Because of an increased cost of living, more Americans may find themselves relying on loans to cover large expenses.
According to data from the end of 2022, the number of individuals borrowing money increased from previous years, with an estimated 22 million Americans having at least one loan taken out in their name.
There are many different loans borrowers rely on, each with their own payment requirements.
One type of loan that has received more attention in recent years is a payday loan. Payday loans are a short-term loan, typically unsecured.
Unlike most other loans, payday variants only provide a small amount of cash and are generally repaid in a short period of time. However, payday loans typically have a significantly higher interest rate.
Payday loans can be convenient, but because of the short repayment time, they can also be more dangerous than other types of loans. Learn more about using a payday loan and how they work in the sections below.
Understanding Payday Loans
On paper, payday loans might seem simple because there are fewer requirements than long-term loans. However, payday loans are considered some of the riskiest loans and could damage your finances if you are not prepared for them.
Another complication with payday loans is how much the rules differ depending on the state you live in. There are even some states where payday loans may not be available.
Payday loans are intended to provide a small amount of money to cover immediate needs until the next paycheck.
As a result, most loans typically need to be paid back with interest in two weeks, with some lenders offering up to one month. Some payday loans are available online, while others require you to get approval at a physical branch.
How much you can borrow varies depending on the state. Your state can also determine the maximum amount you can borrow as well as how high lenders can set interest rates and fees.
There are many ways to take out a payday loan. Most lenders either issue cash or a check, but some may deposit the loan directly into your bank account.
Payday loans generally include a finance charge, which is normally based around the amount you borrow. Your finance charge acts as your annual percentage rate (APR), which determines your interest rate.
Payday loans have some of the highest APRs of any loan, on average resulting in an interest rate of 15 to 20 percent. Because of the short repayment period, these loans do not accrue as much interest.
However, on average, you can expect to pay around $50 to $100 extra in interest, depending on how much money you borrowed.
Reasons to Choose a Payday Loan
Despite having high interest rates, many borrowers still prefer payday loans to other alternatives. One of the main reasons is due to accessibility.
Payday loans typically have the fewest requirements of any loan. Most lenders do not even run a credit check or ensure you have the means to pay your loan back.
In most cases, the only requirement is that you must have a bank account and prove you are currently employed. Because there are fewer checks and requirements, it may be easier to get a payday loan immediately.
Payday loans can also often be the most reliable option in a financial emergency. Many borrowers use the money from a payday loan to put a down payment on an unexpected expense, such as a medical bill or car repair.
Others may use a payday loan to stay afloat for a week or two while waiting for their next paycheck to come in. Because of the high interest rates, it is not always feasible to rely on payday loans.
Maximum Amount You Can Borrow
According to 2022 data from the CFPB, the average amount borrowed through a payday loan is $350, which must usually be repaid within two weeks.
In most states, there is a maximum limit of $1,000, with a minimum of $50. In several states, there is an additional stipulation that you can only borrow up to 25 percent of your monthly income.
As of writing, the states with the lowest maximum cap are California and Montana at $300.
There are also additional fees based on how much you borrow. These range from $10 to $30, depending on your state.
Repaying Your Payday Loan
There are several different methods to repay your loan. In most states, you are required to pay your loan back immediately on the next payday.
Unlike with other types of loans, most payday loans are paid entirely in full and do not use a payment plan. Some lenders may offer a small grace window, giving you a few days so your paycheck can be processed.
Many lenders require you to postdate a check as part of the application, which is then filled out upon your due date, whether you have the money.
Others might set up a direct withdrawal from your bank account. If the withdrawal is not made automatically, you are responsible for paying your lender back on the agreed date.
If you miss or are unable to make your payment, your lender can charge you a penalty. The penalties for payday loans are typically a direct charge added onto the loan.
Rollover Variants
In some states, payday lenders may offer rollover loans. With a rollover loan, your lender provides you with a second loan which is applied on top of your first.
You do not have to pay off the previous loan until the due date for the rollover loan. While lenders can provide multiple rollover loans, some will place a strict limit if they believe you are unable to pay off the existing loans.
Payday Loans and Credit Score
Payday loans are unique because they do not usually involve a credit check. As a result, you can apply for a payday loan without having a negative impact on your credit score.
This also means your credit score will not increase from paying off your loan. However, if you miss payments and default on the loan, it becomes delinquent, which can negatively impact your credit score.
Military Exceptions
There are some protections in place for veterans and active service military members through the Military Lending Act (MLA).
The MLA includes a maximum cap on how much you can be charged on your loans. You can also apply for late fee exemptions if you were unable to make the payment because of your service.
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