A payday loan is a type of short-term unsecured personal loan, typically $500 or less, and usually due on your next payday. The loan amount is based on your income and you need an active bank account, valid ID and proof of income (paystub) to qualify.
Payday loans are known to have very high interest rates. For this reason, you should only take out a personal loan if you are sure you can repay it.
Also known as: Â cash advances, check advances
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How does a personal loan work?
When you apply for a payday loan, the lender confirms your income with a pay stub, collects your checking account information, and then processes the payment for the requested amount.
If the loan is issued at a store, the lender will disburse the money and you must leave a post-dated check for the loan amount plus interest. This check is payable on or around your next payday. If you apply for a loan online, the lender deposits the funds electronically and obtains authorization to automatically debit your bank, credit union or prepaid card account.
Depending on the lender and the state you live in, if you can’t repay the loan by the next payday, the lender will add a fee and the cycle will repeat itself. You must contact the lender if you are unable to repay the loan so that the lender can renew it. If you don’t, the lender may simply deposit the post-dated check, subjecting you to possible NSF returned check fees.
How to get a payday loan?
If payday loans are legal in your state (more on that below), you won’t run out of options. Physical stores aren’t hard to find, but several online alternatives are also available. To qualify for a payday loan, you must have a verifiable source of income, be at least 18 years old, and have an active checking account.
Personal loan interest rates
Interest on a payday loan is usually shown in dollars, ranging from $10 to $30 for every $100 borrowed. Although it may seem like a small amount, $10 on a $100 loan for a two-week term has an annual percentage rate of 260.71%.
Are payday loans legal?
The Consumer Federation of America, a research, advocacy, and education organization, has a helpful page detailing the legal status of payday loans by state. According to the organization, 16 states (GA, NY, NJ, AR, NH, MT, CO, SD, AZ, NC, CT, MD, MA, PA, VT, and WV) and the District of Columbia have coverage for consumers against payday loans. These states outright ban the product or impose rate caps that go against the lender’s business model.
Maine, Oregon, and New Mexico allow low-cost payday loans. However, this should be taken with a grain of salt, as interest rates between these states range from 154% to 261% when fees are factored in. The remaining 31 states allow high-cost payday loans.
In New York, where payday loans are illegal, the Department of Financial Services described the product as designed to trap borrowers in debt. Not only are in-person payday loans illegal there, but the online variants are as well. The state has also banned the collection of payday loan debts.
Efforts to regulate payday loans began in 2017 when the Consumer Financial Protection Bureau introduced rules to protect consumers from “payday debt traps.” These rules became mandatory in June 2022 and included the following protections:
- confirm a borrower’s ability to repay while meeting basic expenses and financial obligations,
- implement a debit attempt limit that caps the number of debit attempts at two
- provide written notice before attempting to debit on an unexpected date or for a different amount.
The FTC has several laws in place to protect consumers from predatory lending practices. Among the many violations cited are failure to comply with the disclosure requirements of the Truth In Lending Act. The FTC also found that payday lenders engaged in deceptive advertising and billing practices as well as abusive collection practices.
Alternatives to payday loans
As mentioned above, you should not take payday loans lightly. They are very risky and you can quickly double or triple your debt. You should only use payday loans as an absolute last resort when you have no other option. Before going down the payday loan route, consider the following:
Alternative payday loans: Available through credit unions, they are similar to payday loans in the loan amount you can be approved for, but have a different fee structure and, importantly, a longer term. Although still a short-term loan, alternative payday loans allow up to six months to repay the funds. To be eligible, you must have been a member of a credit union for at least one month, and not all credit unions offer this alternative.
Payment Plans: If one of the reasons for your financial difficulties is existing debt, consider asking your creditors for a payment plan before taking on more debt with a payday loan. Many creditors prefer to work with their borrowers rather than going through the internal collection process and/or selling the debt to a collection agency. This does not mean that all creditors will have something in place to help you, but you should check before applying for a payday loan.
Financial advice: Continuing this momentum, if you’re having trouble managing your debt, consider talking to a credit counselor. Several nonprofit credit counseling agencies can negotiate your debt, often getting better interest rates or lower repayments. Consulting agencies could also provide you with basic personal finance tools to help you succeed.
Friends and family: Although it can be difficult, asking family and friends for help during a time of financial need is always a better alternative to a payday loan.
If you’ve explored all the other options and found nothing, a payday loan could help you in the short term. You should ensure that you are aware of the very high fees and interest rates, and you should always ensure that you are able to repay the loan plus interest. If you’re not 100% sure you can do it, a payday loan can end up giving you more headaches later on.
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