How do cash advance apps work, and are they better than payday loans?

When you picture a payday rental company, you might think of a mall storefront with green dollar signs and neon slogans like “Payday for every day.” You probably don’t imagine a mobile app advertising on TikTok and sporting a colorful logo.

But cash advance apps like Earnin and Dave offer advances with the same credit and repayment structure as payday lenders, and consumer advocates say they carry similar risks. Both are quick, no-credit-check options to close an income gap or ease inflationary pressures.

Both are not ideal first choices for borrowing quick cash, but knowing their differences can help you save money and not damage your finances.

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Cash advance apps work like payday loans

As with most payday loans, you can use a cash or payroll app to borrow money without a credit check. Also, you must repay the advance plus any agreed fees on your next payday.

A single payment cycle isn’t usually enough time for borrowers to pay off a payday loan, so many people fall into the pattern of getting another loan to pay off the previous one, says Alex Horowitz, chief executive at The Pew Charitable Trusts.

App users may be in a similar cycle. A 2021 Financial Health Network study found that more than 70% of app users make sequential progress. The study doesn’t say why users reborrow loans, but Horowitz says the behavior is particularly similar to payday loans.

“Payroll advances direct to consumers share the DNA with payday loans,” he says. “They’re structured the same, they borrow repeatedly, and they’re timed to coincide with the borrower’s payday, giving the lender strong collection ability.”

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Apps may offer more flexibility

Payday lenders and paycheck advance apps both pull repayment directly from your bank account. If your account balance is too low when you withdraw funds, you may incur an overdraft fee, says Yasmin Farahi, senior policy counsel at the Center for Responsible Lending.

An app may be trying to avoid overdrafting your account. Mia Alexander, vice president of customer success at Dave, says the app checks users’ bank accounts before withdrawing the refund. If the payback makes the balance close to zero or negative, the app may not be able to withdraw funds, she says.

However, apps often include language in their user agreements that even if they try not to overdraw your account, they are not responsible if they do so.

In states that allow payday loans, a payday loan is unlikely to offer a free, unsolicited payment extension like some apps claim. Some states require payday lenders to offer free extended payment plans to problem borrowers, but a 2021 report by the Consumer Financial Protection Bureau says some lenders misrepresent the plans or fail to disclose them.

Also, unlike payday lenders, apps don’t make collection calls. If a user revokes access to their bank account to avoid a refund, the app doesn’t attempt to collect the funds. The user simply cannot get another advance until they pay back the previous one.

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Payday loans cost more

Payday loans tend to have high, mandatory fees, while apps often don’t. Instead, they charge small fees that users can opt-in to throughout the rental process. These fees can add up, but they’re usually less than what payday lenders charge.

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For example, an app might charge a monthly subscription fee or a fee for instant access to funds. Most cash advance apps also require a tip for service.

The fee for a $375 payday loan is typically about $55 over a two-week period, Horowitz says. Since the cash advance app fees are mostly optional, you can easily keep the cost under $10.

Earnin user Sharay Jefferson says she’s used payday loans in the past but switched to a cash advance app because it’s a cheaper way to cover bills and unexpected expenses.

“If you get a $200 payday loan, you might pay off three or more,” she says. “At Earnin, I have to pay back that $200 plus the tip I give them. It’s a lot cheaper.”

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Technically, apps are not lenders

Regulators like the CFPB have not classified paycheck advance apps as lenders, despite their similarities to payday loans.

According to Ram Palaniappan, CEO and founder of Earnin, the app is more like a payroll service or an ATM because it makes it easier to access your own funds. Earnin requires users to upload a time sheet showing they worked enough hours to earn the cash advance amount. Other apps scan a user’s bank account for income and expenses to determine if they are eligible for an advance.

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According to Farahi, apps should be treated like lenders, meaning they would follow the Truth in Lending Act, which requires lenders to disclose an APR. An APR allows consumers to compare costs between financing options. For example, users could compare the APR of a cash advance app to that of a credit card and choose the cheapest.

“People still need to know what the actual cost of borrowing is and be able to evaluate it and really compare that cost to other options,” she says.

Apps would also have to comply with applicable state credit laws. Currently, 18 states and Washington, DC have maximum interest rate caps that could cap app fees, she says.

Prepayment App vs Payday Loans: Which is Better?

If you’re in urgent need of cash, you may have better alternatives than payday loans and prepayment apps, says Farahi.

Local nonprofits and charities can help with basic groceries and clothing. A family or friend could lend you money without charging additional fees. If you have a few hours, a side job could bring in as much money as a typical payday loan or cash advance app.

If the choice is between an app and a payday loan, the app is probably a better option because:

  • It’s cheaper.

  • It must not trigger an overdraft fee.

  • If you don’t pay it back, the app won’t direct you to debt collection.

A cash advance from an app probably won’t put you in a better financial position, Farahi says. But you may be a little less likely to get worse than with a payday loan.

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Annie Millerbernd writes for NerdWallet. Email: [email protected]

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