Facts
How Payday Loans Work
Payday loans are short-term cash loans based on the
borrower's personal check held for future deposit or
electronic access to the borrower's bank account.
Borrowers write a personal check for the amount
borrowed plus the finance charge and receive cash.
In some cases, borrowers sign over electronic access
to their bank accounts to receive and repay payday
loans.
Lenders hold the checks until the next payday when
loans and the finance charge must be paid in one
lump sum. To pay a loan, borrowers can redeem the
check for cash, allow the check to be deposited at
the bank, or just pay the finance charge to roll the
loan over for another pay period.
Payday Loan Terms
Payday loans range in size from $100 to $1,000,
depending on state legal maximums. The average loan
term is about two-weeks. Loans cost on average 470%
annual interest (APR). The finance charge ranges
from $15 to $30 to borrow $100. For two-week loans,
these finance charges result in interest rates from
390 to 780% APR. Shorter term loans have even higher
APRs.
Cost Compared with Other Cash Loans
Payday loans are extremely expensive compared to
other cash loans. A $300 cash advance on the average
credit card, repaid in one month, would cost $13.99
finance charge and an annual interest rate of almost
57%. By comparison, a payday loan costing $17.50 per
$100 for the same $300 would cost $105 if renewed
one time or 426% annual interest.
Requirements to Get a Payday Loan
All a consumer needs to get a payday loan is an open
bank account in relatively good standing, a steady
source of income, and identification. Lenders do not
conduct a full credit check or ask questions to
determine if a borrower can afford to repay the
loan.
Payday Loan Industry
Payday loans are made by payday loan stores, check
cashers, and pawn shops. Some rent-to-own companies
also make payday loans. Loans are also marketed via
toll-free telephone numbers and over the Internet.
At the end of 2005, industry analysts reported
between 23,000 and 25,000 payday loan outlets in the
United States and annual loan volume of $40 billion,
with $6 billion in loan fees paid by consumers.
Legal Status for Payday Lending
Payday lending will be authorized by state laws or
regulations in 36 states and the District of
Columbia, since the Michigan law took effect June 1,
2006. Payday lending is permitted for licensed
lenders in two additional states. Twelve states and
two territories have not enacted payday loan
authorizing legislation. In Maine supervised lenders
can opt for a fee structure that permits limited
payday lending, although Maine has not enacted
industry legislation. For more information, click on
Legal Status.
Tactics to Evade State Small Loan and Usury Laws
Some lenders use sham transactions, such as Internet
access with a rebate schemes, to cloak loans. In
Texas, most lenders now operate as unregulated
"credit services organizations" to evade state small
loan limits set by the Texas Finance Commission
under the small loan law. The Federal Deposit
Insurance Corporation has taken enforcement action
to stop a dozen or so small banks from "renting"
their charters to help payday lenders operate in
states that do not authorize these loans or interest
rates.
Debt Traps
Payday loans trap consumers in repeat borrowing
cycles due to the extreme high cost to borrow, the
very short repayment term, and the consequences of
failing to make good on the check used to secure the
loan. Consumers have an average of eight to thirteen
loans per year at a single lender. In one state
almost sixty percent of all loans made are either
same day renewals or new loans taken out immediately
after paying off the prior loan.
Risk and Cost of Checks for Loans
Every unpaid loan involves a check that is not
covered by funds on deposit in the borrower's bank
account. Failure to repay leads to bounced check
fees from the lender and the consumer's bank.
Returned checks cause negative credit ratings on
specialized databases and credit reports. A consumer
can lose her bank account or have difficulty opening
a new bank account if she develops a record of
"bouncing" checks used to get payday loans.
Coercive Collection Tactics from Check Holding
Basing loans on personal checks leads some lenders
to using coercive collection tactics. Some lenders
threaten criminal penalties for failing to make good
on checks. Others threaten court martial if military
personnel fail to cover payday loan checks. In some
states lenders can sue for multiple damages under
civil bad check laws.
Internet Payday Lending
Internet payday lending adds security and fraud
risks to payday loans. Consumers apply online or
through faxed application forms. Loans are direct
deposited into the borrower's bank account and
electronically withdrawn on the next payday. Many
Internet payday loans are structured to
automatically renew every payday, with the finance
charge electronically withdrawn from the borrower's
bank account.
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