How Do Payday Loans Work?

Written By Mary Beth Eastman
Last updated November 22, 2019

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cash representing same-day loans
January 8, 2019

Simple. Thrifty. Living.

Payday loans provide short-term access to cash after a relatively simple application process. The funds come at a cost. Payday loans are known for their high fees and the potential to cause “debt traps” for borrowers. However, payday loan companies (such as CashnetUSA) can help close the gap when it is crucial to cover critical expenses.

The traditional payday loans process has a short borrowing period of two to four weeks. The borrower provides proof of income, an active bank account, and perhaps other identifying information. They receive a small amount of cash — perhaps a few hundred dollars or less — in exchange for a check postdated for the end of the borrowing period. That check is for the loan amount plus a fee.

The online version of this process is similar. Instead of writing a physical check, the borrower authorizes the lending company to take the money out of their bank account on the agreed-upon date.

Payday Loan Rules

However, some states have strict laws that govern payday loans. In these regions, the company may have to take an additional few steps before approval.

In some cases, the loan period is extended for an additional fee. Other payday loans may require repayment through a structured installment plan instead of a lump sum.

In essence, you should research the best online loans when making your decision, so you know you’re making a good and informed choice. Furthermore, you should live by some guidelines for using payday loans, so you don’t get into trouble.

Payday loans help people who may have no other option to access money on a short-term basis. For many, this means meeting their rent payment, keeping the lights on, or covering medical expenses. This can help those whose credit score may prevent them from getting credit any other way.

The payday loan’s main drawbacks are the flipside of its main benefits. Because most borrowers have limited options, payday loan companies charge high fees. A $15 fee on a two-week loan of $100 works out to an annual percentage interest rate of 391 percent. Installment loans can be just as, if not more, expensive, and drag on for years.

Beware the rollover trap

In addition, a 2014 Consumer Financial Protection Branch study found that 4 out of 5 payday loans are rolled over or renewed. This costs an additional fee each time. Sometimes, people end up paying more in fees than the principal on the original loan. As the debt grows higher, it is harder to pay off. That means some borrowers face accounts going to collections or legal action from lenders.

Despite the potential drawbacks of a payday loan, it can be an important way to access funds for some borrowers. It’s especially helpful if they have a clear plan to pay the funds back quickly.

About the Author

Mary Beth Eastman

Mary Beth Eastman serves as the content manager for Simple. Thrifty. Living, where she is dedicated to helping readers use money and credit wisely. Mary Beth believes that access to the right financial information paired with a growth mindset are essential tools for getting out of debt and building wealth. Mary Beth has a degree in Journalism from Bowling Green State University and has focused her 20-year journalism career on putting readers front and center, carefully considering their concerns and presenting information that will help them in their everyday lives. She has won numerous statewide journalism awards. Her writing on personal finance as been featured on numerous websites in addition to Simple. Thrifty. Living, including Huffington Post and Lexington Law blog. Mary Beth resides in Pittsburgh, Pa., with her family and two rescue dogs.

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