Loans

What is a payday loan?

The information provided on this website does not, and is not intended to, act as legal, financial or credit advice. See Lexington Law’s editorial disclosure for more information.

Unexpected expenses can hit us all at the worst times. Whether it’s a car repair, a medical bill or just making ends meet until your next paycheck, financial strains can leave you needing a quick solution. For some, a payday loan can be one way to bridge that gap. 

Below, we’ll break down the ins and outs of payday loans, from how they work to the potential consequences, so you can make the most informed financial decision and determine if they’re right for you.

What is a payday loan?

A payday loan is a small, short-term loan typically due on your next payday. Unlike other types of personal loans, these loans are designed for borrowers who need quick cash to cover unexpected expenses, such as car repairs, medical bills, or rent. To qualify, borrowers typically need proof of income and a valid bank account.

How payday loans work

To get a payday loan, you typically apply in person at a storefront or online through the lender’s website. You’ll need to provide personal and financial information, such as proof of income and a valid bank account. If approved, the lender usually deposits the loan amount directly into your bank account within 24 hours.

You’ll usually need to pay back a payday loan by your next payday. This often involves authorizing the lender to withdraw the full loan amount, plus fees, directly from your bank account. 

If you’re unable to repay the loan on time, you may have the option to “roll over” the loan. This involves paying an additional fee to extend the repayment deadline, but it can create a dangerous cycle of debt as you continue to accrue fees.

If you default on a payday loan, the lender may take various actions to collect the debt. These can include continued attempts to withdraw the payment from your bank account, selling your debt to a collection agency or even taking legal action.

Payday loan fees and interest rates

Payday loans are notorious for their extremely high fees and interest rates. While specific rates vary by state, they typically carry an annual percentage rate (APR) that can easily exceed 400 percent and, in some cases, reach several hundred percent. 

  1. Fees: A common fee is $15 per $100 borrowed, but can range from $10-$30 per $100, according to the Consumer Financial Protection Bureau.
  2. APRs: A standard two-week payday loan with a $15 per $100 fee has an APR of nearly 400 percent.

Many states have laws limiting the cost of payday loans, and some have even banned payday lending altogether. The Military Lending Act (MLA) also caps the APR on payday loans for service members and their families at 36 percent. This cap helps prevent predatory lending practices that disproportionately affect military personnel.

Which states do not allow payday loans?

As of now, 37 states have laws that permit payday loans, although most have restrictions in place to protect borrowers. Before getting a payday loan, it’s smart to verify whether a lender you’re considering is licensed to provide payday loans in your state. Verify this by checking with your state’s bank regulator or attorney general

Important considerations about payday loans

Payday loans are known for their costly interest rates and fees, which can quickly add up. These high costs can make it difficult to repay the loan on time, leading to a cycle of debt. Some payday lenders also engage in predatory lending practices that target vulnerable borrowers, making it difficult for them to repay their loans. 

Ultimately, payday loans should be avoided whenever possible. Better alternatives are often available, such as borrowing from friends or family, getting a small loan from a credit union, or using a credit card. If you are considering a payday loan, carefully weigh the risks and benefits.

What to do if you get a payday loan

Are payday loans bad? Even though payday loans should generally be avoided, there are steps you can take to minimize the damage if you find yourself in this situation:

  • Repay on time: The most crucial step is to repay the loan in full and on time. This way, you avoid accumulating further fees and interest charges.
  • Check your state’s laws: Familiarize yourself with your state’s laws and regulations regarding payday loans. This will help you understand your rights and protections as a borrower.
  • Avoid rollover fees: “Rolling over” your loan by extending the repayment period can significantly increase your overall costs. Avoid this practice whenever possible.
  • Create a budget: Develop a realistic budget to help you manage your expenses and ensure you have the funds available to repay the loan on time.

By taking these steps, you can minimize the negative impact of a payday loan and work towards getting out of debt.

Alternatives to payday loans

Before considering a payday loan, explore these alternative options:

  • Use overdraft protection: Some banks offer overdraft protection, which can help cover small, unexpected expenses.
  • Find a cosigner: If you can’t qualify for a loan on your own, consider finding a good-credit cosigner.
  • Charge the amount to your credit card or use a cash advance: If you have good credit, using a credit card or obtaining a cash advance may be more affordable than a payday loan, depending on your card’s interest rates and fees. Be aware that cash advances come with high interest.
  • Borrow from friends or family: If possible, consider borrowing from a trusted friend or family member.
  • Ask your employer for an advance: Some employers may be willing to provide an advance on your paycheck.
  • Request more time from your creditor: If you’re facing difficulty making a payment, contact your creditor directly and explain your situation. They may be willing to work with you to create a payment plan.
  • Get a bad credit loan: If you need to get a loan with bad credit, bad credit loans generally offer more favorable terms, lower costs and the potential to improve credit history compared to payday loans.

Take charge of your credit

Understanding a payday loan and the potential risks can help you make more informed financial decisions. While these loans may seem like a quick solution to a financial emergency, their high costs and potential for creating a cycle of debt often outweigh any perceived benefits. 

Get your free credit assessment to learn more about your credit health and see where you currently stand. 

Note: Articles have only been reviewed by the indicated attorney, not written by them. The information provided on this website does not, and is not intended to, act as legal, financial or credit advice; instead, it is for general informational purposes only. Use of, and access to, this website or any of the links or resources contained within the site do not create an attorney-client or fiduciary relationship between the reader, user, or browser and website owner, authors, reviewers, contributors, contributing firms, or their respective agents or employers.

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