What is a Payday Loan and How Does it Work?

Wise Loan Editorial Team
By: Wise Loan Editorial Team
Calendar marked with date of next payday | Wise Loan

Payday loans are short-term loans that allow you to borrow money, usually at a high-interest rate. They derive their name from the requirement that you repay the loan from your next paycheck. Typically, these loans have a duration of two to four weeks, or until your paycheck is deposited into your bank account.

Explore further details about payday loans, such as their mechanics, legality, and alternative avenues to quickly obtain funds during urgent financial situations.

How Do Payday Loans Work?

Payday loans can be obtained both online and in person. If you choose the in-person option, you visit a payday loan office to apply. On the other hand, online payday loans operate in a similar manner, but the entire application process is completed online.

In either scenario, payday loan lenders generally do not require a credit check. Instead, they seek evidence of your employment and a specific level of income. Typically, payday loan lenders request your most recent pay stubs to ascertain your regular earnings.

Upon taking out a payday loan, you enter into an agreement with the lender. They provide you with the funds either on the same day or the following day, either as a check or through direct deposit. You commit to repaying the loan directly from your checking account on the due date. Payday loans typically have a duration of two to four weeks, and the repayment is automatically deducted from your account.

How Much Can You Borrow With a Payday Loan?

The amount you can borrow through a payday loan is influenced by various factors, such as the laws of your state and the size of your paychecks. Generally, payday lenders do not approve loans that exceed the amount of your paycheck, as your upcoming earnings are intended to repay the loan within a few weeks.

Payday lending is permitted in thirty-seven states; however, the regulations surrounding these loans differ by state. Each state that allows payday loans has a legally defined maximum loan amount. Here are the maximum loan amounts permitted in the states where Wise Loan operates:

Utah and Wisconsin do not offer payday loans. For a comprehensive explanation of payday loan laws in Utah and Wisconsin, please refer to the National Conference of State Legislatures.

In most cases, the maximum loan amount includes any applicable fees. However, the actual cash you receive may be less than the maximum amount specified. Moreover, payday loan laws may require lenders to restrict the loan amount to a certain percentage of your income, which could further lower these limits in certain instances.
(Source: National Conference of State Legislatures)

How Do You Get a Payday Loan?
How Do You Get a Payday Loan?

To obtain a payday loan, you need to initiate an application process. While the specific procedures may vary slightly among lenders, here is a general outline of the steps involved in acquiring in-person or online payday loans:

  1. Search for payday lenders: Begin by searching for payday loan providers, both in-store and online. It is crucial to find a reputable lender who is authorized to offer loans in your state.
  2. Familiarize yourself with the loan requirements: Conduct research to understand the prerequisites for obtaining a loan. Applying for loans that you are unlikely to qualify for serves no purpose and can potentially prolong the time it takes to access the funds. It may even harm your credit score if lenders conduct credit checks. While payday loan lenders typically do not require a credit check, they may necessitate a checking or savings account and specific documentation.
  3. Gather necessary documents: Create a list of all the documents you will likely need to successfully apply for a payday loan and gather them. Common requirements include a valid state-issued ID or another form of legal identification, a qualified checking or savings account capable of receiving the loan funds and being used to repay the loan at the end of the term, proof of income (such as paycheck stubs), and an address in a state where the lender operates. Additionally, many lenders require contact information, including an email address and phone number.
  4. Complete the payday loan application: Fill out the loan application either online or in person, following the instructions provided by the lender.
  5. Receive your funds: Once your loan application is approved, you typically receive the funds within one business day. Certain lenders may even offer options for same-day or instant funding of approved loans. At Wise Loan, instant funding is available for those who apply and are approved before 5:30 pm CT, and have a Visa or Mastercard debit card associated with their checking account. With instant funding, you can receive the loan funds on the same day of approval. However, the speed of fund disbursement also depends on the processes of your financial institution.

Dangers of Payday Loans

The ease of obtaining payday loans without undergoing credit checks is a key reason why many individuals turn to them during times of urgent cash needs. However, payday loans come with disadvantages that can pose risks to your financial stability.

One significant drawback of payday loans is their high-interest rates. Since payday loan lenders do not assess creditworthiness and may lend to individuals with appropriate income, they incur greater risk. To compensate for this risk, lenders often impose exorbitant interest rates, making payday loans a costly form of debt.

In addition to high-interest rates, payday loans typically have short repayment terms. The repayment period, coupled with the associated fees, can create a payday loan trap that is challenging to escape. To illustrate this point, consider the following hypothetical scenario:

Suppose someone earns $700 every two weeks. Their car breaks down, requiring $400 for repairs. They need the funds before their next payday, as their car is essential for commuting to work. The person borrows $400 from a payday loan lender, agreeing to a $60 fee and a two-week repayment term. From their upcoming $700 paycheck, they owe $460, leaving them with only $240 for living expenses.

However, if another unexpected expense arises or they need to pay rent, they may find it impossible to repay the payday loan. In such cases, some lenders allow the loan to be rolled over for an additional fee. In this hypothetical scenario, imagine the loan can be rolled over for an extra $50. Now, the person owes $510 from their $700 paycheck, leaving them with even less to cover their expenses for the next two weeks.

Furthermore, payday loan repayment behavior typically does not positively impact credit scores since most lenders do not report timely payments to credit bureaus. However, if you fail to repay the loan, the lender is likely to send your account to collections, resulting in a negative entry on your credit report.

Considering the drawbacks associated with payday loans, it is essential to explore alternative options before resorting to them. Here are some alternatives worth considering:

  1. Use a credit card or line of credit: If you have available credit on a credit card or line of credit, consider using it to cover immediate expenses. Although credit cards may have high-interest rates, they are often lower than those of payday loans, and you have more flexibility in repayment.
  2. Borrow from a trusted friend or family member: If you only require a small amount of cash to tide you over until your next payday, consider asking a trusted friend or family member for a loan. If you can promptly repay them, you can avoid the steep fees associated with payday loans.
  3. Explore personal installment loans: Personal installment loans, even for individuals with bad credit, can be a more manageable alternative. These loans allow for longer repayment periods, spreading the payments into smaller amounts that are easier to incorporate into your budget.

At Wise Loan, we offer personal installment loans that are processed quickly, have no hidden fees, and cater to individuals with bad credit. Our application process is simplified, and you may not even need the same income documents required by payday loan lenders. Moreover, we report timely payments to two out of the three credit bureaus, allowing you to build your credit while repaying the loan.

Frequently Asked Questions About Payday Loans

Are Payday Loans Legal?

The legality of payday loans is determined by state regulations. Each state has its own set of regulations, with some states imposing stricter regulations on these loans than others. It’s worth noting that payday loans are prohibited in certain states, including Arizona, Arkansas, the District of Columbia, Georgia, New Mexico, and North Carolina.

Are Payday Loans Fixed or Variable?

Typically, payday loans are repaid in a single payment, and the interest is charged as a one-time fee, resulting in fixed-rate interest. Payday lenders may use various terms such as interest, finance charges, flat-rate interest, or flat fee to describe these charges.

Are Payday Loans Secured or Unsecured?

Secured loans are tied to collateral, meaning that if you fail to repay the loan, the lender can seize the collateral and sell it to recoup their losses. Car loans are a common example of secured loans. On the other hand, payday loans are unsecured as they are not tied to any collateral. However, lenders usually require borrowers to sign an agreement allowing the payment to be deducted directly from their checking accounts.

Can You Get a Payday Loan With Bad Credit?

Yes, most payday loan lenders do not require a credit check. However, if you have bad or poor credit, payday loans are not your only option. There are alternative options available, such as installment loans from Wise Loan.

How Many Payday Loans Can You Have?

The number of payday loans you can have simultaneously depends on factors like your income, the initial loan amount, your lender’s policies, and the laws of your state.

Responsible Lending from Wise Loan

Discover how Wise Loan’s responsible lending practices can help you access the cash you need without jeopardizing your next paycheck. Learn more about payday loans, installment loans, and credit by exploring our blog, or apply for a Wise Loan today.

The recommendations contained in this article are designed for informational purposes only.  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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About the Author

Wise Loan Editorial Team

Wise Loan Editorial Team

Introducing the Wise Loan Editorial Team – a collective of experienced finance and credit professionals dedicated to enhancing your financial path. Our team boasts over three decades of expertise in the finance sector, united in our commitment to deliver reliable and practical financial insights. True to the Wise Loan ethos, our goal is to positively impact the financial well-being of our customers.

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