What is a Payday Loan & How Does it Work?

Payday loans get their name because they must be paid back on your next payday. Payday loans might come in handy by planning appropriately, but you may be wondering what a payday loan is, how it works, and if it could be beneficial for you. 

Payday loans are high interest, unsecured loans averaging $500 to $1000 that you must pay back on your next payday. Most places require a bank account, a steady income, and a valid ID. The interest on a payday loan is typically 391% to even 700%. 

In this article, I’ll explain more about what exactly a payday loan is, including why it might be more helpful than a personal loan, and the real drawbacks of such an option.

I’ll also explain what could potentially happen if you can’t pay back a payday loan.

How a Payday Loan Works?

Payday loans are scary for many people, and for good reason. Since payday loan interest rates are phenomenally higher than any other loan available, they seem daunting.

To look at payday loans from all angles, it’s essential to know what they are and how they work.  Payday loans are short-term, unsecured, high-interest loans averaging $400 with the potential for more or less.

There are currently eighteen states that cap the APR (interest rate) at 36% to protect the people becoming indebted, and in twelve states, payday loans are banned.

Those interest rates are in the triple digits for the states that don’t cap the APR.  Banks will digitally acquire access to your bank account or hold a check with your account and routing number.

Banks don’t typically ask to see your credit score as long as your bank account is in good standing. The lending office will ask for a pay stub or two for proof of income.

You must also have a valid ID.  Once approved for a payday loan, you’ll either get the cash on the spot, or they’ll transfer the money into the bank account on file. 

Payday loans are shorter than most short-term loans because they must be paid back on your next payday or in two weeks.  In this day and age, paying back a payday loan is relatively easy –if you have the funds, that is.

Here are some acceptable ways of paying off your loan: 

• Calling in: You can call the branch you acquired your loan from, and they can process the payment on their end directly through your bank account. You may need to pay a service fee.
• Auto-payment: Typically, you can set up autopay when acquiring your loan. With this, you can forget all about your payment due date because the funds will be removed from your bank on the day set. 
• Go in: You can go into the store you got your loan from and pay using a debit card or authorize it to be withdrawn from your bank account.
• Using a check: Sometimes, you can give your store a check with a written amount for what you want to be borrowed. If you request $500, you would note that amount on the check being held. The store will process your check on the due date.

Payday Loans vs. Personal Loans

Personal loans are secured loans, some short-term, but most long-term. They have lower interest rates since they don’t need to be paid back on your next payday.

One of the drawbacks to a personal loan is that you can only spend the money borrowed for a specific purpose.  Payday loans have great flexibility on who can acquire the loan.

They don’t need a credit check, just a steady income, and a valid ID. Personal loans require a credit check, and typical minimum credit scores are 600 to 630. 

Loans of any type require careful planning before acceptance, or you may find yourself in a rabbit hole that you can’t get out of. Below is what happens when you haven’t planned for a payday loan and what you can do. 

What Happens If You Can’t Pay Back a Payday Loan?

You got a payday loan, but you can’t pay it back on your payday. That’s a spot no one wants to be in, because it means credit points knocked, collections, and even court for the most stubborn cases. 

Just because a payday lending agent doesn’t check your credit score doesn’t mean you don’t get hit with collections and a lousy credit score hit.

As soon as that money is due, your lender will immediately pull the funds from your account in the agreed-upon way. If the debits bounce back too many times, lenders will start calling lawyers, collections agencies, and even references on your application if given. 

You entered into a legal, binding contract when you received the money. Even if it was $100, you must pay it back or deal with being hassled and then punished if you don’t.

Sometimes the hassles can be too much, however.  Threats of jail time are common when you fail to repay a payday loan. These threats are actually illegal, as lenders cannot threaten you with jail for failing to pay off your loan.

However, that doesn’t mean there won’t be legal action against you.  Some lenders will file a criminal complaint against you, and some judges give the seal of approval for a court date.

If this happens, it’s best to call a lawyer as soon as possible to talk about your options for dealing with the situation. 

Bottom Line

Payday loans are an easy way to acquire around $300 and up to $1000 for an emergency before your next payday. As long as your next paycheck can pay off the loan, you won’t need to worry about high-interest rates, potential collections, or criminal complaints against you. 

As long as you plan for the amount you’re borrowing, you can avoid the stress of collections calls and a building interest rate.

If you don’t plan for the money, your payday loan has the potential to last years, where you would pay an excessive amount of money to clear the debt.