Payday and other high-cost loans: the risks

Resources · Cards, loans and credit · 5 min read Building

Key points

• Payday and similar short-term loans charge high fees on small amounts over short periods.
• A fee that looks small for two weeks can be enormous as a yearly rate.
• Rolling a loan over, or taking a new one to repay the old, is where costs really climb.
• The rules and caps on these loans vary widely from place to place.

Payday loans and other high-cost loans

Payday loans are the ones most people have heard of. You borrow a small amount. In some countries you pay it all back, plus a fee, on your next payday, often within a few weeks. In others, such as Australia, these loans run from 16 days up to a year.

They have cousins with similar costs. Short-term instalment loans get repaid over a few months. Car title or logbook loans are secured against your car. Rent-to-own deals and some pawn arrangements fall in the same family, as do some online “instant cash” loans and pay advances.

What ties them together is speed. Fast approval, few checks, small amounts. And high costs compared with what you actually borrowed.

The rules vary a lot. Some countries and states cap fees or interest, or ban certain types outright. Others barely regulate them. The very same product can cost far more in one place than in another.

How the cost adds up

Payday loans are usually priced as a flat fee per amount borrowed, not as a yearly rate. That’s exactly why they look cheap.

A worked example

Assumptions:

• Loan: $400
• Fee: $60 (that is, $15 per $100 borrowed)
• Term: 14 days
• Repaid in full at the end

You pay back $460. The fee is 15% of the loan, for two weeks.

Now stretch that over a year so you can compare it with other borrowing: 15% × 365 ÷ 14 = 391.07% a year, as a simple annual rate. Credit cards and personal loans often sit well below that.

The same maths works in any currency.

The rollover trap

Trouble usually starts when the $460 isn’t there on payday. At that point, many people either roll the loan over, paying the fee to push the due date back, or take out a new loan to pay off the old one.

Here’s the same example, rolled over three times:

Eight weeks in, you’ve paid $240 in fees on a $400 loan. And the $400 itself didn’t shrink by a cent until the very end. Rollover rules differ by place, but this pattern is common.

Other risks

Many of these lenders take repayments straight from your bank account or card. If an attempt fails, your bank may charge its own fees on top of the lender’s.

With a title or logbook loan, you can lose the car if repayments stop.

There’s also the payday squeeze. Repaying the whole loan at once can leave too little for the rest of the month. Which makes the next loan more likely. Missed payments may also show up on your credit report and affect what you can borrow later.

And watch for unlicensed lenders. Some operators simply ignore local rules. Some countries keep a public register of licensed lenders you can check.

Weighing the alternatives

People usually take these loans because they need money fast and feel they’ve run out of options. That’s understandable. There’s no shame in it.

But once you know the real cost, you can hold it up against other choices. Each has its own trade-offs.

An arranged overdraft or a credit card can still be expensive, yet for the same amount they often cost less. Where they exist, community lenders and credit unions sometimes offer small loans. Some countries have government or charity hardship payments, or no-interest loan schemes. Family or friends might be able to help, if that’s possible for you. And if you have an emergency fund, this may be what part of it is for.

Which fits depends on how much you need, how fast, and how soon you can pay it back.

One more thing. If you’re taking short-term loans to cover rent, food or other loan repayments, your budget is under real strain. Free debt help is confidential, costs nothing, and can help you see what options you have.

Common questions

Why are payday loans so expensive?

They charge a flat fee for a small amount over a short time. In the example above, a $60 fee on $400 for 14 days works out to 391.07% a year as a simple annual rate.

What happens if you can’t repay a payday loan?

Many people roll it over or take a new loan, paying fees again without touching what’s owed. If a repayment attempt fails, your bank may charge its own fees, and missed payments may show on your credit report.

Are payday loans allowed everywhere?

No, the rules differ a lot. Some countries and states cap fees or interest, or ban certain types. Others have few limits.

Try it

Put a loan’s amount, fees and term into the true cost calculator to see what it costs in dollars and as a yearly rate.

General information only, not financial advice. Your situation is your own.