If you don’t have a credit card or savings to use in a financial emergency, taking out a payday loan online or in person might seem like a great way to get cash quickly. But payday loans, in states that permit them, have few pros and one big con—the cost.
Before you apply for one, you should fully understand how payday loans work, as well as how expensive and risky these loans are. You might think twice about getting a payday loan in the first place.
A payday loan is a short-term loan that typically comes due on your next payday or the next time you receive income from some other steady source, like Social Security. The loan comes from a payday loan company or online vendor, not a bank. The loan amount is relatively small—generally $500 or less. In fact, many states have laws that limit the amount you can borrow.
One way to get a payday loan is to go to a vendor in person and give the lender a post-dated check. (Post-dating a check refers to writing a check, but putting a future date on the check instead of the date that you sign it.) In return, you receive a sum that’s less than the amount listed on the check. Say you write a check for $500 to the lender. You might get $440 in cash, with the lender keeping $60 as a fee. The lender then waits a few weeks, typically until your payday, and cashes the check once your account has enough money to cover the $500 check.
Another kind of payday loan starts with you signing an agreement giving the lender the right to take money out of your bank account or prepaid card account on your payday to pay back the debt. After you sign, the lender electronically deposits the loan money directly to your account. In our $500 example, the lender deposits $440 in the account and keeps $60 as its fee. In this kind of arrangement, the lender takes the repayment money directly out of the account on your next payday or other date listed in the agreement.
You can also get a payday loan over the phone or online.
Millions of consumers don’t have access to more traditional banking products. And, even if you have bad credit, it’s relatively easy to qualify for a payday loan. Often, lenders will make loans online to individuals with bad credit without running a credit check. The most important factor that a lender will consider when deciding whether to make a payday loan is how much you earn.
To get a payday loan, you typically have to provide proof of your income, such as two recent pay stubs. Payday lenders also ordinarily require that you:
The fees on a payday loan are usually based on increments of the amount borrowed. Lenders often charge a fee of between $10 and $30 for every $100 of the loan amount. These incremental charges make the payday loan a very expensive way to borrow money. Generally, the annual percentage rate (APR) on payday loans ranges from 200% to 500%. (The APR on a two-week payday loan that has a $15 fee per $100 borrowed is around 400%.)
To reduce payday lending abuses, some state laws limit the amount a lender can charge for a payday loan. Other states have gone as far as making payday lending altogether illegal. Under the federal Payday Lending Rule, as of November 19, 2020, payday lenders have to perform an ability-to-repay test before making a loan to figure out whether a borrower will be able to pay the loan back without having to roll it over. (12 C.F.R. § 1041.5). (If you can’t repay payday loan debt when it comes due, you might be able to "roll over" the loan. Paying a fee to delay repayment of a payday loan is generally called "rolling" it over. Of course, the drawback to delaying repayment on the loan is that you’ll have to pay another fee to the lender, potentially leading to a treadmill of debt.)
People who take out payday loans often get onto a treadmill of debt, taking out one payday loan after another to cover accumulated fees. According to the Consumer Financial Protection Bureau, around 70% of people who take out a payday loan end up getting an additional loan within 30 days, and 20% of new payday loan borrowers take out ten or more payday loans in a row.
For instance, let’s say you took out a $300 payday loan for a $45 fee, but can’t pay it back on the due date. To extend the due date, you must pay another $45 fee. Now you're paying a cost of $90 for the $300 loan. If you roll the loan over again, you have to pay $45 for the third time. The loan has now cost you $135, which is almost half of the original loan amount.
The bottom line is that, in most cases, it's best to avoid payday loans altogether. Better and safer options are available for getting your hands on cash quickly.
Instead of getting a payday loan, you might consider some alternatives, like:
For an explanation of the applicable payday lending laws in your state and information about how to handle payday loan debt, consider contacting a consumer protection lawyer or a debt collection attorney. If you want to file a complaint about a payday lender, contact the Federal Trade Commission. Also, beware of scammers trying to collect on fake payday loans.
