Payday loans are small, short-term loans made by check cashing businesses or similar companies at very high interest rates. Usually, the borrower will write a personal check in the amount of something like $100 to $300, plus a fee payable to the lender.
The borrower and lender enter into a contract wherein the lender agrees to hold the check until the borrower's payday, at which time the lender will deposit the check. That is where the name "payday loan" comes from. The borrower gets a quick cash loan, at an up-front fee of something like $15 for every $100 borrowed.
Payday Loans Feature Very High Interest Rates
According to the Consumers Union publication Fact Sheet on Payday Loans, the interest rate for these quick cash advances can be as high as 911% for a one-week loan, 456% for a two-week loan, and 212% for a one-month loan. Lenders justify the incredibly high interest rates because they are making unsecured loans to consumers who are already in financial difficulty and who may not repay the money.
Allowable interest rates may vary from state to state, depending upon the type of regulation a state has in place. Nevertheless, payday lenders have historically been virtually unregulated in many states. Even in states where such lenders are regulated, state statutes may have safe-harbor provisions that exempt payday loan companies from state usury laws.
Quick Cash Advances can be a Trap for Unwary Borrowers
A one-time loan which the consumer repays on time is expensive, considering the interest and fees involved. But many consumers who seek payday advances are already in over their heads in debt. The extremely high interest rates make it difficult, if not impossible, for such consumers to repay the loans. This puts many consumers on a "perpetual debt treadmill," according to the Fact Sheet.
Because they cannot repay the loan when it comes due, many consumers end up extending it by paying the per-$100 fee many times over. These already desperate consumers end up paying much more in fees than their original loan transaction, putting them in worse financial shape than they were in when they started. One consumer, for example, paid $600 in fees on a $400 payday loan.
Alternatives to Payday Loans
Financial experts emphasize that quick cash loans with high interest rates should be avoided. There are some alternatives for people facing pressing financial difficulties:
- Negotiate with creditors. Creditors want to get paid and may be wiling to work with a borrower on repaying the debts.
- Start an emergency savings account. Even a few hundred dollars tucked away could save a lot of money in fees and interest compared to borrowing that amount from a payday lender.
- Obtain a secured credit card (e.g., a card that is tied to a savings account).
- Opt for overdraft protection on one's checking account.
Anyone considering a check advance loan should at least know what they might really end up paying for a small loan. The website for the Consumer Federation of America provides a calculator to help consumers figure out how much that payday loan will really cost.
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