Payday loans are a type of loan that can provide quick cash to those in need, but they come with a hefty price tag. The average interest rate on an average payday loan is a whopping 391%, according to Bennett. That's if you pay after two weeks. By comparison, credit card APRs can range from about 12 percent to about 30 percent, making payday loans much more expensive than traditional loans.
Payday lenders almost always require borrowers to hand in a later date check or to authorize a direct withdrawal from their bank account. The Pew Charitable Trusts reports that it takes the average borrower five months and several loan renewals to pay off their loans. To calculate the APR, or annual percentage rate, of a payday loan, the interest and fees are compared on the amount borrowed with what it would cost over a one-year period. Tribal payday loans usually have higher interest rates than regular payday loans because interest rate limits or other restrictions set by state legislatures do not apply.
You pay the full amount, plus fees and interest, in one payment at the end of the loan term, usually on the next payday. The problem is that most payday loan lenders list the financial charge as a specific amount in dollars and not as a percentage. According to extensive research conducted by Pew Charitable Trusts, up to 12 million Americans use payday loans every year. To qualify for a quick loan, you usually need an active bank account, identification, and proof of income, such as a payment receipt. The loan is due immediately after the next payday, usually in two weeks, but sometimes in a month.
Compare the interest rates on payday loans of 391% to 600% with the average rate of alternative options, such as credit cards (between 15 and 30%), debt management programs (between 8 and 10%), personal loans (between 14 and 35%) and online loans (between 10 and 35%). The payday lender can report the default to the credit bureaus or sell the debt to a collection agency that does, which will harm your rating. Failure to comply also exposes you to harassment by debt collection agencies, which either buy the loan from the payday lender or are hired to collect it. Many local credit unions and banks offer these loans designed to help customers avoid or escape the fast lending trap. That translates to an average annual percentage rate (APR) of 390% or more, according to the Federal Trade Commission (FTC).
Pew says that up to 58% of borrowers struggle to cover their basic monthly expenses, so in reality, payday loans are often used for needs such as rent and utilities. Even if you don't have the best credit and can't get a personal loan from a bank, there are lower-cost payday loan alternatives. It's important to understand how much these types of loans cost before taking one out so you can make an informed decision about whether they are right for you.