Are Payday Loans Legal?
Payday lending in its current form originated in the United States in 1993, and today, payday loans are legal in many states but not all. In states where payday loans are legal, payday lenders must follow both state and federal rules.
State rules determine the maximum loan amount, loan term, and finance charges. The Federal Trade Commission’s Truth in Lending Act requires payday lenders to tell customers about a loan’s finance charges and annual percentage rate (APR), in writing, before extending a loan.
But even in states where payday lending is prohibited, consumers may still be able to borrow money through other means. Options include online payday loans, pawn shop loans, auto title loans, and tax refund anticipation loans. Many of these lenders are legitimate, but some operate illegally or unscrupulously.
States That Prohibit Payday Loans
Thirteen states either prohibit payday loans or cap interest rates such that payday lenders don’t find it profitable to operate there. These states are :
- New Jersey,
- New Mexico,
- New York,
- North Carolina,
- West Virginia.
Payday loans in the District of Columbia are a special case. Although Washington, DC, is not a state, it is governed by its own set of laws, and the District of Columbia prohibits payday loans.
In these locales, some Native American tribes tend to be exempt from state lending laws. That’s how they’ve been able to offer payday loans to residents of states that ban such loans, sometimes by teaming up with and sharing profits with companies that know how to process the loans.
States That Allow Payday Loans: How Much Can Consumers Borrow?
In the 37 states that do specifically allow payday loans, lenders must follow regulations that determine how much they can lend and how much they can charge.
The most common payday loan limit is $500. The states that limit payday loans to $500 are Alabama, Alaska, Colorado, Iowa, Kansas, Mississippi, Missouri, Nebraska, New Hampshire, North Dakota, Oklahoma, Rhode Island, South Dakota, Tennessee, and Virginia.
Some states get more particular about this $500 limit. Colorado says the amount financed can’t exceed $500 at any time. Mississippi says that the $500 cap includes any fees, while Oklahoma says it’s okay if the finance charge makes the loan amount exceed $500.
The limit is less than $500 in some states. These include California ($300), Louisiana ($350), and Minnesota ($350). Wyoming, Wisconsin, Utah, and Maine have no maximum loan amount, and Oregon’s limit is $50,000. The other states that allow payday loans to fall somewhere in between.
State Caps on Payday Loan Fees
In states where payday loans are legal, laws may restrict the fees lenders can charge. For example, Alabama caps finance charges at 17.5 percent of the amount advanced, which would be $87.50 on a $500 loan, the maximum allowed in the state.
Some consumer advocates would like to see a federal law limiting a payday loan’s annual percentage rate to 36 percent, which is quite low compared to the typical payday loan.
A 36 percent APR cap — similar to the highest rates credit card companies charge — means that lenders get $1.38 per $100 borrowed instead of the typical $15 per $100 borrowed. In 2019, Hawaii, Illinois, Kentucky, Michigan, Missouri, and South Carolina have proposed legislation limiting a payday loan’s APR to 36 percent. Payday lenders might not be willing to offer a service for so much less than they are accustomed to charging if these proposals become law. Their business model could become unprofitable.
State Caps on the Number of Payday Loans
Another way state law regulates payday lenders is by limiting how many payday loans consumers can take out at once or per year. They do this by creating a statewide database of payday loans that lenders are required to consult before approving a loan.
Many states don’t allow payday loan rollovers. When a borrower can’t repay a payday loan when it’s due, lenders may allow them to take out another loan to repay the first one, which means paying another finance charge.
Should Payday Loans Be Legal?
Payday loan advocates say that these loans can help consumers avoid bank overdraft fees, utility reconnection fees, late payment fees, and other costs that might be pricier than a payday loan. Payday loan opponents point out that these loans can actually lead to overdraft fees. There’s truth to both arguments.
Here’s what can happen: When someone takes out a payday loan, they usually must grant the lender access to their checking account in one of two ways: with a post-dated check or with an electronic debit authorization. When the loan is due, the lender will attempt to cash the check or debit the borrower’s bank account for the amount borrowed.
If the borrower doesn’t have the money, the check won’t clear or the transfer won’t go through. The bank may then charge the consumer an overdraft fee. The lender might also impose its own fees when a payment doesn’t go through, driving borrowers further into debt.
The answer to the question, “Are payday loans legal?” is that it depends on where you live. About a quarter of US states don’t allow them. The states where payday loans are legal to regulate them in some way, whether it’s limiting how much consumers borrow, how often consumers can borrow, or how much consumers must pay to borrow.
The best way for consumers to not get taken advantage of with any type of short-term loan is by learning about the options and comparing offers from different providers, researching lenders’ reputations, and knowing about the laws that can protect them.