A payday loan, also known as cash advance loans or check advance loans is a type of short-term, high-interest loan that is typically used to cover unexpected expenses or to bridge a temporary gap in cash flow. These loans are typically for small amounts, such as a few hundred dollars, and are due on the borrower’s next payday. Payday loans are often considered predatory lending since they have extremely high-interest rates, do not take into consideration the borrower’s ability to repay the loan, and have hidden provisions that charge borrowers added fees.
How do payday loans work?
Payday loans work by allowing borrowers to borrow a small amount of money, typically a few hundred dollars, with the expectation that the loan will be repaid on the borrower’s next payday. The loan is usually for a small amount, usually less than $1,000, and is intended to be used for emergency expenses or unexpected bills. For example, if a borrower needs $500 to cover an unexpected expense, they might take out a payday loan for that amount. They would then be required to pay back the $500, plus any additional fees or interest, on their next payday.
The process of obtaining a payday loan is usually quick and easy. The borrower typically fills out an application online or in-person and provides proof of income and a valid ID. The lender will typically not check the borrower’s credit score and, if approved, will provide the loan with the understanding that it will be repaid on the borrower’s next payday.
Payday loans can be appealing because they are easy to obtain and can provide quick access to cash. However, the high-interest rates and fees associated with these loans can make them extremely expensive. The average annual percentage rate (APR) for a payday loan is around 400% with fees ranging from $15-$30 for every $100 borrowed, meaning that for a $100 loan, a borrower would have to pay back $115 in just two weeks which equates to an annual percentage rate (APR) of almost 400%.
From the commercial side, payday lenders charge high-interest rates to compensate for the high risk of default and the short-term nature of the loan. They also have high overhead costs as they need to cover their expenses such as marketing, location, staff, and regulatory compliance. Additionally, they target people with bad credit, as they may have no other options to access credit, and they charge high fees to compensate for the increased risk of default.
It’s important to note that payday loans should be used only as a last resort, and only after carefully considering all other options. They are not a long-term solution to financial problems and can often lead to a cycle of debt. Before taking out a payday loan, it’s important to understand the terms and conditions of the loan, including the interest rate and fees, and to consider all alternatives.
How much does a payday loan cost?
Payday loans can be quite expensive due to their high-interest rates and fees. The amount of the fee for a payday loan typically ranges from $10 to $30 for every $100 borrowed, depending on state law and the maximum amount that can be borrowed. A common fee is $15 per $100, which equates to an annual percentage rate (APR) of almost 400% for a two-week loan. For example, borrowing $300 before your next payday would cost $345 to pay back, assuming a fee of $15 per $100.
However, this is not the only cost associated with payday loans. Rollovers are another potential cost if the borrower is unable to pay when the loan is due and state law permits rollovers. In this case, the payday lender may allow the borrower to pay only the fees due and extend the due date of the loan, but the borrower will be charged another fee and still owe the entire original balance. For example, if a rollover fee of $45 is charged, the borrower would still owe the original $300 loan and an additional $45 fee when the extension is over, for a total of $90 in charges for borrowing $300 for just four weeks.
Additionally, some state laws require payday lenders to offer extended repayment plans to borrowers who are experiencing difficulty in repaying the loans. These laws vary by state and may or may not permit or require a fee for using a repayment plan.
Late fees may also be charged if the loan is not repaid on time, and the lender or the borrower’s bank may also impose an “NSF” or non-sufficient funds charge if the check or electronic authorization is not paid due to lack of funds in the account.
If the loan funds are loaded onto a prepaid debit card, there may also be additional fees such as fees to add the money to the card, fees for checking the balance or calling customer service, fees each time the card is used, and regular monthly fees.
Risks of a payday loan
- Steep borrowing costs: Due to the high interest rates and hidden fees, payday loans can potentially derail your financial health and credit score.
- Risk of default: The biggest danger of payday loans is when they turn from a short-term stopgap into a long-term drain on your finances.
- Excessive rollover fees: If you don’t have a plan to pay your payday loan off in full on the requested date, you’ll have to roll your loan over, meaning you’ll be responsible for the principal balance and additional fees and accrued interest. This is a vicious cycle that could land you in high-interest debt down the road.
Are payday loans legal?
Payday loans are legal in some states in the United States, but not in all. Sixteen states and the District of Columbia have laws in place that prohibit extremely high-cost payday lending. These states protect their citizens from usurious payday lending by prohibiting the product outright or by setting rate caps or usury limits. For example, Georgia prohibits payday loans under racketeering laws, and New York and New Jersey prohibit payday lending through criminal usury statutes, limiting loans to 25 percent and 30 percent annual interest, respectively.
On the other hand, there are three states that permit lower-cost payday lending. Maine, Oregon and New Mexico have laws in place that authorize small loans secured by access to the borrower’s bank account at lower than typical rates. For example, Maine caps interest at 30 percent but permits tiered fees that result in up to 261 percent annual rates for a two-week $250 loan.
Finally, thirty-one states authorize high-cost payday lending. These states have either enacted legislation authorizing payday loans, failed to close loopholes exploited by the industry to make high-cost loans, or deregulated small loan interest rate caps. Payday loan states include Alabama, Alaska, California, Delaware, Florida, Hawaii, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Michigan, Minnesota, Mississippi, Missouri, Nebraska, Nevada, North Dakota, Ohio, Oklahoma, Rhode Island, South Carolina, Tennessee, Texas, Utah, Virginia, Washington, Wisconsin, and Wyoming. However, some of these states have implemented regulations to limit the risks of debt-trap. For example, Washington limits borrowers to eight payday loans per year, and Virginia requires loans to be payable in two pay cycles.
Protections for service members
The Military Lending Act provides special protections for servicemembers and their dependents, including caps on interest rates for certain types of consumer credit. This means that payday lenders may be prohibited from charging active duty servicemembers and their dependents more than 36% APR on consumer credit.
Payday loans vs. personal loans
Payday loans and personal loans are both types of short-term loans that can be used to cover unexpected expenses or to bridge a financial gap. However, there are some key differences between the two that can make one a better option than the other depending on the borrower’s situation.
Payday loans are typically small, short-term loans that are secured by the borrower’s next paycheck. They are often used to cover unexpected expenses such as car repairs, medical bills, or emergency travel. Payday loans typically have high interest rates and fees, and they are due on the borrower’s next payday. This means that borrowers have a short period of time to pay back the loan and if they are unable to pay it back on time, they may end up taking out multiple payday loans to cover the costs. This can lead to a cycle of debt that can be difficult to break.
Personal loans, on the other hand, are typically unsecured loans that can be used for a variety of purposes. They are usually larger than payday loans and have longer repayment terms, usually ranging from one to five years. Personal loans have lower interest rates than payday loans and may have more flexible repayment options. This means that borrowers have more time to pay back the loan and may be able to reduce the overall cost of borrowing.
Alternatives to a payday loan
There are several alternatives to payday loans, including:
- Credit cards: Credit cards can be used for unexpected expenses, but they typically have lower interest rates than payday loans.
- Personal loans: Personal loans may have lower interest rates and fees than payday loans, and they typically have longer repayment terms.
- Borrowing from friends or family: This can be a low-cost option, but it may not be feasible for everyone.
Payday loan alternatives to avoid
While there are many alternatives to payday loans, it’s important to be cautious when considering other forms of high-interest, short-term loans. Some alternatives, like auto title loans, can be even more expensive than payday loans and can result in the loss of your vehicle if you are unable to repay the loan.
Is it a good idea to get a payday loan?
It is generally not a good idea to get a payday loan. The high-interest rates and fees can make it difficult to repay the loan, which can lead to a cycle of debt. Additionally, the risk of losing your bank account or vehicle if you are unable to repay the loan can make payday loans even more dangerous. It is important to consider all options and alternatives before taking out a payday loan, and to make sure you fully understand the terms and conditions of the loan before borrowing.
FAQ
What happens if I can’t repay a payday loan?
If you are unable to repay a payday loan, the lender may take legal action to collect the debt. This can include wage garnishment, bank account seizure, or the repossession of any collateral used to secure the loan. It’s important to communicate with the lender if you are unable to repay the loan, as they may be willing to work out a repayment plan.
Does paying back payday loans build credit?
Paying back a payday loan will not typically help you build credit, as payday loans are not reported to credit bureaus. However, if you are unable to repay the loan and it goes into default, it can negatively impact your credit score.
Are payday loans hard to pay back?
Payday loans can be difficult to pay back due to the high-interest rates and fees associated with them. Additionally, the short repayment terms can make it difficult for borrowers to come up with the necessary funds to repay the loan on time. This can lead to a cycle of debt where the borrower is constantly taking out new loans to pay off the original loan.
In conclusion, payday loans can be a risky and expensive way to borrow money, and should be avoided if possible. It is important to consider all options and alternatives before taking out a payday loan, and to make sure you fully understand the terms and conditions of the loan. If you do decide to take out a payday loan, be sure to repay it on time to avoid additional fees and interest charges. It is also recommended to seek financial counseling or advice before making this kind of decision.
