Understanding How Payday Loans Work

Every now and then, people find themselves in a tight financial bind.

Perhaps, an unexpected expense crops up, like an unforeseen auto repair. Often, these expenses occur at extremely inopportune times, typically between paydays. You know you will have enough money on your next payday, but the bills just will not wait.

In situations like these, consumers have turned to payday loans to help them get by financially until their next payday.

How to Get a Payday Loan

Payday loans, also called payday cash advances, are essentially short-term loans that generally need to be repaid in 14 to 31 days. The idea behind these loans is the borrower should be able repay the loan by his or her next payday, hence the name "payday" loans.

Typically, payday loans are much easier to acquire than other types of loans, which can come in handy for those with less-than-perfect credit or no credit at all. Most payday lenders merely require borrowers to be 18 or older, have an active checking or savings account and earn a steady income, either through employment or a government program.

To acquire a payday loan, the borrower simply needs to provide a check to the lender, made out for the amount of the loan plus any fees. For online payday loans, the borrower provides his or her checking or savings account information rather than a physical check. Funds then are deposited directly into the borrower's account.

Understanding Payday Loan Costs

Because payday loans are intended to serve as short-term loans, the fees associated with these types of loans are high compared to other types of loans. However, if borrowers use payday loans responsibly, they can keep these payday loan fees at reasonable levels.

Additionally, it is important for anyone considering securing a payday loan to fully understand how the fees are applied. Payday loan finance charges can range from 10 percent of the loan amount up to 30 percent, depending on the lender.

Here is an example of how the payday loan fees work. If a payday lender charges a 15 percent fee for payday loans and the loan amount is $500, then the payday loan fee would be $75. This fee would equate to a 460 annual percentage rate, also called an APR.

It is important to note that the payday loan fee is determined based on the total amount of the loan, which includes the fee itself. So, if you secure a payday loan of $500, the $75 fee would be taken out of that amount and you would receive $425.

While a 460 APR seems high, many people might feel that the single charge of $75 is manageable. Where most people get into trouble with payday loans is when they are unable to repay the loan by the original due date.

Typically, payday lenders will allow borrowers to roll-over their payday loans, extending the repayment period. However, the lender will charge additional fees to do so.

In the example above, if the borrower was unable to repay the loan by the original due date, he or she would be charged another $75. With this new charge, the total fee for the loan now equals $150, which equates to a 920 percent APR.

Because these fees can add up quickly, it is important for payday loan borrowers to do everything they can to repay a payday loan by the original due date. Again, these loans are meant to be short-term loans only. If you are unable to repay a payday loan by your next payday, then these types of loans are not for you.