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How Do Payday Loans Work?

getting advice on loan options
A loan you can get quickly that isn’t due until your next payday sounds like a good idea. But how do payday loans work? Are they the start of a cycle of expensive fees and paying high interest?

It’s tempting when you’re in a financial bind to look for a quick solution. Payday loans seem simple, but they often come with extra costs that could hurt your wallet more than you bargained for this month.

According to the Consumer Financial Protection Bureau (CFPB), nearly 25% of people who take out a payday loan default on that loan, and more than 80% have to borrow money again within 14 days.
 

What is a payday loan?

Data from the FDIC shows that approximately 24 million adults, or 11% of the population, are underbanked. This means they are relying on financial services like payday lenders.

While driving around your city, you may have seen the storefronts advertising “quick cash” or “no credit check required.” Understanding how payday lending services work can help you make an informed decision about whether payday loans are the best option for you.

Payday loans are short-term loans, typically for two weeks. You can write a post-dated check, or provide a debit card number, and receive cash that same day.

When the date on the check rolls around, the lender will cash your check to pay the loan in full. You can also arrange to return to the loan office and pay back the loan with cash if you have it.

Payday loans can end up being more costly than they appear at first glance, since these types of loans target people who need money right away while they wait to get paid again. Lenders charge higher interest rate and fees when compared to a traditional bank loan.
 

What happens if I can’t pay a payday loan?

The average payday loans is $1,000, and with a staggering interest rate of 260%, costs can add up quickly, according to the CFPB.
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Depending on the terms of the loan, you will be turned over to a collection agency or debt collector, and these agencies may report you to the credit reporting companies.
If you cannot pay your loan at the due date, you can ask to renew the loan. The lender will treat this like another payday loan, charging you another round of fees.

Payday loans may also hurt your credit score if you can’t pay, says Mellissa Slover-Athey, Director of Community Engagement for SouthState Bank. “Depending on the terms of the loan, you will be turned over to a collection agency or debt collector, and these agencies may report you to the credit reporting companies.”

Consider this example before you use a payday loan service:
Let’s say you need $200 for a car repair, medical bill or another expense that won’t wait. Payday lender charges you a $30 fee for $200 borrowed. You write a post-dated check to a payday lender and leave with the money.

When the loan due date rolls around, something else has come up and you can’t pay back the $200. The lender allows you to extend your loan, but the lender charges you a $30 renewal fee plus a $30 late fee for the $200 loan. And what if your next paycheck isn’t as much as you anticipated? You may need to extend the loan again for another $30 fee plus an additional $30 late fee. Now you’ve paid $150 in fees alone when you only needed $200.
 

What are better options than a payday loan?

If you do need to borrow money for a purchase or bill, take some time to look around for the best terms and rate. As you saw, payday lenders charge high fees and interest.

Even if you don’t think you’re eligible, check with your bank about a personal loan. Many banks offer reasonably priced loans that allow you to borrow the money you need at a much lower interest rate. You may also be eligible for a line of credit.

You may be tempted to overdraw your checking account to cover a purchase. Be mindful, however, that non-sufficient funds (NSF) fees you incur can add up quickly if there are multiple transactions. You can link your savings account to your checking to cover any accidental overdrafts.

Setting up good financial habits before you get into a pinch will make those tight budget days easier. Pay yourself first by putting money into an emergency account for unexpected expenses. Even just $10 a week will add up and build a financial cushion.

If you find yourself forgetting to put money into your emergency fund, set up an automatic transfer to build your savings without you having to worry. You can also automatically send a portion of your direct deposit into a savings account.

SouthState Bank makes automating your savings easy, with our “Round Up to Save” program. Every time you make a purchase with your debit card, we round up the transaction amount to the next dollar and transfer the difference to your savings account, automatically. Then, at the end of the year, we match 2% of your savings, up to $250.

SouthState also offers a Secured VISA™ credit card for those needing to rebuild their credit. Once you begin saving, you can “borrow” from yourself via a cash-secured credit card. Cash-secured cards report payment activity to credit reporting agencies, which may improve your overall credit score.

Things to Remember

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Icon for Things to Remember
  • Whether you need to borrow $50 or $5,000, it is important to remember that credit is not free. Be sure to account for fees and interest when you are planning how to pay back the loan.
  • If you are considering two lenders, take note of the fees they will charge, such as fees for reviewing your loan application, servicing the account or for late payments.
  • Practice paying yourself first by setting up automatic drafts to your savings account or emergency fund.
This article should not be considered legal advice.
 

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