Payday Loan: How It Works and Risks

Table of contents
pros and cons of payday loans
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Payday loans are high-interest loans that you’ll have to pay back on your next payday (hence the name). How they work and their limitations depends on your state. In fact, some states prohibit payday loans altogether.

If you live in one of the following states, then you won’t be able to apply for a payday loan:

  • Arizona
  • Arkansas
  • District of Columbia
  • Georgia
  • Hawaii
  • New Mexico
  • North Carolina

💡 Note: Some states have implemented limitations on payday loans instead of prohibiting them. Washington has a limit of eight payday loans per year. Ohio implemented a cap of 28% APR on payday loans. And Virginia requires payday loans to be payable in two cycles instead of one.

Can Payday Lenders Take Money Directly from Your Bank Account?

Yes, payday lenders can electronically take money from your bank if you signed a payment authorization form or an ACH authorization.

Payday lenders may also just require you to write a post-dated check instead of requesting ACH authorization. In this case, they can’t electronically take money from your account.

💡 Note: If you change your mind regarding the payment authorization you signed, you can always revoke your authorization. If you do so, you’ll still owe the debt, but the lender can no longer electronically take the money from your account.

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What are the Risks of Payday Loans?

The greatest risk of payday loans is their massive APR which can reach 400% ($15 per $100 borrowed) on some loans. To put this into context, credit cards are already deemed predatory by some people with their APR of 12% to 30%.

Most payday loans have a maximum loan amount of $500. At an APR of 400%, you’ll have to pay back $575 on your next payday. With interest rates that high, you’re likely to just borrow money again immediately after paying it back. This results in a vicious debt cycle that only gets harder to get out of the more time passes.

💡 Note: The following states have implemented a cap on the APR of payday loans: Colorado (45%), Illinois (36%), Louisiana (36%), Maine (18 – 30%), Montana (36%), Nebraska (36%), New Hampshire (36%), Ohio (28%), Oregon (36%), South Dakota (36%), Virginia (36%).

What Credit Score Do You Need for Payday Loans?

There is no credit score requirement for payday loans. In fact, most payday lenders don’t check your credit score since they generally market their service to borrowers with bad credit.

This also means that applying for payday loans doesn’t impact your credit score. This goes both ways since most payday lenders don’t report to the credit bureaus so they can’t be used to build your credit score.

Cushion on the other hand can report your bill and BNPL payments to the credit bureaus if you use the Cushion Virtual Card to pay them. We can also ensure that you never miss a payment again by allowing you to track your due dates on your Google Calendar (which updates in real time!). The Cushion app even allows you to set push notifications for specific bills!

Last Updated on October 10, 2024
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Disclaimer: The information provided in this website is for educational purposes only and should not be considered as financial advice. Consult with a financial professional for personalized guidance regarding your specific situation.
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