Financial Wellness

How do payday loans work?

A deep dive into this financial product that’s harmful to borrowers, and highly lucrative for lenders.
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Right now in our country, millions of people are living paycheck to paycheck with no real way to cover a small financial emergency. When problems arise for people who are struggling to make ends meet, options are limited. Some borrow from friends and family, sell their belongings, or dip into their 401(k)s. But many people — 12 million per year — take out payday loans in these situations. Although payday loans are incredibly common, how many of us truly understand this “service” that so many Americans are making use of? This post offers a deep dive into payday loans: who’s taking them, how they work, and the effect they can have on people who are struggling.

Scary problems, scarier solutions

There’s an unfortunate paradox to be faced by many people who run out of money before payday comes. The less well-off you are, the harder it is to get help. It’s a classic example of “it’s expensive to be poor.”

For example, one way people get extra cash when they need it is with a line of credit or a personal line. But unless you’re already well situated financially — with a relatively high income, or a good credit score — you’ll be offered a very high APR on that product. Or, you’ll be denied altogether.

This is one of the main reasons why people turn to payday loans. As long as you have a checking account and a paystub, you’re eligible. It’s a fast and easy solution, but there’s a big catch. The loans are hard to pay back, due to confusing terms and extremely high fees. In fact, over 80% of payday loans are rolled over or renewed because the borrower is unable to pay them back, resulting in more and more fees.

“We are concerned that too many borrowers slide into the debt traps that payday loans can become.”

— Former CFPB Director Richard Cordray

Those fees are what’s made the payday loan industry so rich. The average payday loan borrower ends up paying back $793 for a $325 loan. In total, Americans paid $12 billion in payday loan fees last year. With payday loans, most people end up in situations far worse than before they took out the loan in the first place.

How payday loans work

After someone finds their local payday loan store — which is usually easy, since there are more payday lenders in the U.S. than McDonalds and Burger Kings combined — here’s how the process works.

Step 1: Get the loan

  1. Decide what loan amount you need. Loans range from $50 to $1,000.
  2. Fill out a registration form at the payday loan store, providing your ID, paystub, and bank account number.
  3. Receive cash on the spot after acknowledging that full repayment will be due on your next payday (usually around two weeks).

Step 2: Pay the loan back

  1. At the time you get the loan, you’d post-date a personal check coinciding with your next payday. With some lenders, you’d instead give permission for them to electronically debit your bank account.
  2. The loan amount would be recouped either via the post-dated check or direct debit — plus a flat fee of $15 to $20 for every $100 borrowed.
  3. When calculated using the same APR model for credit cards mortgages, and auto loans, most payday loan interest rates range from 391% to 521% APR.

What if you can’t pay the loan back?

Over 80% of payday loan borrowers can’t pay their initial loan back on time. If you became one of those borrowers and missed your repayment deadline, you could “roll over” the loan, adding new finance charges to your existing debt.

What a rolled-over payday loan looks like

The average payday loan is $375. If you took this size loan out with the lowest finance charge available ($15 per $100 borrowed), you’d pay a fee of $56.25 on the principal of $375 — for a total loan amount of $431.25

If you couldn’t pay on time, you’d roll over your loan at a new amount of $495.94. This is the “new loan” amount of $431.25, with a brand new round of interest costing $64.69. This is how a $375 loan becomes nearly $500 in less than a month, and is the reason payday loans are effectively debt traps.

Healthier alternatives to payday loans

People who are struggling to make ends meet do need the ability to access money in an emergency. They need to be able to fix the car to get to work so they don’t lose their job; they need to be able to keep the lights on so their kids can do homework.

But too many of the existing solutions, like payday loans, are making employees’ situations worse so financial companies can rake in profits. This is why bodies like the Consumer Financial Protection Bureau (CFPB) have tried to place strong regulations on payday lenders.

One solution is earned wage access; a product that gives workers access to their own paychecks before payday, but does so in a way that doesn’t hinder financial wellness. By making use of their own money, employees can handle cash-flow emergencies while avoiding costly, predatory payday loans. But earned wage access must be paired with other features that enable employees to track spending, set goals, and build savings — this is what will put them on the path to building financial wellness.


To learn more, download our newest e-book: A Guide to Financial Wellness: The Employer’s Handbook for Understanding On-Demand Pay and Financial Wellness Benefits.

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