What Is a Payday Loan?

How do payday loans work?

Payday loans work a little differently than other types of personal or consumer loans. Depending on the lender and where you live, you may be able to obtain a payday loan either online or at a brick-and-mortar institution. You should be aware that payday lending is illegal in many states, which we'll talk about more in a minute.

When you request a payday loan, the lender confirms your income with a pay stub and gathers your checking account information. If you're approved, the lender will provide your loan by cash, check or as a direct deposit.

If you get a payday loan at a physical location, the lender will disburse the cash, and you must leave a postdated check for the loan amount, plus interest. This check is payable on or around your next payday. If you apply for the loan online, the lender deposits the funds electronically and obtains permission to automatically debit your bank, credit union or prepaid card account.

You will be charged a fee if you can't repay the loan by your next payday, and then the cycle repeats. If you aren't able to repay the loan, you have to tell your lender so the lender can renew it. If you don’t, the lender can simply deposit the postdated check, exposing you to possible returned check fees due to insufficient funds.

How do I get a payday loan?

If payday loans are legal in your state (more on that below), you will find no shortage of options. Brick-and-mortar stores aren’t hard to come by, but several online alternatives are also available. You need proof of income and an active checking account to qualify for a payday loan, and you have to be at least 18 years old.

Do payday loans have additional costs?

Payday loans come with interest and extra fees: For every $100 you borrow, fees tend to range from $10 to $30. Typically, a two-week loan comes with fees of $15 per $100 borrowed.

While this may seem like a small amount, that's a 400% annual percentage rate (APR) for a two-week loan, or a daily interest cost of $1.07.

Are payday loans illegal?

Payday loans are considered predatory and are illegal in 21 states and Washington, D.C., as of 2024. According to the nonprofit Consumer Federation of America, payday lending is banned in the following states, either outright or due to rate caps:

• Arizona
• Arkansas
• Colorado
• Connecticut
• Washington, D.C.
• Georgia
• Hawaii
• Illinois
• Maryland
• Massachusetts
• Minnesota
• Montana
• Nebraska
• New Hampshire
• New Jersey
• New Mexico
• New York
• North Carolina
• Pennsylvania
• South Dakota
• Vermont
• West Virginia

In New York, where all payday loans are illegal, the state Department of Financial Services has described the product as being designed to trap borrowers in debt. The state has also banned the collection of payday loan debt.

Efforts to regulate payday loans started in 2017 when the Consumer Financial Protection Bureau introduced rules to protect consumers from “payday debt traps.” As of 2022, payday lenders are no longer allowed to collect payments from borrowers' bank accounts in a manner that leads to excessive fees, among other restrictions.

The Federal Trade Commission, or FTC, has also implemented several laws to protect consumers from predatory lending practices. The agency found that payday lenders have engaged in deceptive advertising and billing practices as well as abusive collection practices.

Alternatives to payday loans

As mentioned above, you shouldn't take out payday loans lightly. They are very risky, and you can quickly double or triple your debt. You should only use payday loans as an absolute last resort when you have no other option.

Before going the payday loan route, consider the following:

Payday alternative loans: These loans are available through credit unions and are similar to payday loans in the loan amount you can be approved for. However, they have a different fee structure and, most importantly, a longer term. While still a short-term loan, payday alternative loans allow up to six months to repay the funds. You must have been a credit union member for at least a month to qualify, though not all credit unions offer this alternative.

Payment plans: If one of the reasons for your financial hardship is existing debt, consider asking your creditors for a payment plan before going into more debt with a payday loan. Many creditors would rather work with their borrowers than go through the process of internal collections and/or selling the debt to a collection agency. This isn’t to say that all creditors will work to help you, but you should check before applying for a payday loan.

Financial counseling: Working with a credit counselor is a safe, low-cost way (or even free) to manage debt. Several nonprofit credit counseling agencies can negotiate your debt, often getting better interest rates or lower repayments. Counseling agencies could also provide you with basic personal finance tools to help set you up for success.

Friends and family: While it may be difficult, asking your family and friends for help during a time of financial need is still a better alternative to a payday loan.

Summary for guide on payday loans

If you've explored all other options and are still considering payday loans, be sure to do your due diligence. You should make sure you're aware of the excessive fees and interest rates associated with payday loans, and you should always make sure you're able to repay the loan plus interest. If you aren't certain you can meet the obligations of a payday loan, it probably is not the right financial decision for you