A payday loan is a small, short-term loan ranging from a few hundred to about a thousand dollars. The loan is named for its original function, which is to supplement the borrower’s cash flow between pay days.

The Process

The borrower usually writes a check payable to the lender for the amount he or she wants to borrow. An interest is always added to the loan in the total amount in the check. The company then gives the borrower the loan, minus the extra the fee. Payday loan fees are usually calculated through percentages or fee per amount borrowed. If you wanted to extend the loans, or have them “roll over,” additional fees would be charged to the interest and the loans you need to pay back.

Controversy

Many critics decry payday loans, arguing that payday lenders target low-income or immigrant communities that may not understand the ins and outs of these loans. Quick cash is more of a temptation among high-poverty neighborhoods with low literacy rates.

On the other hand, defenders of payday loans claim that these lenders provide a service not given in national banks. Payday loans fill a need in the economy by providing small, short-term loans that banks would not normally offer.

Financial Drawbacks

Overall, getting a payday loan does not make sound financial sense. A payday loan gained through writing a personal check to the lender is ultimately more trouble and cost than it’s worth. For example, if you wrote a check for $115 dollars to borrow $100 dollars for 14 days and pay it off successfully, you’ve been gypped. The cost of the initial loan is $15 dollars, which we can calculate as a staggering 391% APR. On the other hand, if you decide to defer the loan three times, the finance charge could add up to as much as $60 to borrow $100. With this kind of interest rate, if you continue to extend the loan, you might pay far more than the amount you originally borrowed.

Additional Problems

Unfortunately, bounced checks and fees are still common for many who deal with unscrupulous business companies. If the lender deposits your post-dated check before the date agreed upon, or if you don’t have enough money in your account to cover the check on the date agreed upon, you can land in some trouble with your bank.

Alternatives to Payday Loans

Payday loans should only be considered in an absolute emergency, and even then it is not advisable. Whenever possible, borrow emergency money from family or friends. Avoid putting yourself in a position to resort to payday loans by saving up a cushion of security money to spend on emergencies. 

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