Personal Financing: How Does Payday Loan Work?

pay day loan

Payday loans are solutions for those who need quick cash but can’t wait until their next payday. This type of loan aims to take care of life’s emergencies and necessities quickly and conveniently.

So the next time you have an emergency and need cash in a hurry, try searching on google for “easy loans Canada” or “payday loan provider near me.” The internet will present you with tons of options. 

While supporters of payday loans suggest that these loans help people with low credit scores, critics say that their short-term, high-interest rates are unfairly targeting and trapping people into lengthy debt cycles.

What is the reality? Here’s a rundown to guide you on payday loans and how they work: 

What Is A Payday Loan?

Payday loans are short-term types of loans that come with high-interest rates. The usual amount for this loan category ranges from $50 to $500. 

Applications are processed either online or at the loan provider office. Most of the time, providers of payday loans are also businesses that provide useful banking facilities, such as foreign exchange, payment of utility bills, and issuance of licenses.

How Do Payday Loans Work?

As mentioned, payday loans are a quick-fix option for customers during a financial downturn. Most of the time, those who avail these loans are households and individuals whose expenses have exceeded their budgets. If you’re curious about how it works, here’s how:

  1. Borrowers of a payday loan fill out a request application. The only documentation needed is your ID, a current pay-slip, and bank account number. Some providers, however, require possession of ATM cards if no supporting documentation is available.
  2. Depending on the provider and the state’s statute, loan sums range from $50 to as high as $500. You’ll receive cash onsite within minutes if approved.
  3. Full payment will be made on the next payday, which is usually a two-week timeline.
  4. This might sound like collateral, but providers ask borrowers to provide a personal check to match their following paycheck. If that’s not possible, borrowers can offer online access to their accounts for lenders to make withdrawals when the due date arrives.
  5. Lenders generally charge interest of $15 to $20 for every $100 that clients borrow, computed based on an average percentage rate (APR). This is the same computation used by credit cards, leases, and car loans, etc. 

What Are Modes Of Payment For Payday Loans?

You’re usually obligated to settle payday loans by your next payday — a one-time, full payment. Since providers have varying conditions of interest, make sure that you inquire about the exact date of repayment.

You will have several options in repaying the debt, depending on the company. Modes of payment often include the following:

  • A post-dated check (usually submitted with your application). 
  • Check payments (presented on your payday).
  • Debit directly from your debit or credit card account.
  • Cash paid to the lender before or during the period leading up to the due date.
  • Online payments using the provider’s website.

Unfortunately, many borrowers of such loans are not able to pay their outstanding balance by the given deadline. This points to the following essential question: 

What Happens If You Aren’t Able To Pay Your Payday Loan?

If a borrower is unable to settle the loan after the two-week period, they may request the provider to “roll-over” the debt. In rolling over, the credit amount piles up on top of the existing credit.

Customers have to pay the original loan amount and finance charges on a “roll-over” loan, plus an additional financing charge on the new total.

For example, your original payday loan amount might be $100. Using the lowest allowable lending rate of $15 per $100 borrowed, the borrower pays a $15 charge on a cumulative $115 loan sum.

Now, if borrowers wanted to “roll-over” the payday loan, that involves the $115 borrowed amount and the $17.25 financing charge. After doing the math, the new total that’s arrived at for the rolled payday loan is $132.25.

How Are Charges Calculated On A Payday Loan?

With payday loans, the average interest or what lenders refer to as ‘finance charges” ranges from 15% to 20%. Rates and other charges may vary according to providers, and depend on the conditions that you commit to.

Also, these rates and charges are approved and regulated by the government as the state mandates the maximum allowable rates and fees payday lenders may set. Interest rates are computed by multiplying the borrowed amount by the interest charge.

You can always ask for a computation from your provider in case you are not comfortable with the rates. A reliable lender wouldn’t mind explaining the interest rates and charges to you. If they refuse to do so, that’s a sign that you should walk away and find another payday loan provider.

Are Credit Scores Affected By Payday Loans?

As payday lenders do not conduct a credit review, applying for payday loans does not impact credit scores. It doesn’t even show on your credit history. Moreover, payday loans are not reflected on your credit report after the loan has been approved. Thus, this type of loan won’t have an impact on your credit score.

However, if you miss some payments and your loan becomes overdue, the lender may pass your neglectful account to collection agencies. That would show up on your credit report. When the collection agency has your delinquent account, they can report it to credit reporting offices, which may affect credit scores.

Are There Other Solutions To Pay Off A Payday Loan?

When things get messy with your payday loan, then loan restructuring is an alternative. This works even if you have a poor credit score. While there are stricter approval requirements for low credit scores, restructuring loans typically offer lower rates and fees than payday loans. These loans prefer to provide longer terms of payment, which would allow you some room to breathe.

Since it has a more extended period of payment and low-interest rates, restructuring a loan will reduce the minimum cost to help you handle your debt.

Additionally, reconstructed loans appear on credit histories, which is a good thing as it can help you build your credit score. Just make sure, though, that you make timely payments.

How Will You Know If A Payday Lender In Your State Is Licensed?

Not every state provides for payday loans, but those states that do implement strict legal licensing under the law. If an unlicensed lender offers payday loans, then the loans can be voided. Having no license to operate implies that the provider has no right to grant a payday loan, or to ask the borrower to repay it.

Every state allowing payday loans has specific loan rules, including whether the loans are accessible from a payday loan provider or an online marketplace. You can ask for more information regarding payday provider licenses through bank regulators or the attorney general of your state.

Are Payday Loans Worth Risking?

In an emergency, payday loans will address an immediate call for money. And, since such loans generally have a costlier average percentage rate (APR), you might get stuck in a debt trap if you fail to make timely payments.

On the other hand, if you are responsible with payments, payday loans have their benefits.

A word of advice when contacting a payday loan provider is that it’s necessary to weigh all of the choices. Never commit to something that you have doubts about. Inquire if you must, and be level-headed while making decisions.

How To Avoid Payday Loans In The First Place?

Poor credit and a lack of discipline are the two most important factors why people slip into a cycle of acquiring payday loans. Overcoming either problem isn’t easy, let alone both of them. But because payday loans keep you in the loop, it’s worthwhile to consider the following tips:

  • Overcome Bad Credit

You can avoid payday loans by opting for regular ones that would eventually mitigate a poor credit background. Try to maintain debts that will increase your credit score faster than just paying off bad debt.

If you have good credit scores, applying and getting approved for regular loans would be easy. That leaves you with the money you need, and there would be no reason for you to run to payday loan lenders.

  • Overcome The “No-Savings” Problem

The best way to do away with the need for payday loans is to be self-funded. The tried and tested way to have sufficient funds for your needs is to save money. If you have enough savings when an emergency occurs, you can always use them to tide you over.

In doing this, you won’t have to worry about applying for loans with payday loan providers.

Final Thoughts

A payday loan is a simple and easy way to handle your financial emergencies. Even with bad credit and no collateral, you can access cash within hours. Regardless of the reason, you can borrow money as long as you pay it back with the next paycheck.

However, you do have a legal obligation to pay the amount borrowed on time to avoid penalties and lawsuits. Take into account the fact that most state laws limit lenders to renew or extend payday loans. 

The next time you face an emergency, consider the above-mentioned explanation of how payday loans work. Maximize your options, ask if you’re unclear about any information provided, and pay back on time.

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