Payday lenders know that you need money, fast, so they advertise themselves as being a quick and easy way to get cash. What they don’t usually advertise is how much it will cost you to take out a payday loan.
Most payday lenders charge a fee, such as $15 to borrow $100. That might not seem like much, but it can add up to an annual percentage rate in the triple digits. Before you take out a payday loan, take a closer look at the interest rate.
What is a Payday Loan?
A payday loan is a short-term loan with a high interest rate. It’s usually for a small amount. The premise of the loan is that you take it out when you need to cash, then you pay back the entire loan on your next payday.
The premise of payday loans doesn’t consider that most people need to use their next paycheck or Social Security check to cover their bills and other obligations. A lot of people have trouble coming up with the cash they need to pay off their debt on payday.
So borrowers are forced to extend the term of the loan, usually paying an additional fee. This is called a rollover. The original loan fee can also get added to the borrowed amount, pushing an already high-cost loan even higher.
Since it can be hard to repay the loan by payday or even by the next two or three paydays, a lot of people end up trapped in a cycle of debt, paying more and more fees without actually reducing the loan amount.
A payday loan looks attractive because it’s often for a small amount. The average loan is around $500, which seems easy to pay off.
The loans are also pretty easy to get. Payday lenders usually don’t do a credit check. Most will only ask you for some form of ID, a checking account and proof of income, like a paystub.
Research from the Pew Charitable Trusts found that 12 million people take out $7 billion in payday loans annually. The average borrower takes out a $375 loan and ends up paying more than $500 in interest.
How do Payday Loans Work?
Borrowers can apply for a payday loan online or in-person at a brick-and-mortar lender. When someone applies for a payday loan, the lender often requires them to provide a post-dated check, written out for the loan amount plus fees, or to set up a direct debit from a bank account.
If you don’t pay the loan back before the due date and don’t contact the lender, it can cash the check or pull the amount owed from your bank account. If there’s not enough money in your account, the check can bounce or the direct debit can fail, leading to more fees.
The lender might also charge you a late fee if you don’t pay the loan back on time or ask for an extension.
Payday loan amounts vary from borrower to borrower but are usually less than $500. The fees on payday loans range from $10 to $30 for every $100 borrowed, according to the Consumer Financial Protection Bureau (CFPB). That adds up to an average annual percentage rate (APR) of 390% or more, according to the Federal Trade Commission (FTC).
Since the cost of payday lending is so high, it’s worth taking a close look at the fine print before you agree to take out a loan. You might be surprised to see how much the cost of the loan is.
Interest rates on payday loans are so high that some states have placed limits on the amount a lender can charge. Some have even gone so far as to ban the loans entirely.
What are the Typical Interest Rates on Payday Loans?
There’s a lot of variation when it comes to payday loan interest rates because some states have set rate caps for payday loan lenders. Some have rates as high as 500%, which is much higher than the 9.5% charged by banks for a personal loan or the 20 to 30% charged by credit cards.
What are the Maximum Interest Rates by State?
Take a quick glance at the states below to see their maximum allowable interest rates on a $300 loan. Though payday loans are illegal in some states, those states have still set an interest rate cap on small-dollar loans. States where payday loans are outlawed or where robust protections are in place are in bold.
- Alabama: 456.25%
- Alaska: 521%
- Arizona: 36%
- Arkansas: 17%
- California: 460%
- Colorado: 36%
- Connecticut: 12%
- Delaware: 521%
- District of Columbia: 24%
- Florida: 391%
- Georgia: 10%
- Hawaii: 460%
- Idaho: 652%
- Illinois: 36%
- Indiana: 391%
- Iowa: 337%
- Kansas: 391%
- Kentucky: 460%
- Louisiana: 478%
- Maine: 217%
- Maryland: 33%
- Massachusetts: 23%
- Michigan: 370%
- Minnesota: 200%
- Mississippi: 521%
- Missouri: 527%
- Montana: 36%
- Nebraska: 36%
- Nevada: 652%
- New Hampshire: 36%
- New Jersey: 30%
- New Mexico: 36% (as of Jan. 1, 2023)
- New York: 25%
- North Carolina: 36%
- North Dakota: 526%
- Ohio: 138%
- Oklahoma: 203%
- Oregon: 154%
- Pennsylvania: 6%
- Rhode Island: 261%
- South Carolina: 395%
- South Dakota: 36%
- Tennessee: 460%
- Texas: 664%
- Utah: 652%
- Vermont: 18%
- Virginia: 173%
- Washington: 391%
- West Virginia: 31%
- Wisconsin: 516%
- Wyoming: 261%
How to Calculate the Interest Rates on Your Payday Loan
The Federal Truth-in-Lending Act requires payday loan lenders to disclose all fees and interest rates to borrowers before a borrower can agree to accept the loan. The lender should give you a disclosure statement that lists the APR, duration of the loan and total cost of the loan.
The problem is that most payday loan lenders list the finance charge as a specific dollar amount and not as a percent. Fortunately, you can use that figure to calculate exactly what interest rate you’re paying.
Let’s say you borrow $400 at a fee of $65, and that the total amount borrowed is due to be repaid in 14 days.
- Divide the fee by the amount borrowed. In our example, that would be 65 divided by 400, which equals 1625.
- Multiply the result from the previous equation by 365, the number of days in a year. You’ll find1625 times 365 equals 59.31.
- Divide the previous result by the number of days in your loan contract. So, 59.31 divided by 14 equals 4.236.
- Turn the decimal into a percent by moving the decimal point to the right two spaces. The total interest rate you’d pay for our example loan is 423.6%.
How High Payday Loan Interest Charges Can Get You Into Trouble
When you apply for most types of loans, such as a car loan, personal loan or a mortgage, the lender checks multiple factors. They’ll look at your credit to see what your borrowing history is like. They’ll also look at your income and the amount of other debt you have.
A reputable lender wants to make sure you have the ability to repay the loan. If you earn $1,000 every two weeks and you have debt payments of $1,000 every month, it’ll be tough for you to repay $500 in just two weeks. Many lenders will turn you down or suggest borrowing less if you don’t have the ability to repay.
Not payday lenders, though. They aren’t required to verify your ability to repay your loan, so they’re more likely to lend you $500, even if your total take-home pay for the month is $2,000 and you have $1,000 worth of other debt payments monthly.
The cost of payday loans starts to add up when borrowers have difficulty repaying the principal. Most lenders give borrowers the option of extending the loan. To do so, you usually pay a fee, such as $15 per $100 borrowed.
That fee doesn’t reduce the principal borrowed. It’s just a fee on top of the fee you already owe.
If you borrow $300 and pay a $45 fee, then extend the loan, you’ll have to pay another $45. You’ll still owe the original $300, plus the original $45 fee.
If you have to extend the loan again, you’ll need to pay another $45. The process can continue on and on, with the fees adding up.
Your best option is to try and find a more affordable way to borrow money, so you don’t get sucked into a debt trap.
What are Tribal Payday Loans?
There are a few key differences between traditional payday loans and tribal payday loans.
Tribal payday loans are payday loans that are offered through companies that say they’re located on tribal land rather than the land of any specific state.
Because the U.S. Constitution recognizes Indian reservations as sovereign nations, the companies offering the loans are not subject to state laws. They only have to meet federal regulations and any tribal regulations on payday loans. This makes tribal payday loans more dangerous for borrowers.
Tribal payday loans usually have higher interest rates than normal payday loans because the interest-rate caps or other restrictions set by state legislatures do not apply.
Borrowers of tribal payday loans may have a harder time discharging the loan in bankruptcy, refinancing the loan, and asserting their rights when lenders request payment.
What is Predatory Lending?
Payday loans are a classic example of predatory lending. Predatory lending occurs when a lender takes advantage of a borrower, who might be in a desperate situation. Predatory lenders usually target people who have credit scores in the “Fair” or “Poor” range (300-630).
Usually, a predatory loan meets the following criteria:
- It’s easy to get approved: A predatory lender wants your money and will agree to let you borrow even if you don’t have a good credit history or the ability to repay. Most predatory loans don’t have a credit check.
- It seems too good to be true: If a loan seems unbelievable, there’s probably a sneaky catch, such as a sky-high interest rate or a repayment plan that buries you deeper into debt.
- It doesn’t give you all the details: For the most part, predatory lending works on omission. A lender won’t give you all the facts or fully disclose the full cost of the loan. You might agree to it, only later to discover the loan’s cost is way more than the loan’s principal
- It doesn’t build your credit: Many predatory lenders won’t check your credit report or report your loan to the credit bureaus. While that can seem like a good thing, especially if you have trouble repaying the loan, it can also hurt you if you need to establish or rebuild credit.
Payday loans are just one example of predatory lending. Other types include subprime mortgages, which don’t verify your income or allow you to borrow more than you can afford, and car title loans, which use your car as collateral.
READ MORE: Step-by-step guide to payday loan consolidation
What Happens If You Don’t Repay Your Payday Loan
Since most payday lenders don’t report your loan to credit agencies, it’s no big deal if you can’t pay the loan back, right? Not quite.
While the lenders themselves won’t report your debt, they can sell your debt to a collection agency. Debt collectors do report to the three credit bureaus. They’re also known for being ruthless when it comes to chasing after borrowers.
A debt collector will call you and send you mail, requesting repayment. Fortunately, the Fair Debt Collection Practices Act (FDCPA) put limits on the ways collectors can pursue you. They can’t call you late at night or early in the morning, for example.
The FDCPA also forbids harassment and puts limits on where debt collectors can contact you. They can’t pursue you at work if they know you’re not allowed to be contacted there.
You can contact the Federal Trade Commission at FTC.gov to report any violations of the FDCPA.
Even if your lender doesn’t sell your debt to a collector, the fees that add up can create a heavy burden on you. Some lenders also threaten to sue if a borrower falls behind on payments.
Settling your debt or negotiating a lower payment can help you finally break free of the payday loan cycle.
READ MORE: Stuck in the debt trap? Here are four legit debt relief companies that can help you
Payday Loan Alternatives
Payday loans aren’t the only option when you need cash, fast. Even if you don’t have the best of credit and aren’t able to get a personal loan from a bank, lower-cost payday loan alternatives exist. Some options include:
- Cash advance apps: A cash advance app gives you an advance on your next paycheck but isn’t the same as a payday loan. The fees on a cash advance are much lower than payday loans and the amount you can borrow is limited to a percentage of your next paycheck.
- Payday alternative loans: If you’re a member of a credit union, check to see if it offers payday alternative loans (PALs). A PAL is meant to be a more affordable option, as the interest rate is much lower (no more than 28%). Although they’re short-term loans, you have more time to repay a PAL, usually between six and 12 months.
- Bad credit loans: So-called bad credit loans are designed for people with damaged or no credit who want to build their credit history. The loans often have higher interest rates than loans for people with good or excellent credit but charge a lot less than payday lenders.
- Installment loans: An installment loan lets you borrow money, then pay it back in equal monthly payments over time. Usually, you have several years to repay an installment loan. While most require a credit check, there are options available for people with limited or poor credit.
- Credit card cash advance: If you have a credit card, you might consider a cash advance if you need money to make it until payday. Credit card cash advances do have fees and charge interest, but the total cost of the advance is usually much less than the cost of a payday loan.
Read more: Doing Your Best to Avoid Payday Loans? Here are 12 Alternatives
The Bottom Line
As far as payday loans are concerned, it’s buyer beware. If lt looks and sounds too good to be true, it probably is.
Before you agree to a payday loan, do the math to see exactly what the interest rate will be.
APR is the interest rate you’ll pay on a loan over the course of a year. It’s expressed as a percentage. The lower the APR, the more affordable the loan.
The Center for Responsible Lending (CRL) is a non-profit organization that works to curb predatory lending. It also aims to educate people about financial products.
Lenders often consider how risky a borrower is when deciding what interest rate to charge. Borrowers with higher credit scores are usually considered lower risk and more likely to repay their loans. They usually get lower rates than people with limited credit or low credit scores.
Payday lenders usually do very little to verify a borrower’s ability to repay the loan or their credit history. Often, payday lenders don’t check a credit report or credit score before approving a borrower.