What Is a Payday Mortgage and How Does It Work?
According to a 2021 survey by PAYMNTS and LendingClub, over 60% of Americans live paycheck to paycheck. When you’re in this situation, the money you make just barely covers your day-to-day expenses. Any unplanned expense, such as a $300 car repair, turns into a financial crisis.
Payday loans — also called check advance or cash advance loans — appear to offer a way out. You can walk into one of the thousands of payday lending offices across the country and walk out with $300 in your hand to pay that repair bill.
But in the long term, these loans often lead to bigger problems. People who use them can end up trapped in a cycle of debt, paying far more in interest each year than they borrowed.
What Is a Payday Loan?
Payday loans are small, short-term loans — typically under $500 — designed to tide you over until your next paycheck. When that paycheck comes, you pay the loan back immediately, in full.
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Payday loans are easy to get. They require no credit check and no collateral — something of value offered to a lender as security for the loan, such as a lien on your house or car. This makes them popular with borrowers who have few assets and bad credit or no credit at all.
Many financial experts consider payday loans a form of predatory lending. These loans charge extremely high interest, and they’re structured in a way that disguises just how high it is. They often have other hidden fees as well.
Most of all, payday lenders don’t consider a borrower’s ability to repay the loan. Because of that, many borrowers have trouble paying them back and must renew them over and over, becoming trapped in debt.
Because of these risks, several states have outlawed payday loans altogether. And most states that allow them have set limits on the amount you can borrow this way.
How Do Payday Loans Work?
Most payday lenders are small businesses with physical stores where you can take out a loan in person. To apply for a loan, you provide the lender with proof of your income, such as a pay stub. You must also provide either a copy of your bank account information.
The lender checks your income and bank information. If everything checks out, they request permission to withdraw funds from your account electronically. In some cases, they ask you to provide a personal check for the loan amount plus interest, dated on your next payday.
After settling all these details, the payday lender either transfers the loan amount to your bank account or hands it to you in the form of cash or a check. The entire process takes as little as 15 minutes.
Some payday lenders operate entirely online. When you borrow from an online lender, the money arrives in your account by online transfer. Often, it arrives the same day.
Repaying a Payday Loan
When your next payday comes, usually in two weeks, you must return to the store to pay back the loan, with interest — a lot of interest. The typical fee for a payday loan is $15 per $100 borrowed. On a yearly basis, that works out to an annual percentage rate (APR) of 391%.
If you don’t show up on the due date, the payday lender simply seizes the money. They either cash your check or deduct the full loan amount from your bank account. If you borrowed from an online lender, they collect the money through electronic withdrawal.
However, if you can’t repay the loan, you can return to the loan office and renew it by paying another fee. Many borrowers do this several times in a row, paying more fees each time.
In fact, this is what usually happens — and how payday lenders make most of their money. A 2021 study by the Consumer Finance Protection Bureau (CFPB) found that more than 60% of people who took out payday loans still owed money on them six months later.
Car Title Loans
A common variant on the payday loan is the car title loan. These short-term loans also require no credit check, but they use your car as collateral. Usually, you must own the car outright to get one. However, some lenders allow them if you have a car loan that’s mostly paid off.
You can borrow more money with an auto title loan than you can with a payday loan. Most lenders offer 25% to 50% of your car’s value over a period of 15 to 30 days. In exchange, you must hand over the title to your car. Many lenders ask for a set of keys as well.
To get the title back, you must return the money along with a fee of around 25%. On a one-month loan, that’s a 300% APR. If you fail to make this payment, the lender seizes your car. Some lenders make you install a GPS tracker so they can find the vehicle more easily.
Once the lender has control of your car, they sell it to recover the cash. In some states, they can keep all the money from the sale, even if it’s more than what you owe.
Like payday loans, title loans can be rolled over if you can’t make the payment, adding more interest to your debt. This happens even more often with title loans than it does with payday loans. The CFPB found that over 80% of title borrowers still owed money after six months.
Pros and Cons of Payday Loans
Payday loans are a popular way to borrow. According to the CFPB, over 4% of all U.S. consumers took one out in 2019. But these loans can pose major risks for borrowers.
Pros of Payday Loans
The main reason so many borrowers rely on payday loans is that they’re easy to get. Payday loans offer:
- Easy Access to Funding. According to the CFPB, the U.S. had over 14,300 payday loan storefronts in 2017 — more than the number of McDonald’s restaurants. And that doesn’t count all the online lenders you can access right from your home.
- No Credit Check. You don’t need good credit — or any credit — to get a payday loan. All you need is a bank account and proof of income. That makes payday loans an option for borrowers who don’t have the credit to qualify for a bank loan.
- No Collateral. You don’t need collateral for a payday loan. The lender doesn’t need it because they have your bank info as security. If you don’t bring back their money, they can just take it.
- Fast Cash. Payday loans are one of the fastest ways to borrow money. You can be in and out of a payday loan storefront with cash in hand in as little as 15 minutes.
- Easy Renewals. If you have trouble paying back a payday loan, it’s easy to renew it. In fact, payday lenders love it when you do this because they can collect more fees.
Cons of Payday Loans
Their convenience is about the only thing payday loans have going for them. Their terms are worse than just about any other form of debt. Drawbacks of payday loans include:
- Sky-High Interest. Payday loan fees range from $10 to $30 per $100 borrowed over two weeks. That works out to an annual interest rate between 260% and 785%. For comparison, the average credit card interest rate is around 17%.
- Renewal Fees. Each time you renew your payday loan, you pay this fee all over again. Within just a few months, you can pay more in interest than the original loan amount.
- Bank Fees. If a payday lender overdraws your bank account to collect on the loan, you pay an overdraft fee to the bank. And if they try to collect and fail, you pay a returned deposit fee. The lender may also charge you a fee for late payment or a returned check.
- Collections. Payday lenders usually don’t quit trying to collect after one attempt. They may make multiple attempts to charge your account, resulting in fees each time. If that doesn’t work, they’ll probably sell your debt to a collections agency. That means a lot of hassle, damaged credit, and in the worst case, a lawsuit.
- Limited Availability. Although payday loan storefronts are widespread, you won’t find them everywhere. In 18 states and the District of Columbia, caps on interest rates make payday lending illegal.
- Bans for Military Members. Even in states where these high-cost loans are legal, federal law bars lenders from charging more than 36% APR to members of the military. Many payday lenders deal with this law by refusing to make loans to service members.
- The Cycle of Debt. The majority of payday loan borrowers roll their loans over repeatedly. They become trapped in an ongoing cycle of debt, often for years. Borrowers interviewed by the Center for Responsible Lending report paying thousands in interest, losing their homes, and filing for bankruptcy.
Alternatives to Payday Loans
Payday loan borrowers have conflicted views about these high-interest loans. In a 2013 Pew poll,a majority of borrowers said these loans took advantage of them. But a majority also said the loans provided much-needed relief.
Fortunately, there are other ways to raise cash in a crisis. Some better alternatives include:
- Payroll Advances. Your employer may be willing to give you an advance on your next paycheck. This means paying you early for work you’ve already done. For instance, if you get paid every two weeks, they could give you half your pay after one week.
- Paycheck Advance Apps. If your employer doesn’t offer payroll advances, consider a paycheck advance app such as Brigit. These apps give you early access to your paycheck for a small fee or no fee at all.
- Personal Loans. A personal loan from a bank, credit union, or online lender requires a credit check but no collateral. These loans have much lower interest than payday loans and give you longer to pay. But people with bad credit can’t always get them.
- Small-Dollar Loans. Some banks offer special small-dollar loans for short terms to existing customers. Examples include Balance Assist from Bank of America and Simple Loan from U.S. Bank. Similarly, some credit unions offer small loans called payday alternative loans, or PALs.
- Peer-to-Peer Loans. Another option is peer-to-peer lending through sites like Prosper. You may qualify even if you have bad credit. You’ll pay high interest rates but not to the same extent as on a payday loan.
- Credit Cards. If you have a credit card, using it for bills is much cheaper than going to a payday lender. If you don’t, you may be able to get one even if your credit is poor. Look into one of the many credit cards for bad credit.
- Cash Advances. For bills you can’t pay with your card, such as rent, consider a cash advance. Taking a cash advance on your credit card is more expensive than normal borrowing but still cheaper than a payday loan.
- Late Payments. If you have bills due on Monday and you don’t get paid until Friday, a payday loan can bridge the gap. But it could be cheaper to wait until Friday and pay those bills late. Even if there’s a fee for this, it could be lower than payday loan interest.
- Negotiating With Creditors. Before taking out a payday loan to cover payments on existing debts, try negotiating with the lender. Sometimes you can get a lower interest rate or work out a repayment plan to make the bills more manageable.
- Pawn Shop Loans. At a pawn shop, you can either sell high-value items outright or borrow money on them. Finance charges can be high but still lower than you’d get from a payday lender.
- Help from Friends and Family. Borrowing from friends and family can be painful. But if you have to do it, it’s better to do it early than to wait until you’re drowning in payroll loan debt. Be sure to draw up a loan agreement as you would for any other loan.
- Emergency Assistance. You can also get emergency financial assistance from government, churches, and community groups. They offer short-term help with rent, food, utility bills, and other emergency needs. Some of them also make small loans at very low interest.
Payday Loan FAQs
Still have questions? Here are some more important facts to know about payday loans.
Are Payday Loans Legal?
In most states, yes. However, 18 states and the District of Columbia have restrictions on lending that make this type of short-term, high-interest loan illegal. This map from the Center for Responsible Lending shows which states allow payday loans.
What Do I Need to Get a Payday Loan?
To get a payday loan, you typically need just three things:
- A bank account in good standing.
- A pay stub or other proof that you have a job with regular income. Your job can’t be military service, as it’s illegal to charge more than 36% APR on loans to service members or their spouses and dependents.
- A valid ID to prove your name and age. You must be at least 18 to get a loan.
Some lenders also ask for your Social Security number as further proof of your identity.
How Much Does a Payday Loan Cost?
Payday lenders typically charge between $10 and $30 for each $100 you borrow. For most people, this fee isn’t just a one-time payment. They renew the loan repeatedly, paying the same fee over and over.
According to the CFPB study, most payday loan borrowers still haven’t paid back their loans after six months. That means they have paid the same fee 13 times. At $15 each, that adds up to $195 in fees on a $100 loan — nearly twice the original loan amount.
How Much Can I Borrow With a Payday Loan?
Even in states where payday lending is legal, there are limits on the size of these loans. In most states, the limit is somewhere between $300 and $1,000. The National Conference of State Legislatures lists the limits on payday lending in all states as of November 2020.
Borrowers can’t always get the maximum amount allowed by law. Many lenders adjust the amount you can borrow based on your income. For example, they may not allow you to borrow an amount more than 25% of your next paycheck.
How Does a Payday Loan Affect My Credit?
If you pay the loan off, it has no effect at all on your credit. The lender doesn’t perform a credit check and doesn’t report on-time payments to the credit bureaus. That means you can’t improve your credit score by taking out a payday loan and repaying it.
However, if you default on your loan, that’s a different story. The lender may report the default to the credit bureaus or sell your debt to a collection agency that reports it. If so, your credit score will suffer.
In short, a payday loan can only harm — not help — your credit score.
What Is the Payday Lending Rule?
The Consumer Financial Protection Bureau issued a new rule governing payday lending in 2017. This rule had two main provisions:
- The Mandatory Underwriting Provision. This first part applied to all loans with balloon payments, in which the whole balance comes due all at once. Lenders could no longer issue these loans without verifying that the borrowers could afford to repay them.
- High Interest Provision. The second part applied to all loans with an APR over 36%. If a borrower defaulted on any such loan, the lender would have to notify the borrower before trying to withdraw payment from their bank account. And if they tried twice to withdraw payment without success, they could not try again without the borrower’s express permission.
This rule was originally scheduled to take effect in August 2019. However, in February 2019, the Trump administration delayed its implementation. It eventually canceled the mandatory underwriting provision entirely.
The second part of the rule stayed in place, but a group of payday lenders challenged it in court. A Texas court upheld the rule in September 2021 and ruled that it would take effect the following year.
However, the lenders appealed the ruling. In October 2021, a higher court agreed to hear the case and to delay the rule in the meantime. Thus, no part of the Payday Lending Rule has taken effect yet, and its legal status is still up in the air.
What Happens If You Default on a Payday Loan?
If you do not pay back the loan, the payday lender will try to collect the money directly from your bank account. If the first attempt fails, the lender will probably keep trying.
Since the Payday Lending Rule still is not in effect, there’s no limit to how many times they can try. Their repeated attempts can result in multiple bank fees for you.
If that doesn’t work, the lender will eventually give up and send the debt to collections. Your credit score will drop, and the debt collectors can harass you with calls and letters. They can even take you to court over the debt. If they win the case, they can garnish (seize) your wages.
One thing debt collectors can’t do is arrest you for failing to pay back your loan. But if they sue you and you fail to show up in court, you can be arrested for that.
What Is the Best Payday Loan for Bad Credit?
Many people use payday loans because they have bad credit. This makes it difficult for them to take out a cheaper loan from a bank or another lender. But personal loans for bad credit do exist — and they’re much cheaper and easier to manage than payday loans.
Some of the best offers are from online lenders such as Earnest and Upstart. For smaller loan amounts, look into small-dollar loans or payday alternative loans from credit unions.
One type of personal loan to avoid is “no credit check installment loans.” These loans have longer repayment terms than a payday loan, but their interest rates are still extremely high. If you take out a $1,000 loan for two years at 87%, you’ll pay over $1,100 in interest.
What Is the Best Paycheck Advance App?
Paycheck advance apps offer an interest-free alternative to a payday loan. These services earn their money through monthly fees or through tips from users. Our top picks include Brigit, Empower, and Earnin.
What Is the Average Interest on a Payday Loan?
The average fee for a two-week payday loan is around $15 per $100 borrowed. That doesn’t sound so bad until you remember that the loan term is only two weeks. On a yearly basis, it works out to an annual percentage rate of 391%.
When you need money urgently, a payday loan is a tempting solution. But with their high fees and short repayment terms, these loans can easily end up costing you far more than you needed to borrow in the first place.
So, before taking out a payday loan, make sure you’ve considered all the alternatives. Compared to payday loans, even high-interest personal loans and credit card cash advances can look like the lesser of two evils.
But any form of borrowing to meet day-to-day expenses is just a stopgap fix. What you really need is to fix the holes in your personal budget. Even if a better budget can’t save you this time around, it can keep you from running into the same problem in the future.
At the same time, take whatever steps to build an emergency fund. That way, the next time you’re strapped for cash, you won’t have to choose between bad debt and even worse debt.