How do payday loans work?

A payday loan is a small, short-term loan, often $500 or less, that you repay in one lump sum on your next payday, plus a fee. A typical fee of $15 per $100 for two weeks works out to an APR of about 391%, so it is one of the most expensive ways to borrow.

Small amounts, very short terms

Payday loans are usually $500 or less and due in one payment on your next payday, typically two to four weeks out. Many states cap the loan size, and some don't allow payday lending at all.

The fee is the interest

State laws that allow payday loans often cap fees between $10 and $30 for every $100 borrowed. A two-week loan at $15 per $100 equals an APR of about 391%.

Lenders don't check if you can repay

Payday lenders generally don't check your credit or whether you can repay while paying your other bills. That is why so many borrowers can't repay on time and roll the loan over.

Servicemembers get a 36% cap

Under the federal Military Lending Act, active-duty servicemembers and their covered dependents can't be charged more than a 36% Military Annual Percentage Rate on most consumer loans, including payday loans.

How a payday loan works

You show proof of income and a bank account, and the lender hands you cash, a check or a deposit, sometimes the same day. In return, you write a post-dated check for the loan plus the fee, or you let the lender withdraw the money from your account electronically.

On the due date, the lender cashes the check or takes the money from your account. If the money isn't there, you can be hit with an overdraft or returned payment fee from your bank, plus a fee from the lender.

Why the APR looks so high

A $15 fee on $100 looks like 15%. But that 15% is for only two weeks. There are about 26 two-week periods in a year, so the same price for a full year is about 391%.

APR lets you compare loans of different lengths on equal terms. Credit cards usually charge about 12% to 30% a year. Even an expensive card is far cheaper than a payday loan for the same amount and time.

How rollovers trap borrowers

Some states let lenders roll over or renew a loan when it comes due. You pay only the fee, and the due date moves out another two weeks. You still owe the full amount you borrowed.

This is where the cost explodes. Every rollover adds a new fee, and none of it lowers your balance. A loan meant to last two weeks can stretch for months while the fees pile up. Depending on your state law or the lender's policy, you may be able to get an extended repayment plan instead, so ask before you renew.

Cheaper alternatives to try first

Start with the bill itself. Ask the company you owe for more time or a payment plan. Then look at a payday alternative loan from a federal credit union, a small personal loan from a credit union or bank, a pay advance from your employer, or help from a local emergency assistance program.

A cash advance on a credit card is also expensive, with a high rate and interest that starts right away, but it usually costs much less than a payday loan. Borrowing from family or friends you trust can work too, if you agree on the terms in writing.

If you already have a payday loan

Repay it on the due date if you can, and don't take a new loan to cover the old one. If you can't, contact the lender right away and ask for an extended repayment plan. A credit counselor or a legal aid attorney can also help. You can look up your state's rules through your state regulator or attorney general.

You can also call your bank to stop an automatic withdrawal you didn't authorize, and file a complaint with the CFPB if a lender breaks the rules. Once you're out, start a small emergency fund, even $25 a paycheck, so the next short month doesn't need a loan.