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What is a Payday Loan? And How Does It Work

The process of borrowing money can be stressful, particularly in the event of emergencies. There are many possibilities for personal loans as well as lines of credit that you can consider.

A payday loan (sometimes known as cash advances) is one possibility. However, they have unique risks and this is why the loans are prohibited in certain states.

It is important to know the benefits and costs when you are considering the possibility of a payday loan. It is then possible to create plans so that you don’t get rushed into making an option.

What is a Payday Loan?

A payday loan is generally a short-term, high-cost credit that is intended to be paid at the time of your next payday. The structure and terms differ based on the state, lender, and individual loan.

What is the process of obtaining payday loans?

Payday loans are typically offered in smaller amounts and have fees depending on the amount of money borrowed. Typically e.g. in California, the amount is $255 Dollars. For instance, the Consumer Financial Protection Bureau defines a typical cost for payday loans as $15 per $100 you take out.

It’s the same as the annual percentage rate (APR), which is close to 400%. This is much higher than the rates for credit cards, which usually are between 12 and 30 percent.

How do you repay a payday loan?

In the event of payday loans, typically, the borrower offers the lender an unpost-dated check for the entire amount borrowed and any charges.

The borrower could also allow the lender to take the amount out of their bank account prior to when the loan is due.

Payday loans risks and Fees

Alongside the original cost and the initial cost, the CFPB warns of a myriad of additional costs and charges that come with payday loans.

This includes rollover charges in the event that you want to extend the term of the loan, late fees for late payments or overdrafts, and non-sufficient funds (NSF) charge if your account at the bank is insufficient at the time of processing your payment, and many more.

Payday loans and credit scores

The typical loan for payday does not need a credit check and proof of capability to pay back the loan. This is one of the reasons why they are appealing to borrowers who may not have other options for financing.

However, as Experian states, the loans can’t help you build credit if they are reported to credit bureaus when you make payments promptly.

If, however, you’re behind on your payments or in a position to not pay the payday loan, there’s a possibility that the loan will be reported to credit bureaus. This can be done by the lender or by a collection agency that assigns your debt. In this case, this could still affect your credit.

Alternatives to Payday Loans

Before taking out cash Payday advances loans or any other types of credit, it’s a good idea to think about your alternatives.

Emergency fund

If you’re in a position with the patience and the resources to prepare for the future, an emergency savings account is an excellent method to shield yourself from the unexpected.

Secured credit cards are an alternative

Secured cards can help you develop credit by ensuring responsible use. When you’ve built your credit score, it could aid you in obtaining an additional card that comes with benefits in the future.

Whatever option you pick, the most important thing is to prepare for the future. If you have additional questions about payday loans, then the CFPB offers a great payday loan information page.


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