Understanding Payday Loans

You might have heard the term “payday loans” before, but never really knew what that meant. Payday loans have roots that date back more than a century, as Pew research notes, with underground "salary lenders" offering one-week loans at high annual percentage rates (APR) ranging from 120 to 500 percent, similar to what payday lenders are charging now. If those who borrowed didn't pay them back, they were publicly shamed, extorted, had their wages garnished, or were threatened with job loss. 

Today, payday loans are short-term cash loans that are based on the borrower's personal check. The borrower writes a check out to a lender in the amount borrowed, plus the finance charge. The check is held for future deposit, while the borrower receives cash in return. Typically the check is held until the borrower's next payday when both the loan and the finance charge come due in full. The borrower can pay the loan by allowing the check to be deposited or pay just the finance charge, rolling the loan over to the next pay period. There are some lenders that provide longer-term payday loans, with payments made in installments that are typically electronically withdrawn from the borrower's bank account on the borrower's pay date. 

Here’s everything you need to know about understanding payday loans and how they work. 

Payday Loan Amounts

Payday loans can range anywhere from just $100 to $1,000, depending on the legal maximum in the borrower's state. The average term is two weeks, which makes sense as many people are paid every two weeks. While many payday loans are paid off in two weeks, some states give you more time than that. The loans typically charge at least a 400% APR, with a finance charge that ranges from $15 to $30 to borrow $100. For a two-week loan, the finance chargers work out to interest rates from 390 to 780% APR. For a shorter-term loan, the APR is even higher. States that don't cap the maximum have the highest rates. In some states, payday loans aren’t allowed at all.

Who the Lenders Are

Payday loans are often taken out at payday loan stores. They may be stores that offer other financial services like check cashing, pawn options, or title loans. There are also online loans in Canada and the United States available, so the borrower doesn't even have to leave their home, with everything conducted via a website or mobile device. 

Banks have also moved into the payday loan industry to earn more revenue. While traditional bank loans require qualification based on income, credit history, and assets, a payday loan from a bank is the same type of loan you'd get from a payday loan store, although they may go by a different name. In many cases, however, they can be worse than the loan obtained at a store because the bank has direct access to the borrower's checking account, and the borrower must agree to allow them to pull funds from the account to repay it.

Who the Borrowers Are

Payday loans are often marketed as "no credit check loans." It isn't necessary to have a good credit score or even a credit history. Getting approved is much easier than a traditional loan - most lenders simply require the borrower to be at least 18 years of age, have an active checking account, proof of income, and a valid ID. The loan is usually approved in a matter of minutes. As a result, they tend to be popular among those struggling with financial difficulties or experienced hardship, such as a vehicle breakdown and having no savings or access to credit.