A traditional payday loan is a short-term loan that must be paid back on the borrower’s next payday. Payday loans are typically small loans. The only collateral, if any, is a post-dated check that can be cashed by the lender if the borrower fails to payback the loan on time.
A traditional payday loan is not paid back in installments; you will instead be expect to pay back the loan in full, including fees and interest, on your next payday. This limits the possible size of the payday loan, especially when we take into consideration that payday loans are typically obtained by low-income workers with limited access to other types of credit.
Before obtaining any loan, it is always advisable to shop around and evaluate various form of credit to find the most beneficial alternative. You may for instance be better off pawning something of value or use a credit card with a payment plan than opting for a payday loan. It all comes down to personal circumstances.
Different types of fast loans are available in different countries. SMS loans ( That we write about here) is an example of a type of fast loan that is popular mainly in Scandinavia where they are promoted heavily through sites like snabbfinans.nu. SMS loans and other alternatives to pay day loans are sometimes more favorable and sometimes less favorable. It is therefore always a good idea to get to know as much as you can before choosing a certain type of credit.
Payday loans tend to be expensive. One of the reasons for this is their high default rate. The lender needs to make enough money on the loans that are paid back to cover his losses on all the defaulted loans. Many people how take out a payday loan are already in financial trouble. Even if they leave a post-dated check, it might bounce when the lender tries to use it to get his money back for the defaulted loan. He could argue his case in small-claims court, but this will take up valuable time and resources and even if he wins in small-claims court the borrower may not have any assets that can be claimed to pay back the loan.
What is required to obtain a payday loan?
The requirements will vary from one lender to another. Some will require proof of employment or similar, e.g. in the form of a payslip. There are also lenders that will run a credit check on potential borrowers.
As mentioned above, some lenders require a post-dated check as collateral. The check will be cashed if you fail to show up and repay the loan on the agreed date.
In some cases, you will be offered a payday loan even if you fail to fulfill the lender’s standard requirements, but the terms and conditions of your loan will be worse than normally since the lender is taking a bigger risk.
Why is the fee so high?
Payday loans are short-term loans, which means that even with a high interest rate the lender will not get much money from you if he charges interest only on your loan.
Example: You borrow £100 that is to be paid back on your payday, which is seven days into the future. The annual interest rate (compounded weekly) is 20%. This might sound like a very high interest rate, and it is, but for a seven day loan the interest will only be £0.38. This is probably not enough to even cover the lender’s administrative expenses for your loan.
Because of this, most payday loans come with a big fixed fee.
Example: You borrow £100 that is to be paid back on your payday, which is seven days into the future. The annual interest rate (compounded weekly) is 20% and the fixed fee is £30. You will therefore pay back £100 + £0.38 + £30. £30.38 is enough for the lender to make profit on your loan.
When you compare payday loans to other available credit solutions, it is important to take both interest rate and fees into consideration. A payday loan might seem like a good idea when you look at the cost of interest only, but turn out to be very expensive when you factor in the fee as well.