If you’re ever in a pinch and need money immediately but don’t qualify for a personal loan, you might think about taking out a payday loan. A payday loan is a short-term, small loan that you repay once you receive your next paycheck, typically two to four weeks after you take out the loan. Payday loans tend to have small loan limits, usually up to $500, and don’t require a credit check.
While they might be easy for many people to get, they can be costly and harmful to you long after you borrow. Here’s how payday loans work, how they impact your credit and alternative options.
How a Payday Loan Works
You can take out a payday loan online or at an in-person location if it’s available in your state. For many payday loan lenders, there’s no credit check involved. It’s enticing for borrowers who don’t have great credit—or any credit—and need cash fast.
Once you complete an application, you’ll write a postdated check for the amount you borrow, including fees and interest, guaranteeing the lender gets paid by your next payday. If you can’t afford to repay the loan by the due date, some lenders have an option to renew or rollover your plan to extend the due date, but this requirement will result in additional fees and interest.
Payday Loan Dangers
Payday loan lenders prey on the most vulnerable groups: those who are in dire need of funds but don’t have a good credit history to borrow from banks, credit unions and online lenders. Because lenders tout immediate funds into your account and no credit check, many borrowers who don’t need to borrow a lot of money look toward a payday loan.
But predatory lenders are everywhere, so much so that some states don’t permit payday loans. Most states regulate payday loans, including repayment terms, finance charges and the loan amount.
Even with regulations in place, interest rates can approach 400%. Conversely, personal loan interest rates can be as high as 36%, and that’s for borrowers with very low credit scores or limited credit histories.
A big danger with payday loans is the repayment period. Traditional personal loans, even those in small amounts, let you repay your loan over the course of a few months. Payday loans, on the other hand, require you to repay the loan anywhere from 14 to 31 days after you take it out. Many borrowers don’t have the funds to pay back the loan in this time frame and, in some cases, end up borrowing more to repay their loan, along with the extra finance charges.
Who a Payday Loan Is Right For
Payday loans are costly and can cause more harm than good. While it’s one way to get money in your hands until your next paycheck, the risks typically outweigh the benefits. We don’t recommend using payday loans. Instead, look toward alternative options, including personal loans, credit cards or even borrowing money from friends or family.
Payday Loan Costs
How much your loan costs depends on how much you’re borrowing, your interest rate, your lender and where you live. Here’s an example of the costs you may experience when you take out a payday loan.
In Iowa, you can borrow up to $500 through a payday loan, and you’ll get charged up to $15 for every $100 you borrow. If you borrow the full $500, that’s an extra $75, or $575 in total. But your annual percentage rate (APR), which is calculated daily, will be much more than that. For example, in Iowa, you can borrow a loan for up to 31 days. If you borrow for the full term, your true APR will be 176%.
To compare, personal loans usually cap their APRs at 36%. If you use a credit card to make a purchase, you’re likely to have an APR that’s less than 30%.
Payday Loan Borrowing Limits
Borrowing limits usually depend on where you live. Since some states don’t allow payday loans, you might not have the option to borrow money through one.
Most states cap their borrow limits at around $500, but limits vary. For example, Delaware caps its borrow amount at $1,000 while California sets a maximum limit of $300.
Repaying a Payday Loan
For many lenders, you set up a single loan repayment when you borrow the money. You’ll typically repay your loan through a postdated check, including the full amount you borrowed plus any fees and interest. However, you may also be able to pay online or through a direct debit from your bank account.
Your payment date will be between 14 and 31 days from when you borrow the loan, usually by your next payday. The loan is repaid in one payment, compared to personal loans, which have installment payments for a set number of months. Personal loan lenders look at your income to make sure you can afford what you borrow, making sure monthly payments fit into your budget.
How Payday Loans Can Affect Your Credit
Many payday loan lenders don’t run credit checks, so applying for a payday loan doesn’t impact your credit score or report. Even if you borrow the money and repay it all on time and in full, the positive payment doesn’t impact your credit, either.
But if you don’t pay your loan back in full and your payday loan lender hasn’t electronically withdrawn money from your account, you could be on the hook for the unpaid balance plus any outstanding finance charges. If you’re long overdue in payments, the lender could get a collection agency involved and the delinquent mark can go on your credit report.
Payday Loan Alternatives
Payday loans aren’t a good option in almost every circumstance. If you can, explore all your other options before taking out a payday loan, including:
- Personal loans. While many personal loan lenders only approve borrowers with at least fair or good credit, there are some lenders that tailor to borrowers with poor or subprime credit scores. Some credit unions have payday loan alternatives, letting borrowers take out loans up to $1,000, depending on the institution. Credit unions are not-for-profit and are more likely to work with borrowers who don’t have great credit.
- Credit cards. If you already have a credit card, consider using it to make a payment or purchase. APRs are lower compared to payday loans and since you already have one, you don’t have to qualify for one. Most cards also offer a cash advance—which allows you to withdraw cash from an ATM—but these transactions come with high APRs and additional fees. However, both options are cheaper than payday loans.
- Borrow money. If you don’t need to borrow much, ask friends or relatives to cover you until you can streamline expenses. Many times, borrowing money from loved ones means you have a little bit of flexibility when it comes to repaying your loan, and often without interest. If you choose this route, agree on terms and conditions that outline how to repay your loan and what happens if you can’t repay it.
In addition to these alternatives, review your financial situation carefully, including your required payments and monthly expenses, to see if you can free up some funds. For example, go over your budget and see if some not-so-dire expenses can wait. You might find you have enough spare cash to cover your needs until your next payday, allowing you to avoid the possible pitfalls that come with a payday loan.
