“I just need enough cash to tide me over until payday”

What is a Payday Loan?

A payday loan, also known as a paycheck advance, is a small, unsecured, high interest, short-term cash loan that is intended to cover a borrower’s expenses until his or her next payday. In most cases, the borrower writes a post-dated, personal check for the advance amount, plus a fee. The lender will then hold the check for the loan period and then deposits it on the due date, or the customer returns with cash including the finance charge to reclaim the check. In some cases, borrowers sign over electronic access to their bank account to receive and repay payday loans.

As an example, say you need to borrow $200 for two weeks. You write a personal check for $230, with $30 as the fee to borrow the money. The payday lender agrees to hold your check until your next payday. When that day comes around, either the lender deposits the check or you collect your check by paying the lender $230 in cash. You also have the option to roll-over the loan and are charged an additional $30 to extend the financing for 14 more days. If you agree to electronic payments instead of a check, the lender would debit the full amount of the loan from your checking account electronically, or extend the loan for an additional $30. If you roll-over the loan three times, then the cost of the initial $200 loan would now be $290 which includes the three finance charges.

The disadvantages of a payday loan is that the borrower runs the risk of becoming trapped in repeat borrowing due to high interest rates, unaffordable repayment terms, and coercive collection tactics. Also, if the borrower’s account is short on funds to cover the check, the borrower may now face a bounced check fee from their bank in addition to the costs of the loan, and the loan may incur additional fees and/or an increased interest rate as a result of the failure to pay. Returned checks from the bank also cause negative credit ratings on specialized databases and credit reports and the borrower can lose their bank account or have difficulty opening a new bank account if they develop a record of “bouncing” checks used in order to get payday loans. Research indicates that payday loan users are almost twice as likely to file for bankruptcy as borrowers who are turned down for a payday loan.

Basing loans on personal checks leads some lenders to using coercive collection tactics. Some lenders threaten criminal penalties for failing to make good on checks and in some states, lenders sue borrowers for multiple damages under civil bad check laws.

Requirements to qualify for a Payday Loan

In order to qualify for a payday loan, all you need is an open bank account in relatively good standing, a steady source of income, and identification. Lenders do not usually conduct a full credit check or ask questions to determine if a borrower can afford to repay the loan.

Internet Payday Loans

Online payday loans are marketed through e-mail, online search, paid ads, and referrals. Generally, a borrower fills out an online application form or faxes a completed application that requests personal information, bank account numbers, Social Security number and employer information. Borrowers may also be required to fax copies of a check, a recent bank statement, and signed paperwork. The payday loan is then direct-deposited into the borrower’s checking account and the loan payment or the finance charge is electronically withdrawn on the borrower’s next payday. Many Internet payday loans are structured to automatically renew every payday, with the finance charge electronically withdrawn from the borrower’s bank account.

Payday Loans compared to other Cash Loans

Legislation regarding payday loans varies widely between different countries and states and some jurisdictions impose strict laws limiting the nominal annual percentage rate (APR) that any payday lender can charge on a payday loan.

Payday loans range in size from $100 to $1,000, depending on state legal maximums. The average loan term is about two-weeks and the loans typically cost 400% annual interest (APR) or more. The finance charge ranges from $15 to $30 to borrow $100.

Payday loans are extremely expensive compared to other cash loans. For example, a $300 cash advance on the average credit card, repaid in one month, would cost $13.99 in finance charges and an annual interest rate of almost 57%. By comparison, a payday loan costing $17.50 per $100 for the same $300 would cost $105 if renewed one time or 426% annual interest. The federal ‘Truth in Lending Act’ treats payday loans like other types of credit and states that the lenders must disclose the cost of the loan. Payday lenders must give you the finance charge (a dollar amount) and the annual percentage rate (APR — the cost of credit on a yearly basis) in writing before you sign for the loan. This APR is based on several things, including the amount you borrow, the interest rate and credit costs you are being charged, and the length of your loan.

Payday loans can easily trap consumers in repeat borrowing cycles due to the extreme high cost to borrow, the very short repayment term, and the consequences of failing to make good on the check used to secure the loan. Borrowers have an average of eight to thirteen loans per year at a single lender.

The Alternatives to Payday Loans

• Shop around first and compare all available offers. Consider a small loan from your credit union or a small loan company. Some banks may offer short-term loans for small amounts at competitive rates. A local community-based organization may make small business loans to people. A cash advance on a credit card may also be possible, but it may have a higher interest rate than other sources of funds: find out the terms before you decide.
• Shop for the credit offer with the lowest cost. Compare the APR and the finance charge, which includes loan fees, interest and other credit costs. You are looking for the lowest APR.
• Contact your creditors or loan servicer as quickly as possible if you are having trouble with your payments, and ask for more time to repay the money. Many may be willing to work you if they believe you are acting in good faith. They may offer an extension on your bills but make sure to find out what the charges would be for that service such as, a late charge, an additional finance charge, or a higher interest rate.
• Contact your local consumer credit counseling service if you need help working out a debt repayment plan with creditors or developing a budget. Non-profit groups in every state offer credit guidance to consumers for no or low cost. You may want to check with your employer, credit union, or housing authority for no- or low-cost credit counseling programs, too.
• Plan, plan and plan. Make a realistic budget, including your monthly and daily expenditures. Try to avoid unnecessary purchases and try to build some savings: small deposits do help. A savings plan, however modest, can help you avoid borrowing for emergencies. Saving the fee on a $300 payday loan for six months, for example, can help you create a buffer against financial emergencies.
• Find out if your bank will offer you overdraft protection on your checking account. If you are using most or all the funds in your account regularly and you make a mistake in your account records, overdraft protection can help protect you from further credit problems. Ensure you understand all the details of both what it costs and what it covers.

The bottom line on payday loans is that they are extremely expensive cash advances that must be repaid in full on the borrower’s next payday and so – try to find an alternative way to get the cash. If you must use a payday loan then try to limit the amount. That is, borrow only as much as you can afford to pay with your next paycheck and still have enough to make it to next payday.

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