What is a Payday Loan?
A payday loan, which is also referred to as a paycheck advance, is a small, short-term loan that is intended to cover the borrower’s daily expenses until he or she receives their next paycheck.
Payday loans are also known as cash advances because they provide a borrower with immediate liquidity to fund whichever expenses or purchases they feel is necessary. As a result of their ability to rapidly increase one’s liquidity, payday loans are typically attached with exorbitant interest rates and ambiguous fees, which can often propel a borrower into massive debts. Due to this unfortunate scenario, the legislation regarding payday loans will vary between states and countries.
Because payday loans are very short-term in nature, the differences between the APR and the effective annual rate are typically substantial. For example, the typical payday loan will offer the borrower between $100 and $200 for a term of two weeks; the APR attached to the loan is typically 26X 15% which equates to an exorbitant percentage of 390% and the typical EAR is 3,685%.
Some jurisdictions, as a result of the fees and heavy interest rates attached to a payday loan, will attach usury limits (the state body will limit the nominal annual percentage rate that a lender can charge a borrower) to payday loans. These efforts are meant to protect the borrower from developing massive debts through the inclusion of unjust fees and penalties. Additionally, some jurisdictions have outlawed payday loans altogether.
Borrowers who embark on a payday loan will secure a small cash loan with the understanding that the payment is due in full when the borrower receives his or her next paycheck. In the United States, the typical payday loan will incorporate finance charges in the range of 15 to 30 person of the amount for the two-week lending period, these fees translate to annual percentage rates from 390 to 800. The borrower of the payday loan is thus required to pay the amount of the loan in full, plus all of the fees attached.
Payday loans are offered as a form of retail lending; however, as a result of the Internet’s ease of access and global reach numerous loans are now offered online. Online payday loans are typically marketed through online searches, paid ads, and from emails. Typically, a borrower will fill out an online application that will request personal information, bank account numbers, a Social Security number and employment information. Borrowers are typically required to fax copies of a check, a recent bank statement, as well as signed paperwork which acknowledges and fortifies an agreement to the structure of the payday loan. Due to the exorbitant fees and interest attached to payday loans the majority of lenders did not process or complete background checks before offering these loans. This process or strategy has since changed due to the collapse of the credit market and the overall instability of the macro economy in the United States.