What Are PayDay Loans and How Do They Work?
People sometimes find themselves in situations in which cash is desperately needed for an emergency. However, most people are paid only once every two weeks. On a tight budget, unplanned emergency expenses can create quite a dilemma. One way many people solve this problem is by taking out what is called a payday loan.
Also known as a payday advance or a cash advance, a payday loan is simply a loan a person takes out with a financial institution with the understanding that the borrower will attempt to pay off the loan with his or her next paycheck.
A borrower seeking a payday loan arranges a small cash loan, and agrees to repay the loan in full at the time of the borrowers next paycheck. Interest is high, typically in the range of 15 to 30 percent of the amount for the two-week period, which translates to a 390 to 780 annual percentage rates (APR). With these rates, borrowers better be sure they can repay the loan at the agreed upon time.
If the borrower’s check bounces, he now faces a bounced check fee from the bank, plus the payday loan agreement will issue additional fees and interest rates to the total amount due
To receive a payday loan, a person will usually have to present materials with him or her to show to the lender. This will include photo identification such as a driver’s license. However, the borrower will also have to bring in some kind of evidence to prove that he or she is actually currently employed. One common example is a pay stub from the borrower’s last paycheck. Bank account statements may also be requested.
Additionally, the borrower will have to sign one or more documents. This documentation will include the legal contract that describes the exact terms of the cash advance. These terms will include the exact interest rates that will be charged on the loan.
The loan documents will also include a description of any possible fees that can be leveled against the borrower under certain circumstances. For example, a hefty fee may be charged if the borrower makes a payment later than what is agreed to in the contract. There may even be a large finance charge for simply taking out the loan. This is why it is extremely important to read over all the details of this documentation very carefully. You’ve heard the warning, “read the fine print.” This is definitely the time to do so.
After the borrower’s ID, proof of employment, bank account information, etc. is verified and he or she signs the documentation to agree to the terms of the loan, the customer will receive the cash amount agreed to.
If the borrower is not able to pay off the loan in full, the loan will more than likely be extended. The loan being extended in this fashion may actually be preferable to the lender. This is because a company that offers payday loans makes most of its profit from very high interest rates and late fees. For example, if the loan is extended three times, the amount of interest charged will probably actually exceed the original amount of the loan. Here’s an example, from the United States’ Federal Trade Commission (FTC):
A payday loan — that is, a cash advance secured by a personal check or paid by electronic transfer is very expensive credit. How expensive? Say you need to borrow $100 for two weeks. You write a personal check for $115, with $15 the fee to borrow the money. The check casher or payday lender agrees to hold your check until your next payday. When that day comes around, either the lender deposits the check and you redeem it by paying the $115 in cash, or you roll-over the loan and are charged $15 more to extend the financing for 14 more days. If you agree to electronic payments instead of a check, here’s what would happen on your next payday: the company would debit the full amount of the loan from your checking account electronically, or extend the loan for an additional $15. The cost of the initial $100 loan is a $15 finance charge and an annual percentage rate of 391 percent. If you roll-over the loan three times, the finance charge would climb to $60 to borrow the $100.
Certain local and federal governments may place limits on the interest that can be charged. Usually, the interest will be limited to a specific annual percentage rate. However, these protections do not exist everywhere. In some states, very few legal limits exist on payday loans. That’s why it is important that that the borrower be very careful to make sure that he or she understands what actual interest rates, late charges and extension fees are defined in the documentation for the loan agreement.
A recent development in the payday advance industry has been the offering of payday loans over the internet. The requirements for receiving an internet payday advance are very similar to those for receiving a loan from thestore in their local strip mall.
The biggest difference is that information will be sent out to the lender via fax as opposed to the borrower bringing that information to the lender in person. If the borrower is approved for the loan, the lender will direct deposit the amount of the loan into the borrower’s checking account, rather than hand them the cash.
The proliferation of payday lenders on the interest is a blessing and a curse. If you are able to pay off your loan on time, and have found a reputable lender, then good for you. But the internet has spawned a thousands of not-so-trustworthy lenders, who are just waiting to prey on desperate victims. Make sure you check out any online payday company. Check with the Better Business Bureau in their city, search for the name of the company with the word “scam” and see what comes up. Just do all the logical things you would normally do for any online company you might want to do business with.
Despite the expenses involved, these kinds of loans are still viewed as useful by many people. They are indeed one of the easiest ways to acquire cash in an emergency. Just read the loan agreement carefully, and no that you truly can pay it off on time.