I don't know who told you this was illegal, but as far as I know, payday lenders are very unregulated. The 1st place to start analyzing this is the loan document itself -- you need to see which state's law governs the transaction, how disputes are resolved, Then see a lawyer licensed in the state whose law governs the loan.
Avvo doesn't pay us for these responses, and I'm not your lawyer just because I answer this question or respond to any follow-up comments. If you want to hire me, please contact me. Otherwise, please don't expect a further response. We need an actual written agreement to form an attorney-client relationship. I'm only licensed in CA and you shouldn't rely on this answer, since each state has different laws, each situation is fact specific, and it's impossible to evaluate a legal problem without a comprehensive consultation and review of all the facts and documents at issue.