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How Payday Loans Work

Payday loans are short-term loans you get to cover expenses until your next paycheck. These loans, which come from payday lenders vs. traditional banks, usually charge a large fee and a high interest rate, and payments are due on or close to your next payday. Those fees depend on your state’s laws for payday lending. Around 2.5 million American households use a payday loan each year, The Economist reports.

Is a Payday Loan Worth the Risk?

A payday loan can fix an urgent need for money in order to help take care of an emergency situation. However, these loans usually have a high Annual Percentage Rate (APR) and if unpaid can quickly turn into a large debt if not paid back right away.

Are Payday Loans Easy to Apply For?

Yes, payday loans are easy to apply for and have been very popular recently because of that ease of use. In fact, in 2015 there were more payday lenders in the U.S. than McDonald’s locations,  according to the Consumer Financial Protection Bureau (CFPB).

These lenders make money through the fees and many of the same people who apply keep coming back over and over again to borrow money this way. Payday lenders received approximately $3.6 billion in fee revenue in 2015, according to the CFPB, and overall it is a $38.5 billion dollar industry, the LA Times reports.

In 2015 there were 15,766 payday loan stores across 36 states which was more than the 14,350 McDonald’s fast food outlets in all of the United States according to the CFPB.

How Much Can I Borrow with a Payday Loan?

The amount that you can borrow with a payday loan can range between $50 to $1000 depending on your state. The average payday loan is $350 on a two-week term according to the CFPB. Each state can set a limit on the size of a payday loan; currently, 32 states allow payday lending with a maximum loan amount that is capped. Maine, Utah, Wisconsin and Wyoming do not cap the amount. Delaware, Idaho and Illinois have the highest cap amount at $1,000, while California and Montana have the lowest at $300.

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Note: 37 states have specific statutes that allow for payday lending. Some states do not have specific payday lending statutory provisions and/or require lenders to comply with interest rate caps on consumer loans: Connecticut, Maryland, Massachusetts, New Jersey, New York, Pennsylvania, Vermont, and West Virginia. Arizona and North Carolina allowed pre-existing payday lending statutes to sunset. Arkansas repealed its pre-existing statute in 2011. New Mexico repealed its payday lending statutes in 2017. The District of Columbia repealed its pre-existing statutory provision in 2007.

Some states also limit each payday loan to 25% of the borrower’s monthly income, such as Nevada and New Mexico. For the 32 states that do permit payday lending, the cost of the loan, fees, and the maximum loan amount are capped.

What Are the Costs of a Payday Loan?

The costs associated with a payday loan are set by state laws with fees ranging from $10 to $30 for every $100 borrowed. A two-week payday loan usually costs $15 per $100.

For example, let’s say you borrow $100 for a 2-week payday loan and your lender is charging you a $15 fee for every $100 borrowed. That is a simple interest rate of 15%. But since you have to repay the loan in two weeks, that 15% finance charge equates to an APR of almost 400% because of the length is only 14 days. On a 2-week loan that daily interest cost is $1.07 ($15 divided by 14 days).

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If the loan term were one year, you would multiply that out for a full year and borrowing $100 would cost you $391. Your lender must disclose the APR before you agree to the loan. Calculated on an annual percentage rate basis (APR), the same as is used for credit cards, mortgages, auto loans, etc.—that APR can range from 391% to more than 521% for payday loans. In fact, it was reported that some payday loans carried an interest rate that was 1900%. By comparison, APRs on credit cards typically range from 12% to 30%.

How Do I Repay a Payday Loan?

You can repay a payday loan usually when your next payday happens either with a single payment or if you receive the necessary amount elsewhere when the loan is due. The due date for payday loans can be around two to four weeks from when the loan was actually granted; make sure to ask for the specific due date or check for the date in the agreement. You can repay a payday loan by writing a check, paying online or authorizing the lender to debit your bank account automatically. If you don’t repay the loan when it is due, the lender can electronically withdraw money from your account.

What Is a Rollover Loan?

Some payday lenders will offer a rollover or renew feature when permitted by state law. If the loan is set to be due soon, the lender allows the old loan balance due to rollover into a new loan, or will renew the existing loan again. This way the borrower would only pay only the fees while the due date for the larger loan balance is extended to a future date. This gives the borrower more time to repay the loan and fulfill their agreement, and can also lead to people racking up big fees if they continue in this cycle.

What If I Am in the Military?

There are protections in place for service members through the Military Lending Act (MLA) for active duty servicemembers and their dependents. The extended MLA protections include a 36% Military Annual Percentage Rate (MAPR) cap to a wider range of credit products, including payday loans, vehicle title loans, refund application loans, deposit advance loans, installment loans, and unsecured open-end lines of credit. The cap additionally applies to fees tacked on for credit-related ancillary products, including finance charges and certain application and participation fees.

How Do Payday Loans Affect My Credit?

Taking out a payday loan does not affect your credit score or appear on your credit report. Payday loans do not appear on your credit report once you accept the loan. They can appear on your credit report if the loan becomes delinquent and that account can be sold to a collections agency. Once a collection agency purchases the delinquent account they can decide to report it as a collection account to the credit reporting bureaus. That debt will then appear on your credit reports. In some cases a payday lenders may file a lawsuit against you for unpaid loans and if a claim is awarded to the lender, it could appear on your credit reports as a judgment and negatively impact your credit.

Is There Option to Help Pay off My Payday Loan?

Debt consolidation is an option to help you repay a loan debt or other additional debts. This can be done through a debt consolidation loan from a bank in order to use that money you borrowed to pay off all the other loans in full. A debt consolidation loan is usually at a lower interest rate but over a longer period of time.

Because it has a lower interest rate and longer repayment term, a consolidation loan can have a lower monthly payment to help you manage your debt repayment. Additionally, the debts it was used to pay off will show as “paid in full” in your credit report, which is considered a positive.

How Can I Find out If a Payday Lender Is Licensed in My State?

Not all states allow payday lending, while other states require payday lenders to be licensed. If a payday loan is made by a lender that is not licensed in that particular state they can consider that loan to be void. If so, the lender does not have the rights to collect or require the consumer to repay the payday loan.

Each state has different laws regarding payday loans, including whether they’re available through a storefront payday lender or online. Some states do not offer payday lending because these loans are not permitted by that state’s law or because payday lenders do not do business in those states. In states that allow payday lending you can find more information from your state regulator or state attorney general.


Editorial Disclaimer: Opinions expressed here are author's alone, not those of any bank, credit card issuer, or other company, and have not been reviewed, approved or otherwise endorsed by any of these entities. All information, including rates and fees, are accurate as of the date of publication.