Payday loans are a type of short-term, high-interest loan that borrowers can access quickly. Also known as cash advance or check loans, payday loans allow people to borrow a small amount of money until their next paycheck. Then, the full loan amount plus fees must be paid back in a lump sum.
Payday loans target borrowers who need fast cash but may not qualify for traditional personal loans or credit cards. They require little to no credit check and can be approved within minutes. However, payday loans come with very high interest rates and fees, leading many to criticize them as predatory lending.
When considering financial options, understanding the distinctions between installment loans and payday loans is crucial, as installment loans often offer more manageable terms and lower overall costs for borrowers.
This comprehensive guide will explain what payday loans are, how they work, their pros and cons, alternatives, and tips for responsible borrowing.
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How Do Payday Loans Work?
Payday loan amounts are typically between $100 to $1,000, with an average loan size of around $375. The repayment term is short, usually coinciding with the borrower’s next pay date or within two to four weeks.
To qualify for a payday loan, borrowers only need to:
- Be 18 years or older
- Have an active checking account
- Show proof of income from a job or other sources
Lenders do not check credit scores or require collateral. The ease of qualifying is why payday loans appeal to people with no credit or very bad credit.
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To get a payday loan, borrowers provide a post-dated check or electronic debit authorization for the full loan amount plus fees. This gives the lender access to the repayment funds from the borrower’s account when the loan comes due, typically on their next payday.
Borrowers can apply for payday loans online or at storefront locations. Approval can happen in minutes. Some lenders deposit the loan funds into borrowers’ accounts instantly, while others require returning to pick up the cash.
Payday Loan Fees and APRs
Instead of interest, payday lenders charge set fees based on the loan amount. A typical payday loan fee is $15 per $100 borrowed. This fee must be paid each time the loan is rolled over or refinanced.
So, for a $300 loan, a borrower would owe $345 after a two-week term. This equals an Annual Percentage Rate (APR) of nearly 400%. APRs on payday loans range from 200% to over 500%.
By contrast, the average APR on credit cards is 15-20%. Personal loan APRs range from around 6% to 36%. So payday loan costs are exceptionally higher than other lending products.
Some states regulate payday loan fees and maximum APRs. But in states without caps, lenders can charge any fees they desire. Even a “low” 200% APR loan can be difficult to pay off if rolled over repeatedly.
Repaying Payday Loans
The full payday loan amount and fees are due in a lump sum on the due date, which is typically the borrower’s next payday. Some lenders allow extensions or rollovers to new loans for additional fees.
To repay the loan, the lender will cash the postdated check or make an electronic withdrawal from the borrower’s account. If insufficient funds exist, the borrower may incur overdraft fees from their bank in addition to late fees from the lender.
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Defaulting on payday loans can lead to increased fees, constant collection calls, wage garnishments, and lawsuits. The steep costs make these loans difficult to pay off for borrowers without extra income available.
Pros of Payday Loans
Despite their high costs, payday loans do come with some potential benefits:
- Quick access to cash – Borrowers can get approved in minutes and receive funds instantly or the same day. This makes payday loans helpful in emergencies.
- Easy to qualify – Payday lenders only require proof of income and a bank account. Bad credit is not a barrier.
- Convenient locations – Many payday loan stores exist across the U.S., and loans can also be obtained online 24/7.
- No collateral required – Payday loans are unsecured, so borrowers do not risk losing personal assets.
For people with poor credit and few emergency resources, payday loans may feel like the only option. If used responsibly for one-time expenses and repaid quickly, their convenience can be beneficial.
Cons of Payday Loans
However, payday loans have many drawbacks to consider:
- Extremely high APRs – Average APRs of 400% make payday loans expensive. Interest and fees rapidly accumulate.
- Short repayment terms – Two weeks or a month to repay a loan creates pressure. It’s easy to “rollover” loans and incur new fees.
- Risk of overdraft fees – If the lender makes withdrawals and insufficient funds exist, the borrower pays overdraft fees to their bank.
- Can hurt credit scores – Failure to repay payday loans damages credit. Even on-time repayment does not help credit since most lenders do not report to bureaus.
- Does not solve long-term issues – For people already struggling financially, a payday loan only provides temporary relief but makes overall finances worse.
Basically, the convenience of payday loans carries a very high price. Borrowers with other options should avoid them due to the risks.
Payday Loan Alternatives
Before choosing a payday loan, consider these less expensive borrowing options:
- Credit union payday alternative loans (PALs) – Offered by federally-insured credit unions, PALs have APRs capped at 28% and applications can help build credit.
- Credit cards – Cash advances on credit cards carry lower interest rates and more flexible repayment terms than payday loans.
- Personal loans – Unsecured personal loans offer fixed rates as low as 6% APR with set monthly payments, but require good credit.
- 401(k) loans – Allows borrowing against retirement savings at low interest. Must repay within 5 years to avoid taxes and penalties.
- Borrow from family/friends – For temporary needs, private loans from people you know may charge little or no interest.
- Negotiate bills – Contact creditors directly to explain your situation and request more time to pay bills. Avoid late fees.
- Peer-to-peer borrowing – Websites like LendingClub allow borrowing and lending between individuals to bypass traditional banks.
- Title loans – Loans issued in exchange for the title to your paid-off car. Better than payday loans but still expensive.
- Pawn shops – Receive cash for items that the pawn shop holds temporarily. Interest rates are high but you won’t lose collateral.
Tips for Responsible Borrowing
If you do take out a payday loan, borrow only what you can afford to pay back with your next check and follow these guidelines:
- Carefully consider your budget and don’t borrow more than you can repay at once.
- Avoid rollovers – Pay back the full loan on time to prevent new fees that make it harder to get out of debt.
- Apply with lenders licensed in your state and check complaints against them with your state regulator.
- Read the loan terms closely so you understand all fees, rates, and due dates before signing.
- Do the math to understand the true dollar cost with fees factored in. This helps avoid shock when repaying.
- Have a plan for repayment that allows paying basic expenses too. Don’t borrow beyond your means.
- Look for lenders that offer extended terms so you have more time to repay without rolling over into a new loan.
- Talk to the lender immediately if you anticipate issues repaying and see if arrangements can be made.
Avoiding payday loans when possible is wise. But if you use them, being an informed borrower can help prevent bigger long-term problems.
Frequently Asked Questions about Payday Loans
Are payday loans legal?
Payday lending is fully banned in 16 states and strictly regulated in others. Check the laws for your state. Lenders must comply with rate caps and licensing requirements where they exist.
Do payday loans help build credit?
In most cases, no. Payday lenders rarely report loans to credit bureaus, so on-time payments are not reflected in credit reports. But defaults can be reported and damage credit.
Where can I get a payday loan?
You can apply at local payday loan storefronts or online. Online lenders offer the convenience of 24/7 access from anywhere, but research companies carefully.
What do I need to qualify for a payday loan?
You typically need to be 18+ years old, have a bank account, show proof of income, and provide ID. Credit checks are rarely required. Some lenders may also require references.
How quickly are payday loans funded?
Many lenders deposit approved loan amounts directly into your bank account as soon as the same day you apply. Others have options to pick up cash instantly
