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Loans updated: 05-27-2019
Payday Loans the ultimate guide
You can't turn on the TV or drive through a major city without seeing advertisements for payday loans. These short-term loans promise a cash loan same day regardless of credit history or source of income and they can be very appealing if you are facing a financial emergency, need money in a hurry, or you can't qualify for traditional loans. Before you take out a payday loan, make sure you know exactly what you're signing up for.
How Do Payday Loans Work?
Payday loans are pretty straightforward. A payday loan is a short-term loan that gives the borrower cash in hand or a direct deposit into their bank account. In exchange for the loan, the borrower either needs to give the lender electronic access to their bank account or a personal check that is held for deposit when the loan is due. You can get a payday loan at a storefront or online and have the cash within an hour.
Payday loans or cash advance loans seemingly offer a cost-effective service to help you get over an unexpected financial crisis. You can walk into a payday loan storefront and walk out with $350 to cover an expense. On your next payday, the $350 plus another $50 in fees comes out of your bank account automatically.
If you don't have enough money in your bank account when the loan amount is withdrawn, you can face penalty fees from the payday lender plus non-sufficient fund fees from the bank. At this point, you have the option to renew the loan, which means rolling over your loan for another two weeks. Instead of paying the full balance, you may only need to pay the interest due -- in this case $50. In another two weeks, you will now owe even more. In addition to the original loan amount, you will need to pay the new interest charges, a fee to renew the loan, and any penalties for being late the first time.
Payday loans are different than personal bank loans in many ways.
Short Loan Term
Payday loans are meant to be paid back when you next get paid. Most loans have a two-week term, but the term can be up to 4 weeks.
Small Loan Amount
When payday loans are legal, there is typically a cap on how much you can borrow. In most cases, a payday loan ranges from $300 to $1,000. The typical payday loan is $375.
Not an Installment
A typical personal loan allows you to make payments on the loan over time. A payday loan is not an installment loan; instead of making regular payments, you will need to pay back the whole loan amount and interest at once.
Payday loans have very high-interest rates, especially when compared to bank loans. Depending on your credit score, a bank loan would have an annual interest rate of 2.5% to 29%. Payday loan borrowers all pay about $15 per $100 borrowed. While this sounds reasonable, it's not the same as 15% APR because the loan only lasts 2 weeks. A loan's APR is the cost of the loan over a year. With a cost of $15 per $100, a payday loan has an APR of 390% if the loan is held for a full 12 months.
Loan is Repaid Automatically
Another important feature of a payday loan is the loan amount and interest charges are repaid automatically when the lender cashes the personal check you provided to get the loan or withdraws the money directly from your bank account on the due date.
Loan is Easy to Renew
With a payday loan, you can go back to the lender if you can't afford to pay on time and renew the loan. In this case, you pay only the fees due, usually without making any payment toward the principal balance, and get another two weeks to pay back your loan with a new interest payment. This feature makes it easy for consumers to get trapped in a payday debt cycle and take months to pay back a small two-week loan.
No Credit Check Required
The fact that a credit check is not required makes a payday loan easy to get, especially for consumers who have very limited access to credit. You do not need any credit at all to get a payday loan, only a bank account and proof of income.
The Average Payday Loan Borrower
There's a stigma attached to payday loans that only financially ignorant people use them. This harmful idea couldn't be farther from the truth. Pew studies find that over half of households in the United States live paycheck to paycheck, including people who are firmly in the middle class. There are also about 70 million Americans who are considered "unbanked" or "underbanked," which means they do not have or cannot get services from a traditional bank. When an unexpected financial crisis hits, millions of Americans have no savings to cover it and very little options for borrowing the money they need.
The simple truth is there are millions of people who have no other credit options than payday loans when they need to repair their car, cover essential medical expenses for a child, or keep food on the table. The payday lending industry grew substantially during the recession when banks shut down over 20,000 branches, most of which were in low-income communities, between 2008 and 2013.
Many consumers actually find that payday loans are a more financially sound solution than alternatives that may require service fees, minimum balances, and fees for overdrafts and bounced checks.
Is Criticism Fair?
In many ways, criticism toward payday loans is fair. While a payday loan can be used responsibly to overcome a short-term financial problem as advertised, a disproportionate amount of borrowers become trapped in debt, taking out up to one dozen or more payday loans in a year, paying thousands to borrow a few hundred, and incurring bank fees in addition to lender fees.
The Debt Trap of Payday Loans
According to the CFPB, borrowers who take out payday loans now often become overwhelmed by high fees and trapped in a cycle of renewing the loans while the balance grows. The CFPB found that nearly 80% of payday loans get renewed into new loans while fees continue to accrue. About 45% of consumers take out a minimum of four payday loans in a row. The CFPB also found that payday borrowers pay an average of $15 in fees for every $100 borrowed which is equivalent to a 391% APR on the average loan of $350.
Payday loans are designed to last for just two weeks, but the average payday borrower is in debt for 200 days out of a year.
While payday loans should, in theory, never go into collections because the lender automatically takes the money out of your checking account, the truth is you can still be hit with bank fees and lender fees if the money is not there in time. Even worse, a payday lender will not stop trying to get the money after one attempt; the lender can keep trying to withdraw the money it's owed or break it into smaller amounts that are more likely to go through. These subsequent withdrawals can happen when you least expect them.
If this doesn't work and the lender still doesn't get all of the money it's owed, you will likely receive phone calls and even demand letters from an attorney. The next step is the lender selling the debt to a collection agency that has the right to sue you in court for the amount you owe. If the collection agency wins, it will get a judgment against you and the ability to garnish your wages. Wage garnishment can continue for months or years until the full amount is paid back.
Payday lenders don't report loans to credit bureaus, but the collection agency usually will. This causes damage to your credit score and makes it harder to improve your credit to qualify for a bank loan.
Payday Loans Can Be Impossible to Afford
The fact that payday lenders do not need to consider a borrower's income in most states can also be detrimental. Even when states impose a cap on how much a consumer can borrow based on their income, the loan can still be virtually impossible to afford. For example, Utah's proposed payday loan reform in 2014 made a reasonable requirement for lenders to determine how much a consumer can afford, but the payday lending industry has no form of underwriting. This means payday lenders can consider the borrower's gross (not take-home) income and base "affordability" on the loan amount and interest without considering fees.
This provision also fails to consider any other obligations the borrower has like credit card payments, rent, a mortgage, and medical expenses. It's possible for a borrower to wind up owing half of their paycheck to the lender and being unable to afford their loan and other obligations.
The fact that payday lenders usually get access to their customer's bank account also means they are always first to get repaid when the paycheck is deposited, no matter how the customer would prefer to prioritize his or her debts.
On the flip side, this can be a benefit for consumers who are unable to qualify for a traditional bank loan due to self-employment income, irregular income, or a non-qualifying source of income like disability or pension benefits. It is worth noting that some payday lenders do choose to voluntarily assess a borrower's ability to repay the loan to make loans responsibly. Borrowers can also choose how much they want to borrow and determine a loan amount that they can afford, with fees.
Despite a great deal of bad press about payday loans, and even a recent decision by Google to ban ads for payday loans on its search results, the fact is millions of consumers rely on payday loans with few alternatives. A study by George Washington University even found that 89% of borrowers were somewhat or very satisfied with the service and 86% believe that the payday lending industry provides a service that is useful. This study did suggest that many consumers feel relieved by taking out a payday loan because they are desperate for help. For 37% of borrowers, desperation was listed as an important factor in influencing their choice to get a payday loan.
According to a Pew report in 2012, about 12 million Americans take out at least one payday loan every year. The average payday borrower is:
- Between 25 and 44. About one-tenth of Americans in their 20s and one-tenth in their 30s have used a payday loan in the last 5 years. Americans over the age of 60 are the least likely people to use a payday loan.
- Low-income. Most people who get a payday loan are below the median household income level of $53,600. Over 70% of payday loan borrowers have household income below $40,000.
- Somewhat uneducated. Over half of payday loan borrowers have just a high school education.
- Divorced or separated. While divorced or separated people only account for 13% of U.S. adults, they make up one-quarter of payday loan borrowers.
- Renters. People who rent are significantly more likely to use payday loans than people who own their home.
- Disabled or unemployed. You don't need wages to qualify for a payday loan; lenders accept disability and unemployment benefits as income. This means people who are unemployed or disabled have a means of obtaining credit that is not available with a traditional lender.
It's also important to point out that while the payday lending industry markets the product as a way to cover unexpected expenses like car repair, the Pew survey found about 70% of borrowers use the loan to cover basic expenses like utilities, rent, and food. Just 16% used the loan for an unexpected, one-time expense.
The Difficulty in Regulating Payday Lending
In the summer of 2016, the Consumer Financial Protection Bureau proposed new rules that would shake up the industry and potentially reduce the risk of borrowers becoming trapped in a cycle of debt. The proposed rules would require lenders to verify borrowers can actually afford their loans, much like the burden placed on banks and traditional lenders. The only exceptions to this rule would be when the loans are for $500 or less or have an interest rate of less than 36%.
The proposed rules would also cap the number of times consumers can take out successive payday loans. After the third loan renewal, borrowers would need to enter a cooling-off period in which they could not get a new payday loan for at least 30 days.
In a further step to protect consumers, the proposed rules would require lenders to provide written notice at least three days before attempting to debit a bank account with an explanation of how much money will be debited and when. Currently, payday lenders usually have access to the customer's bank account to automatically debit the account. If there is not enough money in the account when the money is withdrawn, the customer will face high fees from the bank as well as the lender.
The Community Financial Services Association of America (CFSA), a national trade organization representing the payday lending industry in the U.S., was quick to argue that the CFPB goes too far in proposing national legislation for payday loans by saying it would cut off credit access to millions of Americans who need small loans to cover unexpected expenses.
Regulating payday lending has largely been left up to individual states with mixed results. While many states place limits on payday loans, lenders have found loopholes to get around these rules. The payday lending marketplace accounts for about $40 billion per year and serves over 19 million households; an industry this size can be powerful and resist change with a team of lobbyists and attorneys.
Take, for example, the case of Georgia, which effectively banned payday loans in 2004 by putting in place a strict interest rate cap with high fines and criminal penalties for lenders who ignore the law. While Georgia consumers have been reported to save over $350 million since the law passed, short-term lenders have adapted to the rule by instead promoting similar alternative products like high-interest installment loans and car title loans.
Sometimes getting around regulations requires the lender registering as a different type of business to avoid oversight or simply changing its advertising, but sometimes it's done in a way that can be hard to predict. When lenders in Georgia began advertising installment loans instead of payday loans, they required collateral much like a pawn loan to secure the loan. To get around interest rate caps, they instead charged "fees," such as unnecessary life insurance fees and other hidden costs.
Depending on the state, common ways to limit or regulate payday loans include:
- Capping the number of renewals on a payday loan
- Requiring a mandatory cooling-off period between loans or that a certain amount of the balance must be paid off to renew the loan
- Limiting the number of outstanding loans per consumer
- Instituting payment plans to give a borrower more time to pay without additional interest or fees
- Capping loan amounts based on a borrower's income
According to the Center for Responsible Lending, however, these provisions are usually no more than smoke and mirrors. A rollover ban can be circumvented by allowing a consumer to repay the existing loan and take out a brand-new loan immediately. A cooling-off period can be avoided by going to another payday lender in the area after just one day and getting another loan. According to a study the Center conducted in 2007, 63% of payday loans in Florida went to borrowers with at least 12 payday loans per year while 85% went to borrowers who took out at least 7 loans every year. 45% of the new loans were made a day after a previous loan was paid.
Regulations on payday loans vary a great deal from state to state, but all states generally fall into one of three categories:
- Permissive states with few restrictions. 28 states have very few regulations on payday loans. Lenders may charge $15 or even more for every $15 borrowed with very high-interest rates equivalent to up to 900% APR. Most do limit how much you can borrow, however.
- Restrictive states that ban payday loans. 15 states and the District of Washington ban payday loans completely. Some states cap interest rates at 36% to make payday lending an unprofitable business. It's important to realize that you can still legally get an online payday loan in these states.
- Hybrid states with some regulation. 8 states have a moderate amount of regulation, such as capping interest at $10 per $100 borrowed, limiting the number of loans you can take out per year, or requiring terms longer than two weeks to make payday loans into installment loans.
The Pew report has shown that fewer people use payday loans in states that are more restrictive, despite access to online payday lenders.
Military Lending Act and Payday Loans
The Military Lending Act (MLA) gives active-duty servicemembers and dependents additional protection against predatory and high-interest loans, including payday loans. Under the MLA, active-duty servicemembers and dependents cannot be charged an interest rate above the 36% Military Annual Percentage Rate (MAPR) on most types of consumer loans. The MAPR includes other costs to calculate your loan cost, including finance charges, credit card fees and premiums, add-on products sold with credit, and fees like application fees.
In addition, creditors and lenders can't require that active-duty servicemembers create a voluntary military allotment to have loan payments automatically withheld from their paycheck to pay off the loan.
Along with payday loans, the MLA also includes car title loans, deposit advance products, and installment loans with some exceptions.
Alternatives to a Payday Loan
The best way to avoid the payday loan trap is to look for alternatives instead. If it's essential that you get extra money to cover an unexpected bill or make it to the end of the month, here are alternatives to consider first.
Pay Bills Late
If you're considering a payday loan to avoid paying a credit card, mortgage, rent, or utility bill late, it's probably better to just pay the bill late rather than paying the high fees of a payday loan. The average fee for a $375 payday loan is $56.25 to borrow money for two weeks, but a credit card late payment fee is just $27 (or $37 for a second or subsequent late payment). A late mortgage payment has a $30 fee on average and landlords are usually only allowed to charge up to 5% of the rent as a fee and only after rent is up to 10 days late. The same is true for a car loan, as there is typically a 10-day grace period with an average late fee of $15.
If you go this route, just be sure you know the consequences of paying late and don't let the bill go so long that your vehicle is repossessed (usually after 30 days late) or your account goes to collections.
Request an Extension
Most service providers allow you to request an extension to pay your bill if you can't meet the due date. This is true with most cell phone, internet, cable and satellite, and utility providers. If your payment will be late, call your service provider and let them know what's going on. Ask for an extension until payday to bring your account current. This may not even incur any late fee or other penalties and it can keep the utility company from turning off your water or electricity.
Negotiate with Credit Providers
If existing debt is pulling down your finances, it's worthwhile to first start with your current creditors to negotiate a better rate, payment, or terms. Your creditors don't want you to file for bankruptcy, in which case they likely get nothing, so they may be willing to work with you to negotiate your terms to make your payments more affordable.
There are many ways to negotiate your debt, including:
- Changing your due date to a more convenient time of the month
- Reducing your interest rate (which makes the balance easier to pay down and lowers payments)
- Requesting a temporary payment reduction
- A forbearance agreement in which you make no payments for a specific period of time
- A long-term repayment plan with no or reduced interest charges
- A settlement payout in which you pay off the debt at a reduced amount
If you can't find ways to cut back to get the money you need, it's okay to ask for help. Short-term assistance comes in many forms to help with utilities, rent, and food. Community organizations and churches sometimes even offer short-term loans with no interest charges.
Government programs that may be able to help include:
- Medicaid, which offers free or low-cost health coverage to low-income households.
- Supplemental Nutritional Assistance Program (SNAP), which offers food aid for low-income households. Once called food stamps, SNAP benefits come on an electronic debit card.
- Low Income Home Energy Assistance Program (LIHEAP) offers help with heating and air conditioning for low-income households. This program can help with minor repairs to HVAC systems and weather emergencies in addition to helping you pay for energy costs.
- The Department of Housing and Urban Development (HUD) offers help with subsidized housing and public housing to cover part of your rent.
Pawn or Sell Belongings
When you absolutely need money in a hurry, you may need to make sacrifices. Look for somewhat high-value items you can do without such as jewelry, tools you don't use, collectibles, and electronics. You can start by trying to sell the items on your own through an online auction site, Craigslist, or a yard sale app.
If you can't sell the items yourself or don't have the time, you can take your belongings to a pawn shop. Pawn shops allow you to sell items outright or get a pawn loan in which your belongings serve as collateral. Unlike payday loans, pawn loans are secured by the property you hand over. These loans can last for 1 to 4 months and have a fee of 5% to 25% of the loan amount per month. If you can't pay off the loan when it's due, the pawn shop keeps your property and that's the end of the loan. You will never need to worry about debt collectors, penalties, or overdraft fees.
Request an Advance on Your Paycheck
Another option is simply requesting an advance on your paycheck instead of taking out a payday loan. If you are employed at a large company, your human resources department can let you know if you can get an advance. If you work for a small business, ask the owner directly.
With a payroll advance, you are only getting an advance on money you've already earned. The downside to an advance is your regular paycheck will be smaller so you'll need to be careful that you don't fall behind. A paycheck advance is not always possible, either, as some companies only allow them when you have worked for a specific amount of time and others require that the money be necessary for an emergency. Some employers offer low-interest, short-term loans instead of payroll advances.
There is also an internet company that offers payroll advances with no fees at all. Activehours allows you to send a picture of your timesheet to show how much you've worked to get an advance to your bank account of up to $100 per day. When your paycheck is deposited, the money owed is taken back out of your account. This service has no fee, but you can choose to "tip" for the service.
Try an Online Lender
Online lenders come in all forms, from payday lenders to peer-to-peer lending platforms. With some online lending websites, you will need good to excellent credit to qualify, but this is not always the case. Some lending websites connect low-income borrowers with lenders willing to make a loan. The downside is you may not qualify depending on your income and credit history.
Other Options to Consider
Depending on your situation, the following options may also be worth exploring. While most have fees and other penalties, they may be less than using a payday loan.
- Withdraw from your retirement plan.
- Borrow from a 401(k).
- Borrow against a life insurance policy with a cash value.
- Use a credit card. Even a cash advance is likely more affordable than a payday loan.
- Ask for overdraft protection on your checking account.
- Borrow money from a friend or family member.
If You're Set on a Payday Loan, Do This...
If you have exhausted alternative options and you are sure a payday loan is the best option, don't make the mistake of walking into the first payday lending storefront you see and accepting whatever terms you're offered.
Start by shopping around for a reputable payday lender in your area or online that offers the lowest rates and fees possible. You don't need to commit to a loan to get a quote; request quotes from several companies before picking the loan option that is best for you. This process doesn't need to take much time, but it can save you a substantial amount of money.
Only borrow as much as you need and are sure you can pay back when you get paid. Ahead of your payday, budget to be sure you will have enough money in your bank account for the loan to be paid back and to meet your other obligations. As soon as you are paid, paying off the payday loan should be your first priority to avoid high renewal fees and additional interest charges.