Payday loans are short-term cash advances on a borrower’s upcoming paycheck. They’re usually for small amounts, ranging from $100 to $1,000, and often come coupled with a fee of around $15 per $100 borrowed.

Their name derives from the fact that most of these loans carry repayment terms of two weeks, which is the time between many people’s paychecks. So when a borrower’s “payday” comes around, they can repay their “loan.” Despite this etymology, not every payday loan is structured around a borrower’s pay date. Those terms are left to individual lenders to determine.

Some common uses for these loans include:

• Repayment of existing bills
• Emergency vehicle fixes
• Groceries
• Gifts
• Paying off or paying down large credit card deficits

As mentioned above, the interest rates or fees on payday loans can be extremely steep. In fact, it’s not uncommon to see annual percentage rates (APRs) on payday loans in the triple digits. If we consider that above example of $15 per $100 borrowed, the APR is 390 percent.

Here’s why these products cost so much: payday loans pose a huge risk to lenders.

They don’t require credit checks and they don’t ask for any collateral (aside from a post-dated paycheck or bank account information). As a result, lenders essentially hand money out to complete strangers in exchange for little more than a “promise” that these strangers will repay them. This leads to a high rate of default which must be made up for by charging higher interest rates or fees on the remaining payday loans.

That rate of default, according to a report by the state of Missouri, hovers around 6 percent. To put that in perspective, housing default rates at the end of 2012 were reported to be right around 7 percent. But mortgage lenders are able to repossess a house when a home loan is defaulted on. Payday lenders do not share that same luxury.

Instead they’re forced to abandon their repayment by selling the note off to collection’s agencies for pennies on the dollar. To offset those costs, short-term lenders charge higher interest rates.

Keeping those high fees in mind, there is a time and a place for these financial products. When unexpected financial obligations arise, some people need help. Some will find it cheaper to pay the fees associated with a payday loan instead of subjecting themselves to the late fees associated with looming bills or unexpected expenses. If borrowed responsibly and with the intention of quick repayment, short-term cash advances can be an excellent emergency device tucked safely away in everybody’s financial toolbox.

For more information on short-term borrowing, check out our frequently asked questions, our articles, and news stories.