What Are Overnight Loans?

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When people think of loans, most consider them as long-term debts, that is, obligations that must be paid out over months or years. Even revolving lines of credit, like credit cards, are paid month-by-month, and the shortest bonds tend to mature over weeks or days. Sometimes, though, even shorter-term loans can help organizations and individuals manage cash flow. These are commonly called overnight loans, and both large institutions and individuals make use of them, albeit on a different scale.

Repos

In the financial world, most overnight loans are repos, or agreements to sell someone a financial asset, such as a Treasury security, and then later buy it back, paying interest for the ability to use the money. While this is not precisely a loan, repos function in much the same way and are very often overnight types of debt. A bank or other institution will "sell" assets like bonds and then buy them back the next day. Not all markets or economies use repos this way, but they are common in the United States, especially among large corporations with major investment power.

Uses of Repos

Banks will sell through a repo in order to have instant access to a large amount of cash that they can use to finance other investments or even buy repos of their own for a similar timeframe. Banks that buy repos and earn interest on them have large amounts of earnings they do not want to sit idle. Cash sitting overnight will not make any money, but cash used in a repo can earn at least a small amount of interest. When repos involve millions of dollars, as they often do, these overnight loans can add up to sizable returns.

Payday Loans

On the consumer side, overnight loans tend to be payday loans that fall into traditional unsecured loan structures. The lender does not require collateral to make the loan, but the loan amounts tend to be very small, often no more than a thousand dollars. These loans are not necessarily only a day long, but they can be obtained very easily and are repaid very quickly and in a lump sum, which led to the name. Overnight lenders tend to link directly to a checking account and automatically withdraw money deposited from the next paycheck to end the loan.

Uses

Consumers tend to use overnight loans when they need cash badly and cannot afford to wait for their next paycheck. They effectively borrow against money they have earned but not yet received. Overnight loans come at a high cost, though. Lenders tend to charge high interest rates for small amounts and can trap consumers in rolling overnight loans from paycheck to paycheck.

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