The word “payday” refers to the fact it gives borrowers enough money to make it to their next payday, upon which they must repay the loan, plus interest.
High-interest payday loans are available in 32 states, and permitted in another 12 states with interest rates capped at lower levels, such as in New York, where the rate must not exceed 25%. While rates vary according to states, the national average APR for payday loans is almost 400% and can reach as high as 700% in some states. Around 12 million Americans take out payday loans annually, spending $9 billion on loan fees.
Given the high rates and fees, most borrowers use payday loans as a last resort. But there are many alternatives that won’t leave you owing more than you can afford.
Pros and Cons of Payday Loans
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With a quick and non-invasive application process, almost-guaranteed approval, and same-day transfer of funds – what’s not to like about payday loans? A lot, actually! Before taking a payday loan, it’s important to be aware that there are significant risks – and the biggest risk is that you could end up in a spiral of high-interest debt. According to Pew, the average payday loan borrower spends 5 months of the year in debt and pays an average of $520 in fees each year for the ability to repeatedly borrow $375. If you go for a payday loan you can expect to pay high rates and there also lots of hidden fees and charges.
Best Payday Loan Alternatives
If you find yourself cash strapped or in need of emergency funds, there are alternatives to payday loans out there. Here are a few to consider:
1. Paycheck advance
Some companies offer employees the option of requesting their next paycheck in advance. In almost all cases, a paycheck advance is cheaper than a payday loan. Although some employers charge a small financing fee for a paycheck advance, they’re prohibited from charging such high fees that you would receive less than the monthly minimum wage. On the downside, giving a paycheck advance involves a certain amount of red tape, and according to a recent study only 13% of US employers still offer this perk.
2. Retirement account withdrawal
If you have an individual retirement account (IRA), you may withdraw money at any time. All IRA withdrawals are subject to regular income tax, and people aged less than 59 years and 6 months must also pay a 10% early withdrawal penalty. For example, a person aged in their 40s who pays 25% income tax would pay 35% on their IRA withdrawal. If they withdraw $2,000, they’d pay $700 in taxes and penalties. If they withdraw $10,000, they’d pay $3,500 in taxes and penalties. An IRA withdrawal isn’t the best option around, but if you need a large sum to pay for ongoing expenses, it may still be cheaper than taking out a payday loan each month.
3. Credit card
Credit cards are one of the most popular ways of getting a short-term cash injection, due to the ease of application and approval. The national average credit card rate currently stands at around 17%, making credit cards more expensive than personal loans but significantly cheaper than payday loans. Anyone can apply for a credit card online by providing some basic information about themselves and their income. Getting approved for the best rate does require forward planning such as comparing lenders and taking steps to improve your credit score. If you’re applying for a credit card as a last resort and haven’t done the necessary legwork, you can expect to pay a higher rate.
4. Overdraft protection
Most banks offer overdraft protection, which allows the customer to go into minus, or overdraft, in exchange for a fee. Like payday loans, this is really only a good idea when you run out of other options. While overdraft fees are usually much cheaper than payday loans, repeatedly using this option can hurt your credit – and make it difficult for you to secure a personal loan, mortgage or other bank loan when you really need it.
5. Borrow from family or friends
This is the cheapest but also the trickiest option. If you find yourself with immediate financial needs and have a relative or friend that you can trust 100%, asking them for a loan might be your best option. But beware: money is all too often the source of relationship breakdowns.
6. Personal Loans
A personal loan is an unsecured loan from a bank or non-bank lender whereby the borrower doesn’t need to provide any collateral. Personal loans are frequently used to pay off credit card debt, although they can be used for other emergency scenarios such as unexpected medical bills or home repairs. The best personal loan providers offer lower rates, lower payments, and more security than payday loans. Some online lenders promise to deliver the funds on same or next business day. Applying for a personal loan involves a credit check, but even this has an upside: using a personal loan to pay off debts is a good way to improve your credit score and puts you in a position to obtain better rates in future.
Payday Loans vs. Personal Loans
| APR | Monthly Payments ($1,000 loan) | |
|---|---|---|
| Personal Loans | 4.79% - 35.99% | $3.99 - $29.99 |
| Payday Loans | 90% - 1,000% | $75 - $833 |
Payday Loan Alternatives to Avoid
Some short-term alternatives carry their own risks, such as auto title loans (also known as car title loans) and installment loans. Auto title loans generally offer lower rates than payday loans, but borrower beware: these are secured loans and you risk having your car repossessed if you fail to repay the loan by the end of the term. Installment loans are high-interest loans that, unlike payday loans, are repaid over a period of months or years. The application process and background check are easier than for a personal loan, but the borrower pays the price for this convenience with super-high rates and fees.
What Now?
Payday loans should be a last resort, once other options have been exhausted. The convenience of walking down Main Street or doing a quick Google search and finding hundreds of eager payday lenders can be tough to resist. But payday loans come at a cost, in the form of expensive rates and the risk of ending up in a cycle of debt. Whether it’s a personal loan from a top company or other sources of funding, there are many payday loan alternatives that can deliver cash almost as quickly but without the same level of risk.
