What Is a Payday Loan: Definition and How to Get One

A payday loan, sometimes known as a paycheck loan, is a type of cash advance loan. You borrow money and pay the lender back on your next payday, hence the name. However, the lender can charge exorbitant interest rates, sometimes up to 400%.¹ The National Association of Consumer Advocates consider payday loan lenders to be predatory and warn that getting a payday loan can keep you in a cycle of debt.²

Payday loans can help in an emergency, but can also create a heavy financial burden on the borrower. That’s why you may want to consider other ways to quickly borrow money if you need it.

Payday loans are available to anyone who can provide personal identification, income, and bank account information to the lender. Once the payday loan lender confirms your income and checking account information, they can – in some cases – deliver the cash to you as early as the same day.³

The lender will need your permission to withdraw money from your checking account electronically and will expect you to repay the loan right after your next payday.⁴ If you use an online lender, they will automatically run an electronic withdrawal. If you do not repay the loan in full by the agreed-upon date, the lender will charge a fee, and the cycle repeats with added interest.

While payday loans can be relatively easy to get, they come with considerable fees and unfavorable terms. If you aren’t able to pay back the loan by its due date, many lenders allow payday loans to roll over.⁵

Each time a loan is rolled over or a new one is taken out, the lender can charge more fees, creating a cycle of debt that can be difficult to break. Plus, payday lenders don’t usually report your payment activity to the major credit bureaus, which means it might not help you improve your credit.⁶

For these reasons, try to view payday loans as a last resort.

Is a payday loan secured or unsecured?

Most payday loans are unsecured loans, meaning you do not have to offer a form of collateral to take out the loan. The lender will get your written permission to have the money withdrawn from your checking account. Alternatively, the lender may ask you to write a check in the repayment amount, which they can cash once the loan is due.

Are payday loans legal?

Payday loans are a legitimate credit industry, but they’re only legal in certain places.

Certain states, including Arizona, Arkansas, Colorado, Connecticut, Georgia, Hawaii, Illinois, Maryland, Massachusetts, Montana, Minnesota, New Hampshire, New Jersey, New York, North Carolina, New Mexico, Nebraska, Pennsylvania, South Dakota, Vermont, West Virginia, and the District of Columbia, have prohibited payday loans.⁷

The interest rate on a payday loan is usually on the higher end of the spectrum for short-term loans. Because payday loans are predatory in nature, states that offer them usually cap lending amounts at no more than $500.⁸

Despite this, the APR (annual interest rate) on these loans can still range from 140% to 662% for states that still allow lenders to make payday loans of a few hundred dollars.⁹ For context, the average interest rate on a two-year personal loan has stayed below 12.5% for the past decade.¹⁰

Payday loans and bad credit

Simply taking out a payday loan does not affect your credit. Most payday loaners 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, your debt could be sent to collections, and the collection account could appear on your credit report and hurt your credit score.

Because payday loans have a short turnaround and high payments, there’s a higher likelihood of being unable to repay the loan amount. Not being able to make your payments on time can negatively affect your credit score and prevent you from securing another loan in the future.

In general, payday loans should be the last option. However, if you have no other options, here’s a step-by-step guide on how to get a payday loan:

• Analyze your alternatives. If you haven’t already looked into payday loan alternatives like personal loans or lines of credit, do so before applying for a payday loan. Payday loans are almost always riskier and more expensive than other options.
• Do thorough research on the payday lender. Some payday loan lenders are unethical and may impose abusive loan terms on borrowers. Research different lenders online, read customer reviews, and check if they’re licensed to operate in your state. Go for payday lenders who clearly disclose their terms and conditions, including fees and interest rates.
• Make sure you have all the documents you need. To apply for a payday loan, you’ll need to provide proof of income (like pay stubs), identification (like a driver’s license), and a bank account. Make sure you have all these documents ready to avoid any delays.
• Make a plan to pay back the loan. Before accepting a payday loan, calculate the total amount you’ll owe, including fees and interest, and how much of your upcoming income will need to go towards repaying the loan. Remember, defaulting on a payday loan could mean additional interest charges, damage to your credit score, and even legal action by the lender.

There are many ways to pay off your payday loan. Consider reaching out to your lender and asking about a repayment plan or taking out a new loan at a lower rate to pay off your payday loan debt. You can also get extra cash through a side hustle and put it towards paying off your loans.

If you have federal student loans on top of a payday loan, you can call your loan servicer and see if you can defer your loans or put them in forbearance. You can also consider an income-driven repayment plan, where your monthly payments are lowered to a small portion of your discretionary income. This way, you’ll have more money to allocate toward tackling your payday loan.

If none of these options work, debt settlement or bankruptcy may be the only way to break free of payday loan debt.

Remember, when you miss payments or stop making payments on a payday loan, lenders can turn the debt over to collections, which creates a negative entry on your credit file and could make it difficult to borrow money in the future. Lenders will report that you defaulted to the credit bureaus – which can harm your credit score – and they may even take you to court.

Here are five payday loan alternatives to keep in mind for when you’re short on cash.

1. Try a payday alternative loan

Some credit unions offer payday alternative loans, or PALs, which are loans designed to provide a lower-cost alternative to payday loans. With this option, you can borrow up to $1,000, and the loan term ranges from one to six months.¹¹ As long as you’re a member of the credit union for at least a month, you’re eligible to take out a PAL.

Payday alternative loans can still carry fairly high interest rates. Fortunately, PAL interest rates are capped at 28% by law, far better than what you typically see on a payday loan.¹²

2. Set up a payment plan with the company

If you’re having trouble making payments before you get a payday loan, see if you can set up a payment plan with the company you owe money to. It can be awkward to talk to the company, but this is a better alternative than missing a payment.

Ask if you can put a payment plan in place as a payday loan alternative. You may be able to pay a portion of the payment now and the rest later, or consider an installment plan.

The key is to take action and talk to your lenders about a payment plan to see what options are available.

3. Borrow money from family members or friends

This isn’t an option for everyone, but if you have trusted family or friends who can loan you money, consider borrowing from them. Will your parents loan you some money, interest-free? Do you have a close friend who can spot you?

If you go this route, be clear on the amount and the timeframe in which you’ll pay them back. Going this route can be tricky, and you don’t want to burn any bridges or ruin relationships with family or friends, so consider it carefully. But if it’s an option with no strings attached, this can help you avoid a payday lender.

 4. Take out a personal loan from a bank or credit union

If you have debts to pay back or need to cover your basic expenses, you don’t want to turn to a payday loan as your first option. But you might wonder, “Where can I get a loan that doesn’t have such high interest rates?”

You can consider taking out a personal loan from a bank or credit union. If you have good credit, oftentimes a bank or credit union will offer a much lower rate on a personal loan than a payday loan lender.

Can you get a personal loan with bad credit? It depends on the lender, but your approval odds might be diminished. And remember, though some personal loans may be easier to get due to their less stringent credit score requirements, they typically come with higher interest rates.

5. Use a line of credit

If you want to borrow money without taking out a loan, consider using a line of credit. Financial institutions may offer a line of credit you can draw upon when you need funds. A line of credit is different from a loan in that there’s a set amount available from which you can draw. You only pay interest once you borrow the money.

In addition to the options above, Chime members have multiple ways to try to avoid payday loans.

• Get Paid Early. Chime’s app gives eligible members faster access to their money. If you have a Chime account and set up direct deposit, you will be able to access your money up to two days earlier than traditional banks.¹³
• SpotMe. If you just need a little extra money to cover an expense, Chime also offers its own SpotMe for eligible members. Instead of charging an overdraft fee, Chime spots its members up to $200 fee-free.¹

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 above payday loan alternatives, you can find a different solution.

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