Payday Loans: Pros, Cons and Cautions

Payday loans
Erik MartinMay 2, 2022
Key Takeaways:
  • Payday loans are unsecured loans with very short terms.
  • Payday loans are some of the most expensive financing available.
  • You should consider payday loans a last resort for financing emergencies.

Need money fast? Don’t want to go through the hassle of applying for a typical loan and waiting for approval? A payday loan offers quick, convenient cash when you need it with few questions asked. But it comes with a serious catch.

Take the time to answer critical questions before getting a payday loan, such as how do payday loans work? Who is eligible for one? What interest rate will I be charged? And are there better options?

What are payday loans?

Loans come in many different types, sizes, and forms. If you seek to buy a home, you pursue a mortgage loan. You can obtain a home equity loan when you want to make home improvements. A new car can be financed via an auto loan. Higher education is typically funded via student loans. And a personal loan can be had when you need cash for virtually any reason.

One type of personal loan is called a payday loan. This is an unsecured loan, which means it does not require you to put up collateral, like a home, to secure the funding. A payday loan is typically a short-term but high-cost loan that often must be paid back by your next payday, usually in a single payment or when income is received from a different source such as Social Security or a pension.

The deadline date for repayment, indicated in the payday loan agreement, is commonly two to four weeks from the date the loan was created.

The funds provided by the lender come in the form of cash, check prepaid debit card, or electronic money deposited into your bank account.

What are the pros and cons of a payday loan?

Perhaps no loan option is as quick or dependable as a payday loan. That’s because it’s relatively simple to apply and qualify for this financing, and you usually get the money within 24 hours.

The biggest drawback to a payday loan is that this type of loan tacks on an exorbitant fee for the convenience of quick cash. The lender may charge, for example, a fee of $10 to $30 for every $100 you borrow. That equates to an annual percentage rate (APR) that can exceed 400%. Compare that to the APRs on many credit cards, which charge between 12% and 30%.

Say you borrow $500. That means you may have to pay back $650 total ($500, plus $30 for every $100 borrowed) within two to four weeks.

(Depending on your state’s laws, there may be a cap on how much the payday lender can charge for fees. Also, the federal Military Lending Act has special protections in place for active duty service members and their dependents that impose a ceiling of 36% on the Military Annual Percentage Rate a payday loan can charge these borrowers.)

Also, there is a ceiling on how much you can borrow via a payday loan. According to the Consumer Financial Protection Bureau, the usual loan limit is $500 or less (many states set a cap on payday loan sizes).

“Plus, payday loans also have significantly shorter repayment periods, so the default rate for payday loans tends to be much higher than for other lending options,” says Mila Garcia, co-founder of iPaydayLoans in Kirkland, Washington.

Another disadvantage associated with payday loans is that they may be difficult to find in your area. In fact, some states do not allow payday lending at all.

“Additionally, while a payday loan generally won’t hurt your credit, not paying it back will,” cautions Anthony Martin, CEO of Choice Mutual. “If you find yourself unable to pay back your payday loan, it can be sent to a collections agency, negatively affecting your credit score.”

How do you qualify for a payday loan?

As mentioned, you don’t need collateral to be eligible for a payday loan. And a payday lender typically does not consider your capacity to pay back the loan while meeting your other financial responsibilities. In other words, it’s relatively easy and quick to qualify for a payday loan. The lender may not even check your credit. The amount you are approved to borrow will depend on your anticipated short-term income.

“These loans can often be applied for online and are processed very quickly, with most payday lenders even open to accepting borrowers with low credit scores. All you need is a bank account and proof of income that verifies your ability to repay the loan in time,” says Garcia.

Esther Strauss, with Step By Step Business in Austin, Texas, says the application process is simple.

“Simply walk into a payday lender’s office, show your identification and a paystub, and you’ll probably get your money on the spot or by the next day. The same is true of online payday loans. You apply online, but the money will be electronically transferred to your bank account,” explains Strauss.

Who are good candidates for a payday loan?

Payday loans are ideal options for those in need of fast cash for minor emergencies, “like unexpected car repairs or urgent utility bills, as most credit lenders will be able to deposit these funds in your account within 24 hours after approval,” Garcia notes.

“They’re often targeted at people who live paycheck to paycheck and need $500 to $1,000 as soon as possible to cover their costs,” says Shawn Plummer, CEO of Atlanta-based The Annuity Expert.

How do you repay a payday loan?

To pay back a payday loan, you typically write the lender a post-dated check for the full balance – including any fees involved. Alternatively, you can permit the lender to electronically deduct the funds from your bank, prepaid card, or credit union account. This way, if you don’t repay the loan by the due date, the lender can cash your check or electronically debit the money from your account.

Payday loans are usually set up to be paid off in a single lump-sum payment. Some state laws allow lenders to renew or roll over a loan at its due date, letting the consumer merely pay the fees due while the due date for the remaining balance gets extended. Depending on the lender and the payday loan, the loan may be structured to be repaid over a longer period via installments.

What are better alternatives to payday loans?

There are less expensive options than a payday loan you can pursue.

“Many banks and credit unions now offer similar quick personal loan services for much smaller fees,” continues Plummer. “It’s better to turn to your trusted local credit union than walking into a payday lender and asking for this type of loan. Compare the interest rates, and you’ll typically find much better terms than what you get from a payday lender.”

Or, consider a traditional personal loan instead.

“Personal loans are generally easy to qualify for, charge less interest and fees, and offer an easier payback schedule than a payday loan,” recommends Martin.

Instead, consider a credit card cash advance, “which can be a better alternative to a payday loan. It still costs money, but much less money than a payday loan,” adds Strauss.

Most experts are in agreement about payday loans.

“In almost all cases, a payday loan should be avoided and other options sought,” Strauss advises. “Too many people get themselves into trouble, and their payday loans end up going to collections, which limits their ability to get better forms of credit in the future.”

Garcia agrees. “It’s often best to not pursue a payday loan unless you have exhausted all other options and are completely confident that you can afford to repay the full amount with interest on time,” she says.

Frequently Asked Questions
How do payday loans work?
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A payday loan is a short-term unsecured loan that doesn’t require collateral – only proof of income via pay stubs and a bank account. It typically must be paid back within two to four weeks with a steep fee or high interest attached, usually in a single payment. The lender’s funds come via check, prepaid debit card, or electronic money deposited into your bank account. To repay a payday loan, you usually write a post-dated check for the entire balance – including any fees involved. Or, you can allow the lender to electronically withdraw the funds from your bank, prepaid card, or credit union account. If you don’t repay the loan by the deadline, the lender can cash your check or electronically debit the money from your account.

What interest rates are charged for payday loans?
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Payday loans often incur a costly fee for the convenience of fast money. The lender may charge, for example, a fee up to $30 or more for each $100 you borrow. That equates to an annual percentage rate (APR) of 400% or more. Compare that to the APRs on many credit cards, which charge between 12% and 30%.

Who offers payday loans?
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Payday loan lenders are available in many states through small credit merchants with brick-and-mortar locations and on the Internet via online lenders. 

61 Comments

aalbert12 morrison, Apr, 2014
Awesome! Immense information there.
CClifford Porterfield, Mar, 2014
I live in Michigan, Did an online payday loan. Couldn't afford to repay it and still can't. They called me today threatening me with a charge of "Attempt to Defraud a Financial Institution." I have heard of that charge but my understanding of it was that one it only applied to federally chartered banks protected by the FDIC this was an online company. They said I had until 3pm today to come up with the full balance or they were putting this into court with that charge. They took my account information but I never issued them a check. In fact I never even had a book of checks to issue one from. The question is, can they actually come after me on that charge under Michigan law? Or is it just the garnishment, levy, and liens they can do?
BBill Admin, Mar, 2014
When it comes to crimes, only district attorneys and prosecutors can file charges. You, me, and your payday lender can walk into the local office of our district attorney or prosecutor and wave our arms around and say so-and-so committed a crime. But it's the exclusive domain of our district attorneys and prosecutors to bring criminal charges in court, even if a payday lender insists otherwise.

It is possible for a lender to file a civil lawsuit against you for breach of contract. Or, if the lender has proof (such as an admission from you) you never intended to repay the loan, then it might try to include an argument for civil fraud.

You mentioned Michigan. Read the Bills.com article Michigan Collection Laws to learn more about your state's rules and exemptions.
PPatricia Bailey, Mar, 2014
I have dealt with these collection companies very successfully when they have purchased the "loan" from the original lender. It is against the law to threaten you with those types of charges. Go to the Consumer Fair Credit Protection Act. There is a new federal agency that was created to protect you from these scoundrels. Record those calls. I won two lawsuits where they had to pay my attorney and paid me a small award for distress. Gather information - ask them to PROVE THEY OWN THE DEBT. MOST CAN NOT - THEY ARE NOT THE ORIGINAL LENDER. GOOD LUCK.
BBill Admin, Mar, 2014
Patty, thank you for your comment. If I may make a small clarification, the Fair Credit Reporting Act (FCRA) is a law that amended the Consumer Credit Protection Act.
ddebbie smith, Mar, 2014
I have a payday loan on a bankruptcy post petition, once I put it on the amended schedule the payday loan says suspended. I've asked this numerous times, even tried googling an answer, What is suspension of payday loan and can they eventually start taking money from my account again??
BBill Admin, Mar, 2014
Your bankruptcy lawyer is your best source of information about which accounts the court discharged. He or she will review the discharge documents issued by the court, and advise you accordingly.

If the court discharged the payday loan, then the payday lender violates state and perhaps federal law if it attempts to collect the debt. If the court denied your request to add the loan to your petition, then the loan is still collectible.
ddebbie smith, Feb, 2014
I filed bankruptcy and put a payday loan on it. it was a post petition so unsure if it will be discharged. I checked the site where payday loan was taken from and it states the loan was suspended. I am unsure what this means and what can happen. Can the pay day loan comp comes after me, Please explain the suspension etc. Thank you
PPeggy Puckett, Feb, 2014
I have a small loan from a Payday loan company. After quite a while with this company and never forfeiting on it, they now call me numerouse times a day at home & work, on the day payment is due, and if I have not made the payment by the next day, they are calling my references stating its in reference to a "Legal" matter. Please advise what I can do to stop this harrassment until the loan is paid off. Thanks.
BBill Admin, Feb, 2014
Original creditors are given wide leeway, when it comes to what they can do to collect a debt. They are not subject to the same rules that collection agents are, in most states. Collection agents' conduct is governed by the Fair Debt Collection Practices Act, a federal law.

Some states have their own, stricter debt collection laws. See if your state has a law that restricts the conduct of original creditors that would prevent what they are doing. While they may be allowed to call a third-party to get the contact information of a debtor, seeing they have your contact information, the repeated calls to your references seem shady. Consult with a lawyer in your state that handles Fair Debt Collection Practices Act violations. That kind of lawyer generally doesn't take a fee from you, but collects from the collection agent, if the lawyer can prove a violation has occurred.