How do payday loans work?

Step by step

1. You apply with an ID, proof of income and a checking account, in a store or online.
2. The lender reviews your income and bank history. Many use specialty databases instead of the major credit bureaus.
3. You sign an agreement that must show the finance charge in dollars and the APR.
4. You authorize repayment with a postdated check or permission to debit your account.
5. You receive the money as cash, a bank transfer or a prepaid card.
6. On the due date the lender cashes the check or debits your account for the loan plus the fee.

What the fee means

Payday lenders quote a fee per $100, most often $15. On a two-week loan that equals an APR of about 391%, because the same fee would be charged 26 times in a year. The APR lets you compare a payday loan with a credit card (about 25%) or a credit union loan (up to 28%).

A worked example

Take a $400 loan in a state where the fee is $15 per $100. The fee is $60, so $460 is due in 14 days, an APR of 391%. A borrower who can afford only the fee renews, and each renewal costs another $60. After three renewals that borrower has paid $180 in fees and still owes $460 on the next due date.

What happens on the due date

If the money is in your account, the loan ends. If it is not, three things can happen. The lender may offer a rollover, where you pay the fee and the due date moves, although many states limit or ban this. The debit may fail, triggering a returned-payment fee from the lender and an overdraft or insufficient-funds fee from your bank. Or you can ask for a payment plan, which many states require lenders to grant.

Why costs grow

A $300 loan with a $45 fee looks manageable. Renewed four times it has cost $225 and the $300 is still owed. The Consumer Financial Protection Bureau has found that most payday loan volume comes from borrowers caught in sequences like this.

Your rights

• The finance charge and APR must be disclosed in writing before you sign.
• You cannot be arrested for failing to repay.
• You can revoke a lender’s authorization to debit your bank account.
• Service members and their dependents are covered by a 36% rate cap.

Where to go next

See the rules and prices in your state, price a loan with the calculator, or compare cheaper alternatives.