Payday lending is the practice of lending relatively small amounts of money, often $500 or less, for a short period of time, often just until the borrower’s next payday (hence the name). Proponents support payday loans, sometimes called “payday cash advances,” for a number of reasons, chief among which is that they’re an excellent way for cash-strapped people with damaged credit to obtain money for emergencies.
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How a Payday Loan is Made
Different payday loan companies each apply their own routines and details to the process, but basically, the borrower applies for a loan and provides documentation of regular, reliable income, such as pay stubs and bank statements. The lender usually relies on that information alone in the decision to issue the loan, although a tightening web of regulation and legislation is imposing greater due diligence obligations on payday lenders in many jurisdictions.
When the loan is issued, the borrower gives the lender a check for the full amount of the loan plus all interest and fees, postdated for the next payday. The borrower must then repay the loan on or before the next payday, or the lender will deposit the check. If the lender deposits the check against an insufficient balance, check-return fees will be assessed against both the borrower and the lender, and the borrower will become liable for them as well as for the unpaid loan, plus late fees imposed by the lender.
Payday lenders aren’t in business to lose money, and so when a borrower is unable to pay a loan on time, the lender is often willing to extend the loan until the next payday, usually at the same interest rate plus a special fee for extending the loan. In such cases, they generally require that the interest due, plus the fee, be paid at the time the loan is extended so that the principal value doesn’t increase.
Payday Loan Interest Rates
Payday lending organizations are in business to make a profit, and they do incur costs in the process. Thus, to issue a $100 loan for a period of 2 weeks for $15 interest may not seem like an onerous interest rate, but the fact is that annualized, the interest amounts to $390, or an annual percentage rate (APR) of 390%. If there’s a $5.00 fee for extending the loan, that brings the actual annual cost of the loan to $515, or an APR of 515%. By contrast, a $100 cash advance on a credit card might not even cost a total of $30 in interest, if only the interest payments are made.
Payday lenders justify these higher rates by pointing out that they’re dealing with a small portion of the credit market and thus can’t rely on a high volume of loans from which to make their profit. Consumer advocates, on the other hand, claim that the payday loan industry targets those least able to meet the interest rates – the working poor with damaged credit – and insist that the convenience to borrowers doesn’t justify the high-interest rates.
Regulation and Legislation
In the US, most regulation of credit and lending is done by the states, not the national government. Payday lending is outlawed outright in fifteen states; some others have effectively driven payday lenders out of their states with strict usury laws, limiting the interest and fees that any lender can charge. At the national level, the Department of Defense (DoD) categorizes payday lending as “predatory,” and asserts that young members of the armed forces are especially vulnerable to these lenders, with the interest payments ruining their finances and jeopardizing their security clearances.
In some cases, in fact, DoD reported that payday lending even interfered with some troops’ deployment to combat zones. In response, the US Congress has imposed strict limitations on the interest rates which can be charged when lending to members of the US military.
Other states have imposed creative regulations and restrictions, such as capping the permissible interest rate, limiting the number of times a borrower’s loan can be extended as well as the number of times a borrower can take out a payday loan in a year, and requiring that past-due borrowers be given significant amounts of time to pay their past-due balances interest-free.