A payday loan (also called a paycheck advance or payday advance) is a small, short-term loan that is intended to cover a borrower's expenses until his or her next payday. Typical loans are between $100 and $500, on a two-week term and have interest rates in the range of 390 percent to 780 percent (APR)[1]. The loans are also sometimes referred to as cash advances, though that term can also refer to cash provided against a prearranged line of credit such as a credit card.
Though payday lending is primarily regulated at the state level, the United States Congress passed a law in October 2006 that caps lending to military personnel at 36% APR. The Defense Department called payday lending practices "predatory", and military officers cited concerns that payday lending exacerbated soldiers' financial challenges, jeopardized security clearances, and even interfered with deployment schedules to Iraq.
Lenders say these loans are often the only option available to consumers with bad credit or who cannot get a bank loan, credit card, or other lower-interest alternatives. Critics counter most borrowers find themselves in a worse position when the loan is due than they were when they took the loan, with many getting trapped in a cycle of debt.
Retail lending
Borrowers visit a payday lending store and secure a small cash loan, usually in the range of $100 to $500 with payment in full due at the borrower's next paycheck (usually a two week term). Finance charges on payday loans are typically in the range of $15 to $30 per $100 borrowed for the two-week period, which translates to rates ranging from 390 percent to 780 percent when expressed as an annual percentage rate (APR)[1] The borrower writes a check to the lender in the full amount of the loan plus fees. On the maturity date, the borrower is expected to return to the store to repay the loan in person. If the borrower doesn't repay the loan in person, the lender may process the check traditionally or through electronic withdrawal from the borrower's checking account.
If the 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. For customers who cannot pay back the loan when due, members of the national trade association are required to offer an extended payment plan at no additional cost. In states like Washington, extended payment plans are required by state law.
Payday lenders require the borrower to bring one or more recent pay stubs to prove that they have a steady source of income. They are also required to provide recent bank statements. Individual companies and franchises have their own underwriting criteria.
Internet lending
Online payday loans are marketed through e-mail, online search, paid ads, and referrals. Typically, a consumer 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 fax copies of a check, a recent bank statement, and signed paperwork. The loan is direct deposited into the consumer's checking account and loan payment or the finance charge is electronically withdrawn on the borrower's next payday
Examples
For example, a borrower seeking a payday loan may write a post-dated personal check for $460 to borrow $400 for up to 14 days. The payday lender agrees to hold the check until the borrower's next payday. At that time, the borrower has the option to redeem the check by paying $460 in cash, or renew the loan (a.k.a. "flip the loan") by paying off the $460 and then immediately taking an additional loan of $400, in effect extending the loan for another two weeks. In many states, "flipping" or "rolling over" the loan is not allowed. In states where there is an extended payment plan, the borrower could choose to opt into a payment plan. If the borrower does not refinance the loan, the lender may deposit the check. In this example, the cost of the initial loan is a $60 finance charge, or 390% percent APR.
When the Consumer Federation of America conducted a survey of 100 internet payday loan sites, it found loans from $200 to $2,500 were available, with $500 the most frequently offered. Finance charges ranged from $10 per $100 up to $30 per $100 borrowed. The most frequent rate was $25 per $100, or 650% annual interest rate (APR) if the loan is repaid in two weeks
Pricing structure of payday loans
Defenders of the higher interest rates say processing costs for payday loans do not differ much from other loans, including home mortgages. They argue that conventional interest rates for lower dollar amounts and shorter terms would not be profitable. For example, a $100 one-week loan, at a 20% APR (compounded weekly) would generate only 38 cents of interest, which would fail to match loan processing costs.
Critics say payday lenders' processing costs are significantly lower than costs for mortgages and other traditional loans. Payday lenders usually look at recent pay-stubs, whereas larger-loan lenders do full credit checks and making a determination about the borrower's ability to pay back the loan.
Variations on payday lending
A minority of mainstream banks offer advances for customers whose paychecks or other funds are deposited electronically into their accounts. The terms are similar to those of a payday loan; a customer receives a predetermined cash credit available for immediate withdrawal. The amount is deducted, along with a fee, usually about 10 percent of the amount borrowed, when the next direct deposit is posted to the customer's account. After the programs attracted regulatory attention[18][19], Wells Fargo called its fee "voluntary" and offered to waive it for any reason. It later scaled back the program in several states.
Income tax preparation firms often partner with lenders to offer refund anticipation loans to filers. These loans are not technically payday loans (because they are repayable upon receipt of the borrower's income tax refund, not at his next payday), but they have similar credit and cost characteristics. A car title loan is similar to a payday loan, but it is secured by the borrower's car. These loans are available only to borrowers who hold clear title (i.e., no other loans) to a vehicle. The maximum amount of the loan is some fraction of the resale value of the car. These loans may be available on slightly better terms than an unsecured payday loan, since they are less risky to the lender. If the borrower defaults, then the lender can attempt to recover costs by repossessing and reselling the car.
