What Are Payday Loans and How do Payday Loans Work?

Payday loans are quite conventional in the USA as it’s the easiest way to acquire money without signing up for a regular bank loan. A payday loan is a small amount of money provided by online lenders at relatively high-interest rates (400% to 1000%).

You are then required to pay the amount back when you receive your next paycheck. It should be mentioned though that you can fall into major financial problems with this method of loaning. With this regard, it is advisable to know every crucial aspect about payday loans, what they can provide, and what the drawbacks are.

Characteristics Of A Payday Loan

  • Short Term Loan

    Firstly, you’ll only be allowed to borrow small amounts of money. The amount can range from $100 to $1000. Payday loans are also short term loans as the amount is due when you receive your next paycheck (usually two weeks).

  • No Additional Installment Fees

    Traditional bank loans require small monthly installments when paying off a loan. A payday loan is paid in full on the due date with additional interest fees.

  • Higher Interest Rates

    When you take out a loan with a bank, the interest rate is calculated according to your credit rating and the type of loan you are opting for. If you have a good credit score, you can pay lower interest rates. But if you have a bad credit rating, you can be charged up to 25% in interest rates. With payday loans, you get charged a fixed interest rate. Usually, the fee is $15 per $100 borrowed.

  • Special Features Of A Payday Loan

    • There is no credit check.
    • You will have an automated repayment.
    • There is an easy renewal or rollover payments.

What Are Payday Loans Dangers

Payday loans are different from conventional bank loans and are authorized by state laws or regulations in thirty-two states. Fifteen states and the District of Columbia protect their borrowers from high-cost payday lending with reasonable loan rate limitation and other interdictions. Three states set lower limit for the loan rate or longer terms for slightly less expensive loans.

Because payday loans are easier to attain, you would find that the risk of debt trap will increase exponentially because of the high-interest rates of a payday loan. These dangers include:

High Costs

Payday Loans have a rather high APR. But this is not the only problem. The other face of this problem is that some lenders might not disclose all the information beforehand.

Difficulty to Repay

Because of the high costs, you can face the situation when you are not able to repay the entire amount when the amount is taken automatically from your account.

Debt Trap

Rolling over a loan should be treated as a last resort solution because it can seriously threaten your financial well-being on a long-term.

Let's Have a Closer Look the Main Risks of Payday Loans: Rollover

As mentioned before, in case of opening up a payday loan account, you’ll be required to pay back the amount when you receive your next wages. But sometimes, when you can’t repay your loan on time, you are offered to roll over the payday loan.

When you can’t pay the money back when payment is due, you’re given the option to roll over the payday loan. But this requires you to pay a fee to delay the payback amount. The fee you pay to renew or rollover the payday loan doesn’t reduce the loan amount you owe.

There are some advantages and drawbacks to rolling over your payday loan.

The only advantage is you get to have a few more weeks of peace before the payment is due again. You’ll be financially stable during this time.

But the setback is that the interest rate will increase. This means that when you roll over your payday loan, you’ll be paying back double the interest on your amount.

If you borrowed $300 and you agreed to pay the loan in 14 days at a 15% interest rate ($45), you would pay back $345 on the due date. But if you opt for a rollover, you will pay $45 to renew the due date, and you would receive an additional two weeks to pay the amount back.

You would subsequently be charged an additional 15% on the new two-week term. Which means the amount payable increases with $90 in total (30% interest charge).

If you keep rolling over your payday loan, the interest rate will increase, which subsequently increases the due amount. Short term payday loans often have annual percentage rates (APR) of up to 300% and can sometimes be much higher. For example, a 15-day payday loan will have an APR of 390%.

How to Avoid the Dangers of Payday Loans

One of the best ways to avoid payday loans dangers would be to always have some savings in your bank account. This way, you can put small amounts of money in the savings account each month. In case of emergencies, you can withdraw your savings and spend it on what you need. In this way, you won’t even need a payday loan, and this is the direct way to avoid debt traps. But again, this is now always the case.

There are ways that you can use payday loans to your advantage. If you’re not in a financial routine and you need fast cash for an emergency, then a payday loan could benefit you.

  • Always think twice before taking a payday loan. Ask yourself enough questions before you engage into any borrowing relationship.
  • Collect your paycheck early and budget your next paycheck accordingly.
  • Pay attention to the red flags associated with payday lending, and only use legit and trusted lenders.
  • Try to find and use emergecy assistance in case of need. There are lots of institutions and organizations that provide financial help for healthcare, food, and utilities expenses.
  • Ask help from your family and friends.
  • Deal with your own debts & don’t let them pile up.
  • If you know for sure that your rights as a borrower have been violated, consider reporting the issue to the bodies in charge.

Budgeting will help you pay the loan without causing additional financial stress on yourself. You will have more peace of mind because you would always have a clean credit record when you pay off your debt. Be smart out there!

References and Sources

  1. “What Does it Mean to Renew or Roll Over a Payday Loan?” – https://www.consumerfinance.gov/ask-cfpb/what-does-it-mean-to-renew-or-roll-over-a-payday-loan-en-1573/

  2. “5 Advantages of an Ordinary Savings Account” – https://money.usnews.com/banking/articles/advantages-of-an-ordinary-savings-account

  3. “Debt Traps” – https://www.incharge.org/debt-relief/debt-traps/

  4. “5 Frustrating Debt Traps and How to Avoid Them” – https://www.huffpost.com/entry/5-debt-traps-that-are-com_n_4989536

  5. “Legal Status of Payday Loans by State” – https://paydayloaninfo.org/state-information