Thanks to the advances in financial technology, if there’s a way for an institution to make money there’s a product for us to purchase. More specifically, the lending industry has found new ways to appeal to more individuals through electronic lending. With a few simple clicks and easy to complete forms, people can apply for loans in a matter of minutes.
This has bred growth and use of the payday loan sector. Other sectors have grown along with it such as traditional lending and short-term installment loans. While this makes applying for loans easier, it also is leading people to ignore the fine print and potentially fall under a cycle of borrowing they cannot get out of.
While payday loans have grown in popularity, many individuals and politicians have criticized the industry and compared it to predatory lending, which was a contributing factor to the 2007-2008 financial crisis.
What Are Payday Loans?
In this article we will focus on payday loans and why they may not be the best borrowing option on the market. First off, what exactly is a payday loan?
A payday loan is a short-term borrowing where the loan is typically repaid on your next payday, hence the name of the product.
Some payday loans can extend a little longer but that varies from lender to lender.
The market payday lenders gear their products towards are low income and people who are struggling with money. Since these are the markets they work in, this is what draws criticism from politicians and others in the finance industry.
Also, the other contributing factor are what some would call unethically high interest rates. If you take a look at any payday lender you will find annual percentage rates that are in the mid to high triple digits. Rates as high as these lead individuals who borrow from payday lenders into repaying significantly more then what they borrowed.
Finally, payday loans are designed to short-term fixes to a financial situation. If you take a look at the fine print on many payday lending websites, you will see that they explicitly say these products are not a long-term finance solution and are a costly method to borrow money.
Combine all these factors and you have a solid understanding of what a payday loan is. But now, we’ll take a look into how the payday loan process works.
How Do Payday Loans Work?
The mechanics of obtaining a payday loan are simple, almost too simple. First, you need to identify the lender you wish to use. There are several choices on the market, probably more than you can humanly research. Once you’ve found and selected the lender you can begin the application process.
Many payday lenders have a quick and painless application process with few requirements. Typically, the requirements include being 18 years of age or older, residing in the United States and having proof of income, usually over $1,000 a month. The lender will ask for your address and other required information including your social security number and income.
One thing you may notice is that many payday lenders will not do a hard credit check, rather utilizing a soft pull or using their own internal metrics. Be leery of these lenders as any sound lender should be completing a hard pull of your credit to validate information.
After you’ve filled out the information you will receive your application decision, which for many is instant. At this point you either are approved or denied. If you are approved, you will be sent the loan documents, which is when you need to pay extremely close attention to the details. The loan agreement is where you will find information such as the annual percentage rate, repayment amounts and if you have a right of rescission.
Upon the signing of your documents you will likely receive funding within 24 to 48 hours. Many people skip over this part (the fine print) and then become even more stressed when the note comes due with an extremely high payment.
It cannot be stressed enough, when you receive the loan agreement you need to pay close attention to ensure you are not being taken advantage of, as some payday lenders are less than ideal.
Payday Loan Laws
Stepping over to the legal side of things, there are several states within the U.S. that have made payday lending illegal, due to the predatory practices and extremely high interest rates. As you can imagine, with suspect lending terms, it can draw heavy legal attention.
The following states currently do not allow payday lending: Arizona, Arkansas, Connecticut, Georgia, Maryland, Massachusetts, Montana, New Hampshire, New Jersey, New York, North Carolina, Pennsylvania, South Dakota, Vermont and West Virginia.
In more recent news, 2020 Presidential candidate Bernie Sanders is part of a bill that looks to cap consumer lending products such as credit cards and payday lenders at an interest rate of 15%. Many believe this has the potential to disrupt and even stop the payday lending industry. While it still has a long way to go before being considered law, it is something worth watching. The angle the bill takes is again, the predatory nature payday lenders portray. The bill ultimately is trying to put an end to loan sharks.
Payday Loan Rates and Terms by State
| State | Legal Status | Citation | Max Loan Amount | Loan Term | Max Fees | Finance Charge per $100 | APR for 14-day $100 Loan |
|---|---|---|---|---|---|---|---|
| Alabama | Legal | Ala. Code §§ 5-18A-1 et seq. | $500 | 10-31 days | 17.5% | $17.5 | 456.25% |
| Alaska | Legal | Alaska Stat. §§ 06.50.010 et seq | $500 | Min: 14 days | $5 + the lesser of $15 per $100 or 15% | $20 | 520% |
| Arizona | Prohibited | Consumer Lenders Act applies. Ariz. Rev. Stat. Ann. §§ 6-601 et seq | Not applicable | Not applicable | Not applicable | Not applicable | Not applicable |
| Arkansas | Prohibited | Ark. Code Ann. 23-52-101 et. Seq., repealed 2011 | Not applicable | Not applicable | Not applicable | Not applicable | Not applicable |
| California | Legal | Cal. Fin. Code §§ 23000 to 23106 | $255 | Max: 31 days | 15% of check | $17.65 | 459% |
| Colorado | Legal | Colo. Rev. Stat. 5-3.1-101 et seq. | $500 | Min: 6 Months | 20%: $0-$300 + 7.5%: $301-$500 plus 45% per annum interest plus monthly maintenance fee $7.50 per $100 borrowed, up to $30, after first month. | Not applicable | Not applicable |
| Connecticut | Prohibited | Conn. Gen. Stat. §§ 36a-563 et seq | Not applicable | Not applicable | Not applicable | Not applicable | Not applicable |
| Delaware | Legal | Del. Code Ann. Tit. 5 2227 et seq. | $1,000 | Less than 60 days | Not Specified | No limit | No Limit |
| Florida | Legal | Fl. Stat. Ann. §§ 560.402 et seq. | $500 | 7-31 days | 10% of check + verification fee not to exceed $5 | $16.11 | 419.% |
| Georgia | Prohibited | Ga. Code Ann. §§ 16-17-1 et seq. | Not applicable | Not applicable | Not applicable | Not applicable | Not applicable |
| Hawaii | Legal | Hawaii Rev. Stat. Ann. 480F-1 et seq. | $600 face amount of check | 32 days | 15% of check | $17.65 | 459% |
| Idaho | Legal | Idaho Code §§ 28-46-401 et seq. | $1,000. Loan cannot exceed 25% of gross monthly income of borrower. | Not Specified | Not Specified | Not specified | No Limit |
| Illinois | Legal | 815 ILCS 122 et seq. | Lesser of $1000 or 25% gross monthly income. Payday installment loan lesser of 22.5% gross monthly income or $1,000. | 13 to 120 days. Payday installment loans 112 to 180 day terms. | $15.50 per $100, plus a $1 verification fee | $15.5 | 403% |
| Indiana | Legal | Ind. Code §§ 24-4-4.5-7-101 et seq. | $550 (not to exceed 20% of borrower's monthly gross income) | Min: 14 days | 15%: $0-$250; 13%: $251-$400; 10%: $401-$500 | $15 | 390% |
| Iowa | Legal | Iowa Code Ann. 533D.1 et seq. | $500 | 31 days | $15: $0-$100 on face amount of check; $10 per $100 thereafter | $16.67 | 433% |
| Kansas | Legal | Kan. Stat. Ann. § 16a-2-404, 405 | $500 | 7-30 days | 15% of loan | $15 | 390% |
| Kentucky | Legal | Kentucky Rev. Stat. Ann. §§ 286.9.010 et seq. | $500 | 14-60 days | $15 per $100 on face value of check + $1 database fee | $17.65 | 459% |
| Louisiana | Legal | La. Rev. Stat. Ann. §§ 9:3578.1 et seq. | $350 | 60 days or less | 16.75% of face-value of check, + $10 documentation fee (After default: months 1-12: 36% per year; months 13 and beyond: 18% per year) | $30 | 780% |
| Maine | Legal | Me. Rev. Stat. tit. 9-A § 1-201 | Not specified | Not Specified | Not Specified | Not Specified | Not Specified |
| Maryland | Prohibited | Md. Code Com. Law § 12-101 et seq. | Not applicable | Not applicable | Not applicable | Not applicable | Not applicable |
| Massachusetts | Prohibited | Mass. Gen. Laws Ann. ch. 140 §§ 96 et seq | Not applicable | Not applicable | Not applicable | Not applicable | Not applicable |
| Michigan | Legal | Mich. Comp. Laws §§ 487.2121 et seq | $600 | 31 days | 15% of first $100, 14% of second $100, 13% of third $100, 12% of fourth $100, 11% of fifth $100, 11% of sixth $100 + any database verification fee | $15 | 390% |
| Minnesota | Legal | Minn. Stat. 47.60 et seq. | $350 | Max: 30 days | $5.50: $0-$50; 10%+$5: $51-$100; 7% (min. $10) + $5: $101-$250; 6% (min. $17.50) + $5: $251-$350 (After default: 2.75% per month) | $15 | 390% |
| Mississippi | Legal | Miss. Code Ann. §§ 75-67-501 et seq. | $500 face value of check | Under $250: maximum of 30 days; $250-$500: 28-30 days | Under $250: $20 per $100 advanced; $250-500: $21.95 per $100 advanced | $20 | 520% |
| Missouri | Legal | Mo. Rev. Stat. §§ 408.500.1 et seq. | $500 | 14-31 days | Not Specified | $75 | 1950% |
| Montana | Prohibited | Mont. Code Ann. 31-1-701 | Not applicable | Not applicable | Not applicable | Not applicable | Not applicable |
| Nebraska | Legal | Neb. Stat. Ann. §§ 45-901 | $500 | Max: 34 days | $15 per $100 or pro rata for any part thereof on amount of check | $17.65 | 459% |
| Nevada | Legal | Nev. Rev. Stat. 604A.010 et seq. | 25% of expected gross monthly income | 35 days | Not Specified | No Limit | No Limit |
| New Hampshire | Prohibited | N.H. Rev. Stat. Ann. 399-A:1 et seq. | Not applicable | Not applicable | Not applicable | Not applicable | Not applicable |
| New Jersey | Prohibited | N.J. Stat. Ann. tit. 17:1 et seq | Not applicable | Not applicable | Not applicable | Not applicable | Not applicable |
| New Mexico | Legal | N.M. Stat. Ann. §§ 58-15-32 to 38 | $2,500 | 35 days | $15.50 per $100; $.50 verification fee per $100 | $16 | 416% |
| New York | Prohibited | N.Y. Penal Code 190.40 | Not applicable | Not applicable | Not applicable | Not applicable | Not applicable |
| North Carolina | Prohibited | N.C. Gen. Stat. 53-281 | Not applicable | Not applicable | Not applicable | Not applicable | Not applicable |
| North Dakota | Legal | N.D. Cent. Code 13-08-01 et seq. | $500 | Max: 60 days | 20% + databasing fee | $20 | 520% |
| Ohio | Legal | Ohio Rev. Code Ann. 1321.35 et seq | $500 | Minimum: 31 days | 28% annual interest | $1.08 | 28% |
| Oklahoma | Legal | Okla. Stat. Tit. 59 §§ 3101 et seq. | $500 | 12-45 days | $15 per $100: $0-$300; an additional fee of $10 per $100: $301-$500 | $15 | 390% |
| Oregon | Legal | 54 Or. Rev. Stat. § 725A.010 et seq. | $50,000 (Loan limit up to 25%of borrower’s net monthly income if earns $60,000 per year or less.) | 31 to 60 days | 36% APR interest, one-time $10 per $100 of loan origination fee, up to $30 | $13 for 31 day loan | 154% APR for 31 day loan |
| Pennsylvania | Prohibited | 63 Penn Stat. Ann. § 2325 | Not applicable | Not applicable | Not applicable | Not applicable | Not applicable |
| Rhode Island | Legal | R.I. Stat. Ann. 19-14.4-1 et seq. | $500 | Min: 13 days | 10% of funds advanced | $10 | 260% |
| South Carolina | Legal | S.C. Code §§ 34-39-110 et seq. | $700 or 30% of gross monthly income, whichever is less | Max: 31 days | 15% of principal | $15 | 390% |
| South Dakota | Prohibited | S.D. Codified Laws 54-4-36 et seq. | Not applicable | Not applicable | Not applicable | Not applicable | Not applicable |
| Tennessee | Legal | Tenn. Code Ann. 45-17-101 et seq. | $425 ($500 check) | Max: 31 days | 15% of the face value of the check | $17.65 | 459% |
| Texas | Legal | 5 Tex. Fin. Code §§ 393 et seq | Not specified | Up to 180 days for CAB agreement | No cap on Credit Access Business fees. Lender interest capped at 10% | No Limit | No Limit |
| Utah | Legal | Utah Code Ann. 7-23-101 et seq | No limit | May not exceed 10 weeks | No usury limit | No Limit | No Limit |
| Vermont | Prohibited | Vt. Stat. Ann. tit. 9 § 41a. | Not applicable | Not applicable | Not applicable | Not applicable | Not applicable |
| Virginia | Legal | Va. Code Ann. §§ 6.2-1800 et seq. | $500 | Min: 2 pay periods | 36% annual interest + $5 verification fee + 20% of loan | $26.38 | 687% |
| Washington | Legal | Wash. Rev. Code Ann. 31.45.010 et seq. | $700 or 30% of gross monthly income, whichever is less | Max: 45 days | 15%: first $500; 10%: remaining portion of the loan in excess of $500 up to the $700 maximum | $15 | 390% |
| West Virginia | Prohibited | W. Va. Code § 46A-4-101 et seq. | Not applicable | Not applicable | Not applicable | Not applicable | Not applicable |
| Wisconsin | Legal | Wis. Stat. 138.14 | Lesser of $1,500 including fees or 35% gross monthly income | 90 days or less | No Limit | No Limit | No Limit |
| Wyoming | Legal | Wy. Stat. 40-14-362 et seq. | Not specified | 1 calendar month | the greater of 20% per month or $30 | $30 | 780% |
Payday Loan Alternatives
In this next section we’ll begin to go over the many different alternatives you can choose from in lieu of a payday lender. Again, a payday lender offers less than ideal rates and tend to take advantage of those who truly need the temporary boost in income. Also, they clearly state it is not a long-term financial solution, meaning you are likely better off using the following alternatives.
Short-term Installment Loans
The first alternative we’ll go over is a short-term installment loan. When you are looking for a payday loan alternative, you should consider looking for installment loans. However, you still need to be mindful because there are many short-term installment loan lenders that have high interest rates.
How a short-term installment loan works is you first have to find a lender that specializes in short-term installment loans. Tribal loans are a popular short-term lender, but you must consider the interest rates because some are still incredibly high. Once you’ve completed your due diligence you can begin the application process.
The usual information is required such as name, address, social security and income. When applying, there are requirements such as you must make a certain amount to be considered for approval. Also, you’ll find that many of the short-term lenders have quick application process and you will likely receive your funds within 24 to 48 hours.
Benefits to installment loans include equal payments that are over several months, allowing for proper budgeting. Also, this eliminates the pressure of having to repay everything within a couple weeks as you would with a payday lender.
Peer-to-Peer Lending
Next on our list is the world of peer-to-peer lending, or P2P lending. Peer-to-peer lending is an installment loan that is funded by a single or many individuals and not a large financial institution. However, a larger business or marketplace will facilitate the process as a slight cost. LendingClub is currently one of the most popular where you can go to obtain a peer-to-peer loan.
How the process works is you begin by identifying your need and amount. From there, you will either be approved or denied. If you are approved, you will have your note put on the marketplace for others to begin investing in. Depending on your credit score and other contributing factors, you will be given a grade, which is the interest rate. From there, once your loan is fully funded you will be given the proceeds and start the repayment process.
This method of lending is suitable for those that have average or less than average credit score. However, you will see your interest rates be higher than current market prices, but that’s because you might look riskier in the eye of an investor. A drawback though is it can take a bit of time to have your loan funded and if you are in a hurry this may not be the most effective option. Compared to payday lending though, this is a must better alternative.
401(k) Loans
Now this next option we’re going to discuss can go two ways, and it involves your 401(k). As you already know, your 401(k) is an employee sponsored retirement vehicle where you contribute pre-tax dollars and continue to do so until you hit retirement, age 65. However, should an emergency arise, or you simply need money, you can take two avenues regarding your 401(k) plan.
The first method is to simply withdraw money from your 401(k) plan, which is something you want to avoid if possible. Should you take an early withdraw, you not only are subject to taxes on your proceeds, but you will also incur a 10% penalty for early withdraw. This can be upwards of 30% taken out of your proceeds. While the taxes are unavoidable the 10% can be.
Our other method of utilizing proceeds in a 401(k) are to take out a 401(k) loan. This loan is through your employer and your retirement plan assets are used as collateral. Not every employer does this but you save money by not paying the 10% penalty and your payments are typically deducted through your payroll.
Before you go with either option it’s critical to understand if it is worth your while to do so. Retirement funds should be a last resort because if done incorrectly, can cost you large sums of money in taxes and penalties.
Credit Union Short Term Loans
Last on our list of alternatives to payday loans is a credit union short-term loan. Short-term in these examples would be anything between 1 to 5 years. Now, one of the benefits you’ll notice right out of the gate are credit unions tend to have reasonable rates for their personal loans. This will give you an advantage because you can likely get a somewhat competitive rate and solve your short-term funding needs.
How obtaining a loan through a credit union works is you will visit the institution of your choice and begin the application process. Many places allow you to begin the process online as well. From there, you will likely need to provide proof of income and your credit will be run. Remember, this is a proper financial institution that does more than just loans. From there, you either receive an approval or denial.
The process of obtaining a loan with a credit union typically takes a day or two, maybe slightly longer in other instances. If you have a bank that offers the same products you can go to them as well and see what they’re offering. Keep in mind that some credit unions have restrictions on who can become a member, so ensure you are looking for community credit unions.
Bonus: Check our our ultimate guide on bad credit loans.
Payday Loan Comparisons
Now that you have a solid understanding of the various alternatives to payday lending, we can do an in-depth comparison of each and see why you should be avoiding payday loans. Ways that payday lenders make it easier include expedited application processes and same day funding. They want you in and out as quickly as possible, so you don’t have enough time to look at the details of your loan. However, this section will help you avoid those mistakes.
Payday Loans vs Installment Loans
First on our list of comparisons are payday loans versus installment loans.
With a traditional installment loan, you have the benefit of repaying your loan over a period of time with fixed payments, rather than needing to repay everything in a lump sum payment a few weeks down the road. Depending on where you apply for your installment loan, you should find the process to be simple and quick. While the repayment options are favorable you still need to keep in mind the annual percentage rate (APR). There are installment loan companies that will give you the loan, but the interest rate will still be as high as a payday loan.
Taking a payday loan and comparing it with an installment loan, it is the lesser product in almost every way. First, you are stuck with repaying the loan in one lump sum payment, typically when you are paid next, hence the name payday loan. There interest rates are almost all in the triple digits and if you fail to repay the penalties can be severe.
If you have the option you should always look to steer in the direction of an installment loan, especially if you have the time and can afford to shop around.
Payday Loans vs Peer-to-Peer Lending
Next on our versus list is the payday loan against the peer-to-peer loan. P2P lending is still much under the radar compared to other lending products, but it has a sweet spot in the market that makes it attractive.
Starting with the P2P loan, comparing it to the payday loan it is better in every category, except for funding. When you apply for a peer-to-peer loan, you will likely get a high interest rate compared to the current marketplace, but it will be significantly cheaper than a payday loan. Obtaining a loan of this type is an installment loan and you’ll have several years to repay the note, depending on the specifics. However, funding is where a peer-to-peer loan loses because your loan is funded through investors and it could take a day up to several days before your loan is fully funded. In the case of LendingClub, investors can put as little as $25 into a note.
Switching to the payday loan, about the only place it beats a P2P loan is you can typically get your funds within 24-hours and in some cases same day. Beyond that, a payday loan is a losing proposition through and through. Your interest rate will be significantly higher and you will repay the note in a few weeks’ time.
Peer-to-peer lending can be completed online and you will likely receive results quickly. This lending product is much more efficient than a payday loan, as long as time is not of the essence.
Payday Loans vs 401(k) Loan
Now, with the 401(k) there were the two options we discussed. But, no matter if you select to make an early withdrawal or you take out a 401(k) loan, you are still likely to be better off than a payday loan. It gets a little tricky because if you take an early distribution from your retirement plan, you’ll need to calculate a few things, but first, the comparison.
401(k) money is almost always more efficient than a payday loan, but there are tradeoffs. If you are taking an early disbursement, one of the items you will want to calculate are your loss of earnings if you sell your investments. Again, early distributions will cost you around 30% with penalties and taxes, and if your distribution is large enough it can have a real impact on your future earnings.
The other option discussed was the 401(k) loan, which is likely the better option unless you need your complete paycheck. A 401(k) loan will typically have an extremely competitive interest rate because the loan will likely be fully collateralized.
Depending on the need and size of your loan, you can debate between those two. However, ignore the need to apply for a payday lender because if you are in a situation where you are short on funds, taking on a high interest note is likely not the way to go.
Payday Loans vs Credit Union Short-Term Loan
Last on our versus list is a payday loan versus a credit union personal loan, and as you might guess there is no doubting which is the better option, but to be fair we’ll lay out all the points.
With a personal loan from a credit union, you will have the benefits of a competitive rate and the comfort of an installment loan. The process is going to be a bit slower than a payday lender because you are applying at a financial institution that works with depositors as well, and they have to complete proper due diligence. Also, you likely need a little more documentation such as proof of income.
Now, on the one or two categories that a payday loan might win are on the application process speed as well as funding. There are not many institutions that can compete on that, with the exception of tribal lenders. Beyond that, payday lenders are no match compared to the efficiency of a credit union personal loan.
Out of all the versus, you will likely find the best option to use is a credit union loan. The terms are competitive, and you can get a loan for only a couple years. You will have the security of working with an established financial institution and they will complete the proper due diligence before lending to you.
How to Get Out of Payday Loans
After you’ve read this or maybe you’re reading this after the fact, but you’ve already applied for and accepted a payday loan, you should begin to look as quickly as possible on how to repay that loan. Now, you will likely need to have the funds available prior to your next paycheck, otherwise you risk incurring penalties and making the repayment amount greater.
First, if you have the cash available and are able, you need to pay off your payday loan as quickly as possible. Depending on the details within your loan agreement, you may have the option to repay the note early. If possible, pay the loan off early and rid yourself of this inefficient loan. The reason many places will allow for early repayment is the lending is risky to begin with, so if they can get their principal with a little interest back, the institution will take it.
Another way to get out of a payday loan is to refinance or take out a proper installment loan to cover the repayment of the payday loan and then some. We all have emergencies and might make impulse decisions. However, if you can repay the note with a proper and more practical installment loan, you will save yourself time and energy.
The last way to get out of a payday loan is to avoid them all together. No matter how great your emergency is, you would be better off asking family or friends before going to a payday lender. These businesses are purely in it for the profits and many do not have your best interest in mind. Whereas with a credit union for example, they care significantly more about you compared to a payday lender.
Debt Management Resources
With a now thorough understanding of payday loans and the better alternatives, if you are shopping for one there is likely an underlying debt issue. If that’s the case, there are several tools and resources out there to help organize and increase your financial health.
Dave Ramsey is a leader in the personal finance space who has many books out that have helped thousands upon thousands of people organize and build their financial position.
You can also look into governmental help and depending on your income, you can qualify for certain governmental aid services. Regardless of your need, there is a tool out there that can assist.
All the negative light that has been shown onto payday loans is not without cause. With their high interest rates and extremely quick repayment schedules it leaves little room for them to be an effective tool. In fairness, many do openly state that payday loans are an expensive form of borrowing and are not a long-term financial solution.
Instead of turning to a payday loan, seek an alternative form of lending through installment loans, 401(k) proceeds or a personal loan from a credit union. Especially if you can shop, using an alternative lender will not only save you stress, but the loss of unnecessary money to insanely high interest rates. Overall, simply having a healthy financial situation will go a long way into preparing you for what life has in store.
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