How Payday Loans Work: the Truths, the Myths and the Potential Trap

For many people, it can be difficult to make it from paycheck to paycheck. Even one small setback can leave you reeling and trying to figure out where you will come up with the funds to keep the wolf from the door. Payday loans can often seem like a welcome relief when you need money quickly. This type of loan allows consumers to borrow against their next paycheck, often without the need to pass a credit check. Even so, payday loans are not without their drawbacks. Before applying for a payday loan; however, it’s important to understand the truths, the myths, and the potential trap of payday loans.

The Truth about Payday Loans

Payday loans offer the opportunity to receive an unsecured cash advance. The amount of the loan will usually vary based on the applicant’s income, but most such loans range between $500 and $1000. When approved for a payday loan, borrowers are able to cover a variety of different types of expenses, such as:

  • Rent
  • Groceries
  • Utilities
  • Medical bills
  • Auto repairs
  • Home improvements and repairs

Although these are some of the most common expenses for which payday loans are used, there are typically no restrictions regarding how a borrower may use a payday loan. These types of loans get their name from the fact that repayment is tied to the borrower’s next paycheck.

Obtaining a payday loan can be relatively easy, which is another reason why they are often so popular. Applicants can either apply online or in person. The only required documentation is typically some type of identification and bank account information. Payday loans are typically due on the applicant’s next payday. Since the loan is tied to the applicant’s payday and is expected to be paid back within a month or less, most payday loan lenders do not run a credit check. This makes it much easier for consumers with bad credit to receive approval for much-needed loans.

Once an applicant is approved for a $500 loan, funds are usually available within 24 hours or less. In most cases, the funds from the loan are deposited directly into the borrower’s bank account. Borrowers will commit to paying a fee in exchange for the loan and the convenience of receiving the funds they need so quickly.

To ensure the lender is repaid quickly, borrowers will typically need to write a postdated check. This check will cover not only the original loan amount but also the loan fee. Borrowers are instructed that the check will be cashed at the end of the loan term, which is usually on the date of the borrower’s next payday. The borrower may also be required to sign an authorization that will allow the lender to withdraw money from his or her bank account electronically on the designated date of repayment.

Payday Loan Myths

There are often many myths regarding cash advances and payday loans. Prior to applying for a loan, you should understand the truth.

There is No Regulation for Payday Loans

One of the more common misunderstandings regarding payday loans is that there is no regulation regarding these loans. This is not the case. Regulation regarding payday loans is handled by each state; however, there are regulations in place for short-term borrowing in most states. Additionally, under the Truth in Lending Act, payday lenders are required to disclose to applicants the total cost of the loan, including the annual percentage rate and finance charge.

Personal Loans Should Be Considered Before Payday Loans

Although a personal loan from your bank might offer a longer timeframe for repaying the loan and could even provide a lower interest rate, most people find personal loans are not a better option. This is because personal loans often require a longer approval and funding process. When you are in a time crunch and need money quickly, you might not be able to wait weeks to find out whether you are approved for a loan. Furthermore, the underwriting process is often much more stringent. This means that individuals with credit problems might not receive approval.

It Can Be Hard to Pay Back a Payday Loan

While it is true that the time frame for paying back a payday loan is relatively short, it is not impossible to pay back this type of loan. Applicants should keep in mind that they will need to budget for their next payday in order to pay back the loan.

The Potential Pitfalls of Payday Loans

In the event you are not able to repay your loan on time, there is the possibility that you could find yourself in a difficult financial situation. Should this happen, you may need to extend the term of your loan, which would add to the cost of the original loan. The best way to avoid this situation is to make sure you do not borrow more money than you will be able to reasonably repay on your next payday as well as to make certain you fully understand the total cost of the loan, including applicable fees.

Overall, payday loans can provide a quick funding option when you find yourself in a difficult financial situation.