What is a payday loan?
A payday loan is a high interest loan frequently used by borrowers who cannot secure loans from traditional banks. Usually, the loan amount is $500 to $1,000. Payday loans are intended to act as short-term loans, but many borrowers extend the initial loan term.
When you take out a payday loan, you borrow the funds until your next payday. To ensure it receives payment, the lender requires a postdated check for the borrowed amount, plus any fees or interest.
Payday loans frequently are criticized for their high interest rates. Usually, borrowers pay a set fee for every $100 they borrow. Fees vary, but $10 to $15 per $100 is a common amount.
Unfortunately, many borrowers cannot repay their payday loans by the due date so they have to roll over their initial loan into new loans. When annualized, the fees for payday loans amount to an annual percentage rate, or APR, that falls between 390 and 780 percent.
Proponents of payday loans argue that they aren’t meant to be a long-term solution for cash shortages. These loans also serve individuals who have nowhere else to turn when they need to borrow money.
Payday loan example
Consumers with poor credit usually turn to payday loans when they experience financial emergencies. Imagine that your only car breaks down, and it requires $500 in repairs.
Your credit cards are maxed out, you don’t qualify for a bank loan and you cannot get a loan from friends or family. A payday loan is your only option.
When you take out the payday loan, you agree to pay a specified fee for each $100 that you borrow. In this example, assume the fee is $15 for every $100. After you complete the paperwork, you’ll give the payday lender a postdated check for $575 (the $500 that you borrowed and $15 for each $100 of the loan). Once the date on the check arrives, the lender deposits the check and your repayment is complete.
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