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Understanding How Payday Loans Work

how payday loans work

People who are having financial difficulty sometimes turn to payday loans to get the cash they need. But do they understand how payday loans work? Because these loans are very costly, it’s essential to understand them and be clear about how they can affect your finances. Once you know the facts, you may find that there are better options available.

How Payday Loans Work

Writing the Check

When a consumer applies for a payday loan, he or she shows the payday lender proof of income (like a pay stub) and selects the amount of money they want to borrow. A typical loan may be between $500 and $1,000, based on the borrower’s pay amount, and the funds are intended to be repaid from the borrower’s upcoming paycheck. The borrower then writes a check for that amount, plus interest, to be paid to the lender on the date of their next paycheck. Or she may sign other paperwork allowing the lender to withdraw the money from their bank account on that date.

The Loan Rolls Over

Within a few weeks, the loan comes due. The lender tries to cash the check or withdraw the amount owed. In many cases, the borrower doesn’t have enough money to completely pay off the loan. In these cases, they must pay the lender a fee and postpone payment for another cycle. This cycle often repeats for several months before the borrower has enough money to pay the debt.

Who Seeks Payday Loans? 

According to LendEDU, approximately 12 million Americans use payday loans each year to address financial issues they are unable to meet. Startlingly, they pay more than $9 billion in payday loan fees combined. The average payday loan borrower carries this debt for 5 or more months. On average a borrower who seeks a payday loan earns roughly $30,000 yearly and finds it difficult to meet their monthly household expenses.

Where Are Payday Loans Obtained?

Payday lenders are often found in physical locations in cities. Recent statistics find that payday lenders are available in as many as 36 states. Not all states allow payday lending through physical storefronts, however.  Many consumers obtain loans online through payday lenders. In many cases, online lenders are less likely to disclose their fee structure transparently with regard to interest rates, costs of borrowing, and repayment agreements.

Why You Should Avoid Payday Loans

The Consumer Financial Protection Bureau points out that these loans may carry an annual percentage rate of close to 400 percent when all fees are factored in. The bottom line is that payday lending is very costly, and a small loan can quickly turn into a large one after interest and fees are applied.

Here are some startling statistics about Payday Loans according to Sambla:

  • The average payday loan carries $520 in fees from an initial $375 loan
  • The average fee a payday lender charges is $55 per two-week period
  • The average payday loan requires a payment of $430 from the next paycheck, equating to 36% of a borrower’s gross pay
  • Nearly 80% of payday loans are taken out within two weeks of paying off a previous payday loan
  • 75% of payday loans are taken out by those who have previously used a payday loan in the past year

Before turning to a payday loan, it is important to understand how payday loans work, and to be fully informed about how much it will cost you in the end. Before turning to a cycle of deb,  look for any and all alternatives to payday loans. Options may include, asking for an extension from creditors, applying for a loan from a credit union, borrowing from a friend or family member, obtaining side work or making cuts to your household budget to save.

If you are experiencing financial difficulty and are looking for a solution, non-profit credit counseling can help you make sense of all your options. ​Contact us today for a free financial assessment with one of our certified credit counselors.


1 Response to Understanding How Payday Loans Work

  1. Taylor Wright says:

    It’s good to know that the loan comes due in a few weeks. I’m thinking about getting a payday loan since I need to pay rent. I’ll be sure to use these tips as I look for a loan.

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