Payday loan
Payday loans are short-term financial products typically due on the borrower's next payday, often ranging from $100 to $1,500. These loans, also referred to as cash advances, allow borrowers to access quick cash without a credit check, requiring only a steady job and a bank account. However, they come with extremely high-interest rates, ranging from 400% to 900% annually, which can lead to significant financial strain for borrowers, particularly those with low incomes or poor credit histories. Many borrowers find themselves trapped in a cycle of debt, repeatedly rolling over loans or taking out new ones to cover old debts, which can result in accumulating fees that far exceed the original loan amount.
The payday loan industry has roots in historical loan-sharking practices, gaining traction in the 1980s due to deregulation in the banking sector. While proponents argue that payday loans provide essential financial services to those underserved by traditional banking, critics contend that these loans exploit vulnerable populations, leaving them unable to meet basic living expenses. Despite some state restrictions on payday lending, many jurisdictions still allow such practices, leading to widespread availability across the United States. As this industry continues to grow, it reflects underlying economic challenges faced by many individuals.
On this Page
Payday loan
Payday loans are short-term loans that are generally due on the borrower’s next payday. The loans are for small amounts of money, typically $100 to $1500. Also known as "cash advances," payday loans require the borrower to write a check for the full balance of the loan, so the lender can deposit it when the loan becomes due.
The predatory-style lending practices of payday loans have earned them a bad reputation. Most commonly, borrowers of payday loans have low incomes and bad credit history. Their lack of access to credit cards and bank loans steers them toward payday loans, where the interest rates are sky-high. Borrowers pay a rate of 400 percent to 900 percent annually, and many accrue finance charges when they cannot repay the original loans. Some become trapped in an endless cycle of debt, using new payday loans to repay their older ones.
Background
Payday loans have their roots in the illegal loan-sharking practices that began in the late 1800s. Workers who were unable to open bank accounts used loan sharks and pawn brokers to gain access to cash that would carry them to the next payday. Loan sharks, operating unlawfully, would provide short-term loans with high rates of interest. If the borrower did not repay the loans, the loan shark would often resort to violence.
Payday loans, an iteration of loan-sharking, gained popularity in the 1980s. A landmark 1978 Supreme Court case, Marquette Nat’l Bank v. First of Omaha Service Corp., permitted banks to charge interest rates according to the laws of the state where the banks were located, instead of the laws of the states where the borrowers lived. Interest rates shot up as banks and payday lenders opened in areas with liberal laws about interest rates.
Charging high interest rates became legitimized with the federal government’s attempt to deregulate banking. Deregulation, which means reducing government power in an industry, was intended to reduce inflation. The Depository Institutions Deregulation and Monetary Control Act of 1980 had a profound impact on lending because it permitted banks and other financial institutions to charge whatever loan interest rates the market would bear. Payday lenders could legally charge exorbitant interest rates on the loans.
The burgeoning industry was further spurred by the popularity of the Internet, where offers of payday loans multiplied. Internet payday lenders operating across the country and abroad offered the convenience of applying for loans remotely. The high interest rates, unfair finance charges, and other exploitive practices continued in the online form of payday loans.
In 2013, the US Justice Department implemented Operation Choke Point, an initiative to block access to financial services by fraudulent or risky businesses. There was a widespread outcry against this initiative by many businesses, such as payday lenders, who complained they were unfairly targeted. In January 2015, the Federal Deposit Insurance Corp. indicated that Operation Choke Point had ended.
Other attempts to limit payday lenders include laws specific to Native American enclaves and military personnel. However, weak regulations and a Supreme Court case in 2021 that limited the Federal Trade Commission’s Consumer Protection Bureau, a government agency that empowers consumers to better manage their economic lives, have left individuals open to predatory lending.
Overview
Payday loans, also known as "cash advance" loans, are small, short-term loans. These loans usually come due on the borrower’s next payday and have to be repaid in full as a lump sum. Some payday loans are structured differently, such as installments to be paid out over a period of time or interest-only payments.
"Renewals" or "rollovers" involve borrowers paying a fee in order to delay loan repayment because they cannot afford to repay the initial loan. If a borrower rolls over a loan several times, the fees can add up to several hundred dollars.
Finance charges, which are the actual costs of the loans, range from $10 to $30 for every $100 that is borrowed. APR (annual percentage rate, or the price paid to borrow money, stated as a yearly rate) on payday loans is high, ranging from 400 percent to 900 percent. In contrast, the APR on credit cards is typically between 12 percent and 30 percent.
No credit check is necessary to receive a payday loan. The only requirements are a steady job, a bank account, and I.D. Lenders grant the loan funds in a variety of ways. They can load the funds onto a prepaid debit card, give over cash or a check, or electronically deposit money into the borrower’s checking account.
Payday loans have been widely criticized as unfairly targeting the poor. Financial experts and advocates for the poor claim that payday lenders take advantage of people who will clearly be unable to repay their loans. A considerable number of payday loan borrowers, most of whom have poor credit histories, can barely cover their basic living expenses. The lenders recognize from the outset that many borrowers need to use their entire paychecks to live, so they will not be able to repay the loans on time. Instead, the borrowers will be forced to either roll over their old loans or take out new ones. While the lenders earn large sums, the borrowers become trapped in a cycle of debt wherein they are compelled to repay a much greater sum than they had borrowed.
Owners of payday loan shops argue that they offer a valuable service to people who have no other source of quick money. Consumer groups agree somewhat, saying that the banking industry has ignored the needs of poor Americans, leaving them vulnerable to high-interest lenders. Furthermore, stagnant wages and poor economic recovery are reflected in the rapid growth of the payday loan industry in the twenty-first century.
A 2021 CNBC article stated that there were around twenty-three hundred payday advance locations in the United States, lending money to twelve million individuals each year. According to a report by the Consumer Financial Protection Bureau, more than 80 percent of payday loans are either rolled over or followed up by an additional loan within two weeks. Most borrowers remain in debt for at least eleven months as they accrue more fees.
Some states place restrictions on payday loans. The National Conference of State Legislatures explains that forty-two jurisdictions place caps on the interest rates of consumer loans, while fourteen states and the District of Columbia prohibit such loans altogether.
Technology has made it easier than ever to receive a payday loan. Applications (apps) designed by businesses allow consumers to activate a payday loan account within minutes. It is estimated that 33 percent of Americans used cash advance or loan apps in 2022. Some of the most popular apps for such loans are EarnIn, Dave, Chime, Varo, Brigit, and MoneyLion.
Bibliography
Bhutta, Neil, et al. “Payday Loan Choices and Consequences” Vanderbilt Law and Economics Research Paper, no. 12-30, 7 Mar. 2013. dx.doi.org/10.2139/ssrn.2160947. Accessed 3 Jan. 2025.
Douglas-Gabriel, Danielle. "There Are Almost as Many Payday Lenders as McDonald’s and Starbucks. No, Really." Washington Post, 26 Mar. 2014, www.washingtonpost.com/news/wonk/wp/2014/03/26/there-are-almost-as-many-payday-lenders-as-mcdonalds-and-starbucks-no-really/. Accessed 3 Jan. 2025.
“How Payday Loans Work.” Payday Loan Information for Consumers, Consumer Federation of America, paydayloaninfo.org/how-payday-loans-work/. Accessed 3 Jan. 2025.
Kiel, Paul. “Whack-a-Mole: How Payday Lenders Bounce Back When States Crack Down.” ProPublica, 6 Aug. 2013, www.propublica.org/article/how-payday-lenders-bounce-back-when-states-crack-down. Accessed 3 Jan. 2025.
Koku, P. S., and S. Jagpal. "Do Payday Loans Help the Working Poor?" International Journal of Bank Marketing, vol. 33, no. 5, pp. 592-604. doi.org/10.1108/IJBM-11-2014-0164. Accessed 3 Jan. 2025.
Melzer, Brian T. "The Real Costs of Credit Access: Evidence from the Payday Lending Market." The Quarterly Journal of Economics, vol. 126, no. 1, 1 Feb. 2011, pp. 517-55. doi.org/10.1093/qje/qjq009. Accessed 3 Jan. 2025.
Morton, Heather. "Payday lending state statutes." National Conference of State Legislatures, 28 Feb. 2023, www.ncsl.org/financial-services/payday-lending-state-statutes. Accessed 3 Jan. 2025.
“Payday Loans & Cash Advances – What Consumers Need to Know.” Department of Financial Protection and Innovation, dfpi.ca.gov/consumers/managing-debt/payday-loans-cash-advances-what-consumers-need-to-know/. Accessed 3 January 2025.
Ramirez, S. R. "An Examination of Firm Licensing Behaviour after a Payday-Loan Ban." Applied Economics, vol. 51, no. 46, 2019, pp. 5090–103. doi.org/10.1080/00036846.2019.1610709. Accessed 3 Jan. 2025.
Servon, Lisa J. "What Good Are Payday Loans?" The New Yorker, 13 Feb. 2014, www.newyorker.com/business/currency/what-good-are-payday-loans. Accessed 3 Jan. 2025.
“Survey: 33% of Americans Now Use Cash Advance Apps; Many Are Struggling to Repay.” DebtHammer, 17 Oct. 2022, debthammer.org/cash-advance-apps-survey/. Accessed 3 Jan. 2025.
Zibel, Alan. "CFPB Sets Sights on Payday Loans." Wall Street Journal, 4 Jan. 2015, www.wsj.com/articles/cfpb-sets-sights-on-payday-loans-1420410479. Accessed 3 Jan. 2025.