What Is a Payday Loan?
A payday loan is a type of short-term borrowing where a lender will extend high-interest credit based on your income. Its principal is typically a portion of your next paycheck. Payday loans charge high interest rates for short-term immediate credit. They are also called “cash advance” loans or “check advance” loans.
- Payday loans are short-term, very-high-interest loans available to consumers.
- Payday loans are typically based on how much you earn, and you usually have to provide a pay stub when applying for one.
- A number of laws have been put in place over the years to regulate the high fees and interest rates with payday loans.
Understanding Payday Loans
Payday loans charge borrowers high levels of interest and do not require any collateral, making them a type of unsecured personal loan. These loans may be considered predatory lending, as they have extremely high interest, don’t consider a borrower’s ability to repay, and have hidden provisions that charge borrowers added fees. As a result, they can create a debt trap for consumers. If you’re considering a payday loan, then you may want to first take a look at safer personal loan alternatives.
Obtaining a Payday Loan
Payday loan providers are typically small credit merchants with physical stores that allow on-site credit applications and approval. Some payday loan services also may be available through online lenders.
To complete a payday loan application, you must provide pay stubs from your employer that show your current level of income. Payday lenders often base their loan principal on a percentage of the borrower’s predicted short-term income. Many also use a borrower’s wages as collateral. Lenders generally do not conduct a full credit check or consider your ability to repay the loan.
In the U.S., as of 2020, 13 states and the District of Columbia have banned payday loans.
Payday Loan Interest
Payday lenders charge levels of interest as high as 780% in annual percentage rate (APR), with an average loan running nearly 400%. Most states have usury laws that limit interest charges to anywhere from 5% to 30%; however, payday lenders fall under exemptions that allow for their high interest. As these loans qualify for many state lending loopholes, borrowers should beware. Regulations on these loans are governed by the individual states, with 13 states—Arizona, Arkansas, Connecticut, Georgia, Maryland, Massachusetts, New Jersey, New Mexico, New York, North Carolina, Pennsylvania, Vermont, and West Virginia—plus the District of Columbia outlawing payday loans of any kind.
In California, for example, a payday lender can charge a 14-day APR of 459% for a $100 loan. Finance charges on these loans also are a significant factor to consider, as the average fee is $15 per $100 of loan.
Although the federal Truth in Lending Act requires payday lenders to disclose their finance charges, many people overlook the costs. Most loans are for 30 days or less and help borrowers to meet short-term liabilities. Loan amounts on these loans are usually from $100 to $1,000, with $500 being common. The loans usually can be rolled over for additional finance charges, and many borrowers—as high as 80%—end up as repeat customers.
A number of court cases have been filed against payday lenders, as lending laws following the 2008 financial crisis have been enacted to create a more transparent and fair lending market for consumers. If you’re considering taking out a payday loan, then a personal loan calculator can be a vital tool for determining what kind of interest rate you can afford.
Efforts to Regulate Payday Loans
Efforts to regulate payday lenders were proposed in 2016 under the Obama administration and put in place in 2017, when the Consumer Financial Protection Bureau (CFPB), under then-Director Richard Cordray, passed rules to protect consumers from what Cordray referred to as “debt traps.” The rules included a mandatory underwriting provision requiring lenders to assess a borrower’s ability to repay a loan and still meet everyday living expenses before the loan is made. The rules also required lenders to provide written notice before trying to collect from a borrower’s bank account, and further required that after two unsuccessful attempts to debit an account, the lender could not try again without the permission of the borrower. These rules were first proposed in 2016 and set to take effect in 2019.
In February 2019, the CFPB—then under the Trump administration and Director Kathleen L. Kraninger—issued proposed rules to revoke the mandatory underwriting provision and delay implementation of the 2017 rules. In June 2019, the CFPB issued a final rule delaying the August 2019 compliance date, and on July 7, 2020, it issued a final rule revoking the mandatory underwriting provision but leaving in place the limitation of repeated attempts by payday lenders to collect from a borrower’s bank account. Under the Biden administration, it is likely that new leadership at the CFPB once again will take up stricter rules for payday lending.