Protect Your Pockets Series


Understanding the Pitfalls of Pay Day Loans

(originally published May 2009)

Seeking a temporary quick fix to a long-term problem is rarely ideal. Too often (like now) we find our government doing this, and too often it happens with personal finances, as well.

Lately, my office has gotten questions regarding the legitimacy of “pay day loans,” and for good reason. While pay day loans will get you cash you may need to cover expenses quickly, they can have serious long-term consequences. In fact, the Center for Responsible Lending reports that pay day loans cost consumers nearly $5 billion in predatory fees each year.

To obtain a pay day loan, a borrower writes a post-dated check for the amount of the loan plus the lender fees and then receives cash for the amount of the loan. Once the loan period is up, typically in one to two weeks when the borrower’s next paycheck arrives, the lender cashes the check.

Most pay day lenders will charge a certain dollar amount per $100 borrowed; for example, they might charge $15 for every $100. So a borrower looking to get $300 for a two-week period would pay $45 in fees plus the amount of the loan. This borrower would write a post-dated check for $345 and would leave with $300 cash. Two weeks later, the lender would cash the check for the full $345. In this example, the annual percentage rate (APR) is 390 percent.

For one-time borrowers, pay day loans can be a useful solution. However, for some borrowers, they often don’t have enough money in their account to repay the loan. In these situations, lenders will either cash the check, causing it to bounce, or they will offer to roll over the loan for an additional fee. That rollover fee, however, simply keeps the loan outstanding, rather than paying money down on the original principal.

The typical pay day borrower rolls over their loan more than once, and this is where 90 percent of pay day lenders make their money. In fact, the Consumer’s Union estimates the average pay day borrower ends up paying about $500 in interest for a $300 loan and still owes the principal. This over-reliance on pay day loans not only results in borrowers paying more fees in the long run, but can also have a lasting impact on their ability to obtain credit in the future.

Because of their high interest rates and predatory fees, pay day loans should be used as a last resort. Instead, consider getting a small loan from a credit union or local bank, which can sometimes offer lower interest rates than pay day lenders. Also, help get your finances back on track by contacting your local consumer credit counseling service, where they can help work out a debt repayment plan. Finally, take time to reevaluate your money management habits. Create a realistic budget, avoid unnecessary spending, and make a point to save some money each month.

If you feel like a pay day loan is your only option, borrow only as much as you can afford to pay with your next paycheck, and make sure the lender is licensed with the Indiana Department of Financial Institutions by visiting their website at or calling (317) 232-3955. Finally, be especially careful of internet lenders, as borrowing over the internet increases the chances of identity theft.

For more tips on handling debt and managing your finances, visit

Related Information:

- Pay Day Loan Consumer Information

- Learn more about Debt Management

- Learn more about Budgeting