What Is a Payday Loan?

A payday loan is a short-term, high-cost loan – typically $500 or less – that’s usually due on your next payday. Lenders can charge very high interest rates and fees on payday loans, often as much as 400%.

Payday loans can help in an emergency and usually don’t require a credit check, but they can also create a heavy financial burden on the borrower. In fact, the Consumer Financial Protection Bureau (CFPB) warns that taking out a payday loan can lead to a long-term debt trap.

That’s why you may want to consider other ways to quickly borrow money if you need it.

Payday loans often offer quick cash when you’re in a tight spot, though the risks may outweigh the benefits. Here’s how they usually work:

1. You apply with a payday lender in person or online, providing your ID, proof of income, and bank account information.
2. The lender approves the loan and either deposits cash into your account or gives you the cash directly.
3. You give the lender permission to withdraw the loan amount, plus any fees, from your checking account on your next payday.
4. If you can’t repay the loan in full, the loan may “roll over,” adding new fees and increasing your debt. Alternatively, the lender may keep trying to withdraw from your account, which could trigger overdraft fees. The loan could also go into collections, which would damage your credit.

Payday loans don’t require upfront money or collateral. However, the interest rates are extremely high – ranging from 140% to 662% APR in states that allow them. For example, the CFPB notes that a typical two-week payday loan with a $15 per $100 fee equates to an APR of almost 400%.

The average interest rate on a two-year personal loan, by comparison, has stayed below 12.5% for the past decade. The high interest rates and fees of payday loans can trap you in debt.

Payday loans might seem like a quick fix, but they often create more problems than they solve. Here are the main risks you should know about:

• The debt cycle trap: Payday loans have relatively short terms, with a due date typically two to four weeks from when the loan is made. If you can’t pay back your loan, it might roll over into a new loan that charges additional fees and interest.
• Overdraft fees: Lenders withdraw payment from your account automatically. If the money isn’t there, you could face overdraft fees on top of loan fees. Overdraft fees may cost $35 per transaction, depending on your bank.
• Credit damage: If you can’t pay and the debt goes to collections, that mark stays on your credit report for seven years.

Predatory practices: Some lenders don’t disclose fees clearly or pressure you to borrow more than you need.

You should consider payday loans only as a last resort. If you have no other options, here’s a step-by-step guide:

• Really research the payday lender. Some payday loan lenders may impose extreme loan terms on borrowers. Research different lenders online, read customer reviews, and confirm they’re licensed to operate in your state.
• Collect your documents. To apply for a payday loan, you’ll need to provide proof of income, such as pay stubs, along with identification like a driver’s license and your bank account information.
• Make a plan to pay back the loan. Before accepting a payday loan, calculate the total amount you’ll owe, including fees and interest.

Before getting a payday loan, consider asking trusted family or friends for a short-term loan. Be clear on the amount and repayment timeframe. This can help you avoid high fees, but make sure it won’t strain your relationships.

Taking out a payday loan alone does not affect your credit. Most payday lenders don’t look at your credit score before giving you a loan, nor do they report your positive payment history to the three national credit bureaus – Equifax, Experian, and TransUnion.

However, if you don’t pay back the payday loan, the lender could send your debt to collections, and a collection account could hurt your credit score.

Payday loans have a short turnaround and high payments, increasing the chances that you’ll be unable to repay the loan amount. Not being able to make your payments on time negatively affects your credit score.

There are safer, more affordable alternatives to help you cover costs, including cash advance services like Chime’s MyPay®:

1. Chime’s alternatives

Chime members have options when they need access to cash:

• MyPay: MyPay lets eligible Chime members access up to $500 of their pay before payday with no mandatory fees, no interest, and no credit checks.1
• SpotMe®: SpotMe lets eligible Chime members overdraft up to $200 on debit card purchases without fees.2
• Get Paid Early: Eligible members with direct deposit can access their money up to two days earlier than traditional banks.

Learn more about the differences between MyPay, SpotMe, and Get Paid Early.

2. Try a payday alternative loan

Some credit unions offer Payday Alternative Loans, or PALs, which provide a lower-cost alternative to payday loans. You can borrow up to $2,000 with repayment terms of one to 12 months.

PAL interest rates are capped at 28% APR. You’ll need to be a credit union member for at least one month to qualify.

3. Take out a personal loan

If you’re in need of a larger loan, personal loans from banks or credit unions could be a better option. Personal loans generally offer these benefits:

• Lower interest rates than payday loans, often no more than 36%
• Longer repayment terms
• Fixed monthly payments, making it easier to budget
• Potential to improve your credit score if you make on-time payment

Note: If you have a poor credit score, consider applying for a personal loan with a credit union or an online lender who may be more lenient than traditional banks. You may also have the option of applying with a co-borrower to improve your chances of approval.

4. Use a line of credit

A line of credit is a flexible borrowing option allowing you to access funds as needed, up to a set limit. You only pay interest on the amount you borrow.

Many banks and credit unions offer personal lines of credit, which can cover unexpected expenses without the high fees associated with payday loans.

If you’re in debt and wondering how you’re going to pay your bills, opting for a payday loan may seem helpful. But there are better choices to consider first using the alternatives above.

Once you’re looking ahead, start building up your emergency fund. This way, you can handle future unexpected expenses without borrowing money.

To better understand the differences between these borrowing options, read our guide on personal loans vs. payday loans.