How Do Payday Loans Work, and What Are Your Alternatives?

Anelle Valdes
What Is the Difference Between a Loan and a Payday Loan? | Wise Loan

It’s the Monday after payday. You already used most of Friday’s pay to cover bills and buy groceries, but you’re stuck on the side of the road with a broken-down car and you’re not sure how you’ll cover the repairs. At the same time, you need the car to get to work so you can earn that next paycheck.

You might be wondering if a payday loan is right for you.

Find out more about how payday loans work below — and get some info on alternatives — so you can make an educated decision no matter what your current emergency money need is.

What Is a Payday Loan?

A payday loan is a short-term loan meant to be paid back the next time (or two) that you get paid. The purpose of these loans is not to provide a long-term financial solution but to solve an immediate cash-flow problem — usually when someone is facing an emergency or urgent situation.

Some reasons people take out payday loans can include:

  • To cover urgent and unplanned expenses such as an uninsured trip to the doctor, a repair to the home AC system, or the purchase of a new tool for work if an old one breaks.
  • To make ends meet for a week or two if an unplanned expense or other issue has left the family without enough to buy groceries or pay for other necessary items.
  • To cover the cost of an unnecessary purchase that is limited by time, such as an item that is on sale only for the weekend.

How Do Payday Loans Work?

But are payday loans a good idea, even if you’re facing an urgent situation? To make this decision for yourself, you should understand how payday loans work. Here’s a step-by-step guide to the most common version of the traditional payday loan.

  • You need a relatively small amount of money quickly for any reason. Remember that with payday loans, the idea is that your next paycheck can pay off the loan (or your next two paychecks). Given that you still have to fund living expenses, such as rent, gas, and groceries, this tends to limit how much a payday loan can realistically be.
  • You borrow the money from a payday loan lender. The lender agrees to loan the money for a few weeks and usually not longer than a month.
  • The lender charges a finance fee for its trouble. Average payday loan finance fees can be $15 per $100 borrowed. So, if you borrow $500, that’s $75 in finance fees.
  • You pay the amount back on payday. In the above example, your next paycheck would be reduced by $575 (or $288 if you’re paying the loan back over two paydays).
  • The payment is automated. In most cases, the payday loan lender requires that you sign up for automated payments out of your checking account, ensuring that the money is paid back as agreed. At Wise Loan, automated payments are part of our payday loan process.

What Is the Interest on Payday Loans?

You might have noticed that the phrase “interest rate” wasn’t used in the above guide to how payday loans work. That’s because payday loans aren’t installment loans, so you’re not paying back the money over a period of months at a specified interest rate.

That doesn’t mean payday loans don’t cost you any money. The finance fees can stack up high, and when taken in tandem with the requirement that the loan is paid back within a pay cycle or two, you may be looking at a seriously choked-off cash flow.

What Is the Payday Loan Trap?

You might have heard the myth that payday loans are purposefully impossible to pay off so that lenders can trap borrowers into a rolling scheme of finance fees. This isn’t actually true, but that doesn’t mean that the payday loan trap is nonexistent.

Here’s how the payday loan trap might work in reality:

  • You take out a payday loan that (on paper) you can payback. The lender is supposed to be obligated to ensure you actually can pay the loan back and provide a reasonable way for doing so.
  • But life happens. Your grocery bill was higher than expected this week, you got a flat tire and had to replace it, or your child was sick and you needed to pay for urgent care and some medications. For whatever reason, your next paycheck has to stretch farther than you expected.
  • You roll the payday loan into a new payday loan. This means that you borrow the amount you need to pay back the current loan — including the finance fee. You’re also charged a new finance fee. So, if you borrowed $500 with a $75 fee at first, you now need to borrow $575. Perhaps the lender has a roll-over fee of $50, which means you now owe $625.

It’s possible that another series of events could leave you unable to pay again the next time, and you could roll the $625 over into a loan that you now owe $675 on. Many legitimate payday lenders have rules in place to limit this type of activity, but it still leaves you owing a large finance fee for a very short-term loan.

Why Consider a Personal Loan Instead of a Payday Loan?

What do you do if you’re faced with a situation that requires fast cash but you don’t want to get caught in a payday loan cycle? You might want to consider a fast personal loan online.

Wise Loan offers personal installment loans that you can apply for in just a few minutes. If you qualify for the loan — and you don’t need great credit to do so — we can get your funds to you the same day or the next day, depending on what time of day you completed the application.

As you may have noticed, many of these perks are the same as those you would get with a payday loan. Except with an installment loan from Wise Loan, you get some potential advantages that most payday lenders can’t offer:

  • Our repayment terms can cover a few months or a year or two, depending on your loan. Either way, your payments are broken up into much more affordable options than you might find with a traditional payday loan. For example, a $700 loan in Louisiana for 5 months might result in a payment every 2 weeks of $131, allowing you to spread the payments out into more manageable amounts so you can keep more of each paycheck. At Wise Loan, our loan terms are six months for all states, and (for residents of every state but Texas) you can request a longer repayment period.
  • Installment loans may help you build credit. Your on-time payments on personal loans will be reported to the credit bureaus, which is something that traditional payday loan lenders typically don’t do.

Ultimately, whether or not a payday loan is right for you is a personal decision. But that’s true of any type of credit. Make sure you’re informed about your own credit history, understand what you can and can’t afford, and research your options when it comes to loans before you start applying. And if you’re ready for a no-hassle process to a quick cash money loan, consider Wise Loan.

The recommendations contained in this article are designed for informational purposes only.  Essential Lending DBA Wise Loan does not guarantee the accuracy of the information provided in this article; is not responsible for any errors, omissions, or misrepresentations; and is not responsible for the consequences of any decisions or actions taken as a result of the information provided above.

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