What Are Payday Loans?
by Dana George | Updated Aug. 18, 2022 - First published on Sept. 1, 2021
Payday loans are designed to keep borrowers on the hook, paying huge sums in interest.
- Payday loans are short-term loans tendered at very high interest rates to borrowers.
- As of 2022 data, payday loan interest rates ranged from 28% to 1,950%, compared to the average credit card interest rate of 17.92%.
- There are alternatives to payday loans available, such as a cash advance, an auto title loan, a loan from friends and family, and more.
Would you like to pay an interest rate of 400% on a loan? How about 1,950%?
Unfortunately, that is what the average payday lender charges. In this article, we discuss what a payday loan is, how it works, and alternatives you can use if you need money in a hurry.
What are payday loans?
There is no set definition of a payday loan, but they are typically a short-term high-interest loan that is usually in an amount less than $500. Many borrowers who are short on funds before they get their next paycheck go to a payday lender to bridge the gap. Payday lenders lend to people with bad credit or no credit history.
Many people get payday loans for small immediate expenses. These loans usually need to be repaid within a couple of weeks. Since the fees and interest are high, many borrowers are unable to pay them back completely and roll them into another loan, thereby taking on more fees. Payday loans are also known as cash advance or check advance loans.
How do payday loans work?
The amount you can borrow from a payday lender is usually based on your income. You will have to show your paycheck stub when applying for one. To pay back the loan, many lenders will require you to write a post-dated check for the full loan amount (including fees) which they cash when you get your next paycheck. Others will require authorization to directly debit your checking account for the money owed. Many will secure the loan through access to your checking account.
Loan amounts offered are minimal and most states have a maximum amount you can borrow, typically $500. Payday lenders will give you the money either in cash, check, or electronic transfer to your checking account. Payday loans must be paid back in a single lump sum, unlike installment loans (which are paid over time). If you cannot pay back the loan amount, you roll over or renew the loan.
Because many government and financial regulatory authorities consider payday loans to be predatory, 13 states and the District of Columbia have banned them: Arizona, Arkansas, Connecticut, Georgia, Maryland, Massachusetts, New Jersey, New Mexico, New York, North Carolina, Pennsylvania, Vermont, and West Virginia. The other 37 states that allow them have restrictions. Restrictions can include a cap on the interest rate, a maximum loan amount, and a limit on the loan terms.
What is the cost for a payday loan?
According to a personal loan study by The Ascent, you could end up paying 400% or more in interest due to the way payday loans are designed. (Interest rates as of 2022 ranged from 28% to 1,950%). The cost per $100 for a payday loan ranges from $7.50 to $75. Some states have no limit.
The average interest rate on a credit card is 17.92%, according to the CreditCards.com Weekly Credit Card Rate Report. And, at the time of this writing, the annual percentage rate (or APR) on the best personal loans for bad credit tops out at around 35.99%. Given those statistics, using a credit card may be better for you than getting a payday loan that charges 400% APR.
How payday loans keep you hooked
If the interest rate is so high, why do people use payday loans? It is easy to get one. All you need is proof of identification, proof of your gross monthly income, and a postdated check. There is no credit check, making it ideal for people with bad credit or no credit.
If you can't pay the loan back in full by the due date, then the lender will typically roll over what you owe into a new loan. After adding in the interest and additional fees, a small loan can end up being very expensive. When you finally pay the debt in full, payday lenders may end up with more money than you originally borrowed due to excessive fees and interest.
A way out of payday loans
If you are able to qualify for an installment loan from a bank, that will certainly be better than the high interest rates of a payday loan. If you can't qualify for one, here are some other options.
Consider a cash advance
If you have a credit card, a cash advance loan may be the answer. Cash advances typically carry a higher interest rate than regular credit card purchases, so we wouldn't normally suggest you take one out. However, when the choice is between a cash advance with an APR of 30% or a payday loan with an APR of 400% or more, a cash advance is the clear winner. Most cash advances come with fees and begin to accrue interest immediately, so make it a point to pay it off as quickly as possible.
Auto title loan
Do you own your car? Or have more equity than what you owe? You may be able to borrow against it. Since it is backed by collateral (your car), you may be able to get a better rate.
Turn to friends and family
If you need only enough to get you through until your next payday, help from a friend or family member might be the ticket. Before you borrow, though, make sure you can repay the loan as promised. There are few things worse than leaving someone else in the lurch because you couldn't uphold your end of the deal.
Check charitable organizations
Let's say you paid to repair your car but now don't have money to feed your family. A number of organizations offer services to help. There's aid available for just about everything -- from groceries to utility bills to transportation. Need Help Paying Bills offers a long list of organizations, who they help, and how to contact them.
Apply for a bad credit loan
As mentioned, borrowers with poor credit scores may still qualify for a personal loan for bad credit. Your interest rate is likely to be high, but it's better than paying 400% interest.
Taking out an installment loan like this offers several advantages:
- You'll know exactly how much your monthly payment will be and when the loan will be paid in full.
- You can "set it and forget it" by scheduling automatic monthly payments from your bank account.
- If you want to pay the loan off quickly, you can choose a short loan term.
- Personal loans are available from local banks, credit unions, and online lenders.
- You can avoid a predatory high interest rate.
- As long as you stick to the repayment plan, your credit score is likely to go up.
In short, trying one of these options instead of becoming a victim of predatory payday loans is good for your bottom line.
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We're firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers. The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.