Payday loans, also known as cash advances, are short-term, low-balance, high-interest loans typically at usury rates. They are so-named because of a tendency for the funds to be borrowed on a post-dated check or account-withdrawal authorization effective on the borrower's upcoming payday.

These loans are designed to be quick and generally easy to qualify for if the applicant has a job. They are intended to help consumers get some quick cash to hold them over until their next paycheck, hence the name “payday loan.” Payday loans are also called cash advance loans, deferred deposit loans, post-dated check loans, or check advance loans.

Key Takeaways

  • The basic requirements for a payday loan are a source of income, a checking account, and valid identification. Borrowers must be at least 18 years old
  • The application for a payday loan can be approved within minutes, but the loans come with extremely high interest rates that catch many people in a spiral of rising debt.

Basic Requirements for Payday Loans

According to the government's Consumer Financial Protection Bureau (CFPB), most payday lenders only require borrowers to meet the following conditions to qualify for a loan: the borrower must be at least 18 years old, have an active checking account, and must provide some proof of income as well as valid identification. The loan can be approved in as few as 15 minutes. In most circumstances, the borrower writes a check for the loan amount plus a lending fee, and the lender holds onto the check until a predetermined due date.

Most payday loans are extended for just a few weeks. When the loan comes due, the borrower either pays off the loan, or allows the lender to cash the post-dated check or otherwise make a withdrawal from the borrower's account.

The Risk of Payday Loans

Many borrowers run into financial trouble with these kinds of loans when they can’t pay them off when they first come due. Each time the borrower extends the loan, more fees are tacked on. Payday lenders charge a fee of $10 to $30 for every $100 borrowed, according to the CFPB. A $15 fee works out to about 400% annually.

Payday loans are accessible to consumers with poor credit and usually do not require a credit check. About 12 million Americans use payday loans each year, and most of them do not have access to a credit card or savings account, according to the Pew Charitable Trust.

Payday loans are risky, often leading the borrower into much worse financial condition down the road. They are banned in many states.

Payday Loan Interest Rates

Loan requirements should not be the only consideration for people thinking about a payday loan. In terms of annual percentage rates it is not uncommon for payday loans to exceed 500% or even 1,000%. Even though business models and regulations limit the size and duration of payday loans, these types of loans are still an expensive alternative and should be undertaken with care.

Because of the high interest rates, payday loans are the most expensive way to borrow money. Some states have laws regulating how much payday lenders can lend and how much they can charge for loans, while other states, like New York, ban the practice of payday lending altogether. In those states in which the practice is banned, lenders often get around the regulations by partnering with banks in other states.

Payday Loan Amounts

Qualifying loan amounts vary depending on the borrower's income and the payday lender, although most states have laws establishing maximum payday loan amounts. Some states even limit the ability of borrowers to have multiple outstanding payday loans in an attempt to keep consumers from borrowing large amounts at extremely high interest rates. Loan amounts can vary from $50 to $1,000, depending on state law.

Tougher Loan Requirements Shot Down

Under the Obama administration, the CFPB began drafting tougher regulations on payday lenders, including the requirement that they assess a borrower's ability to repay the loan by verifying their income, debts, and living expenses. The goal was to help prevent borrowers from becoming trapped in ever-rising fees as they struggled to repay loans. The new rules were to take effect in 2019 but were gutted by the Trump administration.