A payday loan is a short-term loan designed to provide cash until your next paycheck arrives. These loans are usually for relatively small sums and are paid back in a single lump sum on the due date, not in installments.
They typically carry very high-interest rates. Because the term of the loan is so short the interest cost may seem manageable, but if you fail to pay the loan on time the interest can build up very quickly. Payday loans generally do not require a credit check and are available to anyone with an income and a bank account.
Payday loans may be called cash advance or check advance loans. They are often regulated by government agencies. Many states limit the amount you can borrow in a payday loan and some states prohibit them completely.
How do Payday Loans Work?
Payday loans are typically available through online or storefront lenders. The laws in your state may place restrictions on the amount you can borrow or the interest and fees the lender can charge. Payday loans are completely prohibited in 12 states and the District of Columbia. If you’re considering a payday loan you might wish to look up your state’s regulations.
Payday loans have certain common characteristics:
- Short terms. Payday loans are meant to be paid back on your next payday. The average term of a payday loan is two weeks.
- Low amounts. Payday loans may be as high as $1000 with an average of $350. Many states have limits on loan amounts.
- Lump-sum payments. Many types of loans are paid over time, in installments. A payday loan must be paid in a single lump sum on or before the due date.
- high-interest rates. Most payday lenders call their interest charge a finance fee and quote it as a flat rate for every $100 that you borrow. These fees often translate to an interest rate of over 400% on an annual basis.
- Easy application. Payday loans do not require collateral or a credit check. All you need is proof of income and a bank account.
- Fast access to funds. Payday lenders will often make an approval decision in minutes and the funds you’re borrowing may be available immediately, in cash or by a direct transfer to your account.
- Payment by post-dated check or authorized withdrawal. Payday lenders will ask for a post-dated check or authorization to withdraw directly from your bank account, so they don’t have to pursue the borrower when the loan comes due.
Fast approval, relaxed requirements and quick release of funds make payday loans popular among borrowers who need cash to scrape through to the next payday. The downside is that these loans are very expensive and come with serious risks.
What Are the Requirements For a Payday Loan?
Payday loans are among the easiest loans to get. You will have to be over 18, you will need to have an income and you will need to have a bank account. You may still be rejected outright if not approved for the full amount you wish to borrow. There are several reasons why a payday lender may reject a payday loan application or restrict the size of a loan:
- Your income is too low, or you have not been employed long enough. In some states, a payday lender can only lend a certain percentage of your income. A payday lender may also be unwilling to make a large loan to a person with a low income.
- You have bounced checks recently or have a recent bankruptcy.
- You already have unpaid payday loans. Most payday lenders subscribe to services that track loans.
- You are a member of the military. Federal law prohibits lenders from making loans to active-duty service members at over 36% interest.
- Your bank account was just opened.
Any of these may lead to a payday loan being refused or the amount of the loan restricted.
What Are the Costs of Payday Loans?
Most payday lenders quote a finance charge rather than an interest rate, though they will have to disclose an annualized interest rate in the loan agreement. Many payday lenders charge from $10 to $30 for every $100 you borrow. Finance charges are often regulated by state laws. Some payday lenders in less regulated states may charge annual interest rates as high as 1000%.
$15 per $100 is a common finance charge for a 2-week loan from a storefront lender. On an annualized basis this is equivalent to an interest rate of nearly 400%. Online lenders average interest rates over 600%
If you fail to pay on time you may have to pay additional fees or other charges to extend or “roll over” the loan for another financing period. If the lender tries to deposit your check or withdraw from your bank account, your bank may also impose charges if you don’t have enough money to cover the amount.
If you pay your loan on time, you will only pay the finance charge. If you can’t pay your loan the high-interest and fees can add up very quickly. The interest and fees may exceed the amount of the loan within a few months.
What Are the Risks of Payday Loans?
Payday loans may seem like a quick solution to an urgent money problem, but there’s a high risk of getting caught in a cycle of debt. The average lump-sum payment can be up to 36% of the borrower’s paycheck. 80% of payday loans are either extended or followed by another payday loan within two weeks.
In many states, lenders must allow you to rollover a payday loan over to another pay period. Each time you extend the loan you incur another finance charge. Because the interest rate is so high these charges can accumulate very quickly.
For example, a borrower might agree to borrow $400 for two weeks at a finance charge of $15 per $100 or $60. If the borrower can’t repay the loan, the lender will roll it over for another $60. If the borrower can’t pay the loan for two months, the finance charge will reach $240 and the original $400 will still be unpaid.
What Happens if You Don’t Pay?
If you don’t pay the loan on schedule or agree to roll the loan over, the lender will deposit your post-dated check or debit your bank account. If you don’t have enough money in the account, your bank will reject the transaction and impose a fee. If you have authorized withdrawal from your account, the lender may try repeatedly with progressively smaller amounts. Each unsuccessful account will incur another fee.
Payday lenders employ the most aggressive collection techniques allowed by law and some may go beyond those limits. Expect the lender to pursue you.
Most payday lenders do not report to credit reporting companies, so missed payments will not immediately affect your credit. If the lender sells your account to a collection agency the agency will report it and your credit will be damaged.
Payday lenders can and will sue you even over relatively small unpaid loans. If your lender or a collection agency files a suit, you must appear to defend yourself. If you ignore a court summons you may face a summary judgment against you. If you fail to obey court instructions, you could even face arrest. You cannot be jailed for not paying a debt, but you can be jailed for failing to follow a court order.
Some Alternatives to Payday Loans
Payday loans are easy to get and may seem like a quick solution to a pressing money problem. They are also very expensive and very risky. There are alternatives that you should consider before resorting to a payday loan.
- Delay paying bills or making payments. You may be able to delay regular bill payments without having services cut off. You may pay penalties, but they will probably be less than the cost of a payday loan.
- Sell or pawn items you don’t need. Look around your house for possessions that you don’t use regularly. You may be able to unload them to raise extra cash.
- Ask for an advance on your paycheck. Many employers will make advances on your high-interest salary, though they may not do it regularly. Budget carefully, because the advance will be taken out of your next paycheck.
- Cut unnecessary expenses. Check for subscriptions or memberships you aren’t using. Review your spending carefully and see what you can trim.
- Payday alternative loans. Many banks and credit unions offer these loans specifically to help their customers avoid the risks of payday loans. Ask your bank or credit union.
- Bad credit personal loans. Some lenders specialize in making personal loans to borrowers with bad credit. Your interest rate will be high, but it will be much lower than the interest on a payday loan and you can pay in installments.
- Borrow from family or friends. Nobody wants to do it, but it’s worth it to keep yourself out of the payday loan trap. Set up a written agreement and be sure to pay on time.
- Consider credit counseling. Non-profit credit counseling agencies offer initial free sessions and can help you establish a realistic budget and organize your finances.
- Use a Credit Card. Credit card cash advances carry high-interest rates and you should avoid them whenever possible, but they are still a better option than a payday loan.
- Consider charities. Some charitable organizations will provide short-term assistance to help people avoid falling into the payday loan trap. Ask local churches, community centers and charity groups.
In the long run, the best alternative to payday loans is to avoid them. Careful budgeting, cutting expenses, trying to boost your income and building up savings can get you out of the payday loan cycle permanently.
The Bottom Line
Payday loans provide fast money with minimal requirements. They can seem like an easy solution to an immediate problem. That solution often ends up creating even worse problems. Payday loans are expensive and risky. They can quickly pull you into a debt spiral that’s almost impossible to escape. Whenever possible, look for other alternatives.