How Do Payday Loans Work?

Payday loan process

Payday loans are short-term, high-interest loans of around $50 to $1,000. If you get a payday loan, the lender will often require you to write a postdated personal check or authorize an electronic funds transfer from your bank account for the total amount of the principal you borrowed, plus fees. So, if you got a $400 loan with a 15% fee, you’d owe the lender $460.

These loans often need to be fully repaid in two weeks to align with the receipt of your next paycheck, but the repayment term could go up to four weeks. You can pay the loan off early for the full amount owed, including the entire fee. If the loan’s not already repaid on the due date, your lender will cash your check or initiate a transfer from your bank account.

Payday loans are unsecured, meaning you’re not required to give your lender any collateral (like the title to your car) to get the loan. Also, there are little to no qualifications you need to meet to get it other than having a steady source of income.

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Payday loan rates and fees

With payday loans, you’ll often pay a fee of 10% to 30% of the amount you borrow, which may vary depending on the laws of the state where you live. These fees often equate to an APR of nearly 400% or more. The amount you borrowed will typically be due in two to four weeks.

For example, let’s say you got a payday loan of $500 with a 15% fee totaling $75 ($500 x 15% = $75). Assuming you’re required to repay the loan in two weeks, this fee is equal to an APR of 390%. While you can repay payday loans early, you still owe the entire fee, so doing so doesn’t save you any money, unlike many other consumer loans (most personal loans).

To put the cost of payday loans in perspective, the average rate on interest-bearing credit cards in February 2023 was about 21%, according to Federal Reserve data. However, you only owe interest on the amount you borrow on a credit card if you don’t fully repay the balance at your next billing cycle (credit cards are typically billed every 30 days). If you pay the balance in full by this date, you won’t incur any interest charges.

Even if you use a credit card cash advance, the fees are often much less than those charged for a payday loan. Although cash advance fees vary by the card issuer and type, 5% fees are common. So, let’s say you took a $500 cash advance from your credit card and repaid it in two weeks with no other fees or interest charges. This fee would equate to $25, or an APR of 130%.

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Where to get a payday loan

You can get payday loans from private lenders. These high-cost loans are not offered by banks or credit unions. Plus, many states restrict payday loans, so they’re not available everywhere.

It’s best to avoid payday loans, as they often carry incredibly high costs, making them difficult to pay off. However, if you get a payday loan, choose a reputable lender offering reasonable rates and terms.

Plus, it’s helpful to consider what other customers have to say in their reviews of the payday lenders they’ve used.

Payday loan requirements

Requirements may vary between lenders, but you generally need to have the following to obtain a payday loan:

• A valid Social Security number
• A steady and documented source of income
• A bank account in good standing
• A personal check
• A government-issued photo ID

Payday lenders are more interested in understanding when and how you’ll repay the funds you borrowed than anything else. Todd Christensen, an education manager with Money Fit by DRS, explained, “Unlike traditional loans, payday lenders do not check the borrower's credit history or rating.” As a result, it’s typically very easy and quick to get approved and funded.

Since these loans are so quick and easy to get, lenders charge “high fees to recoup the higher possibility of the borrower defaulting on the debt completely,” explained Christensen.

While it’s easy to get this type of loan, Christensen says, you’ll usually save money if you first turn to payday loan alternatives, such as asking friends and family for money, getting a loan from a credit union or even using a credit card cash advance.

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Paying back a payday loan

Payday loans are typically due in full two to four weeks after they’re given, usually on the customer’s next payday. Assuming you don’t repay the loan early or make other payment arrangements, your loan will be automatically repaid on the due date. On this date, your lender will deposit your check or initiate a transfer from your bank account.

Payday lenders require you to give a postdated check or authorize a bank transfer to ensure they’re repaid before other creditors.

To avoid this trap, Meade suggests building an emergency fund. “While this amount may differ from person to person, it should never dip below one month of expenses,” she noted. “The ideal amount is between three to six months of expenses — the lower end if you are a dual-income family or the higher end if you are single or have fluctuating income.”

Below are a few other important considerations related to paying back payday loans.

How to apply for a payday loan

Should you decide you need a payday loan, you can apply for one by submitting an application with a lender in person, on the phone or online. You’ll typically need to include personal information and details about your employment on the application. You’ll also need to specify how you’ll repay the loan (with a postdated check or by authorizing an electronic funds transfer).

Once you have all the required items for a payday loan, follow these steps:

• Visit a payday loan company in person, call the company, or log on to its website.
• Provide personal information and proof of employment.
• Write a personal check for the loan amount and fees, or provide digital account authorization.
• Take home cash or wait for a direct deposit.
• Repay the loan or apply for loan rollover.

» MORE: How to apply for a personal loan in 5 steps

FAQ

Bottom line

Payday loans are short-term, high-cost loans of $50 to $1,000 or less. These loans are usually repaid in no more than two to four weeks and can carry APRs of nearly 400% or more. They can be a quick funding source, since even those with bad credit can get them. Even so, they’re illegal in some states and are best avoided because they can be hard to repay.

If you can’t afford to repay the loan when it comes due, you might be tempted to renew or roll it over for another two to four weeks. Not only will you need to pay another fee to do this, but it can cause you to get caught in a debt trap that’s tricky to escape.

Before applying for a payday loan, carefully consider how you’ll repay it. If you can’t easily repay the loan, it’s best to avoid it and instead seek out a different source of funding.