What Are Instant Loans and How Do They Work?

An instant loan can get you cash quickly — sometimes within the same day — even if you don’t have strong credit. However, instant loans can put you in a position where you may not be able to make payments due to their sky-high interest rates and fees.

These adverse effects can be even more detrimental for low-income borrowers. A third (34 percent) of payday loan borrowers had an income of $30,000 or less in 2022, according to California’s Department of Financial Protection & Innovation. If you are already struggling to keep up with bills, the high cost of any quick loan may lead to additional financial distress.

What is an instant loan?

An instant loan is a short-term loan that’s typically for a small amount of money and comes with high interest rates and fees. Often, people turn to them because they are facing an emergency — like a car repair or other expensive bill.

Depending on your state laws, these short-term loans are available in a few varieties: payday loans, pawn shop loans and car title loans.

• Payday loans. A payday loan doesn’t require collateral and may offer you cash on the same day you apply. You’re required to repay the loan — plus high interest fees — by your next pay period. They are a common instant loan option, with 12 million U.S. adults using them yearly.
• Pawn shop loans. A pawn shop loan, or pawn loan, is a secured loan. The pawn shop holds an item you own as collateral for the loan. In exchange for the item, you receive a loan in a lesser amount than the collateral’s value. If you don’t return to repay the loan by the payment date, the pawn shop will claim ownership of the item.
• Car title loan. Also known as a pink slip loan, this loan is secured by your vehicle’s title. You still get to drive your car, but you’ll need to repay the loan in full, including interest fees, by the due date. If you don’t repay it on time, the lender can take ownership of your car.

Regardless of which type of instant loan you’re considering or what a lender calls it, an instant loan is a high-risk borrowing option. Consider alternatives first before turning to an instant loan.

Are instant loans a good idea?

In most situations, instant loans aren’t a good idea and should be avoided if possible. Along with steep costs, the short repayment period and potential damage to your credit can make them difficult to manage.

Steep borrowing costs

A typical payday loan APR (annual percentage rate) is 400 percent — and there are few new laws regulating the amount a lender can charge. This means if you need to borrow $400, you’ll pay an extra fee of $60 to get the funds you need today. The fee on its own may seem nominal, but borrowing costs can add up quickly if you’re unable to repay what’s owed on the due date.

Overdraft fees

Lenders generally require access to your bank account to initiate repayment when the loan becomes payable. If you don’t have enough money in your bank account, your lender will still try to transfer funds. This can lead to overdraft fees from your bank — and potentially a non-sufficient funds fee from your lender.

If you fail to request a rollover or extension. If these options aren’t offered in your state, you’ll likely incur penalties until your bank account balance is high enough to cover the full loan amount.

Short repayment periods

If you’re already facing financial hardship, it may be challenging to repay the loan plus any applicable interest and fees within such a short timeframe. In fact, four out of five payday loan borrowers rollover or renew their loan within 14 days, according to the Consumer Financial Protection Bureau.

Unfortunately, this option comes at a cost, and continuous rollovers or renewals could cause the fees to balloon. Using the earlier example, if the lender charges $60 per rollover and you extend the loan twice, the balance will increase to $520 in just one month. And getting a debt consolidation loan for instant loans to prevent a buildup of fees can be difficult if your credit isn’t in good shape.

Potential credit damage

Default is unfortunately far from uncommon — one in five borrowers defaults on their payday loan. If your loan goes into default, debt collectors can report it to credit bureaus. Collection accounts can tank your credit score and linger on your credit report for up to seven years.

Debt collectors can also sue you to recoup the outstanding funds. If the court rules in their favor, your wages might get garnished.

How do instant loans work?

Most instant loans work the same. You submit an application and, if approved, sign a contract that states the cost and due date. APRs on these loans are incredibly high, sometimes going well into the triple digits. Fees vary by state, and each state has its own limits.

1. Submit an application. Payday loans don’t typically require a credit check, but they will require proof of income and a bank account. Lenders are available online or in person, depending on where you live.
2. Give a postdated check or ACH authorization. If you go through the instant 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 with the loan’s due date and amount you owe.
3. Receive your loan funds. The lender will provide the loan amount, excluding fees, as a lump sum in cash. For an online instant loan, this might be directly deposited into your account if you’ve given them access.
4. Repay the loan by the due date. The repayment term for a payday loan is about two weeks, or when you receive your next paycheck. This also varies by lender, depending on the details of the loan agreement. When it’s time to repay the loan, you’ll pay the loan amount and fees.

If you can’t repay the loan on time, some payday lenders offer a rollover to delay repayment for another pay period. Not all states allow rollovers, and this option costs another fee.

What are alternatives to instant loans?

In most cases, you should only use instant loans as a last resort because they generally come with high fees and rates. Before moving forward with one, seek out alternatives with lower borrowing costs than instant loans. That way, you can lower your chances of getting stuck in a debt cycle.

• 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 won’t hurt to try and negotiate.
• Personal loan for bad credit. Although this option also comes with high interest rates, personal loans are still considerably less expensive. According to debt.org, payday loans have interest rates between 300 to 500 percent. A bad credit personal loan may have an APR of 25 to 37 percent, at the highest. Plus, most personal loans offer longer repayment periods.
• Family and close friends. Ask trusted family members and close friends if they’re willing to give you a short-term loan. Make sure you’re both clear about interest and repayment expectations. Make a written agreement, if necessary.
• Speak with 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 can be prepared for unexpected expenses.

While it may not always be an option depending on your finances, try to have a budget in place that works for your income and expenses. Save ahead of time for big expenses that you know about, and build an emergency fund for unexpected large expenses.

Next steps

Instant loans aren’t an ideal go-to when a big expense surprises you. Consider any alternatives before taking on unnecessary fees through a payday loan.

If you believe an instant loan is really your only option, read your state’s regulations for payday lending. States impose maximum loan amounts, fee and rollover restrictions — as well as other requirements for payday lenders — to discourage predatory lending practices.

To learn more about the rules in your state, reach out to your state banking regulator or attorney general.