Payday Lending: Financial Implications & Potential Issues

By Luke Worli posted 03-04-2021 08:52 PM

  

If you're in a tight spot financially, a payday loan might sound like an attractive prospect. It's certainly an easy way out of debt, temporarily. This tends to backfire though. 

So, let's examine this lending type and explain what you can expect after getting a payday loan. 

How Do Payday Loans Work?

Similar to personal and installment loans, you can borrow money through the 'payday' model online or by visiting a lender in person. However, they function a bit differently. 

States tend to limit the borrowing amounts and how much your creditor can charge in fees and interest rates. The reason for these laws is that payday lenders tend to be predatory, squeezing a lot of profit out of their borrowers. 

Either way, once you go through the approval process, you'll receive the funds in cash, check, or bank transfer. You'll need to repay it in full, including the interest, by its due date. The term tends to be short, typically until your next payday - hence the name.

The APRs go sky-high with these emergency funds. Still, many households take them out each year, either for lack of other options or knowledge about the alternatives.

Part of the reason may be that they're easy to get. Lenders don't impose many approval requirements, as they don’t run credit checks or  check your means. Usually, all you need is the identification, a bank account, and proof that you'll receive your next paycheck.

Repaying Payday Loans

You'll generally have to cover the loan amount in a single payment. The creditor could require:

  • A postdated check while you're applying
  • Direct debit from the bank account
  • Online through the website

The issues arise when borrowers fail to repay by the term set in the agreement. You could find yourself in this situation. If you can consolidate, it's generally best to go for this option to avoid harm to your credit.

Payday Loans & Credit Scores

Luckily, applying for a loan doesn't affect your credit score. It won't even appear on your report. However, if you default, you could get reported to a credit bureau and see your FICO score drop. 

How a Default Happens

If there aren't enough funds in your bank account for automatic repayment, the creditor will contact you to collect the debt. Meanwhile, the loan grows with added interest, fees, and penalties.

If they can't collect, lenders might turn to third-party debt collection agencies, who could get much more aggressive. Another option is suing you, which triggers a whole new string of inconveniences. 

Payday Loan Alternatives

These consequences sound frightening, and they are. They often trap you in a cycle, draining money from your account and causing legal trouble. 

You should consider payday loan alternatives first. From borrowing from friends and family to asking for a paycheck advance, these awkward conversations can save you a lot of trouble in the long-run. 

Alternatively, look into local charities and NGOs for much kinder lending conditions. 

The Bottom Line

If you can avoid payday lenders, skip them. However, if they're your only option, there's not necessarily any reason to panic. 

As long as you stay aware of the implications and actively avoid the major pitfalls, you'll get back on your feet without harming your financial future. 

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