How Payday Loans Work

Payday loans are short-term loans that are meant to tide you over should you need cash in an emergency. The loans are typically small, a few hundred dollars or less, and they carry a very high interest rate. The loans are ideally paid back in two weeks or less, which is why they are called payday loans: You borrow just enough cash to get you through until payday.

The Payday Loan Process

Procedures vary from company to company, but a majority of lenders have the same payday loan process. You write a check from your personal checking account for the amount of the loan plus a fee and leave the check with the lender. When your payday arrives, the loan company cashes your check. Some companies allow a “rollover” in the event you can’t repay the loan on the due date. If your original loan is rolled over for an additional week or two, your fee grows higher and higher.

Advantages of Payday Loans

Despite the expensive fees, obtaining a payday loan can sometimes be advantageous. For example, if getting one of these short-term loans will enable you to make your mortgage, car, or credit card payments, you may ultimately save money. A missed payment on your other loans could result in a large late fee. Many traditional credit card lenders also raise your annual interest percentage fee if you are late with even one payment. Missing a credit card payment could, in the long term, cost you much more than the fee charged by a payday lender.

There’s another way a payday loan could ultimately save you money: Making late payments on your traditional loans will adversely affect your credit rating. When your credit rating goes down, every future loan you attempt to get will come with a higher interest rate.

Disadvantages of Payday

Payday loans are meant to be emergency loans; if you rely on them too often, you will dig yourself into a financial hole that may take years to recover from. If you end up with serious cash shortfalls every month, the repayment check you left with the lender may bounce. You’ll then get overdraft fees charged to your checking account. If you bounce too many checks, you may jeopardize your chances of banking with anyone and put yourself at risk for a bad credit rating.

Making the Decision

Even though a short-term, high-interest loan may be necessary in extreme circumstances, proceed with caution. The interest rate on these loans can far exceed 100 percent. The only thing you can do is weigh the advantages against the disadvantages. If you need $200 to fix your car, then paying a short-term lender $240 to get the cash you need may be advantageous. After all, if you have no form of transportation to get to your job, you will lose income and possibly jeopardize your job. In that case, spending an extra $40 in fees may be worth it.

Obviously, getting a payday loan should be your last resort. If at all possible, start saving money to build up an emergency cash reserve so you won’t be at the mercy of a short term lender.

Last Updated: January 20, 2016