Payday loans are not the best way to borrow money, but they do serve a purpose for people who desperately need cash between paydays. A person who needs money prior to his next payday will go the payday loan place and tell them how much money he needs to borrow and when his next payday will be. The borrower will write a “post-dated check” dated for the date of his next payday to the lender for the amount loaned plus the fees. Then the lender will write a check to the borrower for the loan amount which the borrower can use right away.
As most people get paid every week or every two weeks, this is the normal length of time, more or less, for a payday loan. The users of a payday loans can get caught in vicious cycles where they cannot pay the loans back. In many occasions, a borrower will have to “re-finance” the loan or roll it over to the next paycheck. In this case, the borrower would not pay the principal of the loan back, but would only pay the interest or the fee for the new loan.
Per the Federal Truth in Lending Act, the lender must disclose how much interest you pay over the life of the loan and the Annual Percentage Rate, the “APR.” The APR tells you how much interest rate you would pay if you had the loan for one year.
Let’s use a simple math example to explain what goes on with a payday loan. You need go to the payday place and borrow $100 for one week. The lender charges you a $10 fee for the loan. This means you will pay back the loan with $110 seven days from now. Your real interest rate on this loan is of course, 10 percent. However, when the lender discloses you the interest rate, the annual percentage rate will be 520%. ($10 per week times 52 weeks). If you were unable to pay the loan for a year and had to roll the loan over, re-finance, every week for 52 weeks, you would pay $520 in interest for the loan, which is 5.2 times the principal of the loan, $100.
The example given shows why it is so important to pay any debt, especially payday loans off early. In the example of the last paragraph, if you pay the loan off in just one week, your real interest rate will be 10 percent. If you re-finance the loan out every week for a year, you will pay a real interest rate of 520 percent. Payday loans are the best example of why it is so important to get out of debt as soon as possible to reduce the interest rate you pay on your loans.