Why Do Payday Loans Get a Bad Rap
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With big, bright signs offering quick cash, storefronts for payday loans are hard to miss. But while they may offer plenty of promises for easy financial help, there’s more to them than meets the eye. 

Before you go down the financial rabbit hole payday loans can create, there are some things you may want to know.

How Do Payday Loans Work?

Payday loans are usually small, short-term loans with few approval requirements and high costs. Let’s take a deeper look at the factors that set payday loans apart from other types of loans. 

Amount

According to the Consumer Financial Protection Bureau (CFPB), the loan size is generally around $500, although limits may be higher or lower, depending on state laws. Experian offers a look at limits by state — 32 of which have them as of January 3, 2019, while Maine, Wisconsin, Utah, and Wyoming do not have a limit. The highest cap is $1,000 in Delaware, Idaho, and Illinois, and the lowest is $300 in California and Montana.  

Loan Term

Unlike traditional loans, payday loans generally must be repaid quickly, or rolled over into a new loan with additional fees. According to CNBC, the average amount of time before payment becomes due is two weeks, or whenever you receive your next paycheck

Approval Requirements 

If payday lenders have requirements, they are usually very basic and may include

  • An active bank, credit union, or prepaid card account
  • Verification that you have an income source
  • Valid license or state ID (most states require a minimum age of 18)

Generally, payday lenders don’t perform a credit check and don’t report information to Credit Reporting Agencies (CRAs).

Costs

The cost of a payday loan can vary depending on the lender. The CFPB says they generally range between $10 and $30 for every $100 borrowed. So if you borrowed $500, for example, you may be charged anywhere between $50 and $150. 

However, if you aren’t able to pay back your loan when it’s due, you may be facing other fees as well. For example: 

  • A Rollover Fee
    If a lender and the laws of the state you are in allow you to rollover what you are unable to pay into a new loan, you may be charged a one-time fee (in addition to what you already owe in other fees).
  • A Late Fee
    If you are unable to pay back your loan but don’t have the option of rolling it over into another loan, you may be charged a late fee from the lender. If the lender attempted, but failed, in pulling the funds from your account, your bank may also charge you a fee for insufficient funds.

The Downsides of Payday Loans

Labeled as a form of “predatory lending” by some, there are several reasons why they tend to get a bad wrap. Here are a few.

They’re expensive. 

Perhaps the most widely used reason, payday loans tend to have interest rates that are exorbitantly high. According to the CFPB, if a lender charges $15 per $100 borrowed (which is common), that equates to an Annual Percentage Rate (APR) of 400% for a two week loan. On the other hand, as of January 2020, traditional personal loans sit within an APR range of about 6-36%.  

They don’t help in building your credit.

While traditional loans may be reported to CRAs and added to your credit file, payday loans generally aren’t. So if you are diligent in paying off your loan as agreed, you won’t reap the credit boosting benefits. 

On the other hand, if you default on your payday loan and the lender sells the debt to a collection agency, that could be added to your credit report and potentially remain for up to 7 years or more.

They may keep you in a cycle of debt.

Due to the short repayment period and high cost, many borrowers rollover their payday loan several times. This can lead to the accumulation of more fees and a perpetual cycle of debt. 

A study by the CFPB found that over 80% of payday loans are “rolled over or followed by another loan within 14 days.” And, according to Pew, one reason for this is that the average total repayment cost is $430 — which, for the average payday loan consumer, is 36% of their gross paycheck. 

They may use your bank account information to collect payment. 

Oftentimes, a payday lender will collect a postdated check or bank account information to both transfer funds into your account and take them out when payment is due. If the funds are not available, you could potentially incur an insufficient funds fee for each time the lender attempts to collect payment. 

It is possible to revoke payment authorization from the payday lender, but just because they can’t collect the funds from your account doesn’t mean it’s not still owed. 

They may not have very many (or any) lending requirements.

Oftentimes traditional financial products — like personal loans — have certain requirements to ensure you have the means to responsibly manage them. This can protect you (and your credit) just as it protects the lender or creditor from incurring a loss. 

Payday loans, on the other hand, usually don’t have the same stringent requirements, making it easier to get into a hole you can’t get yourself out of. 

It’s a State-By-State Issue

While some states, like Arizona, Arkansas, and Georgia, have prohibited payday loans, other states have created specific rules and regulations in an attempt to protect consumers. Here are just a few examples of how they differ.

  • Alabama
    Maximum Loan Amount: $500
    Maximum Loan Term: Not less than 10 and not more than 31 days
    Finance Charges: “May not exceed 17.5% of the amount advanced.”
  • California
    Maximum Loan Amount: $300
    Maximum Loan Term: Up to 31 days
    Finance Charges: “A fee for a deferred deposit transaction shall not exceed 15% of the face amount of the check.”
  • Idaho
    Maximum Loan Amount: $1000 (maximum principal amount)
    Additional Stipulations: “A payday lender shall not make a payday loan that exceeds 25% of the gross monthly income of the borrower when the loan is made.”
  • New Hampshire
    Maximum Loan Amount: $500
    Maximum Loan Term: At least 7 and not more than 30 days
    Finance Charges: “The annual percentage rate for payday loans shall not exceed 36%.”
  • Wyoming
    Maximum Loan Amount: None
    Maximum Loan Term: One calendar month
    Finance Charges: “No post-dated check finance charge shall exceed the greater of $30 or 20% per month on the principal balance of the post-dated check or similar arrangement.” 

See a comprehensive list of state rules and regulations compiled by the National Conference of State Legislatures as of July 13, 2020 here

Payday Loan Alternatives

The fast cash aspect of a payday loan may be enticing, but there are alternatives that may serve you better in the long run. Let’s take a look at some of the different options.

A Payday Alternative Loan (PAL) 

PALs are small-dollar loans regulated by the National Credit Union Association and offered by some federal credit unions

  • Borrowers must be members of the credit union for at least one month before applying for a PAL. 
  • The loan amounts can range between $200 and $1,000. 
  • The loan term is a minimum of one month and a maximum of six months.
  • The maximum finance cost is usually $20 (the cost to process the loan).
  • The APR is capped at 28%.
  • Up to three PAL loans can be borrowed within a six month period, however, they may not overlap at any point in time. 

Or, another PAL — the PAL II 

A PAL II is similar to the original PAL, with a few exceptions. 

  • It can be any loan amount up to $2,000.
  • The loan term is a minimum of one month and a maximum of 12 months.
  • Borrowers must be a member of the credit union, but a loan can be taken out at the same time membership is established. 
  • A credit union can not charge overdraft fees or a fee for non-sufficient funds (NFS) for a PAL II payment that results in a negative account balance.

Another potential upside to both the PAL and PAL II is credit unions may report your account information to CRAs. If you make on-time payments, this could potentially help improve your credit.  

A Personal Loan

If fast cash is what you’re after, even some personal loans offer same-day approval and cash deposits — often with a much lower APR than a payday loan. In addition, some lenders have options for bad credit or no credit, potentially without a credit check at all. Do your research and what you find might surprise you.

Peer-to-Peer Lending

Not just interested in speed? Then you may want to look into a peer-to-peer lending platform. Many don’t charge an APR higher than 36% and may allow credit scores as low as 600. Just be aware, it may take up to a week or more to be approved for a peer-to-peer loan.

The Bottom Line

The ease of getting cash with a payday loan might be nice, but there are plenty of reasons why they may not be the best option for your financial health going forward. Before you fall into a cycle of payday loan debt consider your options and see if another type of financial product can get you through a rough patch. 

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