How do payday loans work?

Payday loans offer quick relief from financial strain, but they come with a lot of expenses and some risks

Our goal here at Credible Operations, Inc., NMLS Number 1681276, referred to as "Credible" below, is to give you the tools and confidence you need to improve your finances. Although we do promote products from our partner lenders who compensate us for our services, all opinions are our own.

Payday loans may seem like a good option if you need money in between paychecks, but they come with high fees and can be difficult to repay.  (Shutterstock)

Payday loans, sometimes referred to as cash advance loans, are small loans offered through private companies. Borrowers repay these short-term loans with their next paycheck. 

Payday loans are often attractive to borrowers with lower credit scores or who need emergency cash quickly because many payday lenders have low qualifying standards and don’t run a credit check. You should know that payday loans may be considered a form of predatory lending because they often have very high interest rates and a lot of fees. These costs can make payday loans difficult to repay and trap you in a cycle of debt. 

A personal loan for bad credit is a better alternative to a payday loan. Credible makes it easy to see your prequalified personal loan rates from various lenders, all in one place.

How do payday loans work?

When you take out a payday loan, you agree to a short repayment period — typically around two weeks. You may need to write a personal check for the amount you’re borrowing, plus the company’s finance charge. You’ll also sign an agreement allowing the lender to cash the check on a set date. Alternatively, you can repay the loan with cash or pay an additional finance charge to roll the debt over to another week. 

Some payday lenders allow you to have multiple loans and repayments at once. 

In most states, payday loans are available online or at brick-and-mortar locations. Payday loans are illegal in the following states and districts:

  • Arizona
  • Arkansas
  • District of Columbia
  • Georgia
  • New Mexico
  • North Carolina

Other states have guidelines that dictate the maximum amount of a payday loan and the minimum repayment terms. Some states have no policies or payday loan regulations. For more information about payday loan regulations where you live, contact your state attorney general’s office

How much does a payday loan cost?

The cost of a payday loan varies based on a number of factors, such as the payday loan company’s rates, fees, and state laws. Some states have a cap on the maximum amount of fees a payday loan company can charge. These fees typically range from $10 to $30 for every $100 you borrow. A fee of $15 per every $100 borrowed equates to an annual percentage rate of nearly 400%, according to the Consumer Financial Protection Bureau (CFPB). 

Payday lending is more expensive than personal loans, or even credit cards. The average credit card APR was 16.17% as of February 2022, while a 24-month personal loan had an average APR of 9.41%, according to Federal Reserve data

Payday loans can be problematic for people with little income because it’s easy to accrue additional debt. If you don’t pay off your original amount, you’re charged interest and a loan fee to renew the debt. You can easily double or triple the amount you have to repay over several months, which can add up to more than the original amount you borrowed. 


Does repaying a payday loan build credit?

No. Payday loans won’t help you build credit because they don’t operate the same way as a traditional personal loan or credit card. Most payday loan companies won’t report your on-time payments to the credit-reporting bureaus, so those payments won’t raise your score. 

Additionally, many payday loan companies won’t run a credit check when you apply, so they won’t have access to report your score. However, if you don’t make your payments or make a payment late, they can send your bill to collections, which will hurt your credit score. 

Alternatives to payday loans

Payday loans are expensive, and they don’t help you build credit, so you should only consider them as a last resort. If you need money to cover unexpected expenses, here are some better options to consider. 

Personal loans

Personal loans are a practical option for borrowers with excellent credit and borrowers with bad credit equally. While you may pay a higher interest rate if your score is less than stellar, the cost won’t be nearly as high as what you’ll pay with a payday loan. You can typically land rates that are significantly lower than a payday loan. 

Personal loans can provide funds for an emergency or help you consolidate high-interest debt into a single monthly payment. You can apply for personal loans from your computer or phone, and most lenders will deposit the funds directly into your bank account within a few days. If your score is shaky, you may be able to add a cosigner who has good credit, or apply for a secured loan. 

With Credible, you can quickly and easily compare personal loan rates from multiple lenders, and it won’t affect your credit.

Ask your bank or credit union for a small loan

Some banks and credit unions offer small loans to current customers, even if their credit is less than perfect. The upside is that you’re staying with a company you already know (and hopefully trust). Working with your current bank or credit union also means that funds could be deposited into your account much faster than with a different lender. 

Credit unions and banks may have lower (or no) fees and offer benefits like reduced interest rates if you sign up for automatic payments. One downside is that some banks and credit unions require you to have good to excellent credit to qualify for a loan. 


Borrow from family or friends

Borrowing money from family or friends can be tricky. When you owe money to someone you care about, it can strain your relationship. You should only borrow money from someone if you can pay them back quickly. 

On the plus side, your family and friends won’t check your credit, so your score won’t be affected. But they won’t report the payments either, so you get no benefit from repaying the debt except for maintaining a happy relationship. 

If you borrow from a family member or friend, consider writing up your own contract with repayment terms. Creating a professional agreement can help both parties feel more comfortable.