Is a Payday Loan Secured or Unsecured? What That Means and How It Works

Payday loans can help you stretch your money in an emergency situation by letting you borrow against future income. Once you have a better understanding of how payday loans work and so you don't mistakenly make a challenging financial situation even worse.

Here's what you need to know about payday loans and how they work, including whether they are secured or unsecured.

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What Is a Secured Loan?

A secured loan is one that is backed, or secured, by a tangible asset. This asset could be a car, a home, a savings account, etc. Under the terms of a secured loan, the lender can seize this asset, called collateral, if you don’t pay the loan as agreed. Mortgages and auto loans are common examples of secured loans, as are home equity loans and title loans.

What Is an Unsecured Loan?

An unsecured loan is not backed by physical collateral. The lender assesses your ability to pay off the loan based on your income, assets, and previous history of timely payments. If you default on the loan, the lender can send your account to collections, but they can’t come after your property. Credit cards, personal loans, and payday loans are examples of unsecured loans.

The table below shows the differences between secured and unsecured loans.

Just because a loan is unsecured doesn’t mean there are no consequences to not paying it. Failure to make loan payments as agreed can lead to collections actions and damage to your credit.

Payday loans are unsecured, but the lender will ask for a postdated check or your authorization to withdraw funds from your bank account via ACH in order to pay the loan. If there is not enough money in your account to pay the loan when it’s due, you could be subject to collections action and increased fees and interest.

Why Are Payday Loans Considered Unsecured?

Payday loans are considered unsecured because they don't require physical property as collateral. Instead, lenders rely on your next paycheck and direct access to your bank account for repayment.

What Lenders Actually Require

While payday lenders don't require collateral, they want proof that their loan will be repaid. When applying for a payday loan, expect to provide:

• Proof of income

• Evidence of an active checking account

• Government ID

• Sometimes a postdated check or ACH authorization

Why “Unsecured” Doesn't Mean Low Risk

A payday loan is technically unsecured, but lenders take steps to be sure that they will get repaid. When you apply for a payday, loan you need to provide income and bank information so that the lender can withdraw the funds — the loan amount plus fees — on your next payday.

If you have other accounts set up for automatic withdrawal based on your pay schedule, make sure you will have enough in your account to cover these in addition to the payday loan withdrawal. Otherwise, either your bills or your payday loan won't get paid, and/or you could be subject to overdraft fees.

If there is not enough money in your account when your payday loan is due, the lender may roll it over for another pay period. They will charge you the same fee you agreed to when you took out the loan, doubling the amount you’re paying for the money. For example, if you get a payday loan for $500 and pay a $75 fee, the lender will attempt to withdraw $575 from your account on the next payday. If the money isn’t there, or you choose to roll it over, you’ll owe $650 on your next payday.

The ability to withdraw from your checking account, and to roll over the loan with additional fees if the withdrawal attempt is not successful, acts as functional security for the lender. This makes it similar, but not identical to collateral-based loans such as title loans, which use your vehicle as collateral.

The Risks of Unsecured Payday Loans That Borrowers Overlook

Unsecured payday loans can help in an emergency situation, but they are risky. Any borrower should understand these risks before signing for a payday loan.

High APRs and Short Repayment Windows

Payday loans have very high interest rates on an annualized basis. The fees may seem relatively small, but compared to other options, they’re very high. According to the Consumer Finance Protection Bureau (CFPB), fees range from $10 to $30 per $100 borrowed. The fee for a loan that charges $15 per $100 for a two-week loan equates to an annual percentage rate of nearly 400%.

These loans are very short-term, as they are due on your next pay period. Depending on how often you get paid, this can be two to four weeks.

When considering a payday loan, remember that a small loan principal does not equal a small cost.

How Payday Lenders Use Your Bank Account for Repayment

A payday lender will withdraw the loan amount plus fees from your bank account when the loan is due. There are risks associated with this process, especially if you have bills that you have set up on automatic payment. The ACH debit by the payday lender could reduce your bank balance such that there is not enough money to cover your other payments. This can result in overdraft fees, which further reduce your balance, creating a financial spiral that can be difficult to overcome.

Why It's Easy to Get Stuck in a Payday Loan Cycle

If you take out a payday loan and do not have enough money in your bank account to pay the loan when it is due, you may be able to roll over the loan to the next payday. This means you'll be charged another fee for the same loan, and this can quickly escalate.

Here's an example. Suppose you take out a payday loan for $300, and the lender charges a $45 fee. Your next payday rolls around, and you don’t have $345 to pay the loan, so you roll it over. Your loan balance is now $390. If you roll it over again, you’ll owe $435. One more rollover? Now you owe $480. It adds up quickly.

Alternatives to Payday Loans

There are alternatives to expensive payday loans. Here are some other things to try if you have a short-term cash crunch.

Small Personal Loans

If you qualify, you may be able to get a small personal loan to tide you over. You’ll need to pass a credit check, but you can make installment payments instead of having to pay it back all at once, and your interest rate is likely to be much lower. Personal loans are unsecured.

Earned Wage Access

Earned Wage Access is a program offered by some employers that allows employees to access some of the money they’ve earned prior to their normal payday. Employers use a service like Chime Workplace or DailyPay to provide pay on demand to employees, with a small per-transaction fee. EWA is unsecured, but, like a payday loan, reduces the amount of your subsequent paycheck.

Credit Card Cash Advance

If you have a credit card that has an available balance, you may be able to get a cash advance. You’ll pay a fee, and interest if you don’t pay it back before the next statement cycle, but you can spread the payments out if you need to. Your total costs will usually be far less than they would be with a payday loan. Credit card cash advances are unsecured.

Credit Union PALs

Some credit unions offer Payday Alternative Loans, which work like payday loans but with interest rates capped. PALs can be paid back over one to six months. You must be a member of the credit union for at least a month before you can apply. PALs, like payday loans, are unsecured.

FAQs

Can a payday lender take my car if I don't pay?

No. A payday loan is unsecured, so the lenders recourse if you don’t pay is to deduct from your bank account at a future date or send your account to collections.

Does a payday loan affect your credit score?

If your payday loan is repaid on time, it will probably not affect your credit score since most payday lenders don’t report to credit agencies. If you default on your loan and your account goes to collections, it will likely negatively affect your credit score.

What happens if you default on a payday loan?

The lender may roll over your loan, charging you an additional fee. If they still can't collect, they will send your account to a collection agency who will try to collect.

Are online payday loans unsecured too?

Yes. Online payday loans don’t require collateral.

Is a title loan better than a payday loan?

That depends on your situation. If you default on a title loan, the lender can repossess your vehicle, but a title loan may cost you less than a payday loan, and you may qualify for a larger loan amount.

Sources:

• CFPB. "Differentiating between secured and unsecured loan."

• CFPB. 2024. "What is a payday loan?"

• MyCreditUnion.gov. "Payday Alternative Loans."