Payday Loans Explained: How They Work, What They Cost, and What to Know Before You Borrow

a payday loan

A payday loan is a short-term, high-cost loan, typically for $500 or less, that is usually due on your next payday. These loans are often used by people who need cash quickly and don't have access to other forms of credit. They are typically unsecured, meaning you don't need to put up collateral like a car or house.

Payday loans can be obtained through storefront lenders or online, depending on state law. The money can be given in cash, by check, through electronic deposit, or on a prepaid card. Understanding the basic structure before borrowing is key.

• Loan amount: usually several hundred dollars, with $500 being a common upper limit.
• Repayment: typically due in full by your next paycheck, usually two to four weeks.
• Cost: fees typically range from $10 to $30 per $100 borrowed, translating to a high annual percentage rate (APR).

Sources: Consumer Financial Protection Bureau, Experian

Common terms

Understanding the language used in payday lending can help you evaluate the costs and terms of a loan. Here are key terms you will often see.

• Loan amount: The principal sum you borrow, typically a few hundred dollars.
• Fee: The finance charge you pay for borrowing, usually expressed as dollars per $100 borrowed.
• APR (Annual Percentage Rate): A standardized measure of the cost of credit over a year. Because payday loans have short terms, their fees translate into very high APRs, often close to 400% or more.
• Term: The length of time you have to repay the loan. Payday loans are typically due on your next payday, often two to four weeks.
• Post-dated check: A check written at the time of the loan for the full balance plus fees, which the lender may cash if you do not repay as agreed.
• Rollover: When a lender allows you to delay repayment by paying a fee, effectively creating a new loan with additional charges. This can lead to a cycle of debt.

Sources: Consumer Financial Protection Bureau, Experian

How Payday Loans Work: Step by Step

The process for obtaining a payday loan is relatively straightforward, but it's critical to understand the repayment obligations. While the exact steps can vary, the general process is as follows:

1. You apply with a payday lender, either at a storefront or online.
2. The lender typically requires you to have a regular source of income and an active checking account.
3. Instead of a traditional credit check, the lender may require a post-dated check for the full balance including fees, or authorization to electronically debit your bank account on the due date.
4. Upon approval, you receive the loan amount—in cash, check, electronic deposit, or on a prepaid card.
5. You repay the loan in full on your next payday (or by the agreed-upon term), along with all fees.

Sources: Consumer Financial Protection Bureau

Understanding the Costs: Fees and APR

The cost of a payday loan is primarily in the fees, not interest expressed as a traditional rate. In many states, the maximum fee for a payday loan is between $10 and $30 per $100 borrowed. Because the loan term is so short, these fees translate into a very high annual percentage rate (APR).

For example, a typical two-week payday loan with a $15 fee per $100 borrowed equates to an APR of almost 400%. For a typical two-week term, fees of $15 to $20 per $100 borrowed can result in an APR that ranges from 391% to 521%, depending on the exact fee and term length.

To put this in perspective, credit card APRs typically range from about 12% to about 30%. While payday loans can be convenient, they are significantly more expensive than most other forms of credit.

• Typical fee: $10–$30 per $100 borrowed, depending on state law.
• Example APR: A $15 fee per $100 borrowed on a two-week term equals an APR of nearly 400%.
• Comparison: Credit card APRs often range from 12% to 30%, making payday loans substantially costlier.

Sources: Consumer Financial Protection Bureau

State Regulation and Availability

Payday lending is regulated at the state level. Some states allow payday lending, while others do not. In states that prohibit payday loans or where payday lenders have chosen not to operate, you may not find storefront or online options. Even in states that allow payday lending, the maximum loan amounts, fees, and other terms can vary significantly.

State regulators or state attorneys general can provide information about licensed lenders in states that allow payday lending. It's important to check your state's rules to understand the costs and protections that apply to you.

Additionally, active duty servicemembers and their dependents have special protections under the Military Lending Act, including a cap of 36% on the Military Annual Percentage Rate (MAPR).

Sources: Consumer Financial Protection Bureau, Experian, Federal Trade Commission

What Happens if You Can't Repay on Time?

If you cannot repay a payday loan on its due date, the lender may offer to roll over the loan into a new loan, adding more fees. This can lead to a cycle of debt where you pay additional charges but still owe the original amount plus new costs.

Regulatory efforts have aimed to curb these practices. A 2017 CFPB rule, for example, required lenders to determine whether consumers could afford the loan before issuing it, and it curbed repeated attempts to debit payments from borrowers' bank accounts. Note that this rule has faced legal challenges and its current status may have changed.

Statistics show that more than four out of five payday loans are re-borrowed within a month, and nearly one in four initial payday loans is re-borrowed nine times or more, often leading to borrowers paying more in fees than they received in credit.

Sources: Experian, Consumer Financial Protection Bureau

Alternatives to Payday Loans

Payday loans are expensive, and financial difficulties can arise if you are unable to repay on time. It is wise to consider other options that may be less risky, but specific products and their costs vary by lender and location. To learn about potential alternatives like credit union loans, payment plans with creditors, or nonprofit assistance, visit our dedicated page on alternatives.