Payday loans can provide cash in a hurry that will help you get the next paycheck. These loans can lead to debt traps for borrowers due to their high-interest rates and fees. Editor’s Note: Credit Karma is compensated by third-party advertisers. However, this doesn’t change the opinions of our editors. Our editorial content is not reviewed, approved, or endorsed by third-party advertisers. It is accurate to the best knowledge at the time it was posted.
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Payday loans may seem like a lifesaver when you have an urgent need for cash, but they can also lead to debt due to the high fees and short repayment terms.
Although there is no standard definition for payday loans, they are typically short-term loans for $500 or less that you pay on your next payday.
Although these loans are advertised as a way of bridging the gap between your paychecks or helping with an unexpected cost, the Consumer Financial Protection Bureau warns that payday loans can be “debt traps.”
Here’s the reason: Borrowers often can’t afford to repay the loan or pay the fees. They end up paying more fees by “rolling over” the debt, refinancing it, and ultimately paying more fees than they borrowed.
How payday loans work
Although payday loans are sometimes called cash advance loans, deferred deposit loans, or check advance loans, they all work the same way.
You may need to send a postdated cheque to the lender to cover the entire amount plus any fees to get a payday loan. You can also authorize the lender electronically to debit your checking account. The lender will usually then give you cash.
The loan is due on your next payday. This usually takes between two and four weeks. The lender may cash your check, or debit your bank account electronically if you fail to repay the loan and finance charges on the due date.
Many states that allow this type of lending have a limit on the number of loans and associated fees. Companies may charge $10-30 per $100 borrowed, depending on where they are located.
What state regulations apply to payday loans?
Your state may allow you to get other types of personal loans, even though there is no standard definition of what constitutes payday loans. This chart will help you understand the restrictions that apply to what is considered a “payday loan” in your area.
Keep in mind that APR does not always refer to the interest rate. For example, a 14-day loan at 10% interest would translate to 260.71% APR.
High Annual Percentages
Imagine that you receive a $500 loan for two weeks. The fees are $15 per $100 borrowed. According to the CFPB, this works out to an annual percentage rate of nearly 400%.
Payday loans are typically repayable within two to four weeks after the original loan was approved. You should check the regulations of your state as policies can vary.
Additional fees may be charged if you are unable to repay the loan in the agreed time. These fees can add up if the debt is rolled over or re-borrow. According to the CFPB, nearly 25% of payday loans are re-borrowed nine or more times.
Additional fees may include:
Nonsufficient funds fee, if there isn’t enough money in your bank account to pay the loan lenders for cashing your check or withdrawing electronically from your account.
Pay the lender for late fees or return-payment fees if you fail to repay your loan on time
Rollover fees, added to the original loan amount and an initial fee to extend your loan’s due date
Will not build credit
People with poor credit may not be eligible for loans with better terms. Payday lenders don’t usually report your payment history to credit bureaus. This means that the loan won’t help build credit.
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Alternatives to Payday Loans
Payday loans can be a quick fix but there are other options available that will help you avoid falling into debt. These are some options.
You may be eligible for lower-interest personal loans if you are a member of a credit cooperative or can join one. Federal credit unions might also offer members alternative loans to help them pay for small amounts, such as $200-$1000. These loans typically have terms of up to six months and a $20 application fee. APRs are no higher than 28%.
Your employer may be able to advance your paycheck without any fees in some states. This decision is up to the company. Ask your supervisor or someone from human resources about your options.
Mobile apps such as Earnin or Dave can also be used, which will allow you to earn money between your paychecks if certain conditions are met.
Although personal loans can have high-interest rates, you should compare the rates of other lenders. Although you may be eligible for a lower rate and shorter terms than the payday lender in the store, you will not know until you shop.
Look for a lender that reports to major credit bureaus when you are looking for a loan. You can build credit by showing good track records of paying on time for your loans. This will help you qualify for better rates.
You can also work long-term to fix the financial issues that are causing you to be turned down at payday loan counters. Credit counseling could help you create a budget and start a savings account.
Payday loans can be a bad option if you need cash fast.
It is a smart idea to compare loan options and make long-term financial changes that could make a difference. You can start by making a budget, and creating a plan to pay off your debt.