What Is a Payday Loan?

A payday loan is a small-dollar, high-cost loan taken out to cover immediate cash needs. You pay the whole loan back on your next payday.

Some refer to any high-interest rate loan with payday-aligned payments as a “payday loan.” However, if you pay the loan back in installments, it’s usually considered an installment loan.


What Are Payday Loans Used For?

Because of the high cost, payday loans are typically a “last resort” type of loan. Many people use them for urgent needs such as car repairs, late rent and utility bills.

How Does a Payday Loan Work?

Some payday loans are available online, but for some loans you can visit a store. The lender will ask you for some information, including name, address and social security number, and you’ll likely need to provide verification of employment, income and residence. If the lender approves you for a loan, you’ll receive payment via cash, check or direct deposit into your bank account.

Payday loans include a finance charge based on the loan amount. Because repayment terms are so short, the Annual Percentage Rate (“APR”) is typically high. However, APR isn’t the real measure of cost for a payday loan. You must repay the loan by the due date, usually within two weeks or by your next paycheck. Some lenders will have you give them a post-dated check for the full amount plus fee, while others might require you to bring cash into the store on or before the due date.


How Much Does a Payday Loan Cost?

A payday loan will usually charge either a fee or interest. Either way, the cost is typically between $15-$30 per $100 borrowed. There can also be fees related to rolling over the loan (see The Risk of Rollover Loans, below).


Why APR Isn’t a Good Measure for Payday Loans

Because payday loans are repaid quickly, using annual percentage rate (APR) to describe the cost of a payday loan is like a hotel quoting their room costs on a per year basis. That won’t help you if you only want a room for one night!

For example, if you borrow $100 with a $15 finance charge and repay it within nine days, the APR is 608%. But if you borrow the same amount with a $25 finance charge and repay it in 30 days, the APR is 304%. So loan amounts are the same, but the APR is drastically lower on the more expensive loan because the repayment term is longer.

Look closely at the total cost of the loan and when you will be repaying the loan rather than just the APR so that you can be sure of the true cost to borrow.

What are the Advantages of a Payday Loan?

  • Access: Qualifying for a payday loan is usually a quick process. Most payday loan providers verify income but are happy to work with customers who have a damaged or limited credit history.
  • Lower costs: Payday loan fees are often lower than other fees, but not always. If you’re borrowing to avoid other fees, such as late payment or overdraft penalties, make sure the cost of the loan is less than the costs you’re trying to steer clear of.
  • Flexibility: Payday loans can be more lenient than other bills. If you can’t repay your loan on payday, you have the option of rolling over the loan. But beware — rollover loans can be tricky. Read on to find out why.


The Risks of Rollover Loans

Payday loans have a bad rap, but aren’t inherently problematic. However, they are designed to be short-term solutions to short-term problems. Where many consumers run into trouble is with rollover loans. If you’re unable to repay your loan on the due date, the lender may offer to renew or roll over your loan into a new loan. Here’s what that means:

Let’s say you borrowed $100 with a $10 fee but can’t repay the total amount on payday. You can pay just the $10 fee and roll over the loan into a new loan with a new $10 fee. Essentially, the cost of borrowing just went from $10 to $20, and you still owe the original amount.

Renewing your loan might seem beneficial because it gives you more time to pay off the original loan, but you can probably see how the fees start to add up. The best way to manage a payday loan is to borrow only what you can comfortably pay back on your next payday and to repay it in full on the original due date. However, if that’s not an option, you should try to pay more than just the fee to avoid the rollover cycle.

Crafting a Repayment Strategy

Repaying a payday loan is pretty straightforward, but there are a couple of tips that can help you be successful:

  • Don’t borrow more than you need: If you’re approved for more than you need for your immediate emergency, it can be tempting to take the extra cash. But borrowing more than you need could make it hard to repay and lead to excess fees, so it’s best to avoid the temptation.
  • Pay more than just the fee: When it’s time to repay your loan, payday lenders usually offer two options: 1) repay the full amount borrowed plus the fee or 2) pay only the fee and keep the loan until your next payday. However, there is a third option:  pay as much as you can toward the loan balance and roll over the rest, which leaves you less to pay off on your next payday.

When Not to Use a Payday Loan

Payday loans can be helpful when you’re in a financial bind, but there are times they can do more harm than good. It might be a good idea to look for other options if:

  • Missed payments are a frequent issue.  Consider whether your financial situation will change in the next two weeks. Will you be able to repay on time? If you can't see it changing, you’ll run the risk of the rollover cycle.
  • The goal is to get collections off your back.  It’s stressful when a creditor keeps calling about a bill you can’t pay. But adding another loan to the mix could make things worse, not better.
  • The cost of the loan is more than the fee you’re trying to avoid.  If you have to pay a bill late, and the fee is less than the payday loan charge, it probably makes sense to take the late fee and catch up on the bill with your next paycheck. If you’re worried about your credit score, keep in mind that your FICO and VantageScore credit scores only consider accounts past due if they are at least 30 days past due.


Alternatives to a Payday Loan

  • Call your creditor.  Creditors can be reasonable if they see a chance to recoup at least some of their money. Let the creditor know you won’t be able to pay the full amount — they’ll often take that as a good faith effort on your part and may be able to negotiate a payment plan you can afford.
  • Ask for help.  A friend or family member may be able to help out in a pinch, potentially for lower (or no) interest.
  • Miss a payment: Being two weeks late on a bill might be a better option than taking out a loan in order to pay on time. You’ll likely incur a small late fee, but it could be a less costly solution in the long run.
  • Check with your Credit Union: Some credit unions offer Payday Alternative Loans (PAL) to their members.  They are similar to payday loans but typically cost less and have better repayment options.

A credit card cash advance, line of credit, or small-dollar installment loan can also be good alternatives if they’re available to you.

Do Payday Loans Affect Your Credit Score?

Payday loan lenders don’t always report their loans to traditional credit bureaus, which means paying off the loan won’t help your credit score. But, if you don’t pay back the loan, it will likely be sold to a collection agency, at which point it could show up on your credit report and most likely hurt your credit score.


What Happens If Your Loan Goes to Collections?

If you don’t repay your loan, the lender may sell your debt to a third-party collections company. Collections companies vary significantly in terms of how they’ll treat you. Some will call once a month until you pay off the debt, while others may call weekly or even daily. It might be annoying, but it is within their rights to do so. 

However, it’s illegal for a collections company to threaten you with jail time for not paying a loan. Call the Federal Trade Commission (FTC) to report any agency harassing you in that way.


State Regulations

Almost all payday lenders are state-regulated entities, so state laws will determine whether you have access to payday loans. In 50 states, there are 50 variations of lending laws.

  • Some state laws require payday loans to be obtained at a store rather than online. However, some states do allow online payday loans.
  • Some states have different laws around how much you can borrow and how much the lender can charge in interest and fees.
  • Some states effectively prohibit payday loans altogether, and many do so with an APR cap of 36%.

Getting a Payday Loan Online

Some states allow consumers to get payday loans online, so be aware of a few online specifics:

  • Tribal Lenders: Tribal lenders may offer payday loans or high-interest installment loans. They can be an option for consumers in states that prohibit payday loans. Tribal lenders operate under the licensing laws of the tribe that offers it rather than state laws, and the federal government looks at it much as they would a tribal casino.
  • Lead Aggregators:  Lead aggregators are online advertisers that often look like lenders, but they’re not. They may lure you in with a loan offer at a 30% interest rate, then sell your information to an actual lender who charges far more. In addition to the hassle of dealing with an intermediary, having your information sold may land you on several marketing lists.

How do you know what type of website you’re visiting? Check the fine print at the bottom of the page. You should see a disclosure that tells you exactly what type of business you are dealing with, whether it’s a lender licensed by your state, a Native American tribe, an advertiser (lead aggregator), or anything else.  If you don’t see any disclosures, you should consider looking somewhere else.


Bottom Line

With high APR and the potential to get caught in a rollover cycle, payday loans have gotten a bad rap. But payday loans can be helpful in certain situations, and the cost is often not as outrageous as the APR suggests, as long as the loan is repaid on time. If you understand the fees and feel confident about your ability to repay the loan — without getting into a rollover cycle — a payday loan can be just the financial tool you need in a pinch.