What is a payday loan?
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- Payday loans provide a quick influx of cash, but should be considered last resort options.
- You could pay interest rates that equate to 400% APR or more with payday loans.
- Alternatives include local nonprofits, churches, family members, and personal loans.
Payday loans are advertised as fast and helpful ways to get money to cover an unexpected expense. However, payday lenders can often use predatory practices to get borrowers to accept loan terms that severely damage their long-term financial health.
What is a payday loan?
A payday loan is a high-cost, short-term unsecured loan that has a principal that is a portion of your next paycheck. Payday loans are often for small amounts of money, commonly $500 or less. Payday loans provide immediate funds, come with extremely high interest rates, and are usually based on your income.
How do payday loans work?
Payday loans are usually paid back within two to four weeks, and you can get them at a brick-and-mortar payday lender or online. Lenders usually don't conduct a full credit check or take your ability to pay the loan back into account.
Different states have different laws when it comes to payday loans; some states ban payday loans entirely, while others cap the interest rates that lenders can charge.
You might be put in a position where you feel like you have to take out a high-interest loan to cover an expensive medical bill or rent check, but you should try to avoid payday loans if at all possible.
With exorbitantly high interest rates, payday loans can end up costing more than you initially borrowed and can trap you in a cycle of debt. Additionally, payday lenders often target low-income, minority communities and convince them to accept confusing loan terms.
Do payday loans build credit?
Generally speaking, consistent, reliable payments on payday loans don't help you build your credit. However, they can hurt your credit. If you default on your loan and your debt is sent to a debt collector, your debts in collection could damage your credit.
If you want to build your credit, a personal loan or a credit card is a better alternative. Lenders will report payments on those financial products to the major credit bureaus, and you'll see a steady improvement in your score over time if you keep up with your payments.
How to apply for a payday loan
- Compare lenders. Look at different payday lenders to see their offerings. Dig into the fine print of each offering to make sure you understand the repayment structure and any fees.
- Fill out an online or in-person application. Once you've decided on a lender, submit your relevant details, often including your bank account information and income.
- Wait for the lender to process your application. With payday lenders, this process is usually swift and you'll often get your money the same day.
- Receive your money and make a repayment plan. To ensure you don't fall behind on your payments, outline a detailed plan to pay your loan back before you sign on the dotted line.
What are the cons of a payday loan?
What are alternatives to payday loans?
Local nonprofits, churches, family members, online personal loans, and even some credit cards are better options for emergency cash than payday loans, said Graciela Aponte-Diaz, the director of federal campaigns at the Center for Responsible Lending.
"What we've seen in states that don't have payday loans is that there are various resources to help people during emergencies or hardship, but they are out marketed in states that have predatory lending," Aponte-Diaz said.
Before you're in a situation where you're staring down a payday loan, you might consider building an emergency fund to cover three to six months worth of living expenses if possible.
Payday loans vs. personal loans
Personal loans usually have longer repayment terms and lower rates than payday loans. However, they sometimes have higher loan minimums, which may mean you'd have to borrow more money than you'd want.
You can find personal loan alternatives to payday loans more with our lists of the best small personal loans and the best personal loans for bad credit.
Payday loans vs. cash advances
The major difference between a cash advance and a payday loan is that payday loans tend to have higher interest rates and fees than cash advances. Cash advances are often available through your credit card issuer or various apps.
Consider any alternatives you have to payday loans before deciding to get one, as they come with a lot of risk.
Payday loan FAQs
Are payday loans good or bad?
Compared to other borrowing alternatives, payday loans are a bad choice. They often have astronomical interest rates that can trap you in a cycle of debt.
What is a payday loan and is it a bad idea?
A payday loan is a high-cost, short-term unsecured loan that has a principal that is a portion of your next paycheck. Payday loans should be used as a last resort option to finance any of your expenses.
Are payday loans hard to pay?
Depending on your income and other financial obligations, payday loans can be hard to pay back. Payday loans often come with extremely high interest rates and rapid repayment timelines, which can create high amounts of strain on your budget.