Consumer Law

How Payday Loans Work: Facts and Warnings

By Amy Loftsgordon, Attorney
A payday loan is an easy way to get money quickly. But that money comes with a price.

If you don’t have a credit card or savings to use in a financial emergency, taking out a payday loan might seem like a great way to get cash quickly. But payday loans—in the states where they’re allowed—have a significant downside. Before you apply for one, you should fully understand how these types of loans work. You might think twice about getting one.

What is a Payday Loan?

A payday loan is a short-term loan that typically comes due on your next payday or the next time you receive income from some other steady source, like Social Security. The loan comes from a payday loan company or online vendor, not a bank. The loan amount is relatively small—normally $500 or less. In fact, many states have laws that limit the amount you can borrow.

Even if you have bad credit, it’s fairly easy to qualify for a payday loan. The most important factor that a lender will consider is how much you earn.

To get a payday loan, you typically have to provide proof of your income, such as two recent pay stubs. Payday lenders also ordinarily require that you:

  • be at least 18 years old
  • have an active bank account or prepaid card account
  • have an active phone number
  • show a valid government-issued photo ID (like a driver’s license), and
  • provide a social security number.

Despite the above requirements, in most cases, the lender won’t look at your credit report.

How Payday Loans Work

One way to get a payday loan is to give the lender a post-dated check. (Post-dating a check refers to writing a check, but putting a future date on the check instead of the date that you it.) In return, you receive a sum that’s less than the amount listed on the check. For example, if you write a check for $500 to the lender, you might get $440 in cash, with the lender keeping $60 as a fee. The lender then waits a few weeks, typically until your payday, and cashes the check once there is enough money in your account to cover the $500 check.

Another kind of payday loan starts with you signing an agreement giving the lender the right to take money out of your bank account or prepaid card account on your payday to pay back the debt. After you sign, the lender electronically deposits the loan money directly to your account. In our $500 example, the lender deposits $440 in the account and keeps $60 as its fee. In this kind of arrangement, the lender takes the repayment money directly out of the account on your next payday or other date listed in the agreement.

Payday Loan Fees

The fees on a payday loan are usually based on increments of the amount borrowed. Lenders often charge a fee of between $10 and $30 for every $100 of the loan amount. These incremental charges make the payday loan a very expensive way to borrow money.

Generally, the annual percentage rate (APR) on payday loans ranges from 200% to 500%. (The APR on a two-week payday loan that has a $15 fee per $100 borrowed is around 400%.) To reduce payday lending abuses, some state laws limit the amount a lender can charge for a payday loan. Other states have gone as far as making payday lending altogether illegal.

Rolling Over the Loan

If you can’t repay payday loan debt when it comes due, you might be able to “roll over” (extend) the loan. Of course, the drawback to delaying repayment on the loan this is that you’ll have to pay another fee to the lender.

For example, let’s say you took out a $300 payday loan for a $45 fee, but can’t pay it back on the due date. To extend the due date, you must pay another $45 fee. Now you are paying a cost of $90 for the $300 loan. If you roll the loan over again, you have to pay $45 for a third time. The loan has now cost you $135, which is almost half of the original loan amount.

People who take out payday loans often get onto a treadmill of debt, taking out one payday loan after another to cover accumulated fees. According to the Consumer Financial Protection Bureau, around 70% of people who take out a payday loan end up getting an additional loan within 30 days, and 20% of new payday loan borrowers take out ten or more payday loans in a row.

What Happens If You Don’t Repay the Loan

If you neither repay the loan on the due date nor roll it over, the lender will try to collect the debt by calling you repeatedly and sending aggressive letters. The calls and letters might threaten legal action, and the lender could end up suing you in court. If the payday lender—or a collection agency that buys the debt from the lender—eventually gets a court judgment against you, it might be able to garnish your wages or levy your bank account.

To avoid a lawsuit, you might be able to arrange a settlement with the lender to pay off the debt for less than you actually owe. Lenders are sometimes willing to consider reasonable settlement offers. A reasonable offer, though, is usually at least half of the full debt amount.

Getting Help

If you aren’t able to settle a payday debt and the lender sues you, you might—depending on your situation—want to consider filing for bankruptcy. For an explanation of the applicable law and information about how to handle payday loan debt, consider contacting a consumer protection lawyer or a debt collection defense attorney. To find out if bankruptcy might be appropriate in your situation, contact a bankruptcy attorney. If you want to file a complaint about a payday lender, contact the Federal Trade Commission.

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