Understanding Payday Loans

Know your options—and the risks—before borrowing

Borrowing money can be stressful, especially for an emergency. There are a lot of choices for personal loans and lines of credit. Payday loans (sometimes called cash advance loans) are one option, but they can come with unique risks and are even illegal in some states.

It pays to understand the costs and benefits when considering a payday loan. Then you can make a plan so you aren’t rushed into a decision.

What Is a Payday Loan?

A payday loan generally describes a short-term, high-cost loan that’s designed to be repaid on your next payday. The terms and structure can vary by state, lender and the individual loan.

How Do Payday Loans Work?

These loans are usually for small amounts and come with set fees based on the amount borrowed. For example, the Consumer Financial Protection Bureau (CFPB) describes a typical fee for a payday loan as $15 for every $100 you borrow. This is the same as an annual percentage rate (APR) of nearly 400% interest, which is much higher than credit cards, which typically range between 12–30%.

In exchange for a payday loan, the borrower usually gives the lender a post-dated check for the full amount borrowed, plus fees. Or the borrower might authorize the lender to electronically withdraw that amount from their bank account on the due date.

Fees and Risks

In addition to the initial fee, the CFPB warns of numerous other fees and costs associated with payday loans. These can include rollover fees if you need to extend the duration of your loan, late fees for missing a payment, overdraft and non-sufficient funds (NSF) fees if your bank account is short when the payment is processed, and more.

Payday Loans and Credit Reports

A typical payday loan doesn’t require a credit check or proof of your ability to repay the loan. This is part of the appeal for borrowers with no credit or bad credit who may not have other financing options. But, as Experian explains, these loans also can’t help you build your credit if they aren’t reported to the credit bureaus when you pay them on time.

However, if you’re late on payments, or you’re unable to repay your payday loan, there’s a chance that the debt will be reported to the credit bureaus. This could be done by the lender or a collection agency they transfer the debt to. In that case, it can still harm your credit.

Payday Loan Alternatives

Before relying on payday loans or other risky forms of credit it’s good to consider your options. For example, if you have the time and resources to plan ahead, a healthy emergency savings fund is a great way to protect yourself from the unexpected. A secured credit card is another option. Secured cards help you build credit with responsible use. And as you build your credit, that can help you qualify for a card with extra perks in the future.

Whichever option you choose, the key is to plan ahead. And if you have more questions on payday loans, the CFPB has an excellent payday loan resource page.

We hope you found this helpful. Our content is not intended to provide legal, investment or financial advice or to indicate that a particular Capital One product or service is available or right for you. For specific advice about your unique circumstances, consider talking with a qualified professional.

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