How Payday Loans Work
A payday loan is a short-term cash loan that is awarded based solely on the borrower's personal check, which is held for a future deposit or electronic access to the borrower's bank account. To get a payday loan, the borrower will write a check for the amount of the loan plus whatever fee is charged. The borrower then receives cash in return for that personal check. Sometimes, borrowers sign over the right for the lender to electronically access their bank accounts in order to receive and repay the money for payday loans.
The lender will hold the check until the customer's next payday. At that date, the loan and finance charge must be paid in full. Borrowers can either allow the lender to deposit the check, redeem it for a cash payment, or pay the finance charge and roll the loan balance over to another pay period.
Payday Loan Terms
The size of a payday loan typically ranges from $100 to $1,000, depending on what is legal in the state. These loans are typically given for a two-week term. The average annual interest rate (APR) on these loans is 470%. The charges on these loans are usually between $15 and $30 for a loan of $100. If the loan is a two-week loan, these finance charges equal interest rates from 390 to 680%. Loans with shorter terms have even larger APRs.
Cost Compared with Other Cash Loans
Other cash loans, in general, are relatively much less expensive than payday loans. Consider that a $300 cash advance from an average credit card has a finance charge of $13.99 for one month, which amounts to an annual interest rate of just under 57%. On the other hand, a payday loan for the same amount will cost $17.50 for each $100, or $105 if renewed one time. This will add up to 426% annual interest.
Requirements to Get a Payday Loan
There are few questions to answer and no credit check is involved when seeking a payday loan. All that is necessary for approval is an up-to-date bank account, a reliable source of income, and proper identification.
Payday Loan Industry
Payday loan stores, pawnshops, and check cashers are the types of companies that make payday loans. Some companies that offer rent-to-own products also offer payday loans. The Internet is another place where you can get a payday loan, and some are marketed through toll-free phone numbers.
CLR reported around 25,000 payday loan outlets in the United States in 2006. This resulted in at least $28 billion in annual loan volume, with loan fees paid by consumers totaling almost $5 billion.
Legal Status for Payday Lending
Thirty-six states and the District of Columbia currently have laws that regulate or authorize payday lending. Michigan is the most recent state to have done so, as it passed this type of legislation on June 1, 2006. Licensed lenders are permitted to make payday loans in two other states. Two territories and twelve states do not currently have payday loan authorizing laws. Supervised lenders in Maine can choose to use a fee structure that allows some payday lending, but Maine does not have industry legislation at this time. To find out more about the legal status of the industry, click on Legal Status.
Tactics to Evade State Small Loan and Usury Laws
Some lenders cloak loans through sham tactics. These can include tactics like offering Internet access with rebate schemes. Texas, for instance, has many lenders that call themselves "Credit Service Organizations", which are unregulated, so they can evade the limits set by the Texas Finance Commission and the state's small loan laws. The Federal Deposit Insurance Corporation is working to stop around a dozen banks from "renting" charters to help payday lenders work in states where it is not legal to do so.
Because payday loans have a high borrowing cost, a short repayment term, and strict consequences when borrowers do not pay the loan, these loans can trap consumers into a repeat borrowing cycle. The average amount of loans that consumers make with the same lender is between eight and thirteen. One state has nearly 60% of all its loans made as same day renewals, or brand new loans that are taken out as soon as the consumer has paid off the previous loan.
Risk and Cost of Checks for Loans
The checks written to secure a payday loan are checks that are not covered by any funds in the customers' bank accounts. This means that these checks bounce when the customer does not pay, resulting in fees from the borrower's bank and the lender. Also, returned checks can negatively affect the consumer's credit history. Consumers can also lose their personal bank accounts if there are too many bounced checks recorded on the account, especially if these bounced checks were used to get payday loans.
Coercive Collection Tactics from Check Holding
Some lenders use coercive collection tactics because they have consumers' personal checks to secure loans. Criminal penalties are sometimes threatened for those who cannot make good on checks. Sometimes, military personnel are threatened with a court martial if they do not pay their payday loan checks. Some states allow lenders to sue for multiple damages for bad checks with civil bad check laws.
Internet Payday Lending
Using the Internet for payday loans adds the risk of security breaches and fraud. Applications are filled in online or faxed to the lender when consumers apply for Internet payday loans. The money is directly deposited into the borrower's bank account through an electronic transfer. They are also electronically withdrawn on the following payday. Many Internet payday loans renew automatically each payday, and the lender automatically withdraws the finance charge from the borrower's account with an electronic transfer.