In this article:
- How Do Payday Loans Work?
- How Much Can I Borrow with a Payday Loan?
- What Are the Costs of a Payday Loan?
- How Do I Repay a Payday Loan?
- What Is a Rollover Loan?
- What if I Am in the Military?
- How Do Payday Loans Affect My Credit?
- Are There Options to Help Pay off My Payday Loan?
- How Can I Find out If a Payday Lender Is Licensed in My State?
- Is a Payday Loan Worth the Risk?
- What Are Alternative Options to a Payday Loan?
- Know Your Options
A payday loan is a short-term loan that can help you cover immediate cash needs until you get your next paycheck. These small-dollar, high-cost loans usually charge triple-digit annual percentage rates (APRs), and payments are typically due within two weeks—or close to your next payday.
Payday loans are not for the faint of heart. They can be difficult to repay and could end up costing you much more than you expected if you're not careful. Before you apply for one, it's important to know what you'll get and what's expected from you in return.
How Do Payday Loans Work?
Payday loans function differently than personal and other consumer loans. Depending on where you live, you can get a payday loan online or through a physical branch with a payday lender.
Different states have different laws surrounding payday loans, limiting how much you can borrow or how much the lender can charge in interest and fees. Some states prohibit payday loans altogether.
Once you're approved for a payday loan, you may receive cash or a check, or have the money deposited into your bank account. You'll then need to pay back the loan in full plus the finance charge by its due date, which is typically within 14 days or by your next paycheck.
Payday loans come with a finance charge, which is typically based on your loan amount. Because payday loans have such short repayment terms, these costs translate to a steep APR. According to the Consumer Federation of America, payday loan APRs are usually 400% or more.
Despite the high costs, The Economist estimates that roughly 2.5 million American households take out payday loans each year. There are a few reasons for this popularity. One is that many people who resort to payday loans don't have other financing options. They may have poor credit or no income, which can prevent them from getting a personal loan with better terms.
Another reason may be a lack of knowledge about or fear of alternatives. For example, some people may not be comfortable asking family members or friends for assistance. And while alternatives to payday loans exist, they're not always easy to find.
Many people resort to payday loans because they're easy to get. In fact, in 2015, there were more payday lender stores in 36 states than McDonald's locations in all 50 states, according to the Consumer Financial Protection Bureau (CFPB).
Payday lenders have few requirements for approval. Most don't run a credit check or even require that the borrower has the means to repay the loan. All you typically need is identification, a bank account in relatively good standing and a steady paycheck.
How Much Can I Borrow with a Payday Loan?
The average payday loan is $350 on a two-week term, according to the CFPB. But payday loans can range from $50 to $1,000, depending on your state's laws. Currently, 32 states allow payday lending with a capped maximum loan amount. Maine, Utah, Wisconsin and Wyoming do not have a cap. Delaware, Idaho and Illinois have the highest cap amount at $1,000, while California and Montana have the lowest at $300.
Some states, including Nevada and New Mexico, also limit each payday loan to 25% of the borrower's monthly income. For the 32 states that do permit payday lending, the cost of the loan, fees and the maximum loan amount are capped.
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.
What Are the Costs of a Payday Loan?
The costs associated with payday loans 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 two-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 the loan length is only 14 days. On a two-week loan, that daily interest cost is $1.07.
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. While it's typical to see an APR of 400% or higher, some payday loans have carried APRs as high as 1,900%. By comparison, APRs on credit cards typically range from 12% to 30%.
How Do I Repay a Payday Loan?
You're generally required to repay a payday loan with a single payment by your next payday. Because lenders have varying repayment terms, make sure to ask for the specific due date or check for the date in the agreement.
Depending on the lender, you may have a few options to pay off your debt:
- A postdated check when you apply
- A check on your next payday
- Online through the lender's website
- A direct debit from your bank account
- Another form of credit
If you don't repay the loan when it is due, the lender can electronically withdraw money from your account.
Unfortunately, many payday loan borrowers can't repay the debt by the due date. In fact, the CFPB found that 20% of payday borrowers default on their loans, and more than 80% of payday loans taken out by borrowers were rolled over or reborrowed within 30 days.
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 roll over into a new loan or will renew the existing loan again.
This way, the borrower would 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. But it also means racking up big fees if they continue in the cycle.
What if I Am in the Military?
If you're an active-duty service member or a dependent of one, there are protections in place for service members through the Military Lending Act (MLA). 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?
Because payday lenders often don't run a credit check, applying for a payday loan doesn't affect your credit score or appear on your credit report. Also, payday loans won't show up on your credit report after you've accepted the loan. As a result, they don't help you improve your credit score.
That said, they can appear on your credit report if the loan becomes delinquent and the lender sells your account to a collection agency. Once a collection agency purchases the delinquent account, it has the option to report it as a collection account to the credit reporting bureaus, which could damage your credit score.
Are There Options to Help Pay off My Payday Loan?
Debt consolidation is an option to help you repay a payday loan debt, even if you have bad credit. While bad credit debt consolidation loans have stricter approval requirements, they typically charge much lower interest rates and fees than payday lenders. They also tend to offer longer repayment terms, giving you more breathing room.
Because it typically offers 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 debt will show up on your credit report, which can help you work on building your credit score as long as you make loan payments on time.
How Can I Find out If a Payday Lender Is Licensed in My State?
Not all states allow payday lending, but those that do require payday lenders to be licensed. If a payday loan is made by an unlicensed lender, the loan is considered void. This means that the lender doesn't have the right 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. In states that allow payday lending, you can find information about licensing through your state's bank regulator or state attorney general.
Is a Payday Loan Worth the Risk?
A payday loan can solve an urgent need for money in an emergency situation. However, because these loans usually have a high APR, if you can't pay it back on time, you could get caught in a vicious cycle of debt.
Bottom line: It's important to consider all your options before approaching a payday lender.
What Are Alternative Options to a Payday Loan?
In most cases, you shouldn't need to resort to using a payday loan. Here are a few alternatives that may meet your needs and save you money.
Bad Credit Personal Loans
Some personal lenders specialize in working with people with bad credit. Whether you need to cover some basic expenses, cover an emergency or consolidate debt, you can usually get the cash you need.
And while your interest rates will be higher than on other personal loans, they're much lower than what you'll get with a payday loan.
Family or Friends
Asking a loved one for financial assistance is never a fun conversation. But if the alternative is being driven deeper in debt, it may be worth it. Just be sure to create an official agreement and stick to it to avoid damaging your relationship.
Bad-Credit Credit Cards
Most credit cards designed for people with bad credit require a security deposit, which won't help your cash shortage. But some credit card issuers offer unsecured credit cards with low credit requirements.
Retail credit cards, for instance, are often in reach for people with bad credit. And while they typically come with low credit limits, many of them can be used outside the store.
Even some bank-issued cards, such as the Indigo® Platinum Mastercard® and the Credit One Bank® Platinum Visa® for Building Credit, accept borrowers with low credit scores.
Know Your Options
Payday loans can provide borrowers with short-term cash when they need it, but they're not the only option available. If you need cash, make sure to consider all of your options before opting for one that could make your life more difficult.
And if you have bad credit, be sure to check your credit score and report to determine which areas need your attention. In some cases, there could be erroneous information that could boost your credit score if removed. Whatever you do, consider ways you can improve your credit score so that you'll have better and more affordable borrowing options in the future.
Want to instantly increase your credit score? Experian Boost™ will be available in early 2019 and helps by giving you extra credit for the utility and mobile phone bills you're already paying. Until now, those payments did not positively impact your score.
This service will be completely free and can boost your credit score fast by using your own positive payment history. It can also help those with poor or limited credit situations. Other services such as credit repair may cost you up to thousands and only help remove inaccuracies from your credit report.
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.