How Do Payday Loans Work?
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Payday loans, also called cash advances, are a type of small, short-term loan that is available to people who have bad credit and may not be able to get a traditional loan. Amounts range from $100 to $1,000. However, because of their extremely high interest rates, which can top 400%, they are controversial, and are not available in all states.
What You Need
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To qualify for a payday loan, you typically need proof of steady income of at least $1,000 for at least three months, and a checking account for the past three months. You must also be at least 18 years old. Income may be from employment or from state or federal assistance, such as disability payments.
In 2006, Congress capped the interest rate for payday loans to military personel at 36%, leading some lenders to discontinue lending to service members.
What Happens
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Payday loans are available at check-cashing centers or online.
Payday lenders charge a fee of at least $15 (and as much as $30) for every $100 borrowed.
Say you need a loan for $400, but don't get paid for two more weeks. You write a postdated check to the payday lender for $460 ($400 cash advance, plus $60 in fees), and the lender electronically deposits $400 into your checking account.
You usually are given one to two weeks to pay the loan back in full. At that time, the lender deposits the post-dated check you originally wrote, in this case for $460.
What If You Can't Repay?
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If you don't have enough money in your account to cover repayment, you may have two options, depending on the company. You can renew the original loan of $400, paying another $60 in fees. Or you can do a back-to-back transaction, writing a new post-dated check to cover the original one. This involves paying new fees again---higher ones, this time. Instead of borrowing $400, you are now covering an unpaid debt of $460, so you would pay an additional $69, for a total check amount of $529.
If the lender deposits your check and it bounces, your bank will charge you bounced check fees. Also, the lender can potentially start legal proceedings against you for nonpayment.
Not Just Once
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Unfortunately, a 2003 study showed that just 1% of people who used payday loans only used them once in the course of a year. Most people use them 5 or more times a year. They then end up owing far more in fees than the amount they originally borrowed. In the example here, you would need to write a check for $803 to roll over the original loan for the fifth time. Remember, you only borrowed $400 to start with. Assuming a two-week loan period, you've more than doubled your debt to that lender in just two and a half months.
Some borrowers who are behind get a cash advance from a different payday lender to repay the original company, and are then in debt to a new firm.
A study by the Center for Responsible Lending found that, even after controlling for income and other variables, payday loan companies were far more likely to be located in African-American and Hispanic neighborhoods. Payday loans are considered a predatory lending practice by most consumer interest groups, including the National Consumer Law Center.
Other Options
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Other options for quick cash include pawn shops, which generally have longer repayment periods, and cash advances on a credit card. Though not cheap, credit card advances are much less expensive than rolling over a payday loan. Even if you have bad credit, you may be able to get a secured credit card.
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