Payday Loan Examples
Doug Smith

Defined Tag: Payday Loans.

A payday loan or cash advance is a small, short-term loan (typically up to $500) without a credit check that is intended to bridge the borrower's cash flow gap between pay days. Note, however, that the term cash advance can also mean cash provided against a prearranged line of credit such as a credit card.

The loan is typically given in cash and secured by the borrower's post-dated check that includes the original loan principal and accrued interest. The maturity date usually coincides with the borrower's next pay day. On the maturity date the lender processes the check traditionally or through electronic withdrawal from the borrower's checking account.

Payday lenders typically operate small stores or franchises, but large financial service providers also offer variations on the payday advance. Some mainstream banks offer a "direct deposit advance" for customers whose paychecks are deposited electronically. Some income tax preparation firms partner with lenders to offer "refund anticipation loans" to filers.

As of 2001, payday lending is legal in Canada and in twenty-five of the United States. Elsewhere in the US, a payday lender may affiliate with an out-of-state chartered bank to conduct business.

Example of A Common Scenario

Let's say you write a personal check for $115 to borrow $100 for up to 14 days. The check casher or payday lender agrees to hold the check until your next payday. At that time, depending on the particular plan, the lender deposits the check, you redeem the check by paying the $115 in cash, or you roll-over the check by paying a fee to extend the loan for another two weeks. In this example, the cost of the initial loan is a $15 finance charge and 391 percent APR. If you roll-over the loan three times, the finance charge would climb to $60 to borrow $100.

Controversy

As a form of subprime lending, such as high interest rate credit cards, payday lending is the subject of controversy. Some critics claim that payday lenders target the young and the poor, near military bases and in low-income communities, who may not understand the time value of money. Others go further, comparing payday lenders to loan sharks due to high interest rates-- typically 250% or more when annualized. There have been reported cases in which payday lenders have pursued criminal bad check charges, despite the fact that they (presumably) knew the check was bad at the time when it was written. Likewise, it is argued that the interest rates on payday lending (and on rent to own) unfairly disadvantage the poor, compared to the middle class who pay at most 25% or so on their credit cards.

Defenders of the higher interest rates note that payday loan processing costs do not differ much from their higher-principal, longer-term counterparts such as home mortgages. They argue that conventional interest rates at these lower dollar amounts and shorter terms would not be profitable. For example, a $100 one-week loan, at a 20% APR (compounded weekly) would only generate 38 cents of interest, which would fail to match loan processing costs. They also argue that the interest on a payday loan is less than the costs associated with bounced checks or late credit card payments. They also argue that the interest cost accurately reflects the increased risk of default, a concept known as risk based pricing.

This article is licensed under the http://www.gnu.org/copyleft/fdl.html GNU Free Documentation License. It uses material from the http://en.wikipedia.org/wiki/Payday_loan Wikipedia article "Payday loan".