What is a Payday Loan? Understanding the Basics

Strapped for cash and tempted by the promise of fast funds? Enter the world of payday loans, where money is often just a few clicks away. But before you dive in, it’s crucial to understand what you’re signing up for. 

Payday loans are short-term loans that may seem like a quick fix, but they can come with long-term consequences. This is everything you need to know about payday loans, how they work, and their alternatives.

Table of contents

• What is a payday loan?

• How do payday loans work?

• How much does a payday loan cost?

• How do payday loans affect credit?

• How to get a payday loan

• What happens if you can’t pay back a payday loan?

• Payday loans vs personal loans

• Alternatives to payday loans

What is a payday loan?

A payday loan is a short-term, high-interest loan typically used to cover emergency expenses until your next paycheck. Borrowers often take out small payday loans ranging from $100 to $1,000, with repayment terms as short as two weeks. 

Payday loans are often easy to qualify for, typically requiring only proof of income and a bank account. However, their convenience comes at a cost, as they typically carry exorbitant payday loan interest rates that can trap borrowers in a cycle of debt.

How do payday loans work?

Payday lenders provide quick cash, often without performing a traditional credit check. Here’s how they work step-by-step:

1. Payday loan qualifications: To qualify, you’ll usually need a steady income, an active bank account, and a government-issued ID. No credit check is required, which can make them fairly accessible.

2. Payment terms: Borrowers are expected to repay the loan in a lump sum, including fees, by their next payday.

3. Where to get payday loans: You can find payday loans online or through brick-and-mortar lenders offering same day payday loans. These options are marketed for their speed and ease.

While the process seems simple, the reality is that the high fees and short repayment terms can make it difficult to escape the debt trap.

How much does a payday loan cost?

Payday loans are notorious for their high costs. Lenders typically charge a flat fee of $10 to $30 for every $100 borrowed. While that might not sound like much, it translates to astronomical APRs.

Example: If you borrow $500 with a $75 fee and a repayment term of two weeks, your APR would exceed 390%. If you can’t pay on time and roll the loan over, the costs quickly add up.

How do payday loans affect credit?

Payday advance loans don’t typically require a credit check, and generally won’t show up on standard credit reports. However, there are two crucial points to consider:

• If you repay the loan on time, it won’t help improve your credit score

• Defaulting can result in the lender sending your account to collections, which negatively impacts your credit report and stays there for up to seven years.

How to get a payday loan

If you’re exploring how to get a payday loan, know that it may not even be a viable option in your area, as payday loans are banned in many states. Many states also forbid lenders from charging above a set APR amount. 

Before considering a payday loan

1. Explore all alternatives: Contact existing creditors about repayment plans on existing, seek assistance from nonprofit credit counseling services or investigate lower-interest options from credit unions and banks. 

2. Understand the costs: Payday loans often carry very high APRs that can trap borrowers in debt. Calculate the total repayment amount including all fees to fully understand what you’ll owe.

3. Verify lender legitimacy: Ensure any lender is licensed in your state and complies with state interest rate caps and lending laws. Be wary of online lenders that may not follow regulations.

If you decide to proceed with a payday loan

1. Gather required documents: You’ll need a government ID, proof of regular income, and an active bank account.

2. Review terms thoroughly: Pay special attention to the APR, all fees, repayment schedule, and consequences of late/missed payments. Understand whether the loan will auto-renew.

3. Have a repayment plan: Before signing, ensure you can repay the full amount when due from your next paycheck while still covering essential expenses.

What happens if you can’t pay back a payday loan?

Failing to repay a payday loan can have severe consequences:

• Additional fees: Late fees and rollover charges add to the loan amount.

• Collection actions: Lenders may send your account to collections or sue you in court.

• Bank account issues: If the lender has access to your account, they may overdraft it, leading to bank fees.

• Credit damage: Defaulting can harm your credit score and remain on your report for years.

Payday loans vs personal loans

While payday advance loans and personal loans might seem similar, they’re vastly different in cost, terms, and accessibility.

Payday loans

• Short-term loans with repayment often due in two weeks.

• Extremely high interest rates, with APRs that can reach 400% or more.

• Limited to small payday loan amounts, usually under $1,000.

• Easy to obtain, but carry significant financial risks.

• Can trap borrowers in a cycle of debt due to high fees and short repayment terms.

Personal loans

• Longer repayment terms, often ranging from 1 to 7 years.

• Require credit checks and a more thorough application process.

• Lower interest rates, especially for borrowers with good credit.

• Fixed monthly payments with a clear payoff date.

• Can be secured (requiring collateral) or unsecured.

• Loan amounts can range from $1,000 to $100,000.

• Can be used for a variety of needs, with more favorable terms for borrowers.

Looking for better loan options? Learn more about how personal loans work and the benefits of personal loans.

MoneyLion offers a service to help you find personal loan offers. Based on the information you provide, you can get matched with offers for up to $50,000 from our top providers. You can compare rates, terms, and fees from different lenders and choose the best offer for you.

Alternatives to payday loans

If you’re considering a payday loan, you might want to explore these other options first.

• Personal loans: Typically offer better terms and lower interest rates; however, you’ll need at least decent credit to qualify.

• Earned wage access: In general, these can be cheaper than payday loans, as they allow you to access a portion of your unpaid wages upfront.

• Cash advances: Cash advances on a credit card can be expensive, but they are an alternative to payday loans. Similarly, you may able be able to find 0% APR cash advances.

• Borrow from family or friends: This option might save you from high fees, just make sure to agree to a repayment plan.

• Non-profit community loan programs: Some organizations offer low interest payday loans to those in need.

• Side jobs or gig work for extra income: Platforms like Uber or TaskRabbit can help you earn quick cash.

• Use of savings or emergency funds: Tap into your savings to cover unexpected expenses.

Weighing the Costs and Alternatives

While payday loans provide fast cash, their high costs and short repayment terms make them a risky option. Understanding payday loan laws by state and exploring alternatives like personal loans or community programs can help you avoid financial pitfalls. 

Whether it’s a personal loan or cash advance, start by exploring MoneyLion’s tools first to help you make informed financial decisions without falling into the payday loan trap.

FAQs

Why are payday loans so much easier to qualify for than traditional bank loans?

Payday loans require minimal qualifications, such as proof of income, making them accessible to those with poor credit.

Is a payday loan secured or unsecured?

A payday loan is unsecured, meaning it doesn’t require collateral.

Are payday loans fixed or variable?

Payday loans typically have fixed terms and fees.

What is the difference between a title loan and a payday loan?

A title loan uses your vehicle as collateral, while a payday loan is unsecured and based on your income.