While advocates of payday loans say they grant loan access to people with poor or no credit, critics say these “short term” loans unfairly target minority populations and trap people into lengthy debt cycles.
So, how do payday loans work? Here's a breakdown to help you figure things out for yourself. In this article, we'll explore what a payday loan is and how it works, how to qualify, differences from state to state, some pros and cons of payday loans, and some responsible alternatives to payday lending.
But first ...
A typical payday loan is a small-dollar loan (usually about $100-$1,500) with a two-week term that is due in a single lump payment on your next payday. At least, that’s how it works in theory.
If the term “payday loan” doesn’t ring a bell, here are some other names for it:
According to the Consumer Financial Protection Bureau (CFPB):
“To repay the loan, you generally write a post-dated check for the full balance, including fees, or you provide the lender with authorization to electronically debit the funds from your bank, credit union, or prepaid card account. If you don’t repay the loan on or before the due date, the lender can cash the check or electronically withdraw money from your account.”
These loans target people with poor or no credit, or little financial literacy, who need access to cash immediately. But if you have bad credit or no credit, what other options do you have to access fast cash in an emergency?
We'll explore some responsible alternatives to payday loans at the end of this piece, but first let's break down how to qualify for payday loans.
It is quite easy for payday loan borrowers to qualify for this type of short term loan. All a borrower needs is to have an open checking account in good standing. The payday borrower will also need to prove their income and have some form of identification. A payday loan lender will not run a credit check or ask further questions. Since lenders do not check your credit score, many borrowers find themselves in a payday loan trap, unable to pay their debt within their repayment term.
Here’s why some people turn to payday loans, despite the often negative consequences:
The number one advantage of payday loans is that they’re easy to access. In fact, many cash advance lenders promise access to cash within 24 hours and an immediate lending decision. Some are even available 24 hours a day, 7 days a week and have online applications.
Unlike traditional loans, which can take time to apply for, these loan applications can take as little as five minutes.
Traditional lenders usually require a Social Security number, photo ID, proof of income, a credit check and will verify your ability to repay a loan. Unlike traditional personal loans, most “fast cash” loans have fewer requirements to apply.
Generally, all you need to apply for a payday loan is to:
While having fewer requirements makes getting cash more convenient, keep in mind that the additional requirements from banks and other lenders were often put in place to help protect you.
Unlike traditional loans where you need good credit to be approved, payday loans don’t require a credit history. Since they don’t pull your credit, that also means no hard credit inquiry, which can lower your credit score by several points.
Except in rare cases, however, payday loans won’t help build the credit you need to move onto higher quality financial products in the future.
Learn how to build credit by reading our post on “How to Build (or Rebuild) Credit.”
Unlike a car title loan, traditional auto loan or mortgage, payday loans are not secured by personal property. This means that if you default (don’t pay), the lender can’t seize your property as a consequence.
While not secured, payday lenders often have access to your bank account as a condition of the loan, which is a different type of risk. They can also take other measures, such as sending your debt to collections or taking you to court over outstanding balances.
When it comes to payday loans, the Federal Trade Commission, a government regulatory body focused on preventing fraudulent, deceptive and unfair business practices, states:
“The bottom line on payday loans: Try to find an alternative. If you must use one, try to limit the amount. Borrow only as much as you can afford to pay with your next paycheck – and still have enough to make it to next payday.”
Which brings us to the first disadvantage of payday loans. …
Depending on the state, payday loans have high interest rates that average about 400%. For comparison, many personal loans charge about 4%-36% interest, while credit card interest ranges from about 12-30%.
This image shows just how high these rates can go, depending on where you live.
To break this down into a more concrete example, here’s what a payday loan of $500 could cost you in a few different cities across the US as of July 2019:
Looking at this city sample, it could cost $55-$102.27 to borrow a total of $500.
In contrast, if you had a $500 loan with a 30% APR, you would only pay an extra $25.12 in interest for a three-month term, making the total cost of the loan $525.12.
Here’s how much that lower interest rate would save you in each of the cities above:
Following this example, you could save anywhere from $30-$77+ for every $500 you borrow if you use a traditional loan instead.
Notice also, __with the 30% interest loans, you have a longer time period to pay back less money. __
However, many traditional lenders require a minimum credit score to qualify. And the better your credit, the more money you could save over time.
Payday loans are sometimes harder to pay back than a traditional loan, because the lender did not verify your ability to repay before lending you money. Payday lenders don’t generally assess your debt-to-income ratio or take your other debts into account before giving you a loan either.
A predatory loan is defined as having unfair, misleading or unaffordable terms and has the potential to trap users in a cycle of debt. Payday loans are viewed as a type of predatory loan because of the high costs that can escalate quickly.
__Some warning signs of predatory loans include: __
Each time you extend (rollover) a loan, a payday lender charges additional fees, increasing your out-of-pocket costs for borrowing the money.
In fact, __nearly 1 in 4 payday loans are borrowed more than 9 times. __
Rolling the loan over can significantly increase the amount of time it takes to repay the loan, sometimes adding months or years to the original two week terms.
According to a 2016 report by the Center for Responsible Lending, payday lenders are mostly located in minority communities. In fact, the report found, there are about 8.1 payday loan stores per 100,000 people in African American and Latino communities, while mostly white neighborhoods only had about 4 for every 100,000 people.
That means there are twice as many payday lenders in communities of color as there are in white communities.
According to Keith Corbett, Executive Vice President of the Center for Responsible Lending, payday lending in communities of color is comparable to Jim Crow laws. In an NPR interview Corbett states that in the Jim Crow era, everyone said it was a free market, so it was “okay” for people of a certain color to have to ride in the back of the bus.
“The argument to place these fringe financial services in our community is pretty much the same. And think about it. If you are in a low-income community and the only place you see for financial transactions is a payday lender or a rent-to-own shop, it becomes a normal situation.”
He continues by calling out the financial disparity between white communities and communities of color, citing the large gap in interest rates as a possible cause:
”And so what happens is if one community is paying no more than 15% to borrow money and the other community is paying 300-400% minimum, the community will never get out of poverty,” Corbett states.
To gain access to a fast cash advance, borrowers are often required to grant the payday loan lender access to their bank account. While setting up direct deposit to make bill and loan payments is pretty common now, this account access works a little differently.
"Some payday lenders attempt to recover their money by taking what they're owed directly from borrowers' checking accounts, which borrowers grant access to as a condition of the loan. But unexpected withdrawals from the [payday loan] lender can rack up pricey overdraft fees and damage credit scores," CNBC reports.
Many payday lenders have you write a postdated check – meaning in this case, a check that is dated to be cashed after your next payday – when you get the loan. If you don’t have enough money in your account when they cash the check, you could face expensive overdraft fees and bounced check fees (also known as insufficient funds) from your bank as well as returned or failed payment fees from the lender.
These extra fees add to the already high costs charged by payday lenders. If you find yourself in this situation, contact your bank immediately to discuss your options for protecting your account.
Just like other lenders, if you fail to pay a payday lender for long enough, they can take you to court and try to get a judgment against you for failure to repay a debt. If a judgment is ordered, you could face wage garnishment, imprisonment or other consequences.
Keep in mind, however, that legal battles are expensive. In the case of small-dollar loans, it’s not always worth the time and money involved for the lender to sue. However, some companies or debt collectors will threaten to sue or threaten wage garnishment to scare you into paying them back quickly.
If you receive these threats, consider getting help from a local nonprofit organization focused on debt management, an Accredited Financial Counselor or a Certified Credit Counselor who could help you with your unique needs.
Last but not least, payday loans do not help you build credit because they do not generally report to the credit bureaus.
Some versions of payday loans in some states allow you to work your way up to lower interest loans that can be paid in installments and that report to the credit bureaus. However, this installment loan option is rare and little information is available on how long it takes, or how many unreported loans at high interest rates are required before you're able to build credit with their loan.
Similar to medical debt, payday loans usually only report your debt to the credit bureaus if it gets sent to collections. So while payday loans can’t help you build credit, they could hurt your credit if you’re not careful.
If you build good credit, you could qualify for higher quality financial products, including personal loans and credit cards with lower interest rates.
__To learn how to start building credit, check out our blog post “How to Build (or Rebuild) Credit.” __
Ultimately, it’s important to remember:
Some states prohibit payday lending as of spring 2019, including:
The District of Columbia also prohibits payday lending.
However, according to the National Conference of State Legislatures, 37 states have specific statutes that allow for payday lending. Other states do not have specific payday lending provisions or require lenders to comply with interest rate caps on other consumer loans.
These states include:
Each state has different regulations that govern the maximum interest rate (if any) cash advance loans can charge, as well as the maximum loan amount, loan terms and finance charges allowed. In 2019, there are also several pending pieces of legislation concerning payday loans.
Here’s a closer breakdown of the states that do allow payday loans:
|State||Max Loan Amount||Loan Term||Finance Charges|
|Alabama||$500||Minimum 30 days||May not exceed 17.5% of amount advanced.|
|Alaska||$500||Minimum 30 days||Nonrefundable origination fee can’t exceed $5.
Fee can’t exceed $15 for each $100 advance, or 15% total amount of advance, whichever is less
|California||$300||31 days maximum||Can’t exceed 15% of total advance amount.|
|Colorado||$500||No maximum. 6 months minimum.||Can’t exceed 36% annual percentage rate. See here for additional regulations concerning origination fee, interest rates & monthly maintenance fees.|
|Delaware||$1,000||60 days maximum||Can vary based on loan terms.|
|Florida||$500 for single payment loans, not including fees||31 days maximum (7 days minimum)||Fees can’t exceed 10% of the original cash advance.
Fees can’t exceed 8% outstanding transaction balance on biweekly basis.
Additional verification fees may also be charged.
Prepayment penalties prohibited.
|Hawaii||$600||32 days maximum||Check casher fee can’t exceed 15% face amount of check.|
|Idaho||$1,000||n/a||Can't provide a loan that exceeds 25% of the gross monthly income of the payday borrower.|
|Illinois||$1,000 or 25% of consumer’s gross monthly income for single payment loan||120 days maximum (minimum 13 days)||Can’t charge more than $15.50 per $100 loaned. Can’t exceed $1 verification fee.
There are also limits on whether a lender can make a payday loan to a consumer based on how much other payday loan debt they already have.
|Indiana||$550||Minimum 14 days||Limited to 15% on first $250 of principal.
Limited to 13% of the amount over $250 for loans from $250-$400.
Limited to 10% of the amount over $400 for loans from $400-$550.
|Iowa||$500||31 days maximum||Can’t exceed $15 on $100 cash advance or more than $10 on following $100 increments.|
|Kansas||$500||30 days maximum (7 days minimum)||Can’t exceed 15% of cash advance amount.
Contract rate can’t be more than 3% per month of loan proceeds after maturity date.
No insurance charges/other charges permitted, except returned check fees.
|Kentucky||Limit 2 payday advances per customer for $500 total||60 days maximum||Can’t exceed $15 per $100 loan amount.
$1 per transaction fee for required data to be submitted.
|Louisiana||$350||30 days maximum||Can’t exceed 16.75% of cash advance. Can’t exceed $45.
Additional rules and interest charges apply if the loan remains unpaid after the contract matures.
|Maine||None||n/a||Fees vary depending on loan amount and unpaid balances.|
|Michigan||$600||31 days maximum||Service fee can’t exceed:
15% of first $100 cash advance.
14% of second $100 of cash advance.
13% of third $100 of cash advance.
12% of fourth $100 of cash advance.
11% of fifth or sixth $100 of cash advance
|Minnesota||$350||30 days maximum||Up to $50: can’t exceed $5.50.
$50-$100: can charge 10% of loan proceeds + $5 administrative fee.
$100-$250: 7% of loan proceeds with minimum of $10 + $5 administrative fee.
$250-$350: 6% of loan proceeds with minimum of $17.50 + $5 administrative fee.
Additional rules apply for after loan maturity.
|Mississippi||$500, including fees||30 days maximum||Can’t exceed $20 per $100 of cash advance up to $250.
Can’t exceed $21.95 per $100 advance between $250-$500.
|Missouri||$500||31 days maximum (14 days minimum)||Lenders can only charge simple interest.
No payday borrower must pay accumulated interest and fees exceeding 75% of initial loan amount.
|Montana||$300||n/a||Can’t exceed 36% per year, not including insufficient fund fees.|
|Nebraska||$500||34 days maximum||Can’t exceed $15 per $100 of advance.|
|Nevada||In combination with other outstanding loans, can’t exceed 25% of customer’s gross monthly income||35 days maximum||Can vary based on loan terms.
APR can’t exceed lesser of 36% or max APR under federal law.
|New Hampshire||$500||30 days maximum (7 days minimum)||Can’t exceed 36% APR|
|North Dakota||$500||60 days maximum (15 days minimum)||Fees can’t exceed 20% of original cash advance and do not count as interest.|
|Ohio||$1,000||12 months maximum (91 days minimum). Minimum may be less if total monthly payment does not exceed 6% of borrower’s monthly gross income.||Interest can’t exceed 28% per year.
May charge monthly maintenance fee that doesn’t exceed 10% of original loan amount or $30.
If original loan amount is greater than $500, may charge 2% of original loan amount.
Can charge up to $20 for returned or dishonored payment.
Can charge check cashing fee, not to exceed $10.
Damages, costs and other disbursements, may not exceed original loan amount.Fees and charges can’t exceed 60% of original loan amount.
|Oklahoma||$500, not including finance charge||45 days maximum (12 days minimum)||Can’t exceed $15 for every $100 advanced up to first $300 advanced.
May charge additional $10 for every $100 advanced in excess of $300.
|Oregon||$50,000||60 days maximum (31 days minimum)||Can’t exceed 36% interest per year.
Can’t charge more than 1 origination fee of $10 per $100 of loan amount or $30, whichever is less.
|Rhode Island||$500||13 days minimum||Can’t charge check- cashing fees that exceed 3% amount of advance or $5, whichever is greater, if check is payment from state public assistance or federal social security benefit.
Can’t charge check-cashing fees for personal checks that exceed 10% of original loan or $5, whichever is greater.
Can’t charge check-cashing fees that exceed 5% of original loan or $5, whichever is greater, for all other checks.
Can’t exceed 10% of amount advanced in transaction fees.
|South Carolina||$550||31 days maximum||Can’t exceed 15% of original loan amount.|
|South Dakota||$500||n/a||Can’t exceed 36% per year.|
|Tennessee||$500||31 days maximum||Fees can’t exceed 15% of original loan amount and do not count as interest.|
|Texas||Varies||For a loan of $100 or less, 1 month for each multiple of $10 cash advance or 6 months, whichever is less. For a loan of $100+, 1 month for each multiple of $20 of cash advance.||Varies widely depending on loan type and amount.
$0-$30: Acquisition charge can’t exceed $1 for every $5 of cash advance.
$30-$100: Acquisition charge can’t exceed one-tenth of cash advance amount. Acquisition fees are separate from interest.
|Utah||None||Varies depending on rollover selection.||Can’t collect additional interest on payday loan with outstanding principal 10 weeks after loan executed.|
|Virginia||$500||At least two times the borrower’s pay cycle||Simple annual percentage rate may not exceed 36%.
May charge loan fee not to exceed 20% of original loan amount.
Verification fee can’t exceed $5.
|Washington||$700 or 30% of borrower’s gross monthly income, whichever is lower||45 days maximum, unless extended through agreement||Can’t exceed 15% of first $500 of principal.
Can’t exceed 10% of portion in excess of $500.
|Wisconsin||None||n/a||No limit on interest charged before maturity date of payday loan.
If not paid by maturity date, may charge interest at max of 2.75% per month. This changes if you have more than 1 payday loan.
Can’t provide payday loan if customer has more than $1,500 or 35% of gross monthly income in payday loans.
|Wyoming||None||30 days maximum||Can’t exceed the greater of $30 or 20% per month on principal balance of original loan.|
This chart is current as of August 2019. For proposed bills and the most recent updates to these fees and regulations, click here.
To download a PDF version of this table, click here.
To avoid predatory loans such as payday and auto title loans, there are basically two tracks you can take:
Let’s take a closer look at each.
Before taking out emergency cash to cover a bill, first look at any payment due dates, then at the dates when late fees start to accrue. Consider other consequences of late payments, and try to prioritize what you owe.
For example, many traditional lenders have a 15-day grace period before they charge a late fee. If you just need to wait for your next paycheck, would paying one bill a few days late (but before you get charged a late fee) keep you from having to borrow money to make ends meet?
If you’re experiencing a financial hardship, try talking to your landlord, your utility company, your lender or whoever you owe money to and see if they’ll work with you. It doesn’t always work, but sometimes it does, so it’s worth a try. Just give them a call and ask.
In certain cases, you might qualify for student loan forbearance or deferment, or consider bankruptcy as an alternative. If you’re considering these options, try to connect with a nonprofit organization that could help you manage debt, or with an Accredited Financial Counselor or other reputable professional to get the help and advice you need.
Mission Asset Fund (MAF) is a San Francisco-based nonprofit organization that provides 0% interest loans through lending circles to people in need across the country. Not only are these loans 0% interest, MAF also reports your payments to the three major credit reporting agencies.
There is a small caveat though. MAF requires you to take a few short financial literacy courses prior to qualifying for a loan. But if taking those courses could save you 400% on interest over a payday loan, isn’t the extra time worth the wait?
Payday Loan Alternatives (PALs) are small-dollar loans that range from $200-$1,000, with loan terms ranging from 1-6 months. Many credit unions also offer financial counseling at no additional cost to their members.
The catch with this payday loan alternative is you often have to be a member of the credit union for at least one month before taking out this short term loan. To gain access to a PAL, talk to your local credit union or bank.
While you might not qualify for a loan on your own if you have poor or no credit history, with a cosigner, you could gain access to a personal loan with better interest rates and build your own credit history while you’re at it.
What is a cosigner exactly? A cosigner is someone you have a close relationship with – like a parent or spouse – who agrees to take full legal and financial responsibility to pay your debt if you can’t or don’t. Ideally, a cosigner should be someone who has great credit.
Just remember, if you don’t pay back the loan, you would not only put the financial burden on your cosigner, you could also damage their credit. (See more about how co-signers affect your credit.) So if you go this route, make sure you will be able to pay off the loan as agreed.
Since emergencies can happen at any time, the best approach is to prepare as much in advance as you can. That way, if you do experience financial hardship, such as job loss, medical bills, unexpected car repairs, etc., you’ll be able to either borrow the money through a high quality loan product or credit card, or have the money saved to cover what you need.
Here are some strategies you can start today to help avoid predatory loans in the future.
Make sure part of your future financial plan is to save money for emergencies. Some personal finance experts recommend you set aside 3-6 months’ worth of living expenses in an emergency fund. This fund should be a savings account you use only during emergencies, but can access quickly when you need it.
While 3-6 months’ worth of living expenses can sound like an overwhelming amount to try and save if you live on a tight budget, remember that every little bit you set aside helps. For example, if you saved just $5 a week for a full year, by the end of the year you would have over $240. And that’s before you add the interest your money earns in a savings account.
Unlike with money in a checking account, which sometimes charges fees, a savings account can help grow your money by earning interest. The interest on a savings account is known as the Annual Percentage Yield (APY). Be careful not to confuse APY with Annual Percentage Rate (APR) which is the amount of money you get charged for using a financial product.
Many online banks now offer pretty high APYs – at least compared to the national average – and don’t require a minimum deposit to open a savings account. So you can start a savings account with just a few dollars.
For example, some banks, like Ally, offer an APY of over 2%, while some larger national banks like Bank of America offer closer to 0.03% as of spring 2019. When you get a savings account with a higher APY, you can grow the money you do have in your savings faster.
Aside from potentially trapping you in a debt cycle, many payday loans (most?) don’t help you build credit even if you pay them off, since they do not report your payment history to the credit bureaus.
To gain access to more traditional loan products or credit cards with more competitive interest rates, it’s important to build positive payment history that proves to lenders you can pay back what you owe on time and as agreed.
When you’re pinched for cash, it can be tempting to fill out a five-minute application to get the money you need through a payday loan. But the quickest way isn’t always the best way, and you could end up paying for that single “payday” loan for years to come. So before visiting the closest cash advance store, be sure to take some time to look over your other options first.
Debt.org. "Payday Lenders and Loans". https://www.debt.org/credit/payday-lenders/
Forbes. "Payday Loans Vs. Cash Advance Loans: What To Know And How To Avoid Them". https://www.forbes.com/advisor/personal-loans/payday-loans-vs-cash-advance/
Lauren Bringle is an Accredited Financial Counselor® with Self Financial– a financial technology company with a mission to help people build credit and savings. See Lauren on Linkedin and Twitter.
Our goal at Self is to provide readers with current and unbiased information on credit, financial health, and related topics. This content is based on research and other related articles from trusted sources. All content at Self is written by experienced contributors in the finance industry and reviewed by an accredited person(s).