Nearly half of Americans don’t have enough in savings to cover a $400 emergency, according to a report from the Federal Reserve. In other words, 47% of the population is living paycheck to paycheck — so what can they you do when money runs short before the next check comes in? As you might guess from its name, that’s what a payday loan is for. A payday loan is a short-term, high-interest loan designed to bridge the gap between paychecks when you have an immediate need for cash. It’s generally recommended you use payday loans with caution (we’ll explain why in a minute), so before you take out a payday loan, here are some things you need to know.
What is a Payday Loan?
There are many terms for this kind of credit — payday loans, cash advance loans, check advance loans, deferred deposit loans or post-dated check loans — and you can get them from a variety of sources. Whether you walk into a payday lender’s store or apply online, the process is basically the same: You provide some personal and financial information, request a loan for a certain dollar amount (secured by a check or your bank account debit authorization), pay a fee for the loan and receive the cash (or a deposit into your bank account). Several factors will determine how much you can borrow, but your credit isn’t one of them. (The “no credit check” aspect of payday loans, along with terms like “fast cash” and “easy” are usually the main selling points in payday loan ads and part of what makes them so appealing to some borrowers, though new rules proposed by the Consumer Financial Protection Bureau in 2016 do require short-terms lenders to measure a person’s ability-to-repay in certain instances.)
Payday loans can be very costly. The loan amounts generally range from $50 to $1,000, depending on your state’s laws. The fees also depend on state law, but the structure might be something like a $15 fee per $100 borrowed, and some states may have a cap on how high the fee can go. Because the loans have such short terms, the cost of borrowing is generally very high. A typical payday loan with a two-week term and a $15 per $100 fee has an annual percentage rate (APR) of nearly 400%, according to the CFPB.
How Does it Work?
Say your car broke down and you decide to borrow $300 for the repairs from a payday lender. You’ll write a post-dated personal check for $340 (the amount plus a $40 finance fee) made payable to the lender. You enter this information online when applying for a payday loan through the internet. The lender then advances you $300 for a set period, usually 14 days. When that period is up, you pay the lender $340 in cash, let them deposit the post-dated check or write another post-dated check for the amount plus an additional finance fee.
If you do not pay the debt in full at the end of the term, you will be charged additional fees and finance charges.
Who Uses These Types of Loans?
Twelve million Americans use payday loans every year, according to the Pew Charitable Trusts. Generally, anyone with a checking account and steady income can obtain a payday loan. However, it is most common for borrowers who don’t have access to credit cards or savings accounts to use this type of lender. Since these loans don’t require a credit check, people with no credit or credit problems often turn to payday loans.
The Pew report found these common characteristics among payday borrowers:
- They’re renters
- Earn less than $40,000 a year
- Do not have a four-year college degree
- Are separated or divorced
- Are African-American
According to that same report, the average borrower takes out eight loans of $375 and spends $520 on interest alone by the time the initial loan is repaid.
What Are the Benefits?
Payday loans can be a good tool for quickly and easily borrowing cash during an emergency if you don’t have other financial options. For example, you might use a payday lender for an immediate and temporary financial need such as a medical bill, car repair or other one-time expense. Payday loans are helpful for people who don’t have credit cards or savings available. Because the loans do not require a traditional credit check, they are easy for people with financial problems to obtain.
What Are the Negatives?
It is crucial that you repay a payday loan as soon as possible. Many people get into trouble with these types of loans when they are unable to quickly repay the debt. If you can’t repay the loan at the end of the term, you’ll be charged expensive additional fees. It is very costly to be stuck in a payday loan cycle for a long time and can lead to larger financial problems. Payday loans are also much more expensive than other methods of borrowing money. In most cases the annual percentage rate (APR) on a payday loan averages about 400%, but the APR is often as high as 5,000%. APRs for credit cards can range from about 9% to 30%, and personal loans generally have lower APRs than credit cards. If possible, it is better to use a credit card or tap into your savings in the event of an emergency.
What About Usury Laws?
Numerous states have very specific laws that regulate the lending industry. Called “usury laws” these regulations define permissible lending terms and rates. Some states also have laws that regulate the amount a payday lender can lend to consumers and how much they can charge for the loan. Other states ban payday lending outright, such as New York. These laws vary widely. Payday lenders often work around these regulations by partnering with banks based in other states, such as Delaware. It is important to read the fine print on the payday loan offer and understand your consumer rights.
Should I Apply for a Payday Loan?
Before you consider applying for a payday loan, step back and consider your options.
Ask yourself if it really is an emergency. Payday loans can be helpful for one-time emergency costs such as medical fees but are not a good idea for funding unnecessary expenses. Is it possible to wait to repair your car or pay your bills until your next paycheck? A late fee on a bill may be cheaper than a finance charge for a payday loan. Think about other ways to borrow money, keeping in mind that they’ll have different fees, pros and cons.
Alternatives to Payday Loans
- Negotiate a payment plan with the creditor
- Charge the amount to your credit card
- Receive an advance from your employer
- Use your bank’s overdraft protections
- Obtain a line of credit from an FDIC-approved lender
- Borrow money from your savings account
- Ask a relative to lend you the money
- Apply for a traditional small loan
- Ask your creditor for more time to pay a bill
- Use a cash advance on your credit card
If you have evaluated all of your options and decide an emergency payday loan is right for you, be sure to understand all the costs and terms before you apply.
- Shop around for a trusted payday lender that offers lower rates and fees.
- Borrow only as much as you know you can pay back with your next paycheck.
- When you get paid, your first priority should be to pay back the loan immediately.
What Can I Do to Prepare for Financial Emergencies?
You can’t always predict an emergency, but you can be prepared. Ideally, you should keep enough money to cover your household expenses for two months or more in a savings account. If this goal is too high, aim to save at least the amount of one paycheck. It is also a good idea to have a few credit cards available for unexpected costs. If you don’t have a credit card, you can search for a credit card online — even people with no credit or bad credit can get credit cards. You can see where your credit stands by viewing two of your credit scores for free on Credit.com.