Payday Loans: Why They Aren't the Fixes You Hope for

When you need money quickly, it might be difficult to get the funds you need via a traditional loan because the time and approval process with many financial institutions can take longer than you have available. As an alternative, payday loans often can be obtained in short order, making them an attractive option. However, there are many downsides to payday loans that can offset the ease of getting quick cash.

What is a payday loan?

A payday loan — also called a payday advance, payroll loan, payday lending, or cash advance loan — typically is a low-amount, short-term loan with a very high-interest rate that generally comes due on your next payday. Payday loan amounts often are for $500 or less, and a credit check is rarely, if ever, required. These loans usually are not available at traditional financial institutions; instead, depending on your state laws, they are offered through online or brick-and-mortar payday lenders.

Why you may need a payday loan

For many borrowers, they may feel like a payday loan is their only option. If they have poor credit, don’t make a lot of money, or are faced with an unexpected emergency, they likely won’t be able to qualify for a traditional personal loan or may not have a credit card to pay for the expense. Instead, a payday loan could be the easiest, fastest way for them to get cash.

Why you should avoid a payday loan

Because payday loans provide quick cash, they can be an attractive choice when you need money to pay for car repairs, replace a broken appliance or cover another unexpected emergency expense. Unfortunately, payday loans come with many drawbacks that can make them more harmful to your finances in the long run.

Payday loans are very costly

Although payday loans don’t always charge an annual percentage rate (APR), their fees could quickly exceed the interest rates on most high-interest rate credit cards. State law typically mandates payday loan fees, which could be between $10 to $30 for every $100 borrowed. For example, say you borrow $100 for 10 days, and the finance charge is $15. That equates to an APR of nearly 400%. Even at the higher end of the spectrum, credit cards usually don’t have interest rates of more than 40% APR. Therefore, with the payday loan, you would be paying 10 times more in interest than you would with a high-interest credit card.
In addition, there may be hidden fees associated with a payday loan that includes a loan application fee, a customer service fee, undisclosed missed or late payment fees, returned check fees, and overdraft fees.

You likely will have to provide banking or credit card information

When applying for a payday loan, you will need to make provisions for repaying that loan on the due date. Oftentimes, the payday lender will require you to write a postdated check for the full amount due, or provide banking or credit card information so they can withdraw the amount due from your bank account or charge your credit card.
If you don’t have the funds to cover those charges, you could be charged overdraft or insufficient funds (NSF) charges by both the payday lender and your bank, resulting in additional fees and increasing your debt load. In addition, you may have a very difficult time keeping the payday lender out of your bank account, given they will be very aggressive in trying to get their money back.

Repayment periods are extremely short

As their name implies, payday loans usually are repaid on the borrower’s next payday. From the date the payday loan is issued, the due date is usually between two and four weeks. If cash continues to be tight, the borrower may find it difficult to repay the loan on time. This is particularly true if that next paycheck is needed for basic living expenses such as rent, utilities, and groceries. As a result, the borrower could incur late fees that will continue to drive up the loan amount.

Your debt could balloon in a hurry

As stated above, the initial amount due on your payday advance could quickly increase if you are not able to repay it on time. Overdraft, late, and rollover fees can double or triple your loan balance in a hurry, making it more and more difficult to pay off in full.
If the debt continues to grow and you don’t make much headway in paying off the debt, the payday lender may start a collections action against you. When doing so, they often are very aggressive, calling you frequently at home and work at all hours of the day and night in order to get their money. Oftentimes, they can be rude and even threatening, and they won’t stop until the loan is paid in full.

You can’t back out of the loan

Unlike other financing options, if you change your mind, you cannot cancel the loan. There is no “preliminary” or “honeymoon” period. Once you commit to the payday loan, you are stuck with it until it’s paid off in full.

What to do if you decide to get a payday loan

If you go ahead with getting a payday loan, make sure to do the following:
  • Find out the payday lender laws for your state to ensure the lender you choose is compliant; your state regulator or attorney general should be able to confirm if the lender is licensed.
  • Look for a direct payday lender, not a “middleman” lender or website that doesn’t lend money directly to borrowers. This could result in additional fees.
  • Compare payday loan terms and conditions with at least three payday lenders to find the most favorable loan for you; look at the fees, APR, and repayment dates for a fair comparison.
  • Choose a payday lender who doesn’t offer rollovers to avoid getting trapped into additional debt.
  • Look for a payday lender who offers extended repayment options that don’t result in exorbitant fees.

Alternatives to payday loans

Although payday loans may seem like a simple solution when you need money fast, there could be some better options available to you.

Credit cards

As previously mentioned, even high-interest credit cards could be a less-expensive alternative to payday loans. Unlike payday loans, which have fees equivalent to as much as 10 times a high-interest credit card, credit cards won’t cost you as much in interest, even if you take a month or two to pay off the balance. Plus, with a payday loan, you are required to pay off the loan balance in full by the due date to avoid paying late fees. With a credit card, you can make an on-time minimum payment on your balance due without incurring late fees.
If you do choose to use a credit card to cover your emergency expense and cannot pay the balance off by your next payment due date, set up a payment plan for yourself to pay the balance off within a set timeframe, such as three months, to avoid paying excess interest on the amount due.

Personal loans

With many banks, obtaining a personal loan can be difficult and time-consuming. The process requires applying and qualifying for the loan as well as an underwriting process for approval. To qualify, you also may need a good credit score and have to provide evidence that proves you can repay the loan as agreed. However, at some credit unions, if you are a member you may be able to obtain a low-balance, short-term loan with favorable terms such as lower interest rates, monthly payments, and a longer repayment period.

Peer-to-peer loans

Using peer-to-peer lending platforms such as Payoff or Prosper, borrowers can obtain a loan from individual investors. Like a traditional loan, you will have to apply for a loan that includes a credit check. These loans are typically unsecured loans, so you won’t need collateral for approval.
If you are approved, you will be offered loan terms including the interest rate. If you accept, the loan listing is submitted to investors, who decide if they want to fund it. If accepted, you will receive the money and enter the repayment period.
Peer-to-peer loans may not be an ideal solution, but they could offer much better terms than a payday loan.

Borrow from friends or family

No one likes to ask friends or family for help, but this may be your most affordable option for getting the money you need. After all, you won’t have to pay fees or interest when repaying the loan. Plus, family and friends likely will allow you more time to repay the money.

Ask for an advance from your employer

If asking friends or family for money is difficult, it might be that much harder to ask your employer for an advance. However, your employer may be willing to provide the money, and then set up a payroll deduction for a specified timeframe to recoup the advance. This could be a cost-effective solution given you won’t be charged fees or interest.

Do side work to earn extra cash

If possible, pick up some side hustles for quick cash. For instance, think of some services you can offer your neighbors: mow or rake their lawns, wash cars, clean out gutters, and so on. Other possibilities include babysitting, performing small home improvement projects such as painting a room or signing up with a rideshare or delivery app.

Sell personal items you no longer need

Look around your home, and see what items you don’t use anymore that you could turn into cash. An extra piece of furniture, a laptop, maybe a gaming system—these not only could be a source of income, but this also could be a great way to declutter your house.

FAQs

Payday loans can be confusing; these are some of the most common questions consumers have about these short-term loans.

What are payday loans used for?

Payday loans often are used for unexpected emergency expenses such as car repairs, home repair, or medical bills. However, many borrowers use payday loans to cover shortfalls when paying for their basic living expenses such as rent, utilities, and buying groceries.

Are there benefits to payday loans?

For borrowers with bad credit, getting a payday loan may be much easier than obtaining funds from traditional lenders. In addition, because you often can get a payday loan quickly—often in one hour or less—these loans provide money when you need it.

What happens if I can’t repay my payday loan?

If you cannot repay your payday loan on time, it’s possible your lender may offer to delay repayment, or roll over the debt to a new due date, for a fee. The danger here is many borrowers fail to repay the loan for months, leading to more and more fees. These fees can quickly exceed the original loan amount, making it very difficult to actually pay off the loan in full. In some states, including California, lenders can sue if you default on your loan.

Do all states provide payday loans?

No. Payday loans are banned in Arizona, Arkansas, Georgia, Maryland, Massachusetts, New Jersey, New York, North Carolina, New Mexico, Pennsylvania, Vermont, and West Virginia.

The bottom line

Payday loans can be a fast and easy way to get money when you need it right away, especially if you don’t have great credit. However, the fees associated with payday loans can be hefty, meaning you may pay much more than you anticipated when you first obtained the loan. As those fees continue to accrue, you may find it difficult to make any headway in reducing how much you owe.
Other options that may be a better choice over payday loans include a credit card advance, personal loans through traditional financial institutions, peer-to-peer loans, borrowing from family and friends, asking your employer for a payroll advance, picking up side hustles, or selling unneeded personal items. These options often have much better repayment terms, making it easy to pay off the debt without digging yourself into a deeper hole.

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