What are instant loans? Everything you need to know

With an instant loan, you can get cash quickly – sometimes within the same day – even if you don’t have good credit. However, instant loans can put you in a position where you may be unable to make payments.

This is because instant loans charge sky-high interest rates and fees. And these negative effects can be even more damaging for low-income borrowers. A third (34 percent) of personal loan borrowers had an income of $30,000 or less in 2023, according to the California Department of Financial Protection & Innovation. If you are already struggling to keep up with the bills, the high costs of a quick loan can lead to additional financial problems.

What is an instant loan?

An instant loan is a short-term loan that is usually for a small amount and carries high interest rates and costs. Often people turn to them because they are dealing with an emergency, such as a car repair or other expensive bill.

Depending on your state’s laws, these short-term loans come in a few varieties: payday loans, pawn shop loans, and car loans.

• Payday loans. A payday loan, also called a cash advance, requires no collateral and can offer you cash on the same day you apply. You must pay back the loan – plus high interest charges – before your next pay period. They are a common direct lending option, used by 12 million American adults each year.
• Pawn shop loans. A pawn shop loan, or pawn loan, is a secured loan. The pawn shop has an item you own as collateral for the loan. In exchange for the item, you receive a loan for an amount less than the value of the collateral. If you do not return to repay the loan before the payment date, the pawn shop will claim ownership of the item.
• Car loan loan. Also known as a pink slip loan, this loan is secured by your vehicle’s title. You can still drive, but you must repay the loan in full, including interest charges, by the due date. If you don’t pay it back on time, the lender can take ownership of your car.

Regardless of what type of direct loan you are considering or what a lender calls it, a direct loan is a high-risk lending option. Consider alternatives before deciding on a direct loan.

Are instant loans a good idea?

In most situations, direct loans are not a good idea and should be avoided if possible. In addition to the high costs, the short repayment period and potential damage to your credit can make them difficult to manage.

Steep borrowing costs

A typical APR (annual percentage rate) for a payday loan is 400 percent – ​​and there are few new laws regulating the amount a lender can charge.

This means that if you need to borrow €400, you will pay an additional fee of €60 to get the money you need today. This fee may seem nominal, but loan costs can quickly add up if you are unable to pay back what you owe by the due date.

Overdraft fees

Lenders typically need access to your bank account to initiate repayment when the loan comes due. If you do not have enough money in your bank account, your lender will still try to transfer money. This may result in overdraft fees from your bank, and possibly insufficient reimbursement from your lender.

If you don’t request a rollover or extension, or if neither of these options are offered in your state, you’ll likely face penalties until your bank account balance is high enough to cover the entire loan amount.

Short repayment terms

If you are already in financial trouble, it can be challenging to repay the loan plus any applicable interest and fees within such a short time frame. In fact, four out of five payday loan borrowers convert or renew their loan within 14 days, according to the Consumer Financial Protection Bureau.

Unfortunately, this option comes at a cost, and continued rollovers or renewals can cause costs to skyrocket. Using the previous example, if the lender charges $60 per rollover and you renew the loan twice, the balance increases to $520 in just one month. And getting a debt consolidation loan for instant loans to avoid a pile-up of costs can be difficult if your credit isn’t in good shape.

Possible credit damage

Unfortunately, default is far from uncommon: one in five borrowers defaults on their personal loan payments. If your loan goes into default, debt collectors may report it to credit bureaus. Collection accounts can lower your credit score and remain on your credit report for up to seven years.

Collection agencies can also sue you to recover the outstanding money. If the court rules in their favor, your wages may be garnished.

How do direct loans work?

Most instant loans work the same. You submit an application and upon approval, you sign a contract stating the costs and due date. The annual interest rates on these loans are incredibly high, sometimes reaching well into the triple digits. Costs vary by state and each state has its own limits.

1. Submit an application. Payday loans typically do not require a credit check, but do require proof of income and a bank account. Lenders are available online or in person, depending on where you live.
2. Provide a postdated check or ACH authorization. If you go through the direct loan process online, your lender will likely require an ACH (Automated Clearing House) authorization from your bank account. If not, you may need to provide a postdated check showing the loan due date and the amount you owe.
3. Receive your loan funds. The lender will provide the loan amount (excluding fees) as a fixed amount of cash. With an online direct loan, this can be paid directly into your account if you have given access to it.
4. Repay the loan within the due date. The repayment term for a personal loan is approximately two weeks, or when you receive your next paycheck. This also varies per lender, depending on the details of the loan agreement. When it’s time to repay the loan, you pay the loan amount and fees and receive your postdated check back.

If you are unable to repay the loan on time, some payday lenders offer a rollover to defer repayment for another pay period. Not all states allow rollovers, and this option still costs a fee.

What are alternatives to instant loans?

Before moving forward with a direct loan, look for alternatives to limit your risk and avoid high costs.

• Negotiate a payment plan. Contact your creditor or servicer to explain your financial situation and see if they offer reduced payment plans. This option may not be available for everything, but it doesn’t hurt to try to negotiate.
• Personal loan for bad credit. While this option also comes with high interest rates, personal loans are still significantly cheaper. According to debt.org, payday loans have interest rates between 300 and 500 percent. A personal loan with bad credit can have an APR of 25 to 37 percent at most. Additionally, most personal loans offer longer repayment periods.
• Family and close friends. Ask trusted family members and close friends if they would give you a short-term loan. Make sure you are clear about interest and repayment expectations. If necessary, make a written agreement.
• Talk to a nonprofit credit counselor. For a long-term solution, discuss your debt options with a nonprofit credit counseling agency, such as the National Foundation for Credit Counseling. Their services are free or low-cost, and they can help you with a debt management plan so you’re prepared for unexpected expenses.

While it may not always be an option depending on your finances, you can try to have a budget that fits your income and expenses. Save in advance for major expenses that you know about, and build an emergency fund for unexpected major expenses.

Next steps

Direct loans are not an ideal choice if you are surprised by a large expense. Consider possible alternatives before incurring unnecessary costs through a personal loan.

If you think a direct loan is really your only option, read your country’s regulations for payday loans. States impose maximum loan amounts, fees and rollover restrictions – as well as other requirements for payday borrowers – to discourage predatory lending practices.

For more information about the rules in your state, please contact the regulator or attorney general of your state bank.