Payday loans are a flashing neon sign at the intersection of desperation and convenience. Offering fast cash at a heavy cost, they’ve earned a deserved reputation as a financial speed trap for borrowers.
What is a payday loan?
It’s a type of borrowing where a lender extends short-term, extremely high-interest (399% APR!) credit meant to hold people over until their next paycheck.
That’s the origin of the name. Why they’re so often included in warnings about predatory lending takes closer examination.
Also known as cash advance or check advance loans, payday loans can be so problematic for borrowers that 12 states have banned them altogether.
The risk to borrowers comes from an accumulation of factors:
- An unsecured loan at a high interest rate
- A short-term repayment deadline
- Almost no consideration given to whether the borrower can repay the loan on its terms
- Hidden provisions that charge borrowers additional fees.
Together, it explains why payday loans are a borrower-beware transaction that’s best avoided.
How Do Payday Loans Work?
Payday loans are typically for smaller amounts of money – $500-$1,000 being a common loan amount. Some states may cap the loan at a slightly lower or higher figure, and, while the repayment deadline might also vary state-to-state, a common loan term is 14-30 days.
Taking out a payday loan often requires you to post-date a check for the lender to cash, or allow a lender to electronically recover the repayment amount (plus fees) on the due date from your bank account.
Borrowers may turn to payday loans to deal with a costly emergency, or simply to provide cash for living expenses. It is never a safe route but it sometimes presents the only route, if a borrower’s credit score makes taking out a personal loan prohibitive or they’ve already taken out personal loans and fallen behind on other debt payments.
Payday loans typically require you to pay back the full amount on the due date, not repay in smaller installments. That can become problematic for borrowers who are sometimes just as pressed for cash two weeks later as they are when ask for the loan.
Many states put limits on the fees that come with payday loan, ranging from $10 to $30 for every $100 borrowed. A two-week payday loan with a $15 per $100 fee may seem reasonable but it equates to an annual percentage rate of 399% . A high-interest credit card ranges from 20%-30%.
More trouble for borrowers can come in states that allow lenders to “rollover” or “renew” loans at the due date. In some cases, that $15 per $100 loan just became $30 per $100. If you can’t repay a payday loan promptly, you can see how the fees add up.
Taking out a payday loan is risky unless you know for certain you will pay it back within two weeks to a month. Becoming a repeat payday loan customer is inviting serious financial trouble.
Are Payday Loans Regulated by the Military Lending Act?
The Military Lending Act offers protection for active-duty service members and their families by limiting the annual percentage rate to 36% on payday loans, vehicle title loans and tax refund loans. It also prohibits a lender from “rolling over” or refinancing the same loan between the same creditor and borrower.
A Consumer Financial Protection Bureau study showed that more than 80% of payday loans are rolled over or followed by another loan within 14 days. So, this protection for active-duty service members and their families exists for good reason.
The 36% cap may preclude service members from qualifying for most payday loans since typical two-week payday loans can have APRs of almost 400%. Creditors who extend those loan terms to borrowers protected under the Military Lending Act, can be subject to penalties.
Active service members should contact their local Judge Advocate General’s (JAG) office to learn more about lending restrictions and how the MLA impacts payday loans and other types of credit.
Risks of Military Payday Loans
Payday loans can not only trap you in a vicious cycle of high interest rates and accumulating fees, but falling behind on these loans could jeopardize your military security clearance .
In securing a payday loan, you can expect initially to provide a pay stub since the loan amount – even though it’s typically a small amount compared to credit card limits – can depend on your income.
But it’s also possible to obtain a payday loan without current employment if you can show a regular source of income such as a pension, unemployment benefits, spousal allowance, etc. That alone underlines how little consideration lenders give to a borrower’s ability to repay the loan while meeting their other financial obligations.
Payday loan lenders are betting on repeat customers, and the numbers cited in a Department of Navy JAG report warn that 99% of payday loans go to repeat borrowers. Only 1% of borrowers take out a payday loan for emergency use, pays it back in full on time and don’t get another payday loan within a year’s time.
So clearly payday lending doesn’t come close to helping people solve the root of their financial problems. Instead, payday lending is a debt trap with interest rates alone that explain why it’s so often included in warnings about predatory lending.
Payday Loans and Credit
No credit? No problem.
If you hear those words, take heed. Anyone whose job depends on making money isn’t suddenly going to help you solve a financial shortfall out of the goodness of their heart.
It’s best to examine all the strings attached to payday loans and make an objective determination to ensure those strings don’t end up financially strangling you and your family.
Having good credit is a factor when applying for a payday loan but having good credit might also help you obtain a personal loan or other credit that don’t carry the same high fees as payday loans.
You can get a payday loan if you have bad credit, but the terms of the loan would likely be less friendly. In either case, payday lenders don’t bother to take into account your ability to repay the loan by the due date.
Payday loans don’t necessarily drag down your credit score, provided you pay back the amount borrowed and accompanying fees on the due date. If you aren’t likely to meet the terms of the loan, though, think twice about participating in this type of punitive lending. Your credit score will suffer, and your ability to borrow money in the future could be damaged.
What to Do Before Pursuing Payday Loans
Active military members especially need to investigate alternatives to payday loans. Since the Military Lending Act caps interest rates at 36%, service members wouldn’t qualify for most payday loans anyway. Consider that a good thing.
There are better strategies for active-duty military:
- Talk to your creditors. See if they’re willing to work with you if you’re unable to meet a deadline to pay a debt. You might be surprised.
- Talk to your Command Financial Specialist. The CFS is charged with providing financial education, training and counseling.
- Visit Fleet and Family Support Centers for private advice.
- On-base banks and credit unions specialize in helping members.
- The Navy and Marine Corps Relief Society typically offers a Quick Assist Loan program for up to $300 (interest-free) with much more reasonable loan due dates than payday loans.
- Contact your Armed Forces Emergency Service Center.
- Military One Source offers advice and referrals 24/7.
- So does the American Red Cross Armed Forces Emergency Service Center.
- A small personal loan or shares secured loan could be a reasonable option and carry much friendlier terms than payday loans.
- A checking line of credit could provide money for unforeseen expenses at an interest rate between 13.9% and 17.9%.
If building an emergency fund for unplanned expenses proves too difficult – and it always sounds easier than it is in practice – the best advice is to do your research on how to plug a hole in the financial dike ahead of time.
After all, the old insurance commercial warning that “life comes at you fast” is still true. And in the case of loans offering even faster and easier solutions, another warning also applies:
About The Author
After a 45-year career in journalism, Robert's focus is helping consumers cope with personal finance issues. Finding solutions to paying off credit card debt, mortgage payments and that darn student loan, is far more fulfilling than explaining why the Cleveland Browns can't win (It's the quarterback!!). Robert wrote about the Browns and all Cleveland sports as a columnist at the Plain Dealer before transitioning to television sports commentary at WKYC. Now, his passion is helping people navigate their personal finances.
- NA (ND). Danger of Payday Loans. Retrieved from: https://www.cnic.navy.mil/regions/ndw/installations/nsa_annapolis/ffr/support_services/counseling_and_assistance/personal_finance_management/danger_of_payday_loans.html
- Zinn, D. Tarver J. (2021, March 26). What Is A Payday Loan? Retrieved from: https://www.forbes.com/advisor/personal-loans/what-is-a-payday-loan/
- Scigliuzzo, D. Cannon, C. (2021, May 17) Charging 589% in the Pandemic Is a Booming Business. Retrieved from: https://www.bloomberg.com/graphics/2021-payday-loan-lenders/
- NA (2020, January 28) Predatory Lending Warning Signs. Retrieved from: https://www.militaryonesource.mil/national-guard/financial-management/predatory-lending-warning-signs/