What Are Payday Loans? How They Work + What To Avoid

Chang Fu
May 21, 2021

A payday loan is a short-term, high-interest loan, usually $500 or less, and often repaid on the borrower’s next payday.

At one point or another, you’ve likely been faced with an unforeseen situation that requires unexpected cash flow. Oftentimes, it’s not cash you have in hand. That’s where short-term cash solutions come in, like payday loans. 

But what are payday loans

A payday loan is considered a cash advance, typically $500 or less, and doesn’t require any collateral to secure it. Payday loan structures and fees vary by state and lender. Generally, these short-term loans must be paid back within a week or two, or by your next payday, hence the name.

Table of Contents:

How Does a Payday Loan Work?

The Traditional Payday Loan Cycle:
Borrowers apply for a payday loan with an ID, checking account, address, and Social Security number. Payday lenders issue a loan for up to $500 for a fee. The repayment of the loan, plus interest, is due at the end of a two-week cycle or can be deferred for a fee. If the loan isn’t repaid, interest is accrued and the cycle continues.

Payday loans are meant to be short-term solutions for emergency use, typically in the form of a cash advance. This type of short-term loan charges a fee to take out a small amount, usually under $500, which is due at the end of a standard two-week period. 

If you can’t afford to pay back the loan in full at the end of the cycle, the lender charges another fee for the repayment to be pushed another two weeks.

As a result, the debt cycle ensues.

The payday loan industry is well known for its predatory practices. Unfortunately, many lenders try to push their customers even further into debt so they take out more debt to pay off their old debt, and further damage their credit score. 

Financial harm from these predatory lenders has resulted in these types of loans being completely banned in 13 states, including New York, New Jersey, and Georgia. Other states have implemented requirements that limit the number of payday loans an individual can legally take out. These states include: 

  • Florida
  • Michigan
  • Illinois
  • Indiana
  • North Dakota
  • Oklahoma
  • South Carolina
  • Virginia

Alternatively, Texas payday loans, Washington state payday loans, and Ohio payday loans, among other states, have looser payday loan statutes. The National Conference of State Legislatures (NCSL) catalogs the full list of the 37 states that allow payday lending and relevant state regulation in each location. 

When you have bad or no credit, it can be difficult to get financial assistance in a timely manner. This begs the question: how can those in financially complicated situations get the cash assistance they need without becoming the latest victim of a predatory lender? 

Enter: an alternative payday loan solution.

With traditional payday loans, many lenders will still approve you despite a poor credit score or debt-to-income ratio. They can do this because they don’t have the same underwriting requirements you would find for larger loans. Depending on how you choose to receive your funds, your cash may be available within minutes. 

While the barriers to entry remain minimal, traditional payday lenders charge a significantly higher annual percentage rate of interest. On average, traditional payday loan APR is between 400% and 700%. Predatory payday loans have been structured to catch you in a vicious debt cycle of borrowing more money over time and accruing interest while destroying your credit. 

Unfortunately, not all lenders are created equal. It’s important to do your research prior to applying for a payday loan. Check NMLS Consumer Access to verify the legitimacy of your financial service provider. 

Comparison of approval, payback schedule, and average APR of alternative and traditional payday loans

Alternative Payday Loans 

Today, alternative payday loans provide a more financially fair short-term cash solution. For example, the mobile-only installment loan from Possible Finance has a relatively low APR compared to most payday lenders, averaging between 150% and 200%. 

Like traditional lenders, you can still get approved in minutes for these loans with bad or no credit. Unlike traditional lenders, Possible Finance offers the option to pay in installments over multiple months instead of with a lump sum payment at the end of a short, two-week cycle. If you need to reschedule payments, you can do so directly in the mobile app. 

To top it off, there are no hidden fees and Possible will report your payments to two credit bureaus — Experian and TransUnion. 

Alternative payday loans from Possible Finance are currently offered in the following states: 

  1. Texas
  2. Florida
  3. Idaho
  4. Washington
  5. Ohio 
  6. Utah 
  7. California

What Do I Need for a Payday Loan?

Most payday loans have simple requirements and a quick online application process that can be done in less than 10 minutes.

Online payday lender requirements:

  • A government-issued ID
  • An online bank checking account
  • Your address 
  • Your Social Security number 

Additional requirements may include:

  • Permission to check your credit history
  • A debit card to disburse your loan
  • A pay stub or other income verification

Stricter requirements reduce the harm that unaffordable payday loan payments cause. While an installment loan from Possible Finance has more stringent restrictions than traditional lenders, these policies ensure the loan is affordable relative to income and won’t create a cycle of debt.

To apply for a cash advance from Possible Finance, borrowers must have the qualifications above, plus: 

  • Three months of income history, with deposits of about $750 per month in the linked checking account. 
  • A positive bank account balance.

How To Get a Payday Loan

There are numerous banks, financial institutions, and lenders that offer online payday loans. Today’s technology allows you to apply for a payday loan, title loan, or any other loan online and receive the loan amount directly in your checking account or on your debit card. 

When you apply for a payday loan, ensure you’re working with a direct lender that does not resell data. Prior to applying for a payday loan, whether online or in person, search your lender on the NMLS Consumer Access website to verify the business’s authenticity.

Low-Interest Rate Payday Loans

A low-interest payday loan is a short-term lending option where you pay less in interest. However, this doesn’t always translate into lower debt costs. 

To make money back, lenders may be forced to charge interest rates that can translate to high annualized percentage rates (APRs) through higher fees and associated charges. When low interest rates are coupled with short repayment periods, that typically causes APRs to skyrocket. 

Low-interest payday loans don’t always mean a lower cost of debt. To get a better picture of the cost of a loan, you have to consider the APR.

Food for thought: Traditional payday loan options average an APR between 400% and 700%. Possible Finance averages an APR between 150% and 200%. 

Paying off Payday Loans

Debt cycles have trapped many Americans in a place where they’re unable to pay back loans. When you miss your payment, you’re charged extra fees and interest while your credit score decreases. In some states, inability to pay loans back can result in criminal prosecution. 

In short, it’s serious, and you should only take out a loan if you’re sure you can pay it back. 

To avoid defaulting on your loan, consider requesting an extended payment plan (EPP), settling or rolling over the loan, or debt consolidation. 

  • Ask for an Extended Payment Plan: An EPP is a plan that you and your lender agree on to make your repayment plan easier by extending your payments. When requesting an EPP expect to explain why you need it, and don’t wait until the day before your payment to make the request.
  • Rolling Over a Loan: When you roll over your loan, you renew it. Lenders will issue a new version of the loan with the same, or different, reference number and may split the loan into multiple loans. 
  • Debt Consolidation: When you consolidate debt, you take out another larger loan to pay off your current debts. Having a single loan payment makes it easier to manage repayments and can result in a lower interest rate.

Payday Loans FAQs

The varied statues between states, easy barriers to entry, and traditionally difficult payback cycles can make it hard to grasp exactly what payday loans are. Before you take out a cash advance, understand the frequently asked questions of borrowers. 

What Is a Payday Lender?

A payday lender is a lender that offers small personal loans within a short repayment cycle to borrowers. These lenders can be found in storefronts, online services, and some banks. 

What Is a Payday Advance?

A payday advance is synonymous with a payday loan and has the same characteristics. It’s a small personal loan, typically $500 or less, that’s traditionally paid back upon your next pay cycle, or within two weeks. 

What Happens If You Don't Pay Back a Payday Loan?

Failing to repay a payday loan can result in fees, collection calls, credit score damage, and, potentially, criminal prosecution resulting in wage garnishment. 

What Happens If I Close My Bank Account and Default on a Payday Loan?

Regardless of the bank account associated with the payday loan being open or closed, when you default on a payday loan, the lender can still remove the funds from the linked account. You’ll still find yourself responsible for overdraft fees, potentially being sent to collections, or summoned to a day in court.

How Many Payday Loans Can You Have In Florida?

In Florida, you can only have one pending payday loan at one time that can’t exceed $500.

Why Should You Be Cautious of Payday Loans?

Most payday loans are attractive with their promise of no credit checks, 100% approval to borrowers and quick cash. However, traditional payday lenders use predatory lending with high interest and APR and short loan repayment cycles that can trap consumers in a cycle of debt.

Possible was founded by people who experienced financial hardship, some even as refugees, and people who have succeeded because they were lucky to receive a helping hand. From the top down, Possible wholeheartedly believes that kindness should be extended to all Americans — and we’re doing our part through financially fair payday loans

Payday loans from Possible are installment loans that build credit with flexible repayment schedules and avoid the harmful practices of typical short-term lenders. Join tens of thousands of satisfied customers and make it to your next payday by installing the Possible Finance app. 

Chang Fu

Chang is an avid writer, among other things, at Possible. He grew up loving reading and writing, creating his own poems and even a book he's now hidden in an old closet, unpublished. His financial experience at a large bank along with his passion for technology to help underserved communities inspires him to write for Possible.

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