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Traditional payday loans usually come from storefront lenders in low-income neighborhoods. Those are still common, but online payday loans are increasingly prevalent. If you’re deep in debt to an online lender you may be wondering if your online payday loan is legal.

Payday loans sound like an easy solution to money problems: you get fast money without a credit check and with minimal requirements. Online payday loans seem even simpler. You don’t even have to leave your home.

That simple solution can quickly turn into a nightmare, with astronomical interest rates and hidden terms that drag borrowers into a debt trap that may see them paying back many times the original amount they borrowed.

Online lenders can be aggressive and often use illegal collection techniques. If you’re being harassed you may feel that you have few or no options. That may not be the case.

💡 Before you make another payment, check to see if your lender is licensed in your state and complying with state laws. If they aren’t, the loan is probably illegal. You may not have to pay.

Online Payday Loans: High-Tech Loansharking

Online payday loans work very much like storefront payday loans. There’s no credit check. All you need is a source of income and a checking account. Loans are typically a lump sum that’s due on your next payday. 

Interest rates are very high, but because the loan term is short the fee may seem affordable.

In most cases, the lender will require you to authorize Automatic Clearinghouse (ACH) payments, letting them withdraw directly from your bank account. 

If everything works well, the lender draws their payment when your paycheck clears, and you’re out of debt. In practice, this rarely happens. Online payday lenders have numerous ways to force you to keep on paying.

Here are some sound reasons to avoid online payday loans.

Unaffordable Interest Rates

Online payday lenders typically charge higher interest rates than storefront lenders.

Loan type and locationAPR
Storefront lump-sum national average391%
Online lump-sum national average652%

Source: Pew Charitable Trusts

☝️ High interest rates drive borrowers into a cycle of repeated borrowing. Even if the borrower pays the loan on schedule they are likely to run out of money again – and look for another loan – before their next paycheck arrives.

Deceptive Terms

Many online payday loan agreements contain language allowing the company to extend or “roll over” the loan at the end of the loan period. The lenders then charge the borrower’s bank account for the accrued interest without touching the principal.

Lenders may do this repeatedly, leaving the borrower making multiple payments without ever reducing the amount they owe.

In order to pay off their principal, the borrower has to specifically request it, often by navigating a deliberately dysfunctional customer service system.

Insecure Data

When you take out an online payday loan you will give the lender key pieces of personal data, typically including your Social Security number, bank details, phone number, address, and place of employment.

Pew Charitable Trusts reports that 39% of online payday loan borrowers had personal or financial information sold to a third party. That produces a high risk of identity theft.

⚠️ Other users reported that their personal details were used to open new loans or other accounts without their permission.

Aggressive (And Illegal) Collection Practices

Surveys indicate that online payday loan borrowers are routinely subjected to threatening and abusive collection practices, even when their accounts are up to date.

Some collectors impersonated law enforcement or representatives of a law office or government agencies. Others threatened to visit or call workplaces or employers, or even to have borrowers arrested.

The Fair Debt Collection Practices Act prohibits these threats, but unscrupulous lenders may use them anyway. In some cases, their calls may even come from scammers who have bought personal information.

Unauthorized Withdrawals

Once you’ve signed an ACH agreement with an online lender they can withdraw money from your account at any time. 46% of online payday loan borrowers report that withdrawals triggered overdraft fees at their banks, escalating their costs. 32% reported unauthorized withdrawals.

Some borrowers had to close their bank accounts to stop the withdrawals. Others reported that banks closed their accounts due to repeated overdrafts.

Types of Online Payday Lenders

Online payday lenders come in several varieties. Knowing what type you’re dealing with will help you determine whether your loan is legal and whether you’re legally obligated to pay it.

Online payday lenders use several models to try to get around state laws restricting short-term high interest loans. They often use complex corporate structures to conceal the identity of the people or companies that are actually lending the money.

Multiple-State Licences

Some online payday lenders seek licenses in multiple states and operate only in states where they hold licenses. This is the most legitimate form of online payday lending. If your lender is licensed in your state your loan is probably legal unless the company violated state laws or the terms of its license.

👉 Only around 30% of online lenders are licensed in all of the states where they make loans.

Single-State License

Other online payday lenders obtain a license in one state with permissive laws and claim that they can “export” this legal regime to other states under a “choice of law” clause in the loan contract.

Regulators in several states have declared this practice illegal and taken legal action against lenders who operate without local licensing.

💡 If your lender is licensed in a state other than yours, your loan may not be legal.

Tribal Immunity

Some payday lenders locate on native American tribal lands and claim immunity from suit under sovereign immunity laws. In most cases, these are non-tribal enterprises that pay a small amount to the tribe under a “rent a tribe” arrangement.

These “tribal loan” companies charge very high interest rates and operate outside any state laws. It is difficult or impossible to sue them and they are largely unregulated.

💡 If you’ve borrowed from a tribal lender that is not licensed to operate in your state your loan may be illegal. You may not be able to sue them, but it will also be very difficult for them to sue you.

Overseas Incorporation

Other online payday lenders locate outside the US to avoid legal action and regulation. They may have offices in the US, but they maintain a corporate entity outside the US to use as protection.

These lenders fall into a regulatory gap, but as with tribal lenders, it may be impossible for them to sue you for collection if they are not licensed to do business in your state.

Is Your Online Payday Loan Legal… And Do You Have to Pay?

Many states regulate or even prohibit payday loans. Regulations typically involve caps on loan amounts, interest rates, restrictions on loan rollovers, and other rules to control abusive lending practices.

👉 You can check your state’s laws here.

If your payday lender is not licensed in your state or if the terms of your loan violate state laws or regulations, your loan may be illegal. If it is, you may not have to pay. The lender or a collection agency will not be able to sue you or garnish your wages for failure to pay an illegal loan.

Several states have officially stated that loans made by lenders without state licenses are illegal. Washington’s Department of Financial Institutions, for example, has stated that “a small loan (defined as a loan that does not exceed $700) made by an unlicensed entity to a person physically located in Washington State is uncollectible and unenforceable in Washington State.”

Norman Googel, a West Virginia assistant attorney general, stated that “If someone makes you a loan that’s illegal, either because they don’t have a license or they violate usury laws, you’re not under any obligation to pay it back.”

How to Check if Your Online Payday Loan Is Legal

If you’ve taken out an online payday loan and you can’t pay or you feel that the lending or collection practices are abusive or illegal, start by contacting the agency in your state that regulates financial institutions. Find out if your lender is licensed in your state.

If the lender is licensed in your state, check your state’s laws on payday lending to determine whether your lender is engaged in illegal practices.

You may need a lawyer’s help to determine whether your loan is legal or not. Your state’s regulatory authorities may be able to help, or you may be able to get free legal advice.

What to Do if Your Loan Is Illegal

If your loan is illegal, there is a good chance that it’s uncollectible and that you do not have to pay it.

💡 If you have determined that the loan is illegal and uncollectible, you can ask your bank to revoke your ACH authorization and prevent further withdrawals. You may need to close the account entirely. Talk to your bank to determine your best course of action.

Once you have revoked the ACH authorization or closed the account, send an email to the lender’s customer service address. Explain that you have revoked their authorization to draw from your account because you have determined that the loan is illegal. Explain why it is illegal.

If you have already paid more than the principal amount, explain that fact and ask for a letter stating that your debt is paid in full.

What Steps Can the Lender Take

If your loan is illegal and uncollectible the lender cannot sue you. They can and will take other steps.

If you revoke your ACH authorization or close your bank account you can expect to hear from a collector very quickly. Explain that you have determined that the loan is illegal and uncollectible.

Don’t expect the lender to simply give up and walk away. They may harass you. They may call your employer or references, so you’ll have to explain the situation and let these people know why you aren’t paying the loan.

☝️ Some tribal lenders may contact your employer and attempt to garnish wages with no court order or on the basis of a tribal court order. This is not legal, but you will have to discuss it with your employer.

You may receive threats and you may have to change phone numbers or email addresses.

The lender may sell your debt to a collection agency. The collection agency or the lender may report your account to the three major credit bureaus. This can do immediate damage to your credit. You’ll have to dispute the account on the grounds that the loan was illegal.

💡 If the lender persists in harassing you, contact the FTC and your state Attorney General’s office or financial regulator.

A call from a debt collector is never a happy experience. If you don’t know how to communicate with debt collectors your first impulse may be to panic. If you want to know what to expect and how to act if it comes to this read our article on How to Communicate With Debt Collectors.

The Best Bet: Don’t Take the Loan

If your online payday loan is illegal in your state it is probably uncollectible and unenforceable. The lender will not be able to sue you for collection.

Don’t expect the lender to give up easily. Expect harassment and threats. Expect the lender or collection agency to contact your employer and your bank. Your best bet is to explain the situation to both before you stop the payments.

You will need to accept that your personal information is out of your control and may be for sale online. You’ll need to take steps to prevent identity theft.

This is not an easy process and it won’t be fun, but it’s better than paying many times the amount of your original loan.

If you’ve already fallen for an online payday loan, it’s too late for this advice. You’ll have to do it the hard way. If you haven’t, don’t do it. No matter how desperate you are, there are better ways. Start by checking this list of payday loan alternatives!