Payday loans market themselves as a quick fix. You need money today. They put money in your account today. Problem solved.
The reality is harder. Payday loans are built in a way that makes it very hard for most people to pay them back on time. The fees add up. The balance grows. What started as a $300 emergency can turn into $1,000 in fees over a few months.
This article walks through exactly why payday loans are bad. We'll also share what to do instead if you need money in a hurry.
The APR is extremely high
APR is the yearly cost of a loan. It's the number that lets you compare loans fairly.
A typical payday loan in the US costs around $15 for every $100 you borrow, for a two-week term. That sounds small. But worked out over a year, it comes to about 391% APR.
The Consumer Financial Protection Bureau has reported average payday APRs above 400%. In some states it's higher still.
By comparison, a credit card is usually 15% to 30% APR. A personal loan from a bank is usually 6% to 36%. Even a cosigner loan for someone with bad credit is around 35.99% at Together Loans. Payday loans are in a category of their own — and it's not a good one.
The repayment window is too short
You're expected to pay back the full amount plus the fee within about 14 days. That's one paycheck.
If your tight month was more than a one-time problem, that next paycheck has to cover the loan, the fee, and all your normal bills. Most budgets can't stretch that far.
Payday loans are designed to be paid back from a single paycheck. But the people who need them most often don't have a single paycheck to spare. That's the trap.
"Rollovers" turn a small problem into a big one
When you can't pay in full, the lender lets you "roll over" the loan for another fee. A rollover means taking out a new loan to pay off the old one. Then another. Then another.
The Consumer Financial Protection Bureau has found that the average payday loan customer takes out 10 loans per year. Eight out of ten payday loans are taken out within two weeks of paying off a previous one. That's not by accident. It's how the business model works.
Here's what rolling over looks like in dollars. Say you borrow $300 for two weeks, with a $45 fee:
- Week 2: you owe $345. You can't pay it.
- Roll over. Another $45 fee.
- Week 4: you owe $390. You can't pay it.
- Roll over. Another $45.
- Week 6: $435. Another $45.
- Week 8: $480. Another $45.
- Week 10: $525.
After ten weeks you've paid $225 in fees. The original $300 you borrowed is still sitting there, not paid down at all.
They can damage your credit
If you fall behind, the loan gets sent to collections. A collections account stays on your credit report for seven years.
Most payday lenders don't report on-time payments to the credit bureaus. That means payday loans rarely help you build credit when they go well. They almost always hurt it when they go badly.
Regular installment loans (loans you pay back in fixed monthly amounts) are different. They report every on-time payment, which actively helps rebuild your credit. Here's more on what affects your credit score.
They target people with fewer options
Payday lenders don't open stores in wealthy neighborhoods. They open in places where people have fewer choices. Places where banks have pulled out. Places where credit unions are scarce.
The marketing is aimed at people in a tight spot. "Bad credit? No problem." "Cash in minutes." "No credit check." These messages work because they find people who feel like they have no other choice.
The truth is that most people in that situation do have other choices. They just don't know about them yet.
What to do instead
There are several options that are cheaper and safer than a payday loan. Most people don't know about all of them. Here's a short list of the best ones.
- A credit union Payday Alternative Loan (PAL). Capped at 28% APR, paid back over 1 to 12 months, borrow $200 to $2,000. You usually need to have been a credit union member for at least a month to apply.
- A cosigner loan. If you have a friend or family member with stronger credit who's willing to sign with you, a cosigner loan is far cheaper than a payday loan. Read more about how cosigner loans work.
- A paycheck advance from your employer. Many employers will advance you a portion of your wages with no interest. Apps like DailyPay and PayActiv do the same thing.
- Negotiating the bill. If you need money for one specific bill, try calling the company first. Utilities, hospitals, and landlords will often offer a payment plan if you call before the due date.
- A community lender. Community Development Financial Institutions (CDFIs for short) and local nonprofits offer small emergency loans to people who can't access regular credit.
For a full guide to each of these options, including what they cost and how to qualify, read our guide to payday loan alternatives for bad credit.
If you're already stuck in a payday loan
If you're already rolling over a payday loan, the most useful thing you can do is talk to a nonprofit credit counselor.
The National Foundation for Credit Counseling offers free or low-cost sessions. They can help you build a plan to pay off the loan and avoid taking out the next one.
Some states also have extended payment plans you can ask for. These give you more time to pay without extra fees.
A consolidation loan from a credit union, a cosigner loan, or a hardship loan from a CDFI can refinance the payday loan into something you can actually afford. The goal is to break the rollover cycle.
The bottom line
Payday loans market themselves as a quick fix. The math is clear that they're usually not a fix at all. They're a way of turning a one-time problem into months of fees.
Almost any other option will leave you better off. A credit union PAL. A cosigner loan. A conversation with the original creditor. All of them beat a payday loan.
If a cosigner loan sounds like it could work for you, apply for a Together Loans cosigner loan online in about 10 minutes. Or read our full guide to payday loan alternatives for bad credit.