Payday Loans

This type of loan is typically characterized by a very high interest rate and a short loan period. It works by having the borrower write a check to the lender that is post-dated to the end of the loan period (usually the borrower’s next payday). The borrower then receives money in the amount of the check minus the interest. At the end of the loan period, one of three things happens: the borrower repays the loan, the borrower defaults and the lender cashes the check, or the borrower ‘rolls over’ the loan. A ‘roll over’ means the loan is renewed for another two-week period and another round of interest is paid. Unfortunately, it’s this last scenario that is the most common. Forty-six percent of payday loans are rolled over.¹ In fact, the terms of the loan—the combination of conditions that the loan must be paid in full and the shortness of the loan period—along with the borrower’s usually challenged financial situation, greatly favor this outcome.

The interest rates on payday loans must also be considered. A typical payday loan might charge from $15 to $20 on every $100 borrowed over the two-week loan period.² That’s 15–20% interest. But consider that this 15–20% is on a two-week period. If you expand that loan period to a year, which is the standard period that banks and credit cards use to calculate interest rates, that 15–20% jumps to 390–560%.¹ This is the actual annual percentage rate or APR on the loan. Given that credit cards average 12% APR,³ that’s very expensive credit indeed.

Use the Credit Comparison Tool to see this type of credit in action.

1. FDIC Center for Financial Research
2. The Center for Responsible Lending
3. Typical credit card loan rate provided by creditcards.com index and was 12.41% as of May 19, 2008