What’s Dangerous About Taking Out a Payday Loan?

Payday loans are short-term, high-cost loans designed to provide quick access to cash, typically for $500 or less. These loans are generally unsecured and based on a borrower’s income, with repayment expected by their next payday.

Understanding the Cost Structure

The cost of a payday loan is structured around fees rather than a traditional annual interest rate. Lenders typically charge a flat fee for every $100 borrowed, ranging from $10 to $30, such as $15 per $100. This fee structure translates into an extremely high Annual Percentage Rate (APR) when annualized.

A $15 fee per $100 borrowed for a two-week payday loan equates to an APR of almost 400 percent. This is significantly higher than credit card APRs, which typically range from 12 percent to 30 percent. Some states may set maximum fees, but even with these limits, the annualized cost remains substantial.

Beyond the initial finance charge, other fees can increase the total cost of a payday loan. If funds are disbursed onto a prepaid debit card, additional charges may apply for checking balances, customer service inquiries, or monthly maintenance. These fees make it difficult for borrowers to repay the full principal, often initiating a cycle of debt.

The Repayment Challenge

The repayment period for a payday loan is short, typically two to four weeks, aligning with the borrower’s upcoming payday. This brief timeframe creates pressure, as the borrower must repay the full loan amount plus all fees in one lump sum. Many borrowers find it challenging to accumulate the entire repayment by the due date, especially when facing other financial obligations.

When a borrower cannot repay the loan on time, lenders may offer a “rollover” or “renewal” option. This allows the borrower to extend the loan’s due date by paying only the fees, without reducing the original principal. A new fee is then charged for the extended period, increasing the total cost of the borrowed funds. This further entrenches the borrower in debt.

Consider a $300 loan with an initial $45 fee, making $345 due in two weeks. If rolled over, the borrower pays only the $45 fee, extending the $300 principal for another two weeks, incurring another $45 fee. The cost for borrowing $300 for four weeks doubles to $90, with the original $300 still owed. This cycle can lead to borrowers paying significantly more in fees than the original amount, trapping them in persistent debt. Many borrowers frequently roll over their loans or take out new ones shortly after repaying a previous one.

Consequences of Non-Repayment

Failing to repay a payday loan can lead to adverse financial outcomes. While lenders often do not report timely payments to credit bureaus, a default can significantly impact a borrower’s credit score if the debt is sent to a collection agency. Collection accounts can remain on a credit report for up to seven years, making it harder to obtain other forms of credit.

Lenders and collection agencies will engage in persistent efforts to recover the debt. Borrowers can expect frequent phone calls and written communications. While laws protect against harassment, the constant contact can be stressful.

Another direct consequence involves bank accounts. Payday lenders often secure authorization to withdraw funds directly from a borrower’s bank account on the due date. Insufficient funds can trigger bank overdraft fees, compounding the borrower’s financial strain. Repeated failed withdrawal attempts may even lead to account closure.

Lenders may pursue legal action to collect unpaid debt, even for small amounts. If a lender prevails in court, they could obtain a judgment allowing wage garnishment or levying bank accounts. Ignoring a court summons can result in a default judgment, further enabling these collection measures.