What Are Payday Loans? Your Questions, Answered

what are payday loans

Most banks don't like risk. If you have less than average credit or income, strict lending rules can make it almost impossible to qualify for a personal loan.

In an emergency, you can turn to payday loans to cover short term expenses. What are payday loans and how are they different from other loan options?

Check out this guide to understanding how payday loans work.


What Are Payday Loans?

Payday loans are a short term solution to cash flow problems. These loans are intended to last you only a couple weeks until your next paycheck, hence the name payday loan.

One of the biggest reasons to choose a payday loan over other loan types is that it's easy to qualify and get cash. Many payday lenders fund your account the same day. 

If you choose to work with an online lender, you can get a loan 24 hours a day, 7 days a week. This gives you flexible options when responding to an emergency in the middle of the night.

Since you don't need collateral or high credit scored to qualify, most payday lenders just need a few basic details from you before issuing a loan. 

Payday loan amounts are usually much smaller than traditional loans and have interest rates in the triple digits. To understand why interest rates on payday loans are so high, you first have to understand how lenders make money.


What's a Good APR?

An APR is the amount of interest you pay daily on a loan. The higher the interest rate, the more money you'll repay the lender.

Most people aim for the lowest possible interest to keep loan payments low. Lenders make money when borrowers repay their loan debts plus interest over an extended period of time.

In 2018, Americans paid more than $104 billion in credit card interest alone. Payday lenders don't have the luxury of offering credit over the long term.

Since borrowers are expecting to repay the debt in just a matter of weeks, the interest rate is much higher than that of credit cards or loans from a bank.

The average interest rate is around 16 percent, but this rate applies to years of spending or borrowing money. Usually, the longer the loan term, the lower your interest rate.


Subprime Loans

A payday loan is a type of subprime loan. If your credit score is between 550 and 669, you're considered a subprime borrower.  Subprime loans are offered to borrowers who can't qualify for traditional loans because of this low credit rating.

These loans are a higher risk to lenders because a low credit score may be a sign of financial mismanagement. Because lenders are afraid you might not pay back the debt because of money problems, they are more likely to charge high fees and interest on the loan.

This makes payday loans more expensive than other types of debt. You'll need to understand how payday loan terms work in order to avoid repaying more in interest and fees than you can afford.


How to Repay a Payday Loan

It's a good idea to have a payment strategy in mind before getting a payday loan. Interest rates on loans can range from 390 to 780 percent. 

When you first get your loan, the lender asks for a personal check for the amount you borrow. The personal check includes any fees applied to the loan.

In exchange, you get instant access to cash. These online payday loans secure personal bank account information instead of a physical check.

The money is deposited into your account and you're expected to repay the debt from the same account. The lender keeps your information on file until your next payday when the entire amount plus fees and interest must be repaid. 

If you can't pay or choose not to pay, you can roll the loan over into your next pay period. Lenders might accept a partial payment, but it's not guaranteed.

If you do get the chance to make partial payments, you'll be expected to make payments on a routine schedule set forth by the lender. 


How to Get a Payday Loan

Not every state allows payday loans. There are 12 states that ban payday loans completely:


  • Arkansas
  • Arizona
  • Connecticut
  • Georgia
  • Maryland
  • Massachusetts
  • New Jersey
  • New York
  • Pennsylvania
  • North Carolina
  • Vermont
  • West Virginia

This means that even if you work with an online payday lender, you can't borrow money if you live in one of these states. Other states have laws that limit how much you can borrow and how interest rates are applied. 

Payday loans are often available through a physical branch you can visit to apply in person. This is the same location you'd visit to make and receive payments.

Other borrowers can apply online using their electronic banking information to set up a new account with a lender. Payday loans range from $100 to $1,000 depending on the limits set by the state. 


Is a Payday Loan Right for Me?

What are payday loans in the end? A payday loan is a short term way to fix small cash flow problems. 

If you've been having financial issues for a while, a payday loan can only worsen your situation. Payday loans are best for people who can repay the debt right away.

When the loan reaches a new payday loan term, the lender usually issues a new loan with new fees and interest to cover the old one. This means the debt can quickly snowball making it impossible to repay.

Make sure you are using payday loans for the right reasons to avoid adding to your financial woes. For more financial information and insights on payday loans, visit the Loans and Frugal Finances sections of our budget blog right now.