Payday & Short-term Loans

What is a payday loan?

Payday loans are small loans (average $300-$1,000) made for a short period of time. You get them by writing a personal check. The lender gives you the money for the check and takes out a processing fee. The lender holds your check until you pay off the loan. Payday loans have short terms and must be paid back quickly, usually within 2-4 pay periods. Payday loans are marketed as a way to help you cover your expenses until your next paycheck. Also called “check cashing”, “payroll advance” and “deferred deposit,” these loans offer a fast way to access emergency money.

Borrowers should use them with extreme caution and pay the amount back as soon as possible. These loans are usually priced at a fixed dollar fee, which represents the finance charge to the borrower. Because the loans have such short terms, the cost of borrowing is very high. In return for the loan the borrower usually provides the lender with a pre-dated check or debit authorization.

How does it work?

Say your car broke down and you decide to borrow $300 for the repairs from a payday lender. You’ll write a post-dated personal check for $340 (the amount plus a finance fee) made payable to the lender. You enter this information online when applying for a payday loan through the internet. The lender then advances you $300 for a set period, usually 14 days. When that period is up, you pay the lender $340 in cash, let them deposit the post-dated check or write another post-dated check for the amount plus an additional finance fee. If you do not pay the debt in full at the end of the term, you will be charged additional fees and finance charges.

Who uses these types of loans?

Generally, anyone with a checking account and steady income can obtain a payday loan. However, it is most common for borrowers who don’t have access to credit cards or savings accounts to use this type of lender. Since these loans don’t require a credit check, people with no credit or credit problems often turn to payday loans. Military personnel and recent immigrants also commonly use payday loans.

Why do people take out payday loans?

Payday loans are one option for quickly and easily borrowing cash during an emergency if you don’t have other financial options. For example, you might use a payday lender for an immediate and temporary financial need such as a medical bill, car repair or other one-time expense. Payday loans are helpful for people who don’t have credit cards or savings available. Because the loans do not require a credit check, they are easy for people with financial problems to obtain.

What are the negatives?

It is crucial that you repay a payday loan as soon as possible. Many people get into trouble with these types of loans when they are unable to quickly repay the debt. If you can’t repay the loan at the end of the term, you’ll be charged expensive additional fees. It is very costly to be stuck in a payday loan cycle for a long time and can lead to larger financial problems. Payday loans are also much more expensive than other methods of borrowing money. In most cases the annual percentage rate (APR) on a payday loan averages 400-550%, but the APR is often as high as 5,000%. A standard credit card has an APR of 12% and a standard loan APR is around 7%. If possible, it is better to use a credit card or tap into your savings in the event of an emergency.

What about usury laws?

Numerous states have very specific laws that regulate the lending industry. Called “usury laws” these regulations define permissible lending terms and rates. Some states also have laws that regulate the amount a payday lender can lend to consumers and how much they can charge for the loan. Other states ban payday lending outright, such as New York. These laws vary widely. Payday lenders often work around these regulations by partnering with banks based in other states, such as Delaware. It is important to read the fine print on the payday loan offer and understand your consumer rights.

Alternatives to payday loans

• Make a realistic budget. Avoid unnecessary purchases and start saving
• Borrow money from your savings account
• Ask a family member or friend to lend you the money (make sure the terms are in writing!)
• Negotiate a payment plan with the creditor
• Charge the amount to a low interest credit card
• Receive an advance from your employer, church or a reputable community-based organization
• Obtain a line of credit from an FDIC approved lender
• Ask your lender or other companies you owe money to for more time to pay the bills
• Apply for overdraft protection. THis is a line of credit so check the APR and fees

If you need help setting up a budget or contacting your creditors to set up a repayment plan, call 1-800-351-4195 to speak with a Certified Financial Counselor who can help you.