What Is a Payday Loan?
A payday loan is a type of short-term borrowing where a lender will extend high interest credit based on a borrower’s income and credit profile. A payday loan’s principal is typically a portion of a borrower’s next paycheck. These loans charge high-interest rates for short-term immediate credit. These loans are also called cash advance loans or check advance loans.
How Payday Loans Work
Payday loans charge borrowers high levels of interest. These loans may be considered predatory loans as they have a reputation for extremely high interest and hidden provisions that charge borrowers added fees.
- Payday loans are short-term, often very high-interest loans available to consumers.
- Payday loans are typically based on how much a borrower earns; a borrower usually has to provide a paystub when applying for the loan.
- A number of laws have been put in place over the years to regulate the high fees and interest rates.
Obtaining a Payday Loan
Payday loan providers are typically small credit merchants with physical locations that allow onsite credit applications and approval. Some payday loan services may also be available through online lenders.
To complete a payday loan application, a borrower must provide paystubs from their employer showing their current levels of income. Payday lenders often base their loan principal on a percentage of the borrower’s predicted short-term income. Many also use a borrower’s wages as collateral. Other factors influencing the loan terms include a borrower’s credit score and credit history, which is obtained from a hard credit pull at the time of application.
In the U.S., as of 2020, 12 states and the District of Columbia have banned payday loans. The 12 states are Arkansas, Arizona, Connecticut, Georgia, Maryland, Massachusetts, New Jersey, New York, Pennsylvania, North Carolina, Vermont, and West Virginia.
Payday Loan Interest
Payday lenders charge borrowers extremely high levels of interest that can range up to 500% in annual percentage yield (APR). Most states have usury laws that limit interest charges to less than approximately 35%; however, payday lenders fall under exemptions that allow for their high interest. Since these loans qualify for many state lending loopholes, borrowers should beware. Regulations on these loans are governed by the individual states, with some states even outlawing payday loans of any kind.
In California, for example, a payday lender can charge a 14-day APR of 459% for a $100 loan. Finance charges on these loans are also a significant factor for borrowers as the fees can range up to approximately $18 per $100 of loan.
Although the federal Truth in Lending Act does require payday lenders to disclose their finance charges, many borrowers overlook the costs. Most loans are for 30 days or less and help borrowers to meet short-term liabilities. Loan amounts on these loans are usually from $100 to $1,500.
Usually, these loans can be rolled over for additional finance charges, and many borrowers end up repeat customers. A number of court cases have been filed against these lenders as lending laws following the 2008 financial crisis have been enacted to create a more transparent and fair lending market for consumers.