How Do Payday Loans Work?

Payday Loan application form.
Image Credit: glegorly/iStock/Getty Images

Payday loans get their name because they're short-term loans — cash to tide you over until your next payday. To get one, you typically need a checking account and a source of income. Be aware, however, that payday loans carry extremely high interest rates, and the Federal Trade Commission recommends considering them only as a last resort.

Getting the Loan

The standard term of a payday loan usually is two weeks. Say you want to borrow $100. The payday lender asks you to write a postdated check for that amount, plus a loan fee. These fees vary by lender, but $15 per $100 borrowed is common. So you write a check for $115, and the lender gives you $100 cash and holds onto your check for two weeks. Alternatively, the lender directly deposits $100 into your checking account, and you authorize the lender to deduct $115 from your account in two weeks.

Repaying the Loan

After two weeks, the lender deposits your $115 check, or directly deducts $115 from your checking account. Now the loan is settled. However, if you don't have the money in your account to repay the loan — and many people who resort to payday loans do not — then you can renew or "roll over" the loan. That means getting another two weeks to repay, for another $15 fee.

High Interest Rates

On the face of it, a $15 fee for borrowing $100 looks like 15 percent interest. But in lending, interest rates typically are expressed in annual terms. A 15 percent interest rate for two weeks equates to an annual rate of about 390 percent. That's far higher than you would pay for, say, a cash advance on a credit card or a personal loan from a bank or credit union.

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