Payday loans seem to be everywhere these days. The industry is huge—there are more payday loan centers than McDonald’s. According to the Federal Reserve Bank of St. Louis, close to 12 million Americans use payday loans each year. And that’s no surprise, considering four out of every ten Americans don’t have savings to cover a $1,000 emergency.
If you’re considering using one for an emergency cash need, it’s crucial that you understand how payday loans work. It’s also important to understand how and why they may hurt your financial situation rather than help it.
Table of Contents:
What is a payday loan?
Payday loans are short-term loans that are meant to provide emergency cash. You can borrow a small amount of money—generally no greater than $1,000—with no credit check or lengthy loan underwriting process. So, you can get the cash you need quickly, even if you have bad credit.
The loan amount, along with fees, will typically be due within two weeks or by your next payday, whichever comes first. Other payday lenders use a process known as deferred deposit, where you post-date a check they can cash at the specified time.
The trouble with payday loans is that they can be a very expensive way to borrow money. All that convenience of no credit check and fast cash comes at the price of high interest and finance charges. This is especially true if you don’t pay back the full amount and finance changes by your next payday.
Payday loans vs other fast-cash products
While payday loans, short-term installment loans, and cash advance loans are often categorized as being the same or similar, there are a few differences that are worth noting:
|Payday Loans||Credit Card Cash Advance||“Short-Term” Installment Loans|
|A short-term loan that comes with few application requirements and a quick turnaround time. In-store or online.||Short-term cash you take borrow through a credit card.||Be careful. A “short-term” installment loan is just a payday loan, as is a “cash advance loan”.|
|Can withdraw the entire amount, though usually no more than $1,000 (excluding Oregon, which has a $50,000 limit.||Not allowed to withdraw the entire portion.||Interest rates on personal loans will be much better than on any payday loan, even with bad credit.|
|You can “rollover” the loan and pay on your next payday, though with more interest and late fees. Interest rates are normally around 400% APR on average.||Accrues interest immediately but can carry debt long-term. Interest rates of 24% APR on average, but can be much higher if you have bad credit||A broader category usually includes loans with longer terms. Any legitimate personal installment loan will require a credit check and a lengthy loan application process.|
|Finance charges average $30 for every $100 borrowed with interest rates as high as 400-500%||Typically, 3-5% of the advance with a minimum fee of $10||Same as payday loans.|
How payday loans work
Payday loans work differently from other personal loan products. Each state has their own set of laws pertaining to payday loans, dictating how much you can borrow and how much a lender can charge in interest and fees. In some states that we list below, you can’t get a payday loan at all.
You can apply for a payday loan and receive your cash in a few different ways. The process may be slightly different if you apply online versus in a brick-and-mortar storefront. But here is what you can generally expect:
- You apply for the loan online or in a store.
- You provide proof of your identity and proof of income.
- Once they verify you are eligible, you get your cash immediately.
- You receive the funds in the form of cash, a prepaid credit card or a direct deposit to your bank account.
- The money is due with finance charges in two weeks or by your next payday, whichever comes first.
- If you don’t pay the money back, you can use a rollover to keep the loan going, but this is where that 400% interest may apply.
In some cases, the amount may not be due in full within 2 weeks. There are payday lenders that offer “installment plans” which make them seem like a regular loan. You pay the amount you borrow back in shorter, fix installment payments.
Payday lenders usually require you to set up ACH withdrawal from your bank account to make payments. That means they get your bank account number and take their money out automatically. This is one of the big dangers of payday loans because they can drain your bank account dry. We’ll talk more about this issue below.
What do you need for a payday loan?
According to the Consumer Financial Protection Bureau (CFPB), to qualify for a payday loan, lenders only require borrowers to:
- Be at least 18 years of age
- Have an active checking account
- Provide proof of income and identification
You also need to live in a state that allows for payday loans. Many states have banned them because they’re a predatory loan product. These include:
- New Jersey
- New York
- North Carolina
- West Virginia
- Washington, D.C.
How payday loan interest and finance charges work
Finance charges always apply to payday loans, even if you pay the balance off on time. A typical payday loan finance charge is $30 for every $100 borrowed. So, if you borrow $500, the finance charges would be $150. You would need to pay back $650 to the payday lender.
If you don’t pay the balance off by the set date, then things quickly get more expensive with interest charges.
Payday loans have increasingly become the face of predatory lending and high-risk loans in America. That’s deserved given that the average interest rate is between 391% and over 600%! So, if you can’t repay the loans, then the interest rate soars and the amount you owe rises. It becomes increasingly difficult to pay off those payday loans.
You may think payday loans are your only solution for handling an emergency bill or paying off another debt, but a payday loan will usually end up giving you more problems than solutions. Think about it this way, if you get a credit card, you’re looking at an average of 15%-30% interest compared to 391%-600%. There are other options like debt management programs (with 8%-10% interest), personal loans (14%-35%), and online lending (10%-35%) that you can consider before opting for a payday loan.
While there are 18 states have capped interest at 36% on a $300 loan, that’s still high for interest charges. The median interest rate is 38.5%. And some states don’t have interest caps at all. In Texas, for example, interest can go as high as 662% for a $300 loan.
So, before you reach out and grab that payday loan, consider other options.
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How AutoPay and ACH withdrawals work and work against you
Automated Clearing House, or ACH withdrawals, are a type of electronic fund transfer that goes from one institution to another through the ACH network. Unlike other forms of electronic fund transfers, ACHs get pulled directly from a checking or savings account. 
There are some drawbacks to ACHs, however, as security is one of the biggest issues. The payer shares their banking information with the payee, and there is always a risk of it falling into the wrong hands.
AutoPay for payday loans functions as it would for a cell phone. You put the card that you want the funds to get taken from every pay period on file, and the money is automatically deducted at the time of payment. The trouble is that if you don’t have funds in your account, then you will get fit with non-sufficient fund (NSF) fees and bank overdraft fees. This can send your balance even further into the red.
It can also be difficult to stop ACH withdrawals. There are plenty of nightmare stories of people borrowing from a payday lender and then not being able to stop the ACH withdrawal. The lender just keeps draining your bank account.
Do I qualify for a payday loan?
It is fairly easy to qualify for payday loans, which is what makes them dangerous. You can get a loan in as few as 15 minutes. It typically won’t require a credit check either, which simplifies things. But that means you skip a crucial step of the lending process.
Lenders do credit checks and put borrowers through the underwriting process to make sure you can afford to repay a loan. So, if you’re given a wad of cash without that, you could end up owing much more than you can afford to pay back. The ease with which you can qualify for payday loans is why most people are not able to handle them properly.
Generally, all payday lenders require you have is:
- An active bank, credit union, or prepaid card
- Proof of income from a job or other source
- Valid form of identification
- Be at least 18 years old
The biggest problems with payday loans
The major issue with payday loans is that you often have a very short time frame to repay the entire amount of the loan. Usually, you only have a few weeks at most to come up with the cash. This is a far cry from how traditional personal loans function because you get the opportunity to pay back your loan over a much longer span of time.
Unfortunately, most people get forced into taking out a payday loan because their finances are already stretched thin. So, taking out a payday loan means committing a future paycheck to make one large payment. And that may cause you even more problems down the line.
If you haven’t had time to catch up on your finances, you may not have the money to cover the full cost of that loan come payday. If you can’t cover the loan, you are essentially forced to borrow again. One of the most troublesome aspects of a payday loan is the fact that you keep falling further and further behind. So, as the fees add up, you end up coughing up a fortune just because you needed to get by.
Even if you manage to pay off the loan right away, a large chunk of your check is likely to get eaten up by that payday loan repayment. That means you could soon run short of funds again, leading you to take out another payday loan, and so forth.
Basically, the problem with payday loans boils down to the fact that you’re committing future income to cover a current crisis. So, if you fall for this trap, you may be stuck in an ongoing cycle of taking on an expensive payday debt.
Understanding payday loan rollovers
Payday loan rollovers refer to the extension of a loan for another term. Borrowers will pay only the fees due, while the principal amount remains unchanged. Usually, rollovers are only available if borrowers are unable to pay back the full amount of the loan. Over 80% of payday loans cover previous loans that got taken out, not an original emergency that prompted taking out a loan in the first place.
Lenders have different rules for what constitutes needing a rollover loan. Your lender will make you aware of these before you agree to the rollover. Rollovers are not a decision to take lightly. If you’re feeling the pressure to pay back your loan and are struggling to do so, debt.com can connect you with certified counselors to help you through it. Call to connect with a counselor for free.
The issue with payday loan stacking
Payday loan stacking is the act of taking out multiple cash advance loans at once, prior to one advance being completely paid off. While most lenders won’t allow you to take multiple loans out through them, many consumers take out multiple loans from multiple different lenders. Not only does it make it harder to keep track of your payments, but each loan could have different terms, intensifying your debt.
Any payday loan not fully paid off will appear on your credit report or be discoverable through your bank statements. This makes your chances of getting approved for a second loan almost impossible. “Any borrower who takes out three payday loans in quick succession must be cut off by the lender, according to new CFPB guidelines.” 
Escaping a payday loan rollover trap
Many payday loan users live paycheck-to-paycheck and are unable to meet their obligation to repay their loan amount in full on time. This allows for the lenders to “rollover” the loan, adding more interest and fees, and snowballing the debt you were already in.
Lyle Solomon has helped over 6,000 people become debt-free and as a “payday loan crusader”, sought to bring payday loan equity to the forefront of people’s attention. Having seen a close friend’s life get destroyed because of his addiction to payday loans, it became his job to help people escape from the horrors of payday loans. He counsels his own clients that there are 11 solutions to get out of a payday loan rollover trap.
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How to stop ACH withdrawals from a payday lender
If a payday lender refuses to work with you, you can block them from taking electronic withdrawals from your bank account by revoking the payment authorization. The steps are:
Step 1: Write the payday loan company (or any business that takes money out of your bank account)
Example of “Revocation of authorization for debits” letter
RE: Revocation of authorization for debits
To Whom It May Concern:
Please stop taking automatic payments from my bank account for payments to my account with your company. My account number with your company is [xxx-xxxx]. I am writing to inform you that I am revoking authorization for you to debit my account via electronic funds transfer:
_This revocation applies to any and all future debits.
_This revocation applies to the next scheduled debit. I have not revoked authorization for other debits.
Step 2: Contact your bank or credit union
When you contact your financial institution, you’ll want to explain, in detail, who you want to block, the payment amounts, and dates. You must make sure to have the correct name of the company as shown in your bank statements. Businesses often have slightly, or completely, different names when they charge your account.
A stop payment order called a “Revocation of authorization for electronic debits,” is what you’ll send your bank or credit union to officially block payments from withdrawal.
Below is a sample letter you would send your institution. Make sure all of the information below is correct:
[Bank/Credit Union Name]
[Bank/Credit Union Address]
RE: Revocation of authorization for electronic debits
To Whom It May Concern:
[Company name] no longer has my permission to take automatic debit payments from my bank account. I have revoked the authorization that had enabled this company to debit my account via electronic funds transfer.
My Name: ___________________________
Checking Account Number: ___________________________
Payee Company Name: ___________________________
Account number with Payee Company: ___________________________
(If you have the information, provide):
Payment amount or range of amounts: ___________________________
Date[s] the schedule payment[s] appeared on my account statement: ____________
Specifically (select one):
_ I have revoked authorization as of _____ date for any future debits by [Company name].
_ I have revoked authorization as of _____ date for the next scheduled debit by [Company name]. I have not revoked authorization for other debits.
Payday loan FAQ
Q:How will a payday loan affect my credit?
Q:Are payday lending practices getting better?
Q:How much can you borrow for a payday loan?
Q:What are the pros and cons of taking out a payday loan?
Cons – High-interest rates, easy to get trapped in “rollover”, lenders can sue you over the money you owe.
Q:What are the interest rates on payday loans?
Q:Do payday loans have application fees?
Q:Can you get denied a payday loan?
Q:Can I take out more than one payday loan at a time?
Q:What if I can’t pay a payday loan back?
Q:Can I pay off a payday loan early?
Q:How long does it take to get money from a payday loan?
Q:Can I be sent to jail for non-payment?
Q:Do military members have different protections?
Find the help you need to get out of payday loan debt.
Article last modified on November 10, 2022. Published by Debt.com, LLC