How do payday loans work?

Whether you want to apply or are just curious, this is the guide to how payday loans really work.

While most people are aware of these loans, whether it be through personal experience or the media attention these loans tend to garner, many are not aware of the actual lending process. This process does differ between lenders but this guide will take you through the steps you can expect.

Quick facts

  • A payday loan is a loan of between $100 and $2,000 that is repaid within terms of 16 days to one year.
  • These loans are technically called Small Amount Credit Contracts.
  • Any loan larger than $2,000 is a Medium Amount Credit Contract ($2,001–$5,000) or Personal Loan (over $5,000) and operates under different fee caps.

Step 1The application

Applying for a payday loan is a quick process that can be completed online or at a lender's shopfront. These lenders must comply with various regulations set by the Australian Securities & Investments Commission (ASIC) in order to ensure you won't be approved for a loan you can't afford.

What you need to give the lender

  • ASIC requires that you give the lender 90 days of bank statements. This is often carried out by you supplying your Internet banking logins, giving the lender read-only access to your accounts
  • Two forms of ID
  • Copies of bills or Centrelink receipts
  • Employment details
  • Information about your income, such as whether you receive Centrelink payments and how much you earn per week

step 2The approval

Whether or not you are approved for a payday loan depends entirely on your financial situation:

  • If you are employed. You are in a good position to receive a payday loan, even if you're on a low income. Lenders look for regular payments from your employer so you will need to be able to show this on your bank statements, that is, not be paid in cash. If you are paid in cash take a look at our guide here.
  • If you receive Centrelink benefits. Many lenders will consider those who receive Centrelink payments for a loan. Some will require that you receive 50% of your income from another source or that your loan repayments can't exceed a certain percentage of your income. There are also restrictions as to what kind of Centrelink you receive.
  • If you have bad credit. Payday loans are a haven for those with bad credit, so this is rarely a problem. Lenders look at your capacity to repay the loan rather than your credit history. However, there will be restrictions if you are currently or have been bankrupt.
  • If you are unemployed. You may be eligible for a loan if you are receiving some sort of income, whether it be through Centrelink or investments. If you can demonstrate a willingness and capacity to repay you may be considered for a loan while unemployed.

step 3Receiving your funds

One advantage of payday loans is how quickly you can receive your funds. This does differ between lenders but you can generally receive your loan amount on the same or next business day, depending on when you are approved and who you bank with.

Many lenders require that you are approved before 2pm on a business day to receive your funds that same day. So if you need your funds sooner rather than later it's best to apply in the morning. You can also consider lenders with a shopfront, as you may be able to receive your funds within the hour.

step 4How much the loan will cost

There is a fee cap on payday loans that is set by ASIC, so you will not be charged more than the following for loans of less than $2,000 with terms of between 16 days and one year.

  • Establishment fee that is 20% of the amount you borrow
  • Monthly fee that is 4% of the amount you borrow
  • A government fee or charge
  • Default fees and enforcement expenses, if necessary

For Medium Amount Loans ($2,001–$5,000) you cannot be charged more than a $400 establishment fee and an interest rate of 48% p.a. For loans over $5,000, the interest rate cannot exceed 48% p.a. including all fees and charges.

Note: These caps only apply to loans from Authorised Deposit-taking Institutions (ADIs) which include banks, credit unions and building societies.

step 5Repaying the loan

Lenders often let you select your own loan term so you can make the repayments manageable within your budget, but the actual repayment days will be automatically scheduled to when you receive your pay. The payday lender will set up a direct debit from your bank account on that day and will usually send you an SMS reminder a day or two beforehand to remind you.
If you do not have sufficient funds in your account when the direct debit is scheduled you need to contact the lender. A failed direct debit will usually result in a charge by your bank and also the lender, so rescheduling the repayment can save you.

step 6Your next loan

There are different requirements as to when you can apply for another loan, or if you can hold multiple loans at once:

  • Applying for a loan with the same lender. Many short-term lenders have a member's area or shorter application form for existing customers. This is because the lender will use your repayment history from the previous loan as well as the details you submitted in your first application to determine your eligibility. Lenders will also have conditions as to when you can apply for a second loan.
  • Applying for multiple loans. Lenders must comply with regulations set by ASIC when it comes to approving you a loan if you are repaying an existing one. Find our about the restrictions on multiple payday loans in this guide.
  • The problem with multiple or subsequent payday loans

Payday loans, while they can be a convenient form of finance, are expensive. If you find yourself applying for more than one payday loan you need to examine your cash flow to understand why you need to, and to try and get yourself in a position where you don't need consistent access to short-term finance. Payday loan repayments can put a serious dent in your cash flow, so keep this in mind when considering a second payday loan.

Picture: Shutterstock

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