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What Is a Payday Loan and What Are Safer Alternatives?

Updated on:
Content was accurate at the time of publication.

Payday loans are small, short-term loans — typically no more than $500 — that many financial experts consider predatory due to their high interest rates and fees. These types of loans are typically marketed to those with little or bad credit, since they don’t require credit checks.

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A payday loan is a small, short-term loan that’s often due on your next payday, anywhere from two to four weeks.

These types of loans are typically $500 or less and high fees that equate to an annual percentage rate (APR) as high as 400%. By comparison, the APR on traditional personal loans is typically capped at 36%, which finance experts consider to be the maximum affordable rate.

Payday loans also usually have the following features:

  • Access to your checking account funds: Most payday loan companies require you to write a post-dated check or authorize them to debit your account, which allows them direct access to the money in your checking account.
  • Potential to roll over an outstanding balance: Depending on state laws, some payday lenders let borrowers “roll over” or renew their loan by paying an additional finance charge to extend the repayment period. However, this can lead you into a cycle of debt, repeatedly borrowing more money to cover debt payments.
  • Usually don’t require a credit check: This makes them accessible to bad-credit borrowers. However, payments won’t appear on your credit report, so it won’t help you build credit, either.

Payday loans don’t require credit checks. Applicants only need a bank account and the ability to verify their identity and income. Since payday lenders don’t check your credit, they’re taking a gamble on your promise to repay — as such, they charge high interest rates and fees to offset the risk in case you don’t.

Because of this, many financial experts warn against using payday loans since the combination of high rates and short repayment terms can trap consumers in cycles of debt. In many cases, consumers have to roll over their payday loan into another loan to repay the first.

When it comes to repayment, payday loans can be structured as installment loans or be repaid via a lump sum.

The cost of payday loans can vary by state and lender. For instance, some states set limits on how much consumers can borrow and how much lenders can charge in fees.

In many states, fees are charged as a flat rate, typically ranging from $10 to $30 for every $100 borrowed. According to the Consumer Financial Protection Bureau, it’s common for lenders to charge a $15 fee for every $100 dollar borrowed.

Most likely, you won’t see this fee upfront. Payday loan terms are typically presented as part of the APR, which includes both the interest rate and other fees. This is why payday loans can have APRs as high as 400%.

The total cost of a payday loan (including interest and fees) will depend on where you live. Some states limit the cost of these loans or require that they be repayable in installments.

The Pew Charitable Trusts analyzed lender data from states that permit payday lending to assess how well state laws protect payday loan borrowers. Here’s a look at the average cost to borrow $500 (or the maximum allowable amount) for four months in a few states; in this example, Colorado and Hawaii have laws safeguarding consumers, while Texas and Idaho do not.

StateAverage cost of interest and feesAverage APR

Source: The Pew Charitable Trusts

Payday lenders generally don’t report payments to the credit bureaus, so a payday loan is unlikely to improve your credit score.

However, if you don’t repay your loan, your payday lender could sell it to a debt collection agency. That agency could then report your unpaid debt to one or more of the credit bureaus and it would show up on your credit report. Since your credit score is calculated by the activity on your credit report, this could cause your credit score to go down.

Alternatively, if you don’t pay your debt, your payday lender could sue you for nonpayment. In that case, if you lose the lawsuit, it could also show up on your credit reports.

If you want to build your credit, consider a credit builder loan or take steps to improve your credit score by paying your bills on time and checking your credit report for errors.

If you’re considering a loan, only borrow what you’re sure you can repay. If you understand the risks and a payday loan is your only option, here’s how you can get one:

  1. Check payday loan laws in your state. Some states don’t allow payday loans at all, while others have strict rules governing these lenders. Use this summary of payday lending statutes from the National Conference of State Legislatures to understand your state’s laws.
  2. Verify that a lender is licensed in your state. If your state allows payday loans, check with the office of your state attorney general or your state banking regulator.
  3. Shop around. Don’t just borrow from whichever payday loan storefront is nearby — check with banks, credit unions and online lenders to see if they offer small-dollar loans. Compare APRs and lender fees, and do the math to see what the loan might eventually cost you if you don’t pay it back in a week or two.
  4. Select a payday lender. Depending on the lender you pick and your state of residence, you may be able to apply for a loan and receive instant loan approval online. Be sure to read the terms carefully and watch for potential late fees or rollover costs.

If you’re in a tough financial position, consider these other alternatives before taking out a payday loan.

  Payday alternative loan (PAL)

If you belong to a federally-insured credit union, see if they offer payday alternative loans (PALs). PALs can be challenging to find (not all federal credit unions offer them), but they’re designed to be a reasonable alternative to predatory loans.

There are two types — PAL I and PAL II — and they’re both unsecured, small-dollar loans. PALs offer repayment terms up to 12 months and a maximum 28% APR, which is far more reasonable than the rates and terms available with payday loans.

  Credit card

If you have a credit card, you may be able to request a cash advance. The process for getting a cash advance is easy: You’ll simply use your card at the bank or ATM to withdraw money.

Doing so can be expensive, though — cash advance APRs are much higher than purchase APRs, and it’s also likely your cash advance will come with a fee. In addition, unlike purchases made on a credit card, cash advances begin to accrue interest right away.

Alternatively, you could simply charge emergency purchases to your credit card. Just be sure to pay off the balance each month, as interest can accrue on any amount left over.

  Personal loan

If you’re looking for a lump sum of money to help with bills, personal loans offer financing with no more than 36% APR. Personal loans come with fixed APRs, which make your monthly payments predictable and easy to budget for.

When it comes to personal loans, you can apply for unsecured or secured loans. If you don’t have good credit, a secured loan — which requires collateral — may be more accessible than an unsecured loan. You can also apply for a personal loan with a cosigner if your credit history is thin or poor. Even if your credit score needs a lot of work, some lenders work with poor-credit borrowers to offer bad credit loans.

  401(k) loan

A 401(k) loan lets you borrow from your retirement savings. With this type of loan, you’re basically borrowing money from yourself, so it might be worth considering if you have bad credit and likely wouldn’t be able to access funds otherwise.

401(k) loans come with more flexible terms and lower interest rates than what you’ll find with a payday loan. You can usually take out up to 50% of your savings (up to $50,000) and you’ll have five years to pay the loan back.

However, there are some notable drawbacks. Your service provider may not allow for this type of loan, and you’ll need to pay taxes on what you ultimately repay. You may also have to pay application and maintenance fees.

Payday loans are legal in some states and illegal in others. In states that allow this type of lending, legislators may place legal safeguards on payday loans, such as setting a maximum fee amount or loan amount caps.

In general, it’s best to avoid predatory payday loans and their sky-high APRs. Many payday lenders require access to your bank account, which means they can make payment withdrawals even if it would overdraw your account. What’s more, high fees and short repayment terms can trap you in a cycle of debt.

If you can’t repay your payday loan, your lender could file a lawsuit against you or sell your debt to a third-party debt collection agency. In both cases, this activity could be reported to the credit bureaus and added to your credit report, causing your credit score to drop. Rather than rolling your payday loan over into another one, consider payday loan consolidation.