Payday loans are easy to get and don’t usually require a credit check. But they have very high interest charges, which makes them difficult to repay. This can lead to a cycle of more and more debt. If you don’t repay the loans on time, you’ll face aggressive collection methods, additional fees, a potential court judgment, and damage to your credit score.
Written by Attorney William A. McCarthy.
Updated November 19, 2021
Payday loans can seem like an easy fix if you’re strapped for cash and payday is a few weeks away. They’re easy to get and typically don’t require a credit check. But the loans come at a high cost and can be difficult to repay within the short 2-4 week term. If you aren’t able to repay them on time, you’ll face some aggressive collection methods and may fall deeper into debt.
This article explains how payday loans work, what they cost, and what some of the risks are. It also provides some options if you, like many people, end up unable to repay the loan. Knowing what you might be getting into will help you make the best choice for your financial situation.
Payday Loans – The Basics
A payday loan is a short-term loan with a high interest rate designed to provide you with quick cash. The amount you can borrow is relatively small, often $500. But the interest rates for these loans are relatively high, often equivalent to a 400% annual percentage rate (APR) or more. As the name suggests, the loans are designed to provide you with a cash advance on your next paycheck. When the paycheck arrives and the loan becomes due, you’ll owe the loan balance plus a hefty fee.
Regulations Vary by State
Before worrying about the terms, you should know where your state stands. State laws regulate these loans, so they can look very different, depending on where you live. Most states regulate them, some prohibit them, and a few don’t have restrictions.
33 states allow the loans but limit the fees, loan amounts, and terms.
13 states prohibit the loans: Arizona, Arkansas, Connecticut, Georgia, Maryland, Massachusetts, New Jersey, New Mexico, New York, North Carolina, Pennsylvania, Vermont, and West Virginia.
Four states allow the loans with no fee restrictions: Delaware, Idaho, Nevada, and Texas. A couple of these states limit the amount lenders can loan and the repayment period.
Many states that allow payday loans require the lender to be licensed. If they’re not licensed, the loan may be considered void and the lender will lose its rights to collect the money.
Roughly half the states that allow payday loans set a maximum loan amount of $500. The other states vary a lot. For example, California’s cap is $300, while Wisconsin’s is $1,500. Lenders don’t have to loan the maximum amount, and they’ll likely take your income into consideration when deciding how much to loan.
You typically need to repay the loan and fees in 2-4 weeks. Many states set the limit at 31 days, but it varies a lot. Lenders just need to comply with state law when setting the term. While other types of loans are repaid in monthly installments, payday loans typically must be repaid in full on the due date. This includes both the loan balance and fees.
The finance charge (fee) is a key factor to consider. The interest charge is typically expressed as a fee because it’s a one-time payment. Many states that allow the loans set a limit on the fee, often ranging from $10 to $30 for every $100 borrowed. The fee starts to look scary when you compare it to other rates, such as rates on personal loans and credit cards. You can compare it to other rates by using the APR.
For example, if your loan amount is $500 and the fee is $20 for every $100 borrowed, your fee will be $100. Let’s say the loan term is two weeks (14 days). Knowing this, we can compute the APR, but it takes a few steps.
First, divide the total fee by the amount borrowed: 100/500 = .2.
Next, multiply that by the number of days in a year: .2 x 365 = 73.
Next, divide that by the loan term: 73/14 = 5.21.
Finally, multiply that amount by 100 to get a percentage: 5.21 x 100 = 521% APR!
For comparison, the APR for credit cards typically ranges from 12% to 30%. It’s even less for personal loans. States vary a lot when it comes to the APR and it’s not always easy to compute. But the amount can range from 36% (New Hampshire) to 1,950% (Missouri).
How Payday Loans Work
Payday loans are typically available online or at in-person locations. Lenders make it easy to get these loans. There’s usually no credit check. This streamlines the process and makes it easier for borrowers with a bad credit history to get approved.
Along with your application, a payday lender will typically request identification and evidence of your earnings like a driver’s license and a pay stub. They will also likely require you to provide a way they can be repaid. This may be either a post-dated personal check made out to the lender or your permission for them to electronically withdraw money from your checking account (along with all of the necessary account information). Online lenders typically just ask for the account information.
The lender will give you the loan funds in cash or by check, or it will direct deposit funds into your checking account. You’ll usually get the cash or check the same day, but it may take up to two days for a direct deposit into your account.
Most payday loans are repaid with a single payment at the end of the term. How you make the payment may depend on how you took out the loan. Some in-store lenders encourage you to return to the store to repay the loan. If you don’t return, the lender will cash the check you provided or withdraw funds from your account. Online lenders typically access your checking account for repayment.
Why Payday Loans Can Be Uniquely Problematic
While payday loans can be easy to get, financial experts strongly advise against them. The loans are problematic for several reasons.
Most traditional loans have a repayment plan of well over a month and the monthly payment is often tailored to your ability to pay. Payday loans, on the other hand, typically require full payment in 2-4 weeks. There’s a reason this causes many people to default. Most people take out these loans to deal with an emergency need for cash. The loan may address the emergency, but life’s other expenses are still there when the loan is due and it catches many people short.
Payday loans are also very costly debt. The fees add up quickly and have to be paid off when that next payday arrives. Many states are taking steps to restrict the fees, but they’re still very high. While California caps the finance charge at 15%, a $300 loan payable in 14 days still has an APR of 391%!
If you can’t pay off the loan, the “refinancing” options from lenders can be expensive. If allowed under state law, lenders may let you roll over your loan for an additional term. But they’ll likely charge new fees each time you do this, which can quickly double or triple your loan cost. And, of course, you’ll continue to owe the principal amount as well.
Some borrowers continuously get new loans to make ends meet. They may see this as their only option if they’re living paycheck to paycheck. This can lead to spiraling debt. They may even end up paying more in fees and charges than they originally borrowed.
The loans are also unique in that the repayment could require you to give up income that might otherwise be exempt from traditional collection efforts. Exempt funds include Social Security payments and student loan disbursements. By giving a payday lender a check or access to your checking account, you’re allowing them access to any exempt funds.
Finally, the Consumer Financial Protection Bureau (CFPB) recently revoked a rule intended to curb payday lending to borrowers without the means to repay. As a result, they may be more widely available to those who are at a greater risk of default.
Payday Loans and Your Credit Score
There’s typically only a downside for your credit score when it comes to payday loans. Because lenders don’t report the loans to credit bureaus — Experian, Equifax, and TransUnion — paying back the loan isn’t going to improve your credit. But if you fail to repay the loan on time, the lender may send your loan to a debt collector. They will have the option to report the collection activity to the credit bureaus. If they do, it will hurt your score.
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What Happens if You Default on a Payday Loan?
Payday lenders are in the business of making loans, and they’ll be prepared if you default. They’ll first turn to the loan agreement for remedies. If they can’t collect the full unpaid balance, they may sell your loan to a collection agency.
The loan agreement will likely state what happens if you default. This typically includes additional fees, including a significant late fee and an interest charge for the extra time you take to repay the loan. You may even be charged a bank fee if the lender tries to cash the check you wrote and there are insufficient funds in your account.
Bank Account Withdrawals
The loan agreement may give the lender permission to withdraw money from your account. They can empty out your account if necessary. If they can’t the money all at once, they can take it out in smaller amounts over time.
To make things worse, each failed attempt to pull the money out of your account could result in a bank overdraft charge. But the CFPB has issued rules designed to limit how often a lender can do this.
Lenders may initiate collection efforts, such as calling you at home or at work. If that doesn’t work, the lender may sell your loan to a third-party debt collector. They will likely try more aggressive collection efforts. Fortunately, the Fair Debt Collection Practices Act (FDCPA) prohibits abusive and deceptive collection practices and limits what debt collectors can do.
The lender or credit agency can also file a lawsuit against you. If successful, the court will issue an order stating how much you legally owe. This order is called a money judgment. This potentially opens the door for them to pursue serious collection methods, including wage garnishment, a bank account levy, or placing liens on your property. Consider getting legal advice if this happens.
Negative Credit History
Having collection activity reported to the credit bureaus will hurt your credit score. This will make it harder to get loans in the future.
A payday lender can’t threaten to have you thrown in jail or otherwise use the criminal process as leverage to collect the debt. Defaulting on the loan is not a crime.
What To Do if You Can’t Pay Your Payday Loan
Emergencies happen and sometimes you need quick cash. Even so, a payday loan should be your last resort. See if you can get a different type of loan or borrow from a family member first. If you do take out a payday loan for an emergency, do everything you can to pay it back on time and avoid rolling it over. If you can’t pay it back on time, there are some things you can do.
Check state law.
Most states that allow payday loans restrict the terms. Make sure the loan follows the law. Also, many state laws require payday lenders to offer extended payment plans (EPPs) that let you repay your loan over a longer period of time. Your state attorney general's office may also have useful information.
Negotiate with the lender.
If you’re at risk of defaulting, consider talking to your lender about a payment plan. Lenders want to get paid and sometimes they’re willing to compromise and even take less than the unpaid balance. Lenders aren’t anxious to send the loan to a collection agency because they lose money.
Refinance and pay it off with other debt.
Look for other forms of less expensive debt to pay off the loan. A personal loan, for example, will have a better interest rate and repayment term. The rate may be higher if your credit history isn’t great, but it will still be less than the fees that are piling up.
A consolidation loan is another option if you need to pay off several high-interest loans or debts like credit cards. The goal of this type of loan is to pay off multiple debts with one loan that has one monthly payment that fits your budget. Payday alternative loans (PALs) are another option some credit unions offer their customers.
Consider filing for bankruptcy.
Depending on your financial situation, filing for bankruptcy can be an option to help you with debt you’re unable to repay. It stops collection activity and allows you to get back on your feet. Most payday loans are dischargeable in Chapter 7 bankruptcy.
Ask for help.
Payday loans are easy to get but can be very difficult to deal with if you can’t repay them. If you’re not sure what to do, you can get advice from a nonprofit credit counselor, bankruptcy attorney, or legal aid office. Credit counseling, for example, can help you get out from under a pile of debt. A credit counselor can help you set up a debt management plan (DMP) and negotiate with lenders.
Payday loans are short-term, small loans with very high fees that are regulated by state law. Many states ban them and most states restrict them. A typical loan amount is $500 and a typical term is two weeks. The idea is to provide you with money from your next paycheck a few weeks early. But it comes at a high cost. While the APR for a credit card is less than 30%, the APR for a payday loan is often around 400%.
The application process is simple but the loans can be problematic due to the short payment term, the fees, and the costly refinancing options. There are also severe consequences if you default. Fortunately, there are a few things you can do when faced with a default, including negotiating with the lender, refinancing with less costly debt, and asking for help from credit counselors or a bankruptcy attorney.