How do Payday Loans work in the USA?

Payday loans have become very popular in the United States as a quick way to get money when people have an urgent need for cash. According to The Economist, the number of households undertaking payday loans annually could be as high as 2.5 million. However, it is important to know the conditions involved in a payday loan as not being well informed could lead to an important debt that can destabilize your finances. At the same time, when done well, they can be a time-saving solution to an urgent need.

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What Are Payday Loans?

Payday loans, as the number implies, are a type of short-term loan. The debt is set to be paid when the person gets their next paycheck and can be directly debited. Although these loans are quickly given, they come with a high-interest rate to offset the risk for the lenders. Loans are ideal to solve small cash crises that might take place when you start a new business and that cannot wait until the next paycheck comes in. They are frequently used for small and unexpected emergencies because they usually are for a smaller amount and need to be paid back shortly.

Today, getting this type of loan is easier than ever as this can be done entirely online. That said, there are also brick-and-mortar lenders and lenders that use both types of formats. Usually, the online process can take a bit longer as verifications might take a few hours or one to two days. However, going to the physical building means you will get to leave with the money you are borrowing immediately. If the situation is urgent, this is bound to be your best choice as there are no delays as long as the loan is approved.

The money can be paid in cash, check, or on a bank deposit depending on your preference. Online loans are usually paid directly to your bank account, making the entire process contactless, which might be preferred by many people.

Regulations for Payday Loans

Interestingly, regulations regarding these loans can vary between different states. One of the things that vary is how much can people borrow or how high the interest rate can be. Fees can also vary depending on regional legislation. Furthermore, this type of loan is forbidden in a few states, with a total of 32 states allowing this lending option.

Some states, like Wisconsin, Wyoming, Utah, and Maine allow borrowers to get as much money as the lender will be willing to lend. However, states like Idaho, Illinois, and Delaware have set a cap of $1,000. Other states are much more conservative on this subject. Montana and California establish their cap at $300.

Another form of regulating the amount borrowed is by income percentage. New Mexico and Nevada only allow loans as high as 25% of the person’s income per month. This is a way to protect the borrower and make sure the loan has the best chance of being paid fully.

How it Works

Getting a payday loan is a fairly simple process. After filling out a form requiring personal information, a recent pay stub is needed as proof of income. Usually, a bank account is the only other additional requirement.

Once the loan is approved, the money is given immediately. If entering this type of loan, you can pay it back -with the agreed-upon interest- at any time before your next paycheck. The mean amount charged is approximately $17 per $100 that have been borrowed.

A post-dated personal check is usually required as a guarantee, and it will be used if payment is not provided first. Full credit checks, as they would be done in a bank, are not performed in this case.

Most lenders offer the option to reborrow the loan if needed. This usually involves an additional charge, which makes the debt even larger. Therefore, this could lead to a vicious cycle of debt and it is best avoided. When possible, is better to skip reborrowing.

An interesting fact about payday loans is that they do not affect your credit score. Some people enter these loans in an attempt to improve their credit score, but this is fruitless as it is not reflected on the credit report. However, in case you default on the loan or a collection agency gets involved, it can damage your credit score as it becomes part of the credit report.It has been reported that approximately one in five borrowers default on their loan. This number is even higher when it comes to online loans. Therefore, it is very important to consider the ability to pay before entering this type of loan. While the quick cash and easy approval process make it an attractive option, the steep interest rates must be taken into consideration.

About Mohit Tater

Mohit is the co-founder and editor of Entrepreneurship Life, a place where entrepreneurs, start-ups, and business owners can find wide ranging information, advice, resources, and tools for starting, running, and growing their businesses.

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