What Is a Payday Loan?

Written by Meri TorresReviewed by Nathan Brown, CFP®Updated: 11th Apr 2022
Share this article

Disclaimer: This post contains references to products from one or more of our advertisers. We may receive compensation (at no cost to you) when you click on links to those products. Read our Disclaimer Policy for more information.

For some people who live from paycheck to paycheck, especially those at the lower end of the scale when it comes to income, they really don’t have many options if they need money for emergency purposes or require money to cover essentials.

And, because their income is generally not enough to cover a lot of their expenses, they find themselves having to borrow money regularly.

If friends and family members cannot assist them, they usually just end up opting for payday loans.

Because they have nowhere else to turn to, these short-term loans seem like the most viable choice when money is required to meet an essential expense.

However, when it comes to repaying the loan, the interest rates and fees are very high. As such, before you decide to get a payday loan, it is important to know the risks associated with the loan and what your alternatives are.

What Is a Payday Loan?

Payday loans are short-term loans that people opt for when they want to cover instant cash needs. They typically have small loan amount limits of about $500 or less, but they carry huge fees.

They are called payday loans because borrowers are expected to repay the loan within one month by the next payday. Some payments are even due within just two weeks.

The loan is not secured, meaning that it is not backed by collateral or assets. These loans are also commonly referred to as cash advance loans, post-dated check loans, or check advance loans.

>> More: Best Bad Credit Loans

How Do Payday Loans Work?

Payday loans do not function in the same way that other loans such as personal loans work. They are available online, or you can get them by physically going to a payday lender branch.

To get the loan, all you have to do is fill out the application form online or at the payday lending office.

The general requirements for applying for a payday loan include a checking account, valid identification, proof of income, and you must be of adult age (18 years or older).

You can get a loan amount of between $50 and $1,000, depending on the law of your state. But most loan amounts do not go past $500.

The loan application can be approved instantly, and you will be given the money immediately; as cash or a check, or the lender can deposit it into your bank account, in which case it will reflect in your account within one to two days.

The annual percentage rate (APR) for a payday loan is between 391% and 521%, which is very high.

The borrower is expected to repay the loan together with the applicable interest and charges by the next paycheck (within 14 to 30 days).

How Is a Payday Loan Different from a Regular Loan?

A payday loan mainly differs from a regular loan in that it is a very short-term loan; it has to be repaid within a month.

On the other hand, you can repay a regular loan over a period of at least 2 years. The other notable difference is that payday loans have a much higher interest rate when compared with regular loans.

And the maximum amount you can borrow with a payday loan is typically $500 or less, whereas, with a traditional loan, the maximum amount is much higher; the amount can be as much as $100,000 or more.

Also, while a regular loan can take a couple of days to process, a payday loan can be approved instantly, and you will have the money instantly.

What Is a Direct Payday Loan?

A direct payday loanis meant to be a short-term finance option for people who require money on an urgent basis.

Together with interest and other fees, this borrowed money must be paid back when the borrower receives their next paycheck.

How Much Can I Borrow with a Payday Loan?

Although the amount you can borrow can range anywhere between $50 and $1,000, the average payday loan amount is $350, payable within two weeks. Ultimately, the maximum loan amount is usually about $500 or less.

What Are the Disadvantages of Payday Loans?

A payday loan can be very handy when you need cash fast. However, they are known for being very difficult to manage.

This is mainly due to the high-interest rates and fees. And, if you are someone who is living from paycheck to paycheck, chances are that you may find it difficult to pay back the debt in full and on time.

The following are a few of the disadvantages of getting a payday loan.

1. Costly Fees

Apart from the very high-interest rates, payday loans also have very high fees and charges. For instance, some lenders charge as much as $7 per day if you are past the due date.

2. High-Interest Rates

Although the interest rates generally differ based on the state in which you live in, the average interest rate for a payday loan is 400%.

That is extremely high considering that the interest charged on personal loans is usually between 4% and 36%, and credit card interest is between 12% and 30%.

3. Restricted Borrowing Limits

Payday loans generally have small amount limits, usually $500 and below. The amount of money you can borrow usually depends on where you reside.

Some states do not allow payday loans, meaning that some people do not have access to payday loans. This is largely because payday loans are predatory and do more harm than good.

4. Puts You in More Debt

Even though payday loans come in handy in emergency situations, they have a high APR, meaning that if you do not manage to repay the loan on time, you may find yourself in a bad cycle of debt.

Because you already have limited funds, when you get a payday loan, the chances that you may end up sinking further into debt are quite high.

The fact of the matter is that many people who opt for these loans struggle to pay off their debt on time, creating a cycle of debt.

Does Paying Back Payday Loans Build Credit?

Paying back payday loans does not build credit. The main reason is that lenders of these short-term loans do not normally report to the credit bureaus.

Although you may find certain types of payday loans in some states that allow individuals to work their way up to lower interest loans that report to credit bureaus and can be paid back in installments, these loan options are quite rare.

At the end of the day, payday loans can even hurt your credit if you struggle to repay the loan.

What Are the Requirements to Get a Payday Loan?

To get a payday loan, you have to be 18 years or older, and you must have a checking account, proof of income, as well as a valid identification document.

Additionally, requires will vary per lender and State, so read the fine print before you commit to a payday loan. And remember, you should avoid a payday loan at all cost.

Alternatives to Payday Loans

A payday loan should be your very last option, something you go for when you absolutely don’t have any other choice.

There are other options you can explore before resorting to applying for a payday loan, including:

1. Personal Loans

Instead of applying for a payday loan that comes with extremely high-interest rates, you can opt for a personal loan from a credit union or bank if you are in a pinch and you need money.

A personal loan is a cheaper option because it attracts interest rates between 10% and 28%. You can get a secured or an unsecured personal loan.

The secured loan requires collateral, while an unsecured personal loan does not require collateral.

2. Borrow Money from a Friend or Relative

You can avoid the risks normally associated with payday loans by borrowing money from a relative or friend.

However, if you decide to take that route, make sure that you agree in writing with the person you are borrowing from regarding the repayment plan and what the course of action will be in the event that you do not repay the borrowed money on time, or you fail to repay it completely.

Should you default in any way, the relative or friend that you will have borrowed from can act accordingly in terms of the written agreement.

3. Credit Cards

Although credit card use is not usually advised, if you really need to buy essentials such as food and other necessary living expenses, it is better to just use your credit card instead of getting a payday loan.

However, it is important that you do not make a habit of using credit cards every time you are in a fix.

4. Cash Advance

Another alternative to a payday loan is a credit card cash advance. It is in no way cheap, but it is a better option when compared to a payday loan.

Most lenders charge borrowers a percentage of the advance as a fee, which is normally 5%. On average, the APR on these advances is around 25%.

Frequently Asked Questions

Are Payday Loans Safe?

Safety is normally an issue when it comes to online payday loans. Although it may seem convenient to simply apply for a short-term loan in the comfort of your own home, it is important to be aware of the risks associated with online payday loans.

For instance, a lot of online payday lenders do not have a license. And it is usually these unlicensed lenders that give out illegal loans, which are often more expensive.

You can avoid falling victim to these lenders by ensuring that you do not share personal information before properly researching the lender.

What Are Payday Loans Good For?

There are several advantages that come with taking a payday loan. To start off, the application process is fast and simple.

All you have to do is to visit the lender’s website, fill out the application form, and in most cases, you will receive the money instantly.

And not much is needed to qualify for the loan; you just have to be 18 years or older, provide basic financial and personal information, and you can even get the loan with poor credit.

Who Should Use a Payday Loan?

A payday loan is the only option for someone who is in need of money urgently and has no alternative.

For instance, if you have poor credit, you may not be able to get a personal loan. And in such cases, a payday loan may be your only option.

Who Regulates Payday Loan Companies?

Payday loan companies are regulated by the Consumer Financial Protection Bureau (CFPB), the Federal Trade Commission (FTC), and State Governments. Payday lenders are highly regulated – as they should be – and are known to be predatory and offer unfair terms for consumers.

Bottom Line: What Is a Payday Loan?

A payday loan is a short-term loan that helps people cover immediate financial needs or unexpected emergencies. In other words, it is the ideal loan for emergency situations that require money fast.

The maximum amount you can get is typically $500. All that is required to get the loan is a valid identity document, proof of income, a bank account, and you must be 18 years or older.

Meri Torres
Meri Torres

Meri B Torres is a former SimpleMoneyLyfe Writer with several years of experience and a deep business background. Holding a bachelors degree and MBA from New York University, Meri loves helping consumers make simple financial decisions and understanding the complex world of finance. Her areas of expertise are personal loans and credit cards.