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Personal Loans

How Do Payday Loans Work?

When you need quick cash, you might consider a payday loan to cover the gap. How do payday loans work? In short, they allow you to get an advance against your paycheck, which you pay back on your next payday.

Payday loans allow you to borrow small amounts of money, but they can be costly. A typical annual percentage rate for these loans can approach 400%, according to the Federal Trade Commission. If you’re considering a payday loan for short-term cash, it’s important to understand how they work, as well as the main pros and cons.

In this guide:

How payday loans work

Payday loans allow you to get a cash advance against your paycheck. You tell the lender how much money you need, verify your income, and walk away with cash in hand, often the same day. You won’t undergo a credit check or meet collateral requirements. 

Here’s the typical process for getting a payday loan:

  1. Locate a payday lender you’d like to work with, and complete a loan application. 
  2. Provide a copy of your most recent pay stubs to verify your income. 
  3. Once approved, agree to the loan terms, and get cash in hand or a cash deposit to your bank. 
  4. Repay the loan as agreed.

Payday loans are often marketed toward people with an immediate need for cash who don’t meet the requirements to qualify for traditional loans or lines of credit. These loans might appeal to borrowers with poor or no credit, but they can be a more expensive way to borrow. 

How do payday loans work online?

Payday lenders can offer loans in person at retail locations or online. Whether you have the option to apply for a payday loan online will depend on how these loans are regulated in your state. Lenders may offer loans online in some states and only in-person loans in others.  

If a lender offers payday loans online, the process for getting one isn’t much different from applying in person. You’ll still need to complete the application and provide proof of income. But instead of paper copies of your pay stubs, you’ll upload electronic copies through the lender’s application portal. 

Loan funds may be deposited directly to your bank account or loaded to a debit card if the lender offers that option. You might need to wait one business day or more to receive loan funds online unless the lender offers an in-store cash pickup option. In many cases, decisions for loan applications submitted online or in person are instant. 

How to get a payday loan

If you’re interested in getting a payday loan, choosing a lender is the first step. It’s wise to shop around to find the right lender. Here are criteria to consider: 

  • Minimum and maximum loan amounts
  • Loan APR and interest rate
  • Fees, if applicable
  • Application requirements
  • Loan funding speed
  • Repayment options

When you’ve decided on a lender, the next step is applying for the loan. You’ll need to provide some documentation here, which can include:

  • Photo ID
  • Recent pay stubs
  • A checking account
  • Proof of residence in the state where you’re applying

As we mentioned, you won’t need collateral for a payday loan because your paycheck effectively serves as the collateral. Applying for a payday loan shouldn’t affect your credit scores, nor will repaying one because most payday lenders don’t report these loans to the credit bureaus. 

Our expert’s take

Kyle Ryan


A payday loan can be a sensible option in plenty of scenarios. It typically comes down to the opportunity cost of that money. If a borrower takes a payday loan of $500, and it costs them $75 in interest over two weeks, what would the impact be if they hadn’t taken it? Are better options available? There are financial matters, such as making payments that are time-sensitive (e.g., life insurance or rent) and could incur penalties if not paid. People also need to put food on their tables and pay their bills, so as long as this is not a consistent trend, it can be helpful. For borrowers with little to no credit, it can be the best of very few options.

How much can you borrow using a payday loan?

The amount you can borrow with a payday loan depends on the lender and state laws regarding these loans. At the lower end, the minimum loan amount may be $50. A typical maximum payday loan amount is $500, but some states impose no upper limit. 

Smaller loan amounts are common with payday lending because you must repay them within a short period. Calculating how much you need to borrow can help you choose the right loan amount to minimize interest charges and fees. 

Whether it makes sense to choose a larger loan can depend on how confident you are that you can repay it on time. It’s also important to understand how repayment is structured and when loan payments are due.  

“You must also account for the fact that your take-home pay the following pay cycle will be less due to paying back the loan amount.”

Kyle Ryan


How do you repay a payday loan, and how much does it cost?

How you repay a payday loan can depend on the lender. Depending on where you borrow, you might have these repayment options:

  • Pay in full using cash, check, or a debit card at a lender location.
  • Pay in full using a debit card or ACH transfer online.
  • Authorize your lender to debit the full loan amount from your bank account at an agreed-upon date.
  • Authorize your lender to debit your bank account in installments to repay the loan. 

Lenders may permit borrowers to renew or roll over their loan rather than paying in full if state law allows it. If you renew or roll over your loan, you’ll pay a renewal or rollover fee on the scheduled due date, but that payment won’t count toward the loan principal.

Here’s an example of what it might cost.

  • You borrow $500 and agree to repay it within two weeks.
  • When the two-week deadline rolls around, you roll the loan over and pay a $50 fee.
  • You do that twice more before paying the loan in full. 
  • Altogether, you’d pay the lender $150 in fees on top of the $500 in principal you borrowed. 

Now, let’s assume you borrow the same $500 and pay it off in 14 days, with $126.90 in finance charges added. If you plug the numbers into a payday loan calculator, the effective APR for the loan works out to 661.69%:

Payday loan calculator image
Source: OmniCalculator

As you can see, the convenience payday loans offer can come at a high price. 

What are the risks of payday loans?

Payday loans can be a risky way to borrow for several reasons. It’s important to know what you’re agreeing to with these loans before you apply. 

Here’s what makes payday loans a less attractive borrowing option than other loans or lines of credit:

  • Loan costs can be exorbitant once you add in interest and fees. 
  • State laws regulate these loans, but they don’t always stop predatory lenders from taking advantage of unsuspecting borrowers. 
  • Payday loans can lead to a cycle of debt if borrowers continue to renew or roll over loans instead of paying off the principal. 

Repeat borrowing is another potential trap borrowers may fall in. If you become dependent on payday loans because you’re going through a financial rough patch, you could cost yourself a sizable amount of money in fees and finance charges. You may also find yourself stuck in an endless cycle of paycheck-to-paycheck living.

Stuck in a payday loan cycle?

Kyle Ryan


Here are the actions you can take. First, analyze your current financial situation. What is your income, and what are your anticipated fixed costs over the next year? Break this down into fixed expenses (e.g., bills, rent, groceries, debt) and variable expenses (such as entertainment and eating out). See how much you have left over. Next, attack your high-interest debt aggressively, and cut back where possible. See whether you can consolidate your loans into 0% balance transfers or another option with a lower interest rate. Institutions exist to help people out of these situations, so take advantage of them. Finally, consider increasing your credit, if possible, and getting a personal line of credit or some other method of lower interest costs.

States can impose laws for payday lending with regard to maximum loan amounts, costs, and loan terms. Some states are more liberal than others when it comes to what payday lenders are allowed to charge and how they can structure loans.

Here are three important payday loan statistics

  • Payday lending is prohibited in 15 states and Washington, D.C. 
  • Just four states impose no cap on the maximum loan amount. 
  • Twenty states have passed laws to cap payday loan rates at 36%, including fees.

More states are making an effort to rein in payday lending, but these loans continue to be problematic for borrowers. The lack of uniformity in regulation can lead to discrepancies in how these loans are treated by state. You may be able to find reputable lenders to be found, but many payday lenders operate to defraud their customers. 

For example, the Federal Trade Commission sued a payday loan enterprise in 2020 on the grounds the company’s loans were deceptively marketed. In 2021, the lender was banned from the industry and agreed to cancel all borrowers’ remaining debt. Nearly $1 million in payments were sent to customers who fell victim to the scheme.

Avoid these red flags

Kyle Ryan


Read the reviews, and evaluate the authenticity of the agency offering the loan. High interest rates are a screaming red flag, especially if they’re accompanied by high fees.

Alternatives to payday loans

When you need money in a hurry, consider these options before a payday loan:

  • Explore installment loans for people with bad credit. 
  • Get a small personal loan from an online lender or credit union.
  • Use a credit card or take a credit card cash advance. 
  • Request a paycheck advance from your employer. 
  • Use cash advance apps to borrow small amounts. 
  • Work out a payment plan with creditors. 
  • Ask friends and family for a loan. 
  • Consider a loan from your 401(k) or a distribution from other investment accounts.
  • Sell or pawn items you don’t need.
  • Get a side hustle, such as driving passengers, delivering packages or groceries, or petsitting.

Each option has pros and cons. For example, bad credit loans might be easier to qualify for than a traditional loan, but you could pay an APR as high as 36%. Friends and family might be willing to lend you money interest-free, but if you don’t pay it back, that could sour the relationship. 

Payday loans can be a quick way to get a loan, but they’re often more expensive than credit cards, personal loans, and cash advances. Weighing all the options and the costs can help you decide on the best way to get cash when you need it.