What are Payday Loans and Why are They Bad?

It’s your worst nightmare: your car engine blew and you can’t get to work. But you have no emergency fund, all of your credit cards are overextended and payday isn’t for another two weeks. How can you get enough money to get it repaired without missing work?

If you’ve ever needed cash on short notice you may have tossed around the idea of a payday loan. While payday loans were first meant to help make ends meet occasionally, they can easily trap borrowers into a bottomless pit of debt. Before you head to the payday loan storefront, you need to understand why payday loans are bad.

What is a payday loan?

A payday loan is a small loan typically due on a borrower’s next paycheck, which is where the name “payday” loan comes from. You don’t have to have good credit to qualify and there’s no credit check. The only requirements are usually income and a bank account. But the cost of the loan is high: payday loans are notorious for high-interest rates and loan fees.

Payday loans are sometimes called cash advances, installment loans, or deferred deposit loans.

How do payday loans work?

Obtaining a payday loan is easy: visit a storefront or apply through a website, verify you have income and a bank account, and the lender will most likely give you the money. You will either receive cash or direct deposit immediately. Sometimes, a lender will require a postdated check for when the loan is due.

The loan is due usually within 14 days, plus a finance charge, which is effectively interest. However, if you can’t pay back the loan on the due date, things could turn ugly fast.

Why are payday loans bad?

While there is nothing wrong with a short-term loan to make ends meet, a payday loan is not cheap. The industry is ever-changing and many lenders lure unsuspecting consumers into a financial trap with sky-high interest rates and fees. 

Most borrowers won’t be able to pay back their original loan when the due date comes around, and they’ll have to take out another loan to pay off the first loan. As you can see this could become a vicious cycle and one you should try to avoid. In fact, more than 90% of payday loan borrowers end up regretting their original loan.

What happens when you don’t pay back the loan on time?

If you can’t and don’t pay back the loan on time, you may find yourself in even more of a crisis.

How so? You will not only pay the interest but an additional late fee. This goes on your balance. Then, you will start having to pay interest on that balance. If you don’t pay on the next payday, you’ll pay even more fees and more interest.

And guess what? You must pay interest on your interest. Just how high are the interest rates payday lenders charge? Very high. Sometimes the annual percentage rate is more than 600%.

And if you don’t make those payments? The debt collector will come after you and you could even end up in court.

Extremely high-interest rates

Payday lenders charge annual percentage rates (APRs) above 400%. By comparison, credit cards rarely charge higher than 30% APRs.

Therefore, the average payday borrower ends up spending $520 in fees just to borrow $375, according to the Pew Charitable Trusts.

The industry is known for predatory lending – signing up borrowers with poor credit to trap them into debt. There’s even a term for this: the payday loan debt trap.

The payday loan debt trap

Most people who take out a payday loan are already in a bad spot financially – otherwise, they wouldn’t be searching for a payday loan.

However, payday lenders know this and intentionally make language confusing and misleading. It’s in their best interest for you to miss your payments and accumulate debt. Let’s just say they’re banking on borrowers not being able to pay. They’re counting on you getting trapped in a cycle of debt you can’t repay as you make multiple rollovers.

Very quickly, borrowers find themselves accumulating more loans than they can pay off. Thus, the borrower finds him/herself caught in a trap of payday loan debt.

Are payday loans legal?

Though there is some federal regulation of payday loans, they are primarily regulated by state laws. 

States protect their citizens from usurious payday lending by prohibiting the product or by setting rate caps or usury limits.

For example, Georgia prohibits payday loans under racketeering laws. New York and New Jersey prohibit payday lending through criminal usury statutes, limiting loans to 25% and 30% annual interest. Arkansas’ state constitution caps loan rates at 17% annual interest.

After permitting high-cost payday loans, New Hampshire capped payday loan rates at 36% annual interest in 2009. Montana voters passed a ballot initiative in 2010 to cap loan rates at 36% annual interest, effective in 2011. Colorado voters passed a similar ballot measure capping rate at 36% in 2018. 

South Dakota voters approved a ballot initiative in 2016 by a 75 percent vote to cap rates for payday, car title, and installment loans at 36% annual interest. Arizona voters rejected a payday loan ballot initiative in 2008, leading to the sunset of the authorizing law in 2010. North Carolina tried payday lending for a few years, then let the authorizing law expire after loans were found to trap borrowers in debt. 

ConnecticutMarylandMassachusettsPennsylvaniaVermont, and West Virginia never authorized payday loans. The District of Columbia repealed its payday law.

The website adds that small loans secured by access to the borrower’s bank account are authorized in three states at lower than typical rates. 

Maine caps interest at 30% but permits tiered fees that result in up to 261% annual rates for a two-week $250 loan. 

Oregon permits a one-month minimum term payday loan at 36% interest less a $10 per $100 borrowed initial loan fees. As a result, a $250 one-month loan costs 154% annual interest for the initial loan, and 36 percent for any subsequent loans. 

New Mexico took steps to limit extremely high-cost lending by instituting an APR cap of 175% while also extending the minimum loan time to 120 days. These loans also require four payments spread out across the loan period instead of a single payment at the end.

Thirty-two states either enacted legislation authorizing payday loans, failed to close loopholes exploited by the industry to make high-cost loans, or deregulated small loan interest rate caps.

Again, here are the payday loan states:

Payday lending is legal in Ohio despite a ballot vote in 2008 that capped rates. The industry switched to lending under other laws which were upheld by the courts and not corrected by the Ohio legislature.

Most states that allow payday lending have some sort of regulation around the number of loans, loan amount, interest rates, and loan terms.

At the federal level, payday lending is regulated by the Consumer Financial Protection Bureau (CFPB).

According to research from the Center for Responsible Lending, about 200 million Americans live in states that allow payday lending without heavy restrictions. And even with the onslaught of new options, borrowers are still searching out these loans.

You can check here to see where your state falls.

Why avoid a payday loan?

Taking out a payday loan is one of the most expensive ways to borrow money.

Payday loans are short-term, high-cost loans that may be due on the borrower’s next payday. 

Their convenience and ease of approval may make them sound like an attractive option when you’re in a pinch, but the consequences of taking out one of these loans can be ugly.

Fees for these short-term loans often range from $10 to $30 for every $100 borrowed. Based on those fee amounts, a $500 payday loan could result in a fee as high as $150. 

Payday loan alternatives if you have bad credit

There are alternatives to risking taking a payday loan that you can explore if you have poor credit, meaning a person’s history of failing to pay bills on time, and the likelihood that they will miss making timely payments in the future.

A person is considered to have bad credit if they have a history of not paying their bills on time or owe too much money. 

Poor credit is often reflected as a low credit score, under 580 on a scale of 300 to 850. People with poor credit will find it harder to get a loan or obtain a credit card.

And loans can affect credit history, for example, a personal loan affects your credit score much like any other form of credit. Make on-time payments and build your credit. Any overdue payments can damage a score if they’re reported to the credit bureaus.

Also, a personal loan can affect your credit score when:

  • You shop for a personal loan.
  • You apply for a personal loan.
  • You regularly repay your loan.
  • You miss a personal loan repayment.
  • You consolidate your debt.

You can always check your credit reports by requesting a free copy from each of three major credit reporting agencies – Equifax, Experian, and TransUnion – once each year at AnnualCreditReport.com or call toll-free 1-877-322-8228.

Top payday loan alternatives

If you need money fast, here are a few other options to explore before turning to a payday lender.

Cash advance apps (aka payday advance apps) 

Like everything else, there’s an app for cash advances. In fact, there are several. Companies like Dave, Earnin and Brigit will let you borrow a small amount from your next paycheck before you receive it. 

These are just some examples that can be better choices than a payday loan because these apps are fast, don’t charge large overdraft fees and you don’t have to pay them back the next day. And if you bank with Chime, there are a few cash advance apps that will transfer money seamlessly into your Chime account.

These apps may be helpful if you need cash in an emergency, and the cost is usually lower than what you’d pay a payday lender.

Why? These apps don’t charge interest. Instead, the apps may charge subscription or expedited funding fees, and many suggest you add a tip. Be aware that you are not obligated to follow an app’s tipping suggestions. Some of the recommended tips work out to about the same amount that you’d pay a payday lender to borrow the same amount of money. Check your math, and donate an amount you think is fair. Remember that a payday lender will charge you between $10 to $30 for a $100 loan. Use an APR calculator to make sure you aren’t overtipping (remember that a credit card will charge you an APR of roughly 30%, so that seems like a fair ballpark.)

If an app pressures you to tip more because a portion goes to charity, don’t let that sway you. Go to the charity and donate directly. That way the charity gets 100% of your money instead of an undisclosed percentage.

Want to learn more about cash advance apps? Check this out:

Personal loans

An unsecured personal loan is a fixed-rate installment loan not backed by collateral and repaid in monthly payments over a specific term, typically two to seven years. When you need money to cover a large expense or to consolidate your debt, a personal loan could be the answer. You can use the funds for anything. To qualify, lenders will look at your credit score, credit report, and debt-to-income ratio. You can obtain a personal loan from some major banks, credit unions, and online lenders. Don’t be discouraged if your credit is bad. There are even lenders who will offer personal loans after a borrower has declared bankruptcy. Just be aware that the lower your credit score, the higher your loan interest rate will be.

Before you apply for any personal loan, make sure the lender is legitimate.

Borrow from friends or family

Ideally, personal finance should be just that: personal. But sometimes it’s best to admit that you’re in trouble. Ask to borrow funds from a friend or family member: mom, dad, spouse, aunt, uncle, or whoever might be able to spot you a loan so you can cover your bills, etc.

Peer-to-peer lending

Peer-to-peer loans are available through online platforms, such as Lending Club and Prosper, that match potential borrowers with investors willing to issue loans. At Prosper, APRs range from 7.95% to 35.99%. Lending Club advertises APRs from 7.04% to 35.89%. Keep in mind that peer-to-peer loans typically come with fees based on the percentage of the amount you’ve borrowed.

Credit cards

Consider a credit card cash advance. Check with one of your major credit cards to see if a loan would be less costly than taking out a payday loan. You can often get a small cash advance straight from the ATM. Note that the interest on a cash advance starts to accrue as soon as you take out the money. There is no grace period like you have with routine credit card purchases. But that interest will certainly be lower than what you’d pay a payday lender.

If your credit is good enough to qualify, some credit card issuers offer an introductory balance transfer with no interest for a set period of time, usually 12 to 18 months. You’ll have to pay a balance transfer fee, but if you can get your debt paid off during the introductory period you can save a significant amount of money.

The Capital Good Fund

The Capital Good Fund is a nonprofit based in Rhode Island that will help you cover emergency expenses. It’s a certified Community Development Financial Institution that helps people fix their finances. It offers small loans and personalized Financial + Health Coaching to families in Rhode Island, Florida, Massachusetts, Illinois, Delaware, Texas, and Colorado. According to its website, the mission is to “create pathways out of poverty and advance a green economy through inclusive financial services.”

The bottom line

When you’re strapped for cash, you’re strapped for cash and that’s it. But if you can swing a loan from dad or mom, a friend, or another family member you might be better off overall. Payday loans can become more trouble than their worth in that you will have to pay back what you owe and then some, along with extra fees and interests.

It’s best to seek other outlets like those listed above, and once your immediate financial crisis has passed, set up a savings plan so that you won’t end up in this situation a second time.


What is debt consolidation?

Debt consolidation rolls multiple debts into a single payment via a personal loan or credit card. Ideally, it can save you time and money.

What types of loans can I consolidate?

Most federal student loans, payday loans, medical bills, credit card debt, auto title loans and any other high-interest debt can be rolled into one bigger loan with one fixed monthly payment.

Can I qualify for a loan if I don’t have a savings account or a checking account?

Most local payday loan centers will approve your loan application even if you do not have an active bank account in your name. But you still need to prove you have sufficient income to repay your debt.

Is it easier to qualify for a loan through a credit union?

Credit unions offer lower fees, higher savings rates, and a more hands-and personalized way to do business and the way they offer customer service to members. Also, credit unions may offer lower interest rates on loans. It may be easier to get a loan with a credit union than a large bank.

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