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How Do Guaranteed Payday Loans Work?

Guaranteed payday loans may seem like a lifeline when you need cash right away, but the high fees and short-term lengths can send you into a vicious cycle of indebtedness.

Although there is no exact definition of what a payday loan is, it is commonly known as a short-term loan, for a small amount, usually $500 or less, that is usually due on your next day: payment and surcharges.

These loans are touted as a way to bridge the gap between paychecks or help with unexpected expenses, but the Consumer Financial Protection Bureau says payday loans can become “debt traps.”

And here’s why: Many borrowers can’t afford the loan and the fees, so they end up paying even more fees, over and over again, to delay having to pay the loan, refinancing the debt until they end up paying more in fees, than for the amount you borrowed in the first place.

How do payday loans work?

Payday loans may have different names — cash advance loans, deferred deposit loans, or online payday loans — but they all work more or less the same way.

To apply for a payday loan, you may need to write a postdated check made out to the lender for the full amount, plus any other fees or charges. Or you can authorize the lender to withdraw money from your checking account electronically. The lender then gives you the cash.

The loan is normally due on your next payday, which can usually be in two to four weeks. If you don’t pay the loan plus finance charges by the due date, the lender may cash your check or charge your bank account electronically.

Many of the states that allow this type of loan limit the amount that can be lent and the accompanying fees. Companies may be allowed to charge $10 to $30 for every $100 borrowed, depending on the state where they are located.

What state regulations are in place regarding payday loans?

If you’re wondering if there are state laws regulating payday loans where you live, keep in mind that some states prohibit payday loans.

And since there is no formal definition of what constitutes a payday loan, your state may allow other types of short-term personal loans. If you’re wondering what restrictions exist for what’s considered a “payday loan” in your state, take a look at the chart below. Just keep in mind that when you read this table, the interest charged is not necessarily the same as an APR. For example, a 15-day loan at 10% interest translates to an APR of 260.71%.

But while payday loans can provide much-needed emergency cash, there are dangers you should be aware of.

Short term terms

Typically, you have to pay off a payday loan within two to four weeks of the initial loan. Check the regulations of the state where you live as they differ from state to state.

Additional costs

If you can’t repay the loan within a short period of time, additional fees may be added on top of the initial loan charge. Those costs start to add up if you keep rolling over the debt or if you keep borrowing. The CFPB says that nearly a quarter of initial payday loans continue to renew nine or more times.

Some of those surcharges may include:

  • An insufficient funds fee, if you don’t have enough money available in your bank account when the lender tries to cash your check or tries to make an electronic withdrawal from your account.
  • Refinance fees are fees that are charged on top of the original loan and the initial charge when the borrower wants to postpone the loan’s due date.

Does not generate credit

People with poor credit may not have access to loans with better terms. But payday loan lenders typically don’t report your credit history to credit bureaus, which means payday loans don’t help you build credit.