How do payday loans work?


Quick Answer

Payday loans are small, short-term loans, typically of $500 or less, that mature or require payment on the borrower’s next payday. Prospective borrowers apply for payday loans either in person at a check-cashing center, online through a direct-lender’s site or via a loan-matching service. Common features associated with these loans include exorbitant interest rates or financing fees, small principals and two-week maturity dates.

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Full Answer

Payday loan applications are straightforward. Payday lenders typically ask for the prospective borrower’s Social Security number, contact information, source of income, checking account number and payday schedule. Credit checks are rarely instituted and approval decisions, which revolve around lenient lending requirements, are rendered within minutes of submission.

After approval, the borrower is notified of the loan terms and repayment schedule. Payday loans often feature finance charges from $10 to $40 for every $100 borrowed. The typical payday loan has an effective annual percentage rate ranging from 300 to 700 percent.

Repayment schedules vary based on the payday lender’s policy. Some payday lenders institute an installment-repayment schedule, where fixed payments are due every payday. Other payday loans, however, institute lump-sum repayments where the principal and interest are due on the borrower’s next payday. If the borrower does not have the funds to repay the loan in full, the lender provides an extension whereby the borrower is charged a substantial interest payment that does not affect the principal amount.

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