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Is There Really Such a Thing as a “Low Interest” Payday Loan?

Alex Huntsberger
Alex Huntsberger has covered loans, credit scores, and personal finance for OppLoans since 2015. He is a graduate of Oberlin College and a regular contributor to the Chicago Sun-Times.
Updated on March 18, 2021
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Unfortunately, the realities of payday lending make low interest rates impossible. Luckily, there are plenty of better (and cheaper) ways to borrow money.

Shopping around for the best rate is a cornerstone of responsible borrowing. Just like you wouldn’t buy the first car you saw or the first house you toured, you can’t just apply for the first online loan or credit card offer that comes your way. You need to do your research and find the best, most affordable product for you and your needs.

The same goes when shopping around for a payday loan or other type of bad credit loan. Typically, people turn to loans like these when they’re in a financial bind and need some quick cash, which generally doesn’t facilitate the most thorough research process. When you need money now, you’re much more likely to settle for the first thing that comes your way.

Still, some payday loan borrowers might hold out hope that they can find a payday loan with a low interest rate—or at least one with a rate that’s significantly lower than the rest. Unfortunately, when it comes to payday loans, even an incredibly thorough research session isn’t going to yield great results. There really isn’t any such thing as a “low-interest” payday loan.

Here’s how payday loans work.

Payday loans are a type of short-term, small-dollar loan, with an average term of only two weeks and an average principal of a few hundred dollars. They are regulated at the state level, so the loan amounts, term minimums, interest rates, and designated “cooling off” periods will depend on where you live. A cooling off period, by the way, refers to the amount of time after a person pays off one loan before they can take out another.

Payday loans get their name from the short turnaround. The idea is that these loans are only designed to “tide the borrower over” until their next paycheck. Oftentimes, the repayment date will be set for the date of the borrower’s next payday and then paid either via a post-dated check or through an automatic debit arrangement on the borrower’s bank account.

These loans generally charge interest as a flat-rate fee. This is different than amortizing installment loans where the outstanding balance accrues interest a little bit at a time. With payday loans, if you were to borrow $400 at a standard 15% interest rate, you would be charged a flat $60 in interest. Paying off the loan early wouldn’t save you any money. And if that 15% interest rate sounds pretty good, well, that’s where things get tricky.

Payday loans are super expensive.

When comparing the cost of different personal loans, it helps to look at the annual percentage rate (APR). This rate calculates the cost of a loan over the course of a full year and accounts for any additional fees and interest. By looking at a loan’s APR, you can get a full, standardized accounting of how much it will cost you in comparison to other loans or credit cards.

APR also happens to reveal the truly staggering cost of payday borrowing. While a 15% interest rate might seem like a fair cost, you have to remember that you’re only paying to borrow money for two weeks. Paying 15% for two weeks is far more expensive than paying 15% over a full year. In fact, that 15% interest rate translates to an APR of 391%!

Now, if the majority of payday loans were paid off on the original due date, that APR wouldn’t be such a big deal. But the opposite is true. The combination of high rates, short terms, and lump sum repayments means that a majority of payday loan borrowers have to roll over their loans—extending the due date in exchange for additional interest—or take out a new loan shortly after paying off their old one. (That’s why cooling off periods are a thing.)

But don’t take our word for it. According to a study from the Consumer Financial Protection Bureau (CFPB), over 80 percent of payday loans are either rolled over or reborrowed. That same study also found that the majority of payday loan borrowers spent 199 days a year in debt and took whopping 10 payday loans annually. In other words, payday loans trap many borrowers in a predatory cycle of debt.

To find a cheaper loan, avoid payday loans altogether.

Payday loans are a type of no credit check loan, which means that they don’t perform any hard credit checks on your borrowing history before lending to you. Unfortunately, many payday lenders take this even further and do nothing at all to verify that you can afford the loan that you’re borrowing.

This creates a different kind of debt cycle, wherein payday lenders issue high-interest loans to people who probably can’t afford them, leading to incredibly high default rates. Those default rates then keep the interest rates high, because otherwise, these lenders wouldn’t be able to break even. Even if a payday lender is charging less than the legal limit, they’re still going to be charging you a lot of money.

Many credit unions offer low-interest payday alternatives.

Even better than a bad credit installment loan is a Payday Alternative Loan (PAL). These loans are offered through credit unions that belong to the National Credit Union Administration (NCUA). They come with loan amounts between $200 and $1,000, payments terms between one and six months, and a maximum interest rate of 28%.

One of the catches with these loans is that you must have already been a member of a participating credit union for one month before you can qualify for them. (Check out this blog post to see if you should drop your bank for a credit union.) Earlier this year, the NCUA Board proposed a new rule to make these loans even more widely accessible. Their proposal included ditching the one-month membership requirement.

Build your emergency savings.

Of course, the best way to avoid taking out a payday loan to cover emergency expenses is to never need one in the first place. Building up an emergency fund that you can easily access will mean that surprise bills don’t send your finances into a tailspin. No matter how much you shop around for the best rate, being prepared will always be your most cost-efficient option.

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