How Do Payday Loans Work?

If you’re in a financial bind and don’t have good credit, a payday loan may be tempting. But there are better options. Payday loans charge very high fees on small amounts and so have exorbitant APRs (in the triple digits). Plus, the typical two-week repayment term can make them difficult to pay off on time, which can lead to an ongoing cycle of increasingly-expensive debt. 

Still not convinced? We cover how payday loans work, why you should avoid them, and alternatives to get same-day cash — even with bad credit. 

What is a payday loan?

Payday loans are high-cost, same-day loans typically granted in amounts of $500 or less. You can use these loans for almost any purpose, similar to a personal loan. The lender typically will not check your credit, but will want to ensure you have a regular source of income before approving the loan. 

To repay the loan, you might provide the lender a postdated check (or other access to your account) that includes the original loan balance, plus interest or fees. If you haven't paid off the loan beforehand, the lender will cash your postdated check on the due date, which could result in overdraft fees if you don’t have the money available. 

The term “payday” comes from the fact that the loaned amount must often be repaid, with fees, by your next paycheck (typically two to four weeks later). Fees generally include $10 to $30 charged for every $100 borrowed, depending on your state. It's these fees combined with the short repayment term that makes payday loans so expensive and often difficult to pay back. You may be able to “roll over” a payday loan to delay repaying it — but that generally means adding another fee. If this process continues, it can lead to a damaging cycle of debt.

While many personal loans require good credit — a FICO score of 670 or higher — there are options if your FICO score is lower than 580. This includes reputable lenders that offer personal loans for bad credit borrowers as well as payday alternative loans (PALs) from credit unions.

Compare personal loans for bad credit

The cost of a payday loan vs. a personal loan

Unlike personal loans, payday loans don’t typically have a traditional interest rate — but they do charge fees. And those fees are often comparable to triple-digit APRs, up to 400% or more, according to a Pew study, depending on the state you live.

Personal loans from top lenders, on the other hand, typically offer APRs below 36%. The average APR on a two-year personal loan was 12.32%, according to the Federal Reserve. Those with poor credit are more likely to qualify for APRs on the higher end of the scale, but even then, the cost difference between personal and payday loans can be immense.

For example, if you were to take out a $500, two-week payday loan that charged $25 per $100, you’d pay $125 in fees for that short-term loan — or about a 652% APR (because it’s such a short repayment term). But if you were to take out a $500 personal loan with a 28% APR and a one-year term, you’d pay $79 in interest overall, and you’d have a lot more time to pay it back.

Payday loan regulations and consumer protection laws

Payday loans are widely recognized as being predatory, so many state regulations place limitations on these products — though they vary widely. For example, regulations in your state may limit how much you can borrow, the upper limit for rates and terms, and even if you can borrow payday loans at all.

Here are a few examples from the National Conference of State Legislatures to give you an idea of just how different these limitations can be, depending on where you live:

Payday loans are also banned in six states (Arizona, Arkansas, Georgia, Hawaii, New Mexico, and North Carolina) and the District of Columbia.

Alternatives to a payday loan

Here are a few options you might want to consider before taking out a payday loan:

• Unsecured personal loans: An unsecured loan doesn’t require collateral, and can be used for almost any purpose. Compared to payday loans, personal loans have lower interest rates and longer repayment terms. Plus, some lenders specialize in lending to borrowers with bad credit, and while you may have a higher rate, it won’t be nearly as high as on a payday loan.
• Secured personal loans: These are a type of personal loan that require you to use collateral, such as your house or car, to qualify, so they can be easier to access if you don’t have the best credit. And by repaying them consistently, you can even build your credit over time. However, you could end up losing your collateral if you stop making payments. So there is risk involved.
• Asking family and friends: If it’s possible, asking a family member or a friend for a loan can be a better option than a payday loan. But to avoid damaging that relationship, first set terms that are agreeable to both parties and lay out what happens if you aren’t able to make a payment.
• Payday alternative loans (PALs): These loans are provided by federal credit unions, and they cap fees at just $20 and interest rates at 28%. Amounts range from $200 to $2,000, and terms go from 1 to 12 months, so they can be more flexible and cheaper than payday loans. The catch is that you do have to be a member of the credit union to qualify.
• “Buy now, pay later” services (BNPL): These services offer the option to buy now and pay later, with common repayment terms of 3, 6, or 12 months. You may even be able to avoid paying interest if you make a payment every two weeks until the amount is paid off (typically 4 equal payments).
• Credit cards: A credit card is likely preferable to a payday loan, as the average interest rate is 21.86% as of August 2024, according to the Fed, compared to the triple-digit APRs on payday loans.
• Credit counseling: You can work with a nonprofit credit counseling organization to manage your finances and provide a debt management plan. The U.S. Department of Justice has a list of approved and reputable credit counseling services to consider, and you can also seek assistance from the National Foundation for Credit Counseling.
• Government assistance: You can visit USA.gov’s benefits portal to see if you may qualify for any assistance with your bills and other needs.

Check Out: How To Get Approved for a Personal Loan

Disclosure: Some lending partners that participate in Credible’s comparison marketplace offer loans to borrowers with scores as low as 550. Borrowers with low scores will have fewer lending options than borrowers with higher credit scores.