What you need to know about payday loans

Payday loans are unsecured personal loans that allow you to borrow a portion of your paycheck before receiving it. They can be tempting if you urgently need money before your next pay period. However, many payday borrowers often roll over payday loan balances they couldn’t repay, and end up in worse financial shape.

Despite consistent warnings about annual percentage ratings (APRs) of up to 600 percent or more, consumers often turn to them because they can be funded quickly and easily. It’s critical to understand how they work and find alternatives, so you don’t end up in an endless cycle of payday loan rollovers.

What are payday loans and how do they work?

Payday loans are small loans — usually $500 or less — that are approved based on how much and how often you’re paid. They’re called “payday” loans because the entire loan balance is usually repaid from your paycheck on your next payday, or within 10 to 14 days of taking it out. Payday loans are a type of no-credit check loan that typically only require proof of your paycheck for approval. That makes them a common choice for borrowers with bad credit.

Funds are usually deposited into the same bank account you receive your paycheck, typically within one business day. The same account is used to withdraw funds to pay back your loan balance plus fees on your next pay day.

Payday lenders don’t charge a traditional interest rate on their loans and you don’t make a monthly payment. You must pay the entire amount borrowed plus whatever payday loan fee they charge when you receive your next paycheck. This may be a shock for consumers used to making minimum payments on credit cards, or spreading payments out over several years like you can with a car or personal loan.

Payday loans can typically be obtained at a local bank or credit union or by applying online. They’re regulated at both the federal and state level. However, many states have laws that limit the fees or interest rates payday lenders can charge, and others have banned payday loans entirely.

How much do payday loans cost?

Payday lenders generally charge a flat fee that ranges between $10 and $30 for every $100 borrowed, according to the Consumer Financial Protection Bureau. They don’t charge an interest rate, because the entire balance plus the fee is due with your next paycheck.

This may confuse consumers who read about the dangers of excessively high payday loan APRs. It’s essential to understand that an annual percentage rate calculation assumes you have a debt for at least a year. The balance of a payday loan plus any fees must be paid in full within a matter of days or weeks.

Payday loan interest rates

You won’t pay a traditional interest rate on a payday loan. Instead, payday lenders often set a finance charge between 15 and 30 percent of the amount you borrow. They must disclose these fees as an annual percentage rate, even though you pay the loan off in a matter of weeks.

The fees associated with payday loans can add up quickly. Across the 31 states that allow these types of loans, consumers pay more than $2.2 billion in fees annually, according to the Center for Responsible Lending.

How much would a $500 payday loan cost?

It’s critical to remember the higher the APR, the more money you’ll have to pay back. For example, if you borrow $500 with a 30 percent finance charge, you’ll have to repay $650 in two weeks. That amounts to a 459 percent APR and is why payday loans are some of the most expensive loans you can get.

If you opt to roll the loan over, you’re on the hook for steeper costs in the form of additional fees. When rolling over a loan, a payday lender may only allow you to pay the fees due for the original loan term and none of the principal. 

If you have a $500 loan for which the lender charged $30 in fees per $100 borrowed, you would owe $150 in order to be able to rollover the loan. And then you’ll still owe the original $500, plus a new $150 finance charge that must be paid when the loan extension elapses and the new due date arrives. In other words, you will end up paying $300 in fees on a loan of $500.

Pros and cons of payday loans

Payday loans can be a convenient way to access fast cash but they aren’t without disadvantages.

Benefits of payday loans

Borrowers often choose payday loans because they don’t require a minimum credit score. If you can prove you’re employed and receiving a regular paycheck, your odds of approval are very high. In fact, many payday lenders advertise payday loans as no-credit-check loans, which means your credit score and history aren’t considered at all.

Because you don’t make a series of payments on a payday loan, there is no payment history for lenders to report to credit bureaus. If you default, a payday lender could send your loan to collections, sue you in court and in some cases even garnish your wages and levy your bank accounts.

Risks of payday loans

If you can’t pay your payday loan off in full on the requested date, you’ll have to roll your loan over, meaning asking the lender for an extension of the original repayment deadline. When rolling over the debt, you’ll be responsible for the principal balance and additional fees and interest. About 80 percent of payday loans are rolled over and research has shown that payday lenders’ bottom lines rely on borrowers being stuck in a cycle of debt. There’s also the high risk of default, which could lead to credit damage and wage garnishment if a lender sues you.

Some states now require payday lenders to offer installment loan options so you can repay a payday loan balance over time instead of all at once. However, in most states, consumer protections are minimal. In fact, you could pay four times more if you live in a state that doesn’t heavily regulate payday lending.

Are payday loans ever worth it?

Yes, if you have no other way to meet a critical need like paying rent, buying food or paying an electric bill before your power is turned off. Studies consistently show that payday loans are helpful for consumers in crisis situations who can’t qualify for credit cards or bad credit personal loans and don’t have family or friends they can borrow from.

The key to avoiding relying on them is to have a plan to repay them in full. That might mean volunteering for extra hours at work, putting in some overtime or taking a temporary or gig job to make extra money.

Alternatives to payday loans

Before you apply for a payday loan, see if you qualify for some of these alternatives.

• Use a credit card. If you have a credit card that’s not maxed out, use it for your expenses or see if it allows for cash advances. Your interest rate is likely to be lower than a payday loan, and you might have 30 days to pay the credit card balance before interest is added. Credit cards also allow you to make a minimum payment, which could give you more time if an unexpected cost pops up.
• Check out a payday alternative loan at your local credit union. Credit unions offer payday alternative loans (PALs) that allow you to borrow between $200 and $2,000 for one to six months. The APR is capped at 28 percent.
• Apply for a personal loan online. A personal loan may allow you to get funds quickly, even with a relatively low credit score. For example, Avant requires a minimum FICO credit score of 550 with an estimated APR ranging from 9.95 percent to 35.99 percent — significantly lower than the estimated 400 percent you’d face on a payday loan. Upstart and SoFi, meanwhile, have no minimum credit scores.
• Ask family and friends for help. Friends and family might not always be able to lend money, but sometimes they can help in ways that can lessen your expenses. For example, they can let you do your laundry at their place, saving your costs at the laundromat, or they can make dinner with you and give you leftovers that will last until payday.
• Find extra income. One way to make extra cash is by selling items that you can live without. Have clothes you can get rid of? Try selling them online or at local second-hand stores. You also can explore renting out a room on Airbnb, trading your unused gift cards for cash or cashing in any unused rewards points on your credit cards.
• Ask your employer for an advance. Check with your employer if you can get an advance on your paycheck to tide you over. Your HR or payroll department may be able to help you out.
• Seek leniency or delay payments. If you owe money on certain bills, you should call each creditor to request an extension on your balance due date until you have the money to pay it back. Some companies will agree to this leniency or find ways to allow you to make partial payments on your bills.
• Use emergency relief services. You might be able to save up for any upcoming payments and eliminate other expenses in your budget by using emergency aid services in your community.
• Consider pawn loans. You could borrow money from a pawn shop by using one of your valuable items as security against your loan. The pawnbroker will hold the item and lend you an amount typically a portion of the resale value, often for a high fee. If you make payments on this loan, you can redeem your item. If you stop making payments, the pawnbroker will eventually sell your item to recover its loss.

Bottom line

In cases when you have no other way to meet a critical need, payday loans can be a helpful, if risky, option. But before resorting to this option, apply for other types of borrowing to see if you qualify for a loan with less expensive terms. If you do proceed with a payday loan, creating a solid plan to pay it back can help avoid getting into a cycle of debt.

Frequently asked questions

• How do you get a payday loan?

• What’s the difference between a payday loan and a personal loan?

• What are payday loan borrowing terms?

• How do you make a payday loan payment?