What Are Payday Loans?

Payday loans, also sometimes known as cash advances, are short-term loans that give borrowers access to fast cash to cover financial emergencies or other expenses. They’re small-dollar loans — typically around $500 — that are issued through storefront and online lenders. Their short repayment terms paired with high-interest rates can make it difficult for borrowers to pay them off on time.

Payday loans are unsecured loans, which means they don’t require collateral in exchange for receiving the money. This is one reason they’re attractive to borrowers, as they don’t have to fear repossession of their assets. 

How do payday loans work?

There are typically two costs associated with payday loans: interest, which accrues over time,  and a flat fee to initiate the loan. The interest on a payday loan is typically a percentage of the amount borrowed.

Borrowers can take out payday loans from storefront or online lenders. As of 2020, 37 states have regulations that permit payday lending, the National Conference of State Legislatures reports. 

Online payday loans

When a borrower takes out a payday loan, funding can appear in their account as soon as the next business day. These loans have a short repayment period, as the loan amount, fees, and interest are due by the borrower’s next payday. The average payday loan is 14 days in length, and loan terms are generally no longer than a month. 

Online payday loans may also require a borrower’s checking account number to withdraw payments. The lender can then automatically withdraw funds when the loan comes due.

Storefront lenders

For a storefront payday lender, borrowers will write out a postdated check to the lender for the amount borrowed plus fees and interest. The lender then gives the borrower cash and waits until the agreed-upon due date to cash the check. Sometimes the borrower will have to go back to the payday lender on or before the due date in order to make the payment in person.

Are payday loans bad?

Payday loans give borrowers with short-term financial needs access to funding, oftentimes regardless of credit history. 

Some research has shown that payday loans can lead to debt, which can be challenging for consumers to pay off. Research also indicates that payday loans can lead to overdraft fees, delinquency on other bills, involuntary loss of bank accounts, and bankruptcy.

Most borrowers are unable to pay back the loan they take out by the loan’s due date. This causes the payday loan to roll over into another borrowing term, which can lead to owing more money than originally planned. Four out of five payday loans were rolled over or reborrowed, the Consumer Financial Protection Bureau reported.

How much can I borrow with a payday loan?

Most payday loans are small-dollar loans that can range between $50-$1,000. State regulations determine the amount you’re allowed to borrow. 

How much do payday loans cost? 

Payday loans will vary in cost based on the state and lender. Some states have particular protections or rate caps for borrowers.

How are payday loans calculated?

Payday loans can cost more than other types of borrowing. For example, on average, a two-week loan for $375 will come with a $55 fee and $520 in interest from repeat borrowing, according to the St. Louis Federal Reserve.

The average payday loan has an annual percentage rate of 400%. Some states have set maximum fees that borrowers have to pay, but it’s common for lenders to charge $15 per every $100 borrowed, according to the Consumer Financial Protection Bureau. 

Determining the cost of a payday loan will vary based on the lender and your state. The loans are subject to state laws, so the size of the loan, cost of the loan, and availability will differ depending on your location.

What are payday loans used for?

When people can’t cover their expenses, they may turn to a payday loan if they don’t have other options. They may use them to pay for everyday expenses such as rent, car payments, utility bills, and groceries, as well as unexpected costs, such as a medical bill, job loss, or household repairs.

Do payday lenders check credit history?

Payday lenders don’t have strict requirements for borrowers to obtain a payday loan. A bad credit score usually won’t prevent you from being able to take out the loan. It’s rare for a payday lender to run your credit report as part of the loan application process. 

Can I get a payday loan with bad credit?

Payday loans traditionally don’t require borrowers to have a particular credit score. Payday loan companies usually don’t factor a borrower’s credit report or credit score.

What are the requirements to apply for a payday loan?

Requirements for payday loans will vary by state and lender. Generally, borrowers need to provide the following personal information to obtain the loan:

1. An account at a bank or credit union, or a prepaid card account
2. Income verification through a job, governmental benefits, or another source
3. Valid ID
4. Proof of age. Loans require borrowers to be at least 18 years old.

What happens if I can’t repay a payday loan?

If you can’t afford your payday loan bill, you may have options, but the outcomes may not be ideal.

Some states allow loans to roll over. With a rollover, you’ll pay the loan fees and your loan’s due date will be extended. You’ll owe the entire original balance along with another fee. This gives the borrower more time to come up with the funds, but also grows their debt.

Some states mandate lenders to offer extended repayment plans for borrowers who have trouble paying back their loans.

Some lenders may take matters into their own hands, and will automatically withdraw the money you owe them directly from your bank account. A payday lender or debt collector can also sue you to collect the amount you owe on a loan. If this happens, a court can force your employer, bank, or credit union to take out money to pay your debts. For a wage garnishment, your employer will be legally required to withdraw money from your wages. A bank garnishment will force your financial institution to take out funds to cover your debts.

Do payday loans affect your credit score? 

It depends. Because most payday loans are single repayment loans, payday loans don’t impact your credit score, even if you make on-time payments, according to the Urban Institute. Payday loan payments aren’t typically reported to the three major credit bureaus (Equifax, Experian, and TransUnion). For this reason, they won’t help you build your credit score.

However, if you default on a payday loan, the lender could give your debt to a collection agency. A collection agency can report the delinquent account to the credit bureaus, which can then negatively impact your score. 

Alternatives to payday loans

Payday loans can be a pricey way to borrow money when you’re short on cash. Payday loans are not your only option for borrowing. Here are several alternative ways to borrow:

Personal loans

Personal loans are installment loans that are paid back on a monthly basis over a set period of time. Personal loans are usually unsecured loans that don’t require collateral. The average APR for a 24-month personal loan in 2019 was 10.32%, according to the Federal Reserve.

Payday Alternative Loans (PALs)

Payday Alternative Loans are issued to members of federal credit unions that are a part of the National Credit Union Administration. The credit union charges a fee to process the loan, which can be up to $20. These loans range between $200-$1,000 and are paid back in one to six months.

Payroll advance

Employers may give their employees an advance on their upcoming paycheck if they need to cover emergency expenses. The payday advance is deducted from their next paycheck. A payroll advance usually doesn’t come with any interest or fees. Check with your employer’s policies to determine if a payday advance is the best option for you.

Borrow from friends or family

Depending on your relationship, you could ask a friend or relative for a loan. Borrowing from friends and family often doesn’t require a credit check or for you to pay fees and interest. The risk here is potentially damaging your personal or familiar relationship if you’re unable to pay them back. Creating a written agreement between both parties with a payment plan may be a good idea.