How Do Payday Loans Work?

Payday loans let you borrow a small amount of money, usually $100 to $500, with the expectation that you’ll repay the amount in full on your next payday. Payday lenders typically don’t have minimum credit score requirements, though they require proof of income. You’ll pay a flat fee per $100 borrowed, and there are additional fees that can add up quickly if you can’t repay the loan by your payday.

Here's a quick breakdown of what the payday loan process looks like:

1. Apply with proof of income and a linked bank account.

2. Borrow a small amount, typically $100 to $500.

3. Agree to a flat fee per $100 borrowed.

4. Repay the full balance in one lump sum on your next payday.

5. If you can't repay on time, expect additional fees or rollover costs.

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What Do Payday Loans Cost?

Take a look at this overview on the average cost of a payday loan.

The Typical Payday Loan Fee

For payday loans, the exact amount varies, but the fee commonly falls in the $10 to $30 range. There's generally a flat fee for every $100 you borrow.

So if you need to borrow $300 and decide to go through a payday lender who charges $20 per every $100, you’d pay $360 total, assuming there aren’t any other fees.

Why Are Payday Loan APRs So High?

While $60 as seen in the example above may not seem like that steep of a price to borrow money when you're in a pinch, payday loans are known for having extremely high annual percentage rates (APRs). APR refers to the annual interest rate you'll pay to borrow money, including any extra fees that are rolled in, and the average payday loan has an APR of about 391%. 

Using the example above, a $60 fee amounts to 20% of the loan principal.

Here's how to calculate APR:

1. Multiply the number of days in a year by the number of 14-day periods in a year — two to four weeks is a typical term length.

2. That gets you 26.07, which you'd multiply by the APR of 20% to get 521.4% APR.

3. That's higher than the average payday loan APR, but definitely not out of the question for a rate a payday lender may charge.

Since borrowers ideally repay payday loans in a matter of weeks, not months, APR isn't necessarily the perfect way to frame the interest rate required. But annualized or not, payday loan interest is uncommonly steep. With personal loans repaid in monthly installments, by contrast, the typical APR ranges from 6% to 36% APR.

Why Paying in a Lump Sum Makes Payday Loans Risky

More than the high APRs, what makes payday loans especially risky is that you're expected to repay the total amount you owe as one lump. Not only that, but you also have to make repayment by your next payday, so within two weeks or less.

If you're borrowing money because your budget is tight and you need some extra cash to cover an emergency expense, you might not be in a position to repay the full amount in such a short period. This could be especially true if you have several bills that are due around the same time, leaving you with little to no cushion in your bank account.

And payday lenders are quick to pile on the fees if you need to push the repayment back: You’ll usually be charged a rollover fee equal to the original loan fee. So in our $300 loan example, rolling over the repayment would rack up another $60, bringing your total owed to $420. If you needed to roll over the repayment date again because you're not able to pay that entire balance in two weeks, that would be another $60. Some payday loan borrowers even end up taking out another payday loan to cover the payment of their first payday loan, trapping them in a slippery cycle of debt with very high fees.

What Happens If You Can't Repay Your Payday Loan?

Here's a look at some solutions if you somehow can't pay back your payday loan before the deadline.

Can You Roll Over or Renew a Payday Loan?

If you can't repay your payday loan when it's originally due, you may be able to roll it over, though this depends on the lender's terms and conditions. Rolling over a payday loan isn't cheap. Each time you roll it over, you're increasing the amount you pay in fees to borrow money. 

The number of times you can renew, or roll over, a payday loan depends on your particular state. Some states won't allow rollovers at all, while others might allow renewals, extensions or refinancing, instead of a rollover in the traditional sense.

Your lender may also offer an extended repayment plan so you can repay the loan over time. These plans might reduce the need to charge any additional fees as well, but can give you a bit more breathing room to repay your balance.

Can a Payday Lender Withdraw Money From Your Bank Account?

When you apply for a payday loan, the lender often requests that you link your bank account. This allows the lender to verify that you have a regular source of income, but it also enables the lender to automatically withdraw money from your account when your paycheck hits. Importantly, you have to give the lender authorization -- it can't be done without your permission.

If you give a payday loan company permission to take money from your account when the loan is due and you don’t have enough funds, you could be charged overdraft or non-sufficient funds fees by your bank. If you haven't given the lender a heads-up that you can't repay in time, it will likely make multiple withdrawal attempts, racking up those extra fees each time.

If You Don't Want a Payday Lender to Debit Money From Your Bank Account

You'll need to provide a post-dated check that they can cash, or you might be required to return to the lender in-person to make repayment. No matter what, the payday lender will want clear assurance that you'll repay the money, so if it turns out that you can't afford repayment by the original due date, you should contact them as soon as possible to discuss your options.

Can Payday Loans Go to Collections?

If you go long enough without repaying your loan, a payday lender can sell your debt to a third-party collections agency. This usually happens after repeated missed payments, though you'll definitely hear from the lender before the account does get sent to collections.

If your payday loan goes to collections, this will appear on your credit report as a negative mark. If you apply for other loans or lines of credit, lenders will see this and are usually hesitant to approve your application. Even if you repay the debt, this mark can stay on your credit report for as long as seven years from the original delinquency.

When Does a Payday Loan Make Sense — and When Is It Risky?

A payday loan could make sense if you have a one-time emergency where you need quick access to cash and you have an upcoming paycheck that you’ll be able to use to pay off the loan. 

It shouldn’t be the first option you consider, especially because you may be able to find cheaper ways to access funds or borrow money, and it’s only worth it if you’re confident you can repay the entire amount by your next payday. 

When a Payday Loan Doesn't Make Sense

If you have an ongoing income gap and are already struggling to pay existing bills, you might not be able to repay a payday loan in full within a few weeks. This is a good sign that you should steer clear of this option, since you’ll quickly rack up fees for renewing the loan.

Beyond the extra fees, if you need to take out an additional loan to pay off your existing one, you'll have to be cautious about your spending and ability to pay everything back. You don't want to fall into a cycle of debt from it.

Should You Get a Payday Loan? Ask Yourself These Questions

If you're considering a payday loan, ask yourself these four questions to decide if it makes sense in your situation:

• Do I have any other options for borrowing money?

• If not, can I reach out to a creditor or biller to negotiate a payment extension?

• Will I be able to pay the loan back by my next payday?

• Am I prepared to pay additional fees if I can’t repay the loan on time?

Alternatives That May Cost Less

Before deciding on a payday loan, it's worth exploring these other options.

• Installment loans: These are personal loans that you repay in monthly installments, rather than one lump sum. The smaller payment amounts can be much more workable on a tight budget.

• Earned wage access: Earned wage access products like MoneyLion Instacash^® aren't loans. Rather, they let you access a portion of your already-earned wages before your next payday. You'll pay 0% interest, but the repayment period is generally pretty short.^*

• Payment extensions: If you're considering a payday loan to cover rent or a bill, you could reach out to your landlord or creditor to see if they’re willing to work with you on a repayment plan. This option could end up being cheaper and less stressful than taking on a payday loan.

• Credit union small-dollar loans. Many credit unions offer payday alternative loans (PALs). Like payday loans, they’re short-term loans for small amounts, but their APR is capped much lower, at 28%.

What To Remember Before Taking Out a Payday Loan

A payday loan could make sense if you need quick access to cash, you don’t have other borrowing options and you’re confident you can repay the amount by your next payday. The biggest risk factor is the lump-sum repayment, so if there's any uncertainty about whether you can cover the entire amount by the due date, you’ll want to explore all your other options first.

The best thing you can do is know exactly what you're agreeing to before signing a payday loan agreement or making any borrowing decision.

FAQs

Do payday lenders check your credit?

Payday lenders usually don't check your credit, but they typically do require some income verification before they’ll approve your application.

Can payday loans affect your credit score?

Payday loans can affect your credit score if you don't make repayment and the lender decides to sell your debt to a collection agency. In that case, it would result in a negative mark on your credit report that can make it difficult for you to get approved for financial products for several years, even if you repay the debt.

How fast do you receive the money?

You can receive money from a payday loan as soon as the same day you apply, though you may have to pay a fee for an instant transfer.

Sources:

• Consumer Financial Protection Bureau (CFPB). 2024. "What is a payday loan?"

• CFPB. 2024. "What does it mean to renew or roll over a payday loan?"

• CFPB. "What can I do if I can’t repay my payday loan?"

• CFPB. "How can I stop a payday lender from electronically taking money out of my bank or credit union account?"

• CFPB. "How do I repay a payday loan?"

• CFPB. "Can a payday lender garnish my bank account or my wages if I don't repay the loan?"

• CFPB. What is a personal installment loan?"

• MyCreditUnion.gov. "Payday Alternative Loans."

• National Credit Union Administration (NCUA). "Permissible Loan Interest Rate Ceiling Extended."

• CFPB. "What do I need to qualify for a payday loan?"

• National Conference of State Legislatures. "Payday Lending State Statutes."