all alternatives first to avoid worsening your financial situation.

Know Your Options

Payday loans can provide short-term cash when needed, but they’re not the only option. If you need money immediately, explore other ways to get emergency cash. If you’re concerned about your credit, check your FICO® Score and Experian credit report for free to understand your standing. While it may not solve your current situation, take steps to improve your credit for better and more affordable borrowing options in the future.

At O1ne Mortgage, we understand the financial challenges you may face. If you need assistance with mortgage services, don’t hesitate to call us at 213-732-3074. Our team is here to help you find the best solutions for your financial needs.