What is a Payday Loan?

Anelle Valdes
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Payday loans are loans that let you borrow funds for a short time period — typically at a high interest rate. This type of loan gets its name from the fact that most payday loan definitions specify that you have to pay back the loan out of your next paycheck. Technically, the loan terms tend to be two to four weeks (or enough time to ensure your paycheck hits your bank account).

Find out more about payday loans below, including how they work, whether they’re legal and what other options you might have for getting fast access to cash when you need it.

How Do Payday Loans Work?

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You can get payday loans online or off. When you apply for in-person payday loans, you do so at a payday loan office. Online payday loans work the same way in-person loans do, but you complete the application process online.

In either case, payday loan lenders don’t typically require a credit check. Instead, you have to prove that you’re employed and have a specific amount of income. Payday loan lenders typically want to see a few of your latest check stubs so they know how much you get paid on a regular basis.

When you take out a payday loan, you sign an agreement with the lender. They give you the cash that day or by the next day — either in the form of a check or a direct deposit. You agree to repay the loan directly from your checking account at the due date. Typical terms for a payday loan range from two to four weeks, and the payment comes out of your account automatically.

How Much Can You Borrow With a Payday Loan?

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How much you can borrow with a payday loan depends on factors including your state laws and how much you make on each paycheck. In general, a payday lender won’t approve a loan amount that’s for more than your paycheck or even all of it. Your paycheck is, after all, what is used to pay back the loan in a few weeks.

Thirty-seven states allow payday lending, but the laws governing these loans vary by state. Each state that allows payday loans has a set maximum loan amount that’s allowed by law. State maximums for payday loans where Wise Loan operates are:

Payday loans are not offered in Utah and Wisconsin. For a complete explanation on payday loan laws in Utah and Wisconsin, please visit the National Conference of State Legislatures.

In most of these cases, the maximum loan amount is inclusive of any fees. The amount you get in cash may be less than the maximum. The details of the payday loan laws may also require lenders to keep loans under a certain percentage of your income, which could lower these caps in some cases.

(Source: National Conference of State Legislatures)

How Do You Get a Payday Loan?

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To get a payday loan, you must apply for one. While the details might be somewhat different with each lender, here’s a common series of steps you would take to get in-person or online payday loans:

  • Search for payday lenders. Start by searching in-store/in-person and online payday loan providers. It’s important to find a responsible lender that’s allowed to provide loans in your state.
  • Read up on the requirements for each loan. Do some research to understand what the requirements are for a loan. Applying for loans you probably won’t qualify for doesn’t do you any good — it can increase the time it takes for you to get the money you may need, and in cases where lenders are checking credit, it can even hurt your credit score. Payday loan lenders don’t usually require a credit check, but they may require a checking or savings account and certain documents.
  • Gather your documents. Make a list of all the documents you might need to successfully apply for a payday loan and gather them. Common requirements for payday loans include a state-issued ID or another legal form of ID, a qualified checking or savings account that can receive the loan funds and be used to pay the loan balance at the end of the term, documents proving your income (such as paycheck stubs) and an address in a state the lender works in. Many lenders also require contact information, including an email address and a phone number.
  • Apply for the payday loan. Complete the loan application online or in person.
  • Get your cash. Once you’re approved, you can usually get your cash within one business day. Some lenders even offer options for same-day or instant funding of approved loans.

Dangers of Payday Loans

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The fact that payday loans have no credit check requirements and can be relatively easy to get cause many people to turn to them when they have an urgent cash need. However, payday loans are not without disadvantages, and some of them can prove dangerous to the stability of your financial life.

Payday Loans Have High Interest Rates

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Since payday loan lenders don’t check your credit and may fund loans for anyone that can demonstrate the right income, they can be risky for the lender. To make up for that risk, payday loan lenders often charge very high interest rates, making this an expensive form of debt.

To add to the issue of high interest rates, payday loans are typically due within the month. That means the interest is charged in the form of a finance fee. The amount of this flat fee depends on how much you borrow. According to the Consumer Financial Protection Bureau, it’s common for payday loan lenders to charge $15 to $30 for every $100 borrowed for a two-week loan.

Say you borrow $200. The fees for that could be as much as $60 total, which means you would have to pay back $260 within two weeks.

Payday Loans Have Short Repayment Terms

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The short repayment terms combined with the high fees can create a sort of payday loan trap that may be difficult to dig out of. Consider the hypothetical example below to better understand the potential danger of payday loans:

  • Someone brings home $700 every two weeks.
  • Their car breaks and they need $400 to fix it. They need the money before their next payday, because they can’t get to work without their car.
  • The person borrows $400 via a payday loan lender and agrees to a $60 fee and payment terms of two weeks.
  • Out of their next $700 paycheck, the person owes $460. That leaves them with $240 of that paycheck to live on.

But what if another issue occurs or the person has to pay rent with that next paycheck? They may realize they can’t pay off the payday loan. In some cases, payday lenders allow loans to be rolled over — for an additional fee. In this hypothetical case, imagine that the loan can be rolled over for an additional $50. Now the person owes $510 out of their $700 paycheck, leaving them even less to live on for two weeks.

How Payday Loans Can Affect Your Credit Score

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In most cases, payday loan lenders don’t report timely payments to the credit bureaus. That means paying your loan back as agreed doesn’t have any positive impact on your payment history or credit. However, if you can’t pay your loan back, the lender will likely send you to collections. The open collections account is reported on your credit report and negatively impacts your score.

Alternatives to Payday Loans

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Payday loans aren’t always the right answer to an urgent need for cash. Here are some other options that you might consider before signing on the dotted line for a short-term payday loan:

  • Use a credit card or line of credit. If you have a credit card or other line of credit with available credit on it, consider using it to cover the immediate expenses you’re facing. While credit cards may come with high interest, the rates are typically lower than what you’ll face with a payday loan. You also have some more flexibility in how you pay the debt back.
  • Borrow money from a friend or family member. If you truly only need a bit of cash to make ends meet or cover an urgent expense until payday, consider asking someone you trust to lend you the funds. They may be willing to do so if you really can pay them back right away, and you won’t be out the high fees associated with a payday loan.
  • Get a personal installment loan. You can find lenders that offer personal installment loans for $500 or more that don’t require you to have great credit. Installment loans can be more manageable to pay back.

Payday Loans vs. Installment Loans

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How are installment loans more manageable than payday loans? When you take out a small personal loan, you usually have months or even a few years to pay it back — as compared to the weeks you get with a traditional payday loan. That means the amount you pay back is broken into numerous smaller amounts, so you’re not taking up a good part of one of your paychecks to cover it.

For example, you might borrow $500 and pay that back with payments of around $50 each. It’s much easier to find $50 out of each paycheck than to find $500 out of your next paycheck when you’re already strapped for cash.

Installment loans from Wise Loan are processed quickly, carry no hidden fees, and you can qualify for one with bad credit. You may not even need the same income documents a payday loan lender would require, making our application even easier. Plus, we report your timely payments to two of the three credit bureaus, helping you build your credit as you pay back your loan.

Frequently Asked Questions About Payday Loans

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Are Payday Loans Legal?

The regulations for payday loans occur at the state level. Each state has different regulations, with some states regulating these types of loans more than others. Some states do prohibit payday loans, including Arizona, Arkansas, District of Columbia, Georgia, New Mexico and North Carolina.

Are Payday Loans Fixed or Variable?

Usually, payday loans are paid back in a single payment and the interest is charged as a lump sum fee. That equates to fixed-rate interest. Payday lenders may use terms like interest, finance charges, flat-rate interest or flat fee to refer to these charges.

Are Payday Loans Secured or Unsecured?

Secured loans are those that are tied to collateral. If you don’t pay the loan, the lender takes the collateral and sells it to make up for its losses. A common example of this type of loan is a car loan. Payday loans are unsecured as they aren’t tied to any collateral. However, lenders do typically require you to sign an agreement that the payment can be taken directly out of your checking account.

Can You Get a Payday Loan With Bad Credit?

Yes, most payday loan lenders don’t require a credit check. However, if you have bad or poor credit, payday loans aren’t your only option. You have other options, including installment loans from Wise Loan.

How Many Payday Loans Can You Have?

The number of payday loans you can have at a time depends on factors such as your income, how much you initially borrowed, the policies of your lender and the laws of your state.

Responsible Lending From Wise Loan

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Find out more about how responsible lending from Wise Loan can help you get the cash you need today without putting your next paycheck at risk. Learn more about payday loans, installment loans and credit by browsing our blog, or apply for a Wise Loan 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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