What exactly is a payday loan?
A payday loan is a small cash advances, and is usually $500 or less. To get a payday loan, a borrower needs to give a payday lender either a postdated personal check or an authorization for automatic withdrawal from your bank account. In return, the borrower will receives the cash, less the lender's fees. For example, with a $300 payday loan, a borrower might pay about $45 in fees, so they will get $255 in cash.
The lender will then hold the check or hold the electronic debit authorization for a week or two. After that time frame, the borrower has the option to (1) pay back the full $300 in return for the original check, (2) let the lender deposit and keep the check for $300, or they can (3) renew or roll over the loan, if the borrower is unable to repay it. Some lenders will accomplish this same effect with "back-to-back transactions," and they will have the borrower write a check for the new advance, while using those funds to repay the prior loan.
Who is it that uses payday loans?
The payday industry currently advertises these loans as both easy and quick ways to get cash, and the industry targets lower income, working consumers, including military personnel, welfare-to-work women, and any others who have little or even no savings and those who live paycheck to paycheck. Many of the cash-strapped borrowers who now get payday loans are unfortunately not able to repay the entire payday loan within the two weeks, and they then end up rolling over their payday loan and therefore pay the renewal fees multiple times. They then get trapped on this "debt treadmill", and the borrowers will then end up typically paying much more in fees than the amount they originally borrowed.
Although many payday loans are marketed as one-time assistance to help pay bills, including utility bills, during a financial emergency, a 2003 study completed by the Center for Responsible Lending has found that over 90% of all payday loans are now made to borrowers who take out five or more payday loans per year. These borrowers, on average, will take out from 8 to 13 payday loans from a single payday lender per year. And, many of these payday borrowers will go to more than one lender, which dramatically increases the total number of payday loans they take out per year. Only one percent of all payday loans are made to one-time emergency borrowers, so you need to be very careful in using one of these loans to help pay utility bills.
What are the costs of a payday loan?
On average, for a two-week payday advance, a borrower will usually pay at least fifteen dollars for every $100 borrowed. However, you need to factor in the duration. For example, with such a short duration these payday loan fees are equal to paying roughly a 400% annual percentage rate (APR). So you need to be very careful in using a payday loan to pay for bills. Borrowers who renew their payday loans will often end up paying more in those fees than they have borrowed! Since the company that lends the payday loan is holding a “live check” as collateral, the borrowers may struggle to renew their payday loans every two weeks, and they very well may fall behind on other bills, like utility, rent, mortgage, electricity, and even groceries bills.
How are payday lenders regulated
State laws will generally determine whether payday lending is permitted in a state or not. Currently, over 30 states now allow payday lending. However, to get around this, several large payday lenders are partnering or using brokering arrangements, or so called or rent-a-charter agreements with commercial banks to circumvent state limits and bans.