Payday Lending Basics

1. What is a payday loan?

Payday loans are small cash advances, usually of $500 or less. To get a loan, a borrower gives a payday lender a postdated personal check or an authorization for automatic withdrawal from the borrower’s bank account. In return, he receives cash, minus the lender's fees. For example, with a $300 payday loan, a consumer might pay $45 in fees and get $255 in cash.

The lender holds the check or electronic debit authorization for a week or two (usually until the borrower's next payday). At that time, the borrower has the option of (1) paying back the $300 in exchange for the original check, (2) letting the lender deposit the check for $300, or (3) renewing or rolling over the loan, if he is unable to repay it. Some lenders accomplish the same effect with "back-to-back transactions," having the borrower write a check for a new advance, and using these funds to repay the prior loan. In renewal and back-to-back transactions, the borrower gets no "new" money, but pays another $45 in fees.

2. Who uses payday loans?

The payday industry advertises these loans as quick and easy ways to get cash, and targets low-income working consumers, including welfare-to-work women, military personnel, and others who have little to no savings and live paycheck to paycheck. Most cash-strapped borrowers who get payday loans are not able to repay the whole loan within two weeks, and end up rolling over their loan and paying renewal fees multiple times. Trapped on this "debt treadmill", consumers typically pay much more in fees than the amount they originally borrowed.

Although payday loans are marketed as one-time assistance during a financial emergency, a 2003 study (PDF) by the Center for Responsible Lending found that 91% of all payday loans are made to borrowers with five or more payday loans per year. Borrowers, on average, receive 8 to 13 payday loans from a single payday lender per year. And, most payday borrowers go to more than one lender, dramatically increasing their total number of payday loans per year. Only one percent (1%) of all payday loans are made to one-time emergency borrowers.

Read stories about payday lending victims.

3. What is required to get a payday loan?

To get a payday loan, most consumers only need to show personal identification, have a personal checking account, and provide proof of income from employment or government benefits, such as Social Security or disability payments. Unlike conventional lenders, payday lenders do not look at a borrower's monthly expenses or her ability to repay the requested loan.

4. What are the costs of a payday loan?

For a two-week payday advance, a borrower will pay at least fifteen dollars for every $100 borrowed. But with such a short duration these loan fees are equal to roughly a 400% annual percentage rate (APR). And as the chart below shows, consumers who renew their loans often end up paying more in fees than they have borrowed!


For borrowers with five, ten, or even twenty repeat loans per year, payday lending functions as chronic debt, instead of helpful credit. These borrowers pay additional loan fees for no new money each time the loan is renewed. CRL estimates that predatory payday lending costs five million Americans $3.4 billion annually.

The societal costs are also great. Since the payday lender is holding a “live check” as collateral, borrowers struggle to renew their payday loans every two weeks while falling behind on other bills, like rent, mortgage, electricity, and even groceries. As borrowers slide deeper and deeper into trouble, payday lenders get paid while other merchants and lenders do not. Social service agencies and faith-based groups pick up the tab for families in trouble.

5. How big is the payday lending industry?

Payday lending has grown rapidly over the last several years. In 2000, the industry consisted of 7,000 to 10,000 payday loan offices, which accounted for 41 million transactions and $1.4 billion in fees. By the end of 2003, according to industry sources, there were approximately 22,000 payday offices generating $6 billion in fees from around 100 million transactions. Total sales volume grew from $10 billion in 2000 to $40 billion in 2003. In other words, the payday lending industry quadrupled in size within three years.

The growth in the payday industry has been fueled by very high profits—an estimated 34% pre-tax return. Payday lenders need only a small amount of cash to make loans. After the first loan, the borrowers is simply reborrowing the money they just repaid, minus the fee. Moreover, these lenders charge annual interest rates of 400% or more, which is much higher than the risk these loans carry. In comparison, the highest credit card rates rarely exceed 29% APR -- less than one-tenth the APR charged on a payday loan -- even though credit cards and payday loans have similar rates of default.

6. Who makes payday loans?

In the early 1990s, payday loans were made by small independent shops that primarily offered check-cashing services. Today, the industry is dominated by large regional or national "monoline" lenders that provide only payday loans, and multi-service lenders that offer an array of fringe banking services such as check cashing, money orders, and bill paying services.

Banks are also becoming more active in this industry, by providing capital to payday lenders and entering into partnerships to originate payday loans in states that prohibit stand-alone payday lending (called "rent-a-charter" deals.)

7. How are payday lenders regulated?

State laws generally govern whether payday lending is permitted in a state. Currently, some 36 states allow payday lending. However, several large payday lenders are using brokering arrangements or rent-a-charter agreements with commercial banks to circumvent state bans and limits. In these cases, payday lenders evade state laws by invoking federal preemption through the Federal Deposit Insurance Act.

This practice is now under attack by some federal regulators and state attorneys general. For example, in Georgia and in Maryland, legislation has been enacted to prevent this kind of arrangement.