Financial Education

What are payday loans and how do they work?

Demonized by one, considered salvation by others: payday loans divide opinions. Understand how this type of loan works and when you should really use it!

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Payday loans: the basics

Money (how do payday loans work)
Fast money is easy: learn what payday loans are. Source: Pixabay

When walking through the streets of any city, it is practically impossible not to come across signs like “fast and easy loan”. This is a specific type of loan. To understand it, you need to know how do payday loans work.

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Next, we will explain everything about the famous payroll loans. Are these the villains of personal finance? Are they some kind of fraud? When should you use them? Understand all this and much more below:

What is a payday loan in simple terms?

In fact, “payday loan” is the common name for payroll loans. It is a specific type of loan, much faster and less bureaucratic than a personal loan.

Typically, applicants for this type of loan receive the money within three days of applying for the amount.

In some cases, the money is delivered by hand or deposited into the account on the same day it was requested. Lenders offering payroll loans also set short repayment terms.

In some cases, full loan repayment must be made within two weeks of applying. In other cases, you must repay the loan on the next salary payment date. Thus, the name “payday loan” came about.

Most lenders offering payroll loans do not require a credit check. Basically, you need to prove that you have a fixed income and that you are already approved.

However, this modality usually practices the highest interest rates on the market. Those applying for this type of loan should expect triple and even four-digit APR rates.

A quick internet search found rate offers ranging from 320% to 1,421% annual interest. However, the borrowed amounts are not usually high.

To understand how do payday loans work, learn about the main advantages and disadvantages of having a service below.

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The benefits of payday loans

  • Little or no bureaucracy to get a loan;
  • There is usually no credit check: even people with bad credit can get a loan;
  • It is possible to get more than one loan in a short period of time;
  • Typically, you won’t need to offer any kind of guarantee.

The risks of payday loans

  • It is the loan modality with the highest APR on the market;
  • You can accumulate unpayable debts if you do not repay the loan within the stipulated period;
  • If you do not make the refund within the stipulated period, your credit could be seriously damaged;
  • Some of these lenders have gained a bad reputation for using questionable collection methods (the Financial Conduct Authority has now improved enforcement of this type of practice).

Payday loan costs and fees

In fact, the interest rates charged on payroll loans are regulated by state laws. Thus, the maximum interest that a lender can charge for this type of loan varies from state to state.

So, if you want to use this service, you’ll have to check your state’s rules. You can find this information most easily by checking with a lender.

However, the average rate allowed by most states is 25% of the requested amount per week. Additionally, some lenders may charge origination fees or fees for late payments.

How much can you borrow?

Like interest rates, the maximum amounts on these loans are also limited by state law. This way, the value may vary according to the state in which you live.

However, on average, the maximum amount that can be claimed is $1,000. As these loans are not included in your credit history, you can accrue more than one of these at the same time.

However, this type of maneuver can pose a high risk to the health of your finances.

Does getting a payday loan impact your credit score?

money and stopwatch
How quick loans affect your credit score. Source: Pixabay

The vast majority of agencies that specialize in payday loans do not require a credit check. Thus, this type of loan will not affect your credit score or history at all.

However, this can change if you delay your payment. In that case, the creditor may report this delay to the credit bureau. If that happens, your credit score could be impacted in the short to medium term.

How can you get a payday loan and what are the requirements?

As we said before, getting a payroll loan is not very complicated. In effect, you won’t need the piles of documents required for personal loans and mortgages. In fact, you will basically need:

  • Personal identification document;
  • Proof of address (water bill, energy bill, etc.);
  • Have an active bank account;
  • Prove income through paycheck or bank statement.

The application process is simple. In some, you can complete all the steps online.

Is a payday loan the best option for you?

Knowing how do payday loans work is not enough to decide whether a loan is the best option for you. This is a difficult question to answer from the other side of the screen and through a post.

However, there are some questions that you must evaluate to arrive at these answers on your own. First, you should only apply for a payday loan after trying all other options.

Most analysts recommend this type of loan only as a last option. Second, you must have cash to pay when the repayment day arrives. Delays can literally cost too much.

Also, make sure that you are requesting this money for an emergency. Using these types of loans is not advisable to buy things you don’t really need.

Are you going to buy decorative objects, and clothes, and carry out purely aesthetic reforms in the house? Do not use payroll loans.

Remember that with this type of loan, you are committing money that you have not yet received. This can generate the need for new loans, which will greatly unbalance your accounts.

Alternatives to payday loans

Now that you know how do payday loans work, get to know alternatives that you can choose (or not) to avoid the payroll loan. In the list below, meet some of them:

Free salary advance

There are mobile apps that advance part of your salary without charging any kind of fee for it. This is also a function of the credit card offered by Walmart stores.

Personal loans with credit unions

This type of lender is known to charge interest rates well below market. This is possible because these organizations do not have a merely profitable purpose. So consider this possibility.

Ask the bank

Go to the bank you already use and apply for low-value loans. This strategy tends to work in many cases. Also, you can get lower loan rates.

Family

Consult with friends and relatives if they can lend you the money you need. This may be the best way to get a loan: 0% APR!

Loan with many installments

This is a bad alternative to payday loans. The more installments a loan has, the more interest you will have to pay. Therefore, do not opt ​​for loans with many installments, even if they are for small amounts.

Car title

car titles, loans
Find out why you need to get away from car titles. Source: Pixabay

This modality can also be a bad alternative because you offer your car as collateral. In fact, I don’t even need to explain why this is a bad idea. If you don’t pay, the bank will keep your car.

There is a simple way to find hundreds of companies willing to offer payroll loans. And the best: you can do it with just a few clicks and in a completely free process.

Want to know more about this opportunity? Check out our post below to learn about the Next Day Personal Loan!

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About the author  /  José Gonçalo

I started reading about finance only to find better options than savings. Since then, I have never stopped studying finance, and I believe that writing about it is the best way to help individuals feel fulfilled and have a healthy financial life. Today, I balance finance and medical school studies.

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