Is a Payday Loan Secured or Unsecured? Know the Differences

It’s the middle of a long, hot Texas summer and your air conditioner suddenly stops working — the good news is that it can easily be repaired. The problem is that you won’t have the $150 needed to make the repair until your next payday — which is more than a week away. What should you do? Turning to a payday lender might feel like your only option.

Because payday loans aren’t secured by collateral, they’re easy to get. You only need a bank account, proof of income and a photo ID. But that easy loan can trap you in a cycle of debt that’s difficult to escape. Here’s what you need to know:

Payday loans are unsecured debt

A payday loan is classified as unsecured debt, so it’s a fast way to come up with the money — you don’t even have to leave home and your credit score doesn’t matter— and there’s no need to risk anything valuable as collateral. Sounds ideal, right? However, it’s actually dangerous.

The ease and convenience of a payday loan are offset by high fees and interest rates and a strict repayment schedule that’s often unrealistic for most borrowers.

READ MORE: Pros and cons of payday loans

What is the difference between a secured and unsecured loan? 

Let’s start with the basics: secured and unsecured loans refer to the amount of risk faced by the lender or financial institution that’s loaning you the cash.

• Secured loans are protected by an asset, usually some form of collateral, in case you fail to make the payments. For example, car loans and mortgages are secured loans. Your car or home is the collateral if you default on your loan.
• Unsecured loans are made without any form of collateral. Essentially all that’s required is a promise to pay back the money. While as a borrower that might sound ideal, this comes with its own disadvantages.

What are the main advantages of a secured loan? 

A secured loan offers some advantages, including:

• Lower interest rates
• You can often qualify for a larger amount of money
• Since you’re putting up collateral, you have a higher chance of approval

You can qualify for secured loans by using a secured credit card, a cash deposit, or even investment accounts as collateral. For eligibility, secured loans usually require good credit and have relatively consistent monthly payments and lower interest rates. But there is an element of risk for the borrower because collateral is involved. Secured loans are usually used for large purchases, such as homes, vehicles, and real estate.

What are the main advantages of an unsecured loan?

An unsecured loan also has a few benefits:

• They’re less risky for the borrower because there’s no collateral
• The lender places fewer restrictions on the money you borrow
• Your credit score usually won’t matter because there’s no credit-report check. 
• The process is faster and can even be done mostly online, utilizing the convenience of online lenders. 

Unsecured loans will almost always have higher interest rates than secured loans.

Unsecured loans are typically used when a borrower needs quick cash for emergency car or home repairs or unexpected medical costs.

How a payday loan works            

A payday loan — also sometimes called a cash advance loan — is usually short-term, has few requirements, and doesn’t require a credit check. The loan amounts are usually small. Payday loans can seem like an ideal way to borrow some quick cash to pay your rent on time to avoid triggering late fees or pay emergency bills, such as a home air-conditioner repair in the middle of summer or to pay an insurance deductible on your car after an accident. That’s really the only pro of a payday loan.

Though it’s an unsecured debt, a payday loan can feel like a secured debt because the collateral is your next paycheck. You generally will be required to pay off your payday loan within a couple of weeks — or by your next payday — which can be pretty tough. This is where borrowers often get trapped in a cycle of debt because payday loan convenience comes with a cost — exceptionally high fees and interest rates. In fact, some payday loans have an annual percentage rate, or APR, as high as 600%. More than 90% of Americans end up regretting their original payday loan.

READ MORE: What you need to know about payday loan interest rates

Do I have to put up something as collateral for a payday loan?

Technically no, because a payday loan is an unsecured debt. However, you may be required to provide a post-dated check or access to your bank account.

Payday loans vs. title loans: What’s the difference

A title loan is secured by the title to your vehicle. A payday loan is unsecured. Both types of loans have very high interest rates and can quickly trap you in a cycle of debt. A title loan is particularly dangerous because if you’re unable to repay the loan, you run the risk of losing your car — and potentially your livelihood.

READ MORE: U.S. payday loan statistics

What you need to know before taking out any loan

When you take out a loan, there are some steps you can take to protect yourself.

If you’re late on a bill payment, try calling the lender or financial institution to politely explain your situation. It’s possible they’ll offer you a grace period, a reduced late fee, or even an extended payment plan. It’s best to be proactive and take action before your credit report suffers, or the loan is handed over to debt collectors.

If you really need to take out a loan, do your homework. Check out the company and regulations in your state. If you’re in the military, you and your dependents might qualify for special protections for you and your dependents.

Research federal laws. The Consumer Financial Protection Bureau (CFPB) has some regulations for payday lenders. Be sure to know your rights, as well as state laws. Payday lending is currently outlawed in several states. Other states have different regulations and oversight in place.

For example, Ohio residents can borrow up to $1,000 from a payday lender and have anywhere from 91 days to one year to repay the money, with a maximum interest rate — or APR — of 28%. But if you live in Texas, there is no interest rate cap, so the APR can often be more than 400% and no maximum loan amount is specified.

READ MORE: Which state has the most payday loan stores?

Linking your bank accounts for automated payments

Many payday lenders will require you to set up automated payments from your bank account or provide a postdated check from your checking account. Be sure to read up on the risks of this. It can lead to overdraft fees if funds are deducted before your paycheck has hit your account or if unexpected expenses leave you without enough funds to cover the automatic withdrawals.

Before taking out any sort of loan, you should establish a clear repayment plan.

If you know you can’t meet the repayment deadline, don’t take out a payday loan. Research your other options. Payday lenders count on borrowers being unable to pay back the first loan. Then the borrower will have to take out another loan with another set of high fees. This leaves borrowers caught in a debt trap. Talk to a lender or credit union and consider a personal loan, ask your family or friends for help or even consider peer-to-peer lending.

READ MORE: In over your head with payday loans? Learn how to escape the debt trap

Steps to avoid using payday loans

You should always explore every possible alternative before taking out a payday loan.

Consider other options to raise some quick cash.

• Consider a cash advance app instead. These apps offer short-term loans similar to payday loans that are repaid from your next paycheck — in fact, they’re sometimes called paycheck advance apps — but the fees are significantly lower. Most lenders charge a small monthly fee, and many use a “tip” structure.
• Take on extra work: Gig work exploded during the COVID-19 pandemic. Look into working a few hours hours a week delivering food for DoorDash, driving for Uber or Lyft, or shopping for Instacart.
• Sell some of your old stuff online.
• Rent space in your home through AirBnB or VRBO.
• Visit a pawn shop and sell some of your unused items.
• Look for simple ways to reduce your monthly bills. Examine phone plans, streaming services and monthly subscriptions to find ways to cut back.
• Explore unsecured personal loan options with your financial institution or credit union. Many offer short-term loans with lower fees and annual interest than a payday loan. As an added bonus, these also may help you with debt consolidation.
• Consider a home equity loan: These will almost always have lower interest rates than a personal loan, and if you’re using the loan proceeds to make home improvements, the interest can even be tax deductible.
• Use the envelope method to build up an emergency cash wad to cover unexpected expenses. Every payday, stash a few dollars into an envelope. Only use that money when an emergency hits. Or make the money a bit more difficult to access by setting up a basic savings account, then make an automatic deposit of just a few dollars from each paycheck. If you never notice the money to begin with, it’s easier to save.
• Finally, sign up with apps that round up your debit card purchases to the nearest dollar and invest that money on your behalf, such as Acorns and Chime. These automatic deposits can add up quickly, and all you need is a few minutes to set up an account.

READ MORE: Practical payday loan alternatives

The bottom line

A payday loan is an unsecured debt, but the loans can quickly make you feel like you’re using your own salary as collateral. Payday loans should only be considered as a last resort, and only if you’re completely certain you can pay the loan off when scheduled. Don’t even consider turning to a payday lender until you’ve explored other financial services and exhausted all of your other options.

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