Payday loans (also referred to as cash advance loans or deferred deposit loans) are a type of short-term loan available to those needing access to immediate cash prior to an upcoming paycheck or income payment check, such as a social security check. Payday loans are high interest, unsecured loans with minimal requirements for approval.
Payday Loan Requirements
Qualifying for a payday loan is relatively quick and easy because of the minimal requirements needed. Lenders usually only require borrowers to have an open checking account, identification, and proof of employment or source of steady income (usually proven by showing previous pay stubs). Credit reports are not required to qualify for a loan, making it easier for those with bad credit to borrow money.
Payday Loan Terms
Typically, payday loans range from $100 to $1,000, depending on the state’s legal maximum or limits set by the lender. Terms on payday loans are short, with a maturity of about two weeks. Financial charges of payday loans are often fixed amounts, ranging from $5 to $10 on every $100 borrowed. When expressed as an annual percentage rate (APR), financial charges on loans can translate into interest rates of up to 400% APR.
Where to Find a Payday Loan
The payday loan industry is rather large, with a variety of businesses providing loans. Businesses that offer payday loans include: payday loan stores, check cashing centers, pawn shops, and some rent-to-own companies. Some companies offer the convenience of setting up a loan by phone or internet. However, many lenders are not licensed, bonded or regulated by important consumer laws.
Payday Loan Regulations
In 37 states, there are regulations or state laws authorizing payday loans. Usury laws are regulations that define permissible lending terms and rates. In addition to usury laws, laws in some states regulate the amount a payday lender can lend to a consumer and how much they can charge for loans.
On October 1, 2007, new federal protections were provided for Service members and their families. Department of Defense regulations prohibit payday loan lenders from charging more than 36% annual interest to all Service members and their families.
Payday Loan Process
After being qualified for a loan, the borrower provides the lender with a postdated check or a debit authorization, both for the full amount of the loan plus added financial charges. The lender then presents the borrower with documentation describing the full terms of the loan, including annual interest rates, late fees, and financial charges. By signing the documents the borrower understands and agrees to the terms of the loan, allowing them to receive their money.
On the maturity date, the borrower will be expected to pay the full amount of the loan to the lender. Some lenders may even provide borrowers with a payment plan to help ensure full payment is made. If a loan cannot be fully paid by the end of the term, the borrower may refinance (or “rollover”) the loan; however, this comes with late charges and additional interest fees.
If loans are left unpaid past the maturity day, lenders may process the postmarked check or debit authorization, depending on which was collected. If the borrower’s account declines the debit authorization or bounces the postmarked check, due to non-sufficient funds (NSF), the borrower will typically incur NSF charges to their account. Additionally, the lender may also impose a returned item fee plus collection charges on the loan.
Payday Loans – Positives and Negatives
When used responsibly, payday loans can be a quick and easy tool for generating cash needed for emergencies, such as car repair, medical bills, rent, utility bills, or other situations needing immediate payment. Payday loans are helpful for those without a credit card or any available savings. When the use of a payday loan can’t be avoided, borrowers should only advance an amount that can easily be repaid by their next paycheck. When payday loans are not paid back immediately, they can create financial struggles on the borrower. Many consumers who use payday loans live life paycheck-to-paycheck, leaving little room for financial emergencies. With the short terms and high interests of payday loans, it can be easy for these consumers to become trapped in a debt-cycle, where they have to repeatedly rollover their loan just to manage the fees associated with the loan.
Payday Loan Alternatives
If paid off quickly, the high interest and short-terms of payday loans can be of minor inconvenience. However, for those who use payday loans despite having the means to reasonably pay them off, using such a loan may end up causing greater financial struggles. For these people, alternatives should be considered before turning to payday loans.
How to Avoid Payday Loans
For many people, payday loans can be avoided by utilizing better money management practices. Following a realistic budget, put together at the beginning of each month, can be the best way of keeping a balance between your earnings and spending. It can also help prepare for emergencies and alleviate excessive spending. Budgeting can be as easy as taking the money you have each month and setting aside a certain amount for preplanned categories such as food, bills and luxuries. By setting realistic limits on the amount you spend each month, you can begin to save money. This takes a lot of discipline, but if done correctly it can prepare you to avoid the struggle of financial emergencies.
Types of Payday Loan Alternatives
Payment Plan with Creditor
If a loan is needed to pay off a creditor, you may consider negotiating the debt with the creditor. As a way of keeping you as a valued customer, most creditors will help you settle a debt by allowing a payment plan. Some creditors may negotiate a lesser amount, sometimes as little as 70%, as settlement for a debt.
Cash Advance on a Credit Card
A cash advance on a credit card may be the closest alternative to using a payday loan. Some credit card companies specialize in handling consumers with financial or credit problems. Credit card companies usually offer cash advances at a lower rate, about 30% APR, than payday loans. If the balance from the cash advance is paid by the next months billing statement, interest on the advance can be avoided.
Credit Union Loans
Credit Unions often offer small, short-term loans to customers, which can sometimes be processed quickly for emergency situations. Since credit unions are non-profit, cooperative financial institutions, loan approval is easier than at a bank and the loans usually have a lower interest rate (about 18% APR). Some credit unions also offer free financial counseling to help members fix their financial problems.
Emergency Assistance Programs
Many social groups, community organizations, and faith-based organizations (such as churches) provide emergency assistance, either directly or through local social service programs. State and federal programs are also available, such as the federal Low Income Home Energy Assistance Program (IHEAP), which assists low-income households that need help paying home heating and cooling bills.
Consumer Counseling Agencies
Consumer counseling agencies are available to those needing assistance with debt. On behalf of the consumer, counseling agencies negotiate with creditors to establish a debt management plan (DMP). Counseling agencies can also help with creating a budget and often provide education about useful financial management practices, all at little or no cost.
Several companies offer military loans to active and retired members of the armed forces. Military loans range from $500 to $10,000. Interest rates on military loans are much lower than payday loans, usually ranging from 33% to 34.99% APR. Military loans can be obtained through the internet.
Some banks offer overdraft protection, which is when a bank covers a payment or withdrawal if sufficient funds are unavailable. As long as it can be paid back quickly, overdraft protection can be used to make a payment or withdraw cash when funds are insufficient. The problem with using overdraft protection is running the risk of having your account closed by the bank. However, at a $5-$20 penalty fee without interest, it can be cheaper than using a payday loan, especially if your bank offers an overdraft line of credit.
Paycheck Advance from Your Employer
Sometimes employees can negotiate an advance in their paycheck. Usually employers will agree to this if the employee is in good standing with the company. However, this should only be used if a cut in future paychecks, due to the advance, will not cause a financial struggle on the employee.
Personal Loans from Family and Friends
Sometimes the most convenient way of obtaining immediate cash is to seek the help of a close friend or family member. Friends and family members are usually willing to help with financial needs if they feel they can trust the borrower to pay back the loan. This can be the easiest way of eliminating any interest or fees associated with other alternatives.
How to Choose a Payday Loan Alternative
1) Choose an alternative with a minimum term of 90 days.
Why: Payday loans have short terms, usually two weeks, leaving borrowers with not enough time to fully pay the loan off, causing them to rollover the loan and incur more charges.
2) Choose an alternative without check requirements or any other forms of unfair collateral.
Why: Most payday loans require a postdated check to obtain a loan. If the check is drawn on an account with insufficient funds, the borrower can encounter a number of penalties such as overdraft fees, penalties from the lender, and the possibility of having their bank account closed.
3) Choose an alternative which fully considers the borrower’s ability to repay the loan.
Why: Payday lenders don’t require any credit checks or deposit account verifications, making them easy to obtain regardless of blemishes in your financial history. This is misleading because lenders often allow payday loans, knowing the borrower can’t pay it back in time, with the hopes of generating more fees on the loan.
4) Choose a loan with rollover limits that are reasonable.
Why: Most payday loans force borrowers into a debt trap by allowing continuous renewals. After four or more rollovers, fees associated with renewing the loan can exceed the original amount of the loan. Choosing a loan with rollover limits can alleviate the possibility of falling into a debt trap. Limits include: limiting the number of rollovers on a loan, prohibiting a prior loan to be paid by a new loan from the same lender, and imposing a cooling period for the time between paying off a loan and opening another one.