Determining the Underlying Interest of a Payday Loan

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Payday loans offer a solution for times when financial emergencies arise. These short-term loans are meant to be paid off by the time a borrower’s next payday rolls around. While payday loans do not carry an interest rate in the way that a traditional loan does, there are fees associated with short-term borrowing that can be interpreted as a type of interest.

How a Payday Loan Works

Payday loans receive their name from the fact that these loans are meant to be paid back the next time a borrower is paid by an employer. Income verification is part of the application process for this reason.

The amount that a borrower earns each pay period will determine how much can be borrowed.

Screen Shot 2014-05-22 at 3.36.24 PMThe application process for payday loans can generally be completed online. Borrowers must be 18 years of age, employed, have a personal bank account and be a U.S. resident. The fact that income is used for approval purposes means that borrowers are generally able to forgo a credit check when applying for a payday loan.

If a person is approved for a loan, the funds may be deposited directly into the borrower’s bank account in as little as 24 hours. As mentioned above, payday loans are expected to be paid back when the borrower receives a paycheck.

Here?s a great breakdown provided by Northcash.com on how to get a payday loan.

Payday Loan Fees

Lenders make money when they offer payday loans to borrowers by charging a fee. This fee usually reduces the amount that the borrower receives. For example, a person who is approved for a $1,000 payday loan may only receive $850. The extra $150 acts as an origination fee on the loan, and the borrower is required to pay back the full $1,000.

There are also fees that are assessed if a borrower pays back the loan late. Payday loans must be paid back in a period that ranges from about two weeks to one month. People who are struggling financially may find that they are unable to pay the entire loan back by the due date, and there are penalties assessed for late payments.

Effective payday loan interest rates tend to be very high. For example, imagine that the person in the above example borrowed $1,000 for one month. Interest of $150 over a period of one month equates to $1,800 over the course of a year. This represents an effective interest rate of 180 percent. While the effective interest rate of a payday loan is high, it is important to understand that these loans are intended to be paid off after a very short period of time.

Getting the Best Rate

One of the best features of a payday loan is that many lenders allow borrowers to apply online. This means that borrowers have the option to find out more about the loan through an online search before committing to a particular lender.

People who are thinking about taking out a payday loan can use comparison websites to determine which lender offers the lowest fees in relation to the amount that is being borrowed. Another way to find the best rate on a payday loan is to ask family members and friends through a social media website.

People who have borrowed using this method in the past may be inclined to provide information about their experience.

While a payday loan is not meant to be a long-term solution to financial problems, this borrowing method works well for temporary financial emergencies. The key to avoiding high fees that translate to an exorbitant interest rate is to shop around and ask others about lenders than are being considered.

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