What is a Payday Loan?
A payday loan is a small short-term loan intended for emergency use to cover expenses between a borrower’s paydays. Often, these loans are also called cash advances, paycheck advances, payday advances, and paycheck loans among other very similar terms. It should be noted that while payday loans are often referred to as cash advances, these are not the same as credit card cash advances in any way.
How a Payday Loan Works
The basic principle behind a payday loan is quite simple. A borrower provides a personal check to be held for future deposit (or electronic access to that checking account) in exchange for immediate funding. With traditional payday loans, the customer writes out a check for the principle amount, which is the amount of cash they receive, plus the loan fee or finance charge. The check will be cashed or electronically deposited on the customer’s payday in order to settle the debt.
Typically, the finance charge and the borrowed amount must be paid all at once, on the customer’s payday. In payday loan stores, customers may provide the cash payment or allow the store to cash their check. If they choose not to pay the loan in full, they may roll it over until their next pay period by paying the finance charge only. With online payday loans, this idea is the same except both funding and payment are done electronically through the ACH system or via bank wires.
Requirements for Borrowers
Though individual payday lenders will vary among their requirements for approval, very little is needed in order to qualify for a payday loan in general. Typically, payday loans require that the borrower be at least 18 years of age, have an open bank account (usually a checking account though some lenders will deposit into savings accounts), and a job. Payday lenders do not run credit checks on their potential customers. Some payday lenders require a packet of information while others simply allow their customers to apply in their store or online.
The Terms and Cost of Payday Loans
The amount customers may borrow for payday loans really depends on the payday loan company but typically the amounts range from $100 to $1,500 and the average payday loan term is about two weeks to correspond with customers’ paydays. When it comes to annual interest, or APR, most payday loans come in around 400% on average. Remember, the finance charges range from $10 to $40 per $100 borrowed. For a two-week loan, these seemingly small charges can translate to huge interest rates. The shorter the loan, the higher the APR will be. This means that payday loans can be quite expensive when not used properly.
Risks to the Consumer
Payday loans involve a pending check to be cashed or electronically deposited on the customer’s payday (or due date). If the loan goes unpaid, there is a check that is not covered by the funds in the customer’s bank account which may lead to NSF fees charged by both the bank and the payday lender, negative credit ratings, and even account closure by the bank. Though the payday lender does not report to the credit agencies, the banks do – so any unpaid checks will get reported.
How to Avoid the Risks
Because payday loans are based on the customer’s payday, it is easy to fall into a debt spiral. Most payday lenders allow customers to borrow repeatedly while not paying off the original principle and that translates to repetitive payments on fees and charges only without reducing the original debt. However, falling into that pattern can be avoided if borrowers are informed and aware of the risk, borrow only what they need (and can afford), and pay their loans off when on their payday. Today, many payday lenders offer payday loan education to their customers to avoid these pitfalls.
Overview of the Payday Loan Industry
Consumers may obtain payday loans from a number of lenders including pawn shops, check cashing stores, payday loan stores, and online payday lenders. In some areas, rent-to-own furniture and computer stores also provide such funding. Lenders market their services over the Internet, on television, and in print. In the United States alone there are more than 25,000 payday loan stores and lenders making it a multi-billion dollar industry. Payday loans are available worldwide.
The Legalities of Payday Loans
Much press is attributed to payday loan laws and the legalities of lending throughout the United States. Many consumer advocate groups call payday lending another form of “loan sharking” and have made efforts to ban the practice. While some states have outlawed payday loans, they are in the minority. Most others have implemented caps on small loans such as payday loans as well as state laws and regulations. Many of the consumer advocacy efforts and laws stem from not only the high cost of payday loans but the questionable collection tactics some unsavory companies have used which include making legal threats and even jail time which go against the FDCPA (Fair Debt Collection Practices Act). It is important to note that not every payday lender falls into this category.