What is a Payday Loan and How Does it Work [Full Guide]

Table of Contents

  1. What is a Payday Loan?
  2. How do Online Payday Loans Work?
  3. The Amount and Interest Rates
  4. Payday Loan Basic Requirements
  5. Terms and Conditions of Payday Loans
  6. Payday Loans Legislation

Payday loans have become popular both due to the high demand and also due to the various advertising companies in mass media and the Internet. These loans are also known under the names of cash advance loans and gained such popularity not without a reason. They are intended as instant financial help for people in the situation of emergency and are available to all borrowers.

In present-day America, about 80% of families live from paycheck to paycheck.
A lot of people get such a small salary that it is frequently not enough to make ends meet. It becomes a real problem when some unexpected expenses come on the way. This is quite understandable that friends can help; however, more and more people tend to choose payday loans against all the other options; and first of all for their convenience.

It is normal that where there’s demand, there’s supply. In the financial sector, this business branch is sufficiently enough presented. With the advent of the Internet, infrastructure has spread even wider.

1. What is a Payday Loan?

Payday loans are small short-term unsecured loans that are supposed to be repaid on the next person’s payday. Such loans are either given against a personal post-dated check that is cashed by a lender on a payday, or they are repaid by means of electronic money transfer when a lender withdraws a repayment from a borrower’s bank account on due payday. The term of an average payday loan is 2-4 weeks.

According to the CFPB 2013 report, a payday loan idea may be good practice for consumers who need immediate funds for a short period of time but they should have a reliable cash income to be able to cover loan within a very tight time scale.

In accordance with the Pew Charitable Trusts 2015 report based on survey payday loans have the following features.

  • These are small cash loans offered for a short term with APR 300-500% on average that are supposed to be repaid in two-week period.
  • The number of Americans that use payday loans annually is about 12 million with an average fee of $520 for a $375 loan.
  • 69% used payday loans to cover recurring expenses.
  • 16% use such loans for cases of an unexpected expense.
  • The survey showed that 75% of borrowers feel that this credit sector is insufficiently regulated.
  • The general public supports CFPB efforts for better regulation of the industry. (CFPB framework proposal)

A certain percent of the respondents are inclined to accept the alternative small cash opportunity provided by banks despite the fact that they are likely to be more expensive than usual credit card offers and similar products.

In accordance with the Online Lenders Alliance Report the following payday loan characteristics can be indicated:

  • Average median loan amount is $428
  • Average median loan cost is $113
  • Average median loan term is 20 days
  • Average median annual days indebted are 73 days

The report also states that “The demand for small dollar, short-term credit remains significant with a modest reduction of 8 percent from $49 billion in 2012 to $45 billion in 2014.”

2. How do Online Payday Loans Work?

You can see a basic payday loan application scheme – what steps are usually involved in the process as it is with the majority of lenders around the country. There can be some variations with regard to a state and a lender.

payday loans work
1. Application

When you apply online, through a build-in application you send your request to a payday lender. The application is very simple and takes little time to be filled in. As soon as a lender gets your application with all the required details, you get contacted by a representative or get an e-mail with further instructions.

2. Approval

Approval takes very little time. A person is generally notified within an hour and given all the further details. One of the reasons for the approval to be so fast is that payday lenders do not perform any credit checks. Your credit score does not make any difference and does not influence on the approval in any way. People with bad credit are approved as fast as the ones whose score is perfect.

3. Funded

The money is transferred directly to a person’s bank account within 24 hours after the application is approved.

4. Repayment

The repayment process is also very simple. As long as money is funded to a person’s bank account, when the time comes, the total loan sum with the interest added is automatically withdrawn from the account by a lender. This is done on the day of the repayment, which is generally the next payday of a borrower. Some lenders allow roll-overs in case a person is unable to repay in time. However, this option is not available in every state and presupposes additional finance charges.

3. The amount and Interest Rates

Payday loans are small loans ranging from $100 to $1,000 on average. The maximum amount of a loan depends on the state and also on the income of a borrower. Such loans are very expensive in terms of interest rates and, this is, perhaps, their distinctive feature.

As long as they are unsecured and frequently can go without credit checks, lending companies charge a lot for convenience and anonymity. Thus, a usual interest rate ranges from $10 to $20 depending on a lender and a state; which amounts to 391% APR for a 14-day loan. The shorter the term of a payday loan, the more expensive it is in terms of interest.

4. Payday Loan Basic Requirements

Payday loans have got shortlist of requirements for potential borrowers.

In the process of getting a regular loan a person has to go through a lot of hassle and paperwork but for the most part, he or she should meet the requirements of a bank and the latter is pretty strict in the majority of cases. Among the main things that a person should have is good or perfect credit history. This comes as a stumbling block for quite a great number of borrowers as it is pretty hard to keep your credit score perfect in the present-day conditions.

Actually, it is much easier to get approval for a payday loan than for other loan types.

The payday loan requirements are minimal.

They include a shortlist of things that are generally not a problem for a borrower to provide. All lenders have their own policies and terms that can differ; however, approval for payday loans is given in case the following requirements are met:

  • An applicant should be a citizen of the US.
  • An applicant should provide proof of age and identity.
  • An applicant should be of age – a minimum of 18 years.
  • An applicant should provide a verifiable physical address (phone or utility bill).
  • An applicant should provide proof of income that is no lower than $1000 per month.
  • An applicant should have a valid checking or savings account in a bank.

Payday loans can be applied by any borrowers regardless of the state of their credit history. No collateral or co-signers are necessary to get approval for a payday loan.

HOWEVER, it should be taken into consideration that payday lenders can perform credit checks at their own will; and the credit decision might be influenced by the state of a borrower’s credit score in question.

The application process takes minutes and it is almost 100% approval service. As it has been aforementioned, payday lenders do not perform any credit checks.

5. Terms and Conditions of Payday Loans

What is important to realize about payday loans is that the terms and conditions are different in different lenders. Even when you take the same loan sum but from another lender or use the services provided by the same lender, you are to read the terms and conditions thoroughly because they change often.

A payday loan is a type of unsecured cash advance and this implies that borrowers do not need to provide any collateral to obtain this loan.

However, applicants should provide a postdated check or permission to the lender to withdraw the loan amount from your bank account once you get the next paycheck.

As far as these loans are short in terms, it’s quite normal that lending companies charge fees and high-interest rates, which are doubled if you fail to repay the loan on time.

The terms and conditions stipulated in the contract include your right to roll over the payday loan. This means you may take another cash advance if you are not able to pay back the previous loan. However, be careful referring to the loan rollover as this can trap you in a bad cycle of debt.

People with bad credit will find the terms and conditions of payday loans very favorable as traditional loan types are frequently unavailable for them.

Before signing the contract you are to be sure you clearly understand the terms and conditions of a payday loan you have chosen. Take out only the sum you are sure you will be able to repay so that to stay away from problems attributed to high rates of interest, rolling over loans, and getting into a debt cycle.

ALWAYS READ the TERMS and CONDITIONS of loans you plan to take.

6. Payday Loans Legislation

Payday loans in the U.S. are subject to state laws regulations. According to the federal Truth in Lending Act all payday lending companies are obliged to disclose loan costs and provide full and clear information about all the financial charges referring to a loan. This refers to interest rates and APR; the latter should be provided in dollar amount and before the actual agreement is signed by a lender and a borrower.

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