What Is a Payday Loan? How It Works & How To Get One

What is a payday loan?

Payday loans are short-term loans known for their sky-high interest rates that often leave the borrower paying back quite a bit more than their original loan amount. Much as the name suggests, payday loans are based on your average paycheck.

These loans are unsecured, which means you won’t have to put up any collateral to borrow money. Instead, you’ll agree to pay back your loan in a predetermined period of time, usually around 30 days, and then pay hefty fees if you fail to settle the loan by the deadline.

How do payday loans work?

Here’s how payday loans work:

1. You approach the lender and ask for a loan.
2. The lender will ask for some information, including your name, address and a government-issued ID card, plus copies of your most recent pay stubs.
3. You’ll receive a loan offer. This may be based on a percentage of your average paycheck or an arbitrary amount.
4. Next, you’ll need to read and sign off on the lending terms, which may include the loan origination fees (basically administrative fees) plus annual percentage yield (APY) or interest rate attached to the loan.

You should receive a payment schedule that shows what you owe and when. Payments can usually be made online by transferring money directly from your checking account to the lender. Some payday lenders may also offer the option to make payments in person.

How much money can you borrow with a payday loan?

According to the Consumer Financial Protection Bureau, you can typically borrow around $500 with a payday loan. However, limits can vary above or below this amount depending on several factors, such as how much money you make and what state you live in.

Before you apply, consider prequalifying for a loan to see what amount you may be eligible for and the terms you might receive. This process typically involves a soft credit check, which won’t impact your credit score, and can provide insight into whether a payday loan is a viable option for your financial needs.

How much do payday loans cost?

Payday loans can be quite pricey because they come with extra fees and very high interest rates on top of what you borrow. For example, some payday loans charge an annual percentage rate (APR) of 400%. Compare that to a typical credit card, which usually charges between 12% and 30% interest.

Say you take out a $500 payday loan that’s due for repayment on your next payday in two weeks. Based on a 400% APR, which is typical of the industry, you’d end up paying back around $622, which is the principal $500 plus $122 in interest.

Many lenders allow you to roll over or renew your payday loan. That would require paying the interest in full ($122 in our example) and then rolling the $500 to your next payday, where you’d owe the full interest amount again. With one loan rollover, you’d end up paying $744 in total, which is $244 more than the original $500 loan—nearly a 50% increase.

Understanding these costs is crucial for effective financial management. Explore our guide on calculating loan interest to learn more about how these costs are determined.

Payday loans vs. personal loans

Payday and personal loans are similar in that they can both get you out of a pinch if you’re low on funds and need some help making ends meet. But variations in how much you can borrow, interest rates, borrowing terms and repayment schedules ultimately make these two very different options.

Let’s explore how payday loans differ from personal loans.

• Amount: Payday lending involves moving around much smaller amounts of money compared to personal loans. With a payday loan, you might borrow around $500. With a personal loan, you could borrow thousands or even tens of thousands of dollars.
• Borrowing terms: Personal loans tend to have generous borrowing terms, giving you a year or longer to pay off what you borrow. Payday lending works on a much tighter schedule, and you’ll likely have to pay back what you borrow in mere weeks.
• Payment: Your bank, credit union or other lender will set repayment terms for your personal loan, but you usually pay a portion of your loan once per month using an online portal. Payday lenders usually expect full repayment of the entire loan plus interest on your next payday.
• Interest rates: The interest rates for payday-based loans are far higher than the rates attached to most personal loans. You may pay around 15% to 20% interest for a typical bank loan (lower if you have great credit) but up to 400% for a loan from a payday lender.

Do payday loans build credit?

Working with payday lenders will not help you build credit because these lenders do not report their loans to any of the three major credit bureaus. Unless your payments are recorded with those bureaus, you won’t get credit for paying on time or paying off the loans in their entirety.

How do I get a payday loan?

You can get a payday loan by visiting a local payday lender’s office or by applying for a loan online. You’ll need to provide a government-issued ID, copies of your pay stubs and some other key information as requested by the lender.

Loans are typically paid out immediately in cash.

Can you get a payday loan without a bank account?

You may find a payday lender that does not require a bank account, but it’s unlikely. Most lenders want to see a bank account as proof that you have money moving in and out regularly. If you find a lender that doesn’t require a bank account, watch out for even higher interest rates—the lender may be hoping you’ll default so you’ll be on the hook for major fees.

Can you get a payday loan without any credit history?

Lending companies that specialize in payday loans don’t care about your credit history. In fact, these loans are set up to cater to people with no or bad credit. They often skip the credit check during the application process, which can make it easier to secure a loan even if you have no credit history.

Risks of payday loans

These are some risks associated with payday loans:

• High interest rates: Charging interest rates that are 10 or even 20 times higher than personal loan interest rates means you’ll pay a pretty penny just for a two-week loan.
• Unreasonable expenses: Roll over your loan even once and you’ll double-up on interest. Do it more than once and expect sky-high bills.
• Cycle of debt: Some experts refer to payday loans as a debt trap. You take out a loan and manage to pay it off, but the high interest makes it even more difficult to make it to your next payday. So, you take out another loan, and the cycle continues.
• No opportunity to build credit: If you couldn’t take out a personal loan because of no or low credit, opting for a payday loan won’t help you get the credit score you need to get approved for better terms next time around.

What happens if you can’t repay your payday loan?

If you can’t pay your loan and find yourself unable to come to a new repayment agreement, your lender can take you to collections or even sue you to get their money back. If they score a favorable judgment in court, you could find your wages garnished, which means a portion of your paycheck will go directly to the lender to help pay off your debt.

Alternatives to payday loans

Here are some alternatives to payday loans that might help you get the money you need without the risk.

• Credit union loans: Credit unions offer some of the best bad credit loans and sometimes have more lenient requirements, making it easier to get a loan if you have low income or bad credit.
• Pawn loans: If you pawn something you own, you can get a portion of its value in cash. You then have a set amount of time to repay your loan plus interest and retrieve your item. Default and the item will be sold.
• Hardship loans: These loans are designed to assist those experiencing financial hardship. They typically have a quick approval process, and you can use them for almost anything, which makes them more flexible than other loan types.
• Cash advance apps: These apps provide small, short-term loans with less stringent requirements and can be repaid automatically on your next payday.
• Set up payment plans for your bills: If you owe medical debt or find yourself short for other bills, you can ask to set up a payment plan or even use equal pay to avoid being hit with huge electric or gas bills in summer and winter.
• Sell your stuff: Unload your collectibles, gently used clothes and spare jewelry in a consignment shop or online to generate enough cash to make ends meet.
• Side hustles: Instead of a loan, see if you can make some extra cash by walking dogs, delivering food or working for a grocery delivery company.