When payday loans first began to gain notoriety, they were exclusively offered through lenders stationed in physical stores. Borrowers would have walk or drive to the payday lender’s location and apply for money in person. Today, however, online payday loans have become the more...
Payday loans, which are sometimes referred to as cash advances, instant loans, and short-term loans, are financing tools that provide quick cash to those with bad credit.
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The term “payday loans” is derived from the fact that the majority carry repayment terms of two weeks, which is the time between most people’s paychecks. The idea is that 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 payday loan lenders to determine, and sometimes vary on a borrower-by-borrower or a state-by-state basis.
Common payday loan terms:
- 10 days
- 14 days or two weeks — this is the most common
- 21 days
- 31 days
- 60 days
- Six months
While most payday loans come with 14-day terms, some extend longer than two weeks. However, very few payday loans carry a duration of longer than one month.
For borrowers who need a little more time to repay their financing, lenders will usually allow a rollover.
Rollovers are when a borrower extends a cash advance by agreeing to pay another fee for another two weeks.
To better define a payday loan rollover, consider the following example:
Imagine John Doe borrows $100 for two weeks at a rate of $15. After those two weeks pass, he would be expected to repay the lender $115.
But if John is unable to repay $115, he can ask for a rollover. That would grant him a two week extension at the cost of another $15 fee.
So when the new rollover duration passes (another two weeks), John would then pay the lender a grand total of $130 for effectively borrowing a payday loan for one month.
Payday loans usually come coupled with fees of around $15 per $100 borrowed, which when coupled with the common duration of 14 days makes payday loans cost just over $1 per $100 borrowed each day.
But, like the product’s duration, its costs can vary on a state-by-state basis.
Some of the more common cost structures are:
- $15 per $100 borrowed
- 15 percent of the total amount borrowed
- 20 percent of the total amount borrowed
When shopping for a payday loan, it’s not uncommon to see advertised interest rates in the triple digits. That’s because United States law dictates that payday loan costs be represented by an “annual percentage rate.”
Annual percentage rate, which is often abbreviated as APR, is the rate that is charged for borrowing, expressed as a single percentage number that represents the actual yearly cost of funds over the term of a loan. In other words, APR is how much a loan costs if you were to borrow that loan for one year.
To calculate the APR of a payday loan, use this formula:
[(Fee / Amount Borrow) * 365 Days] / Loan Term
So on a typical 14-day payday loan of $100 with a $15 fee, the APR calculation would be:
[(15 / 100) * 365] / 14 = 391 percent
Since these cash advance loans are usually only taken out for two weeks at a time (with 14-day terms), the APR of these loans is often in the triple digits. For those looking for a cheap form of financing, these triple-digit interest rates can come across as scary or confusing.
But as previously mentioned, payday loans usually only have a two-week duration, so many argue that expressing a payday loan’s cost as an APR is inaccurate.
Instead, payday loan advocates argue that these products should be measured in simple interest.
Simple interest is calculated by multiplying a loan’s principal, its interest rate, and the number of terms it will be taken out for.
An example of simple interest on 2-week $100 loan with a $15 fee is as follows:
Principal * Interest * Number of Terms
100 x 0.15 x 1
The result is a mere 15 percent, which, in the personal loan space is considered low interest and cheap. So cheap, in fact, that many argue that payday loans are amongst the cheapest forms of short-term financing out there.
For example, if a would-be borrower decided to overdraw his or her bank account at a $36 fee instead of taking out a payday loan, they’d be charged at a rate equivalent to 5,000 percent APR. Compared to some alternatives out there, payday loans are a cheap way to acquire quick money.
Part of the reason why payday loans cost so much is because they are very easy to qualify for.
Cash advance lenders are some of the most indiscriminate lenders in the financial world. They qualify applicants with poor credit, bad credit, and even no credit. In fact, credit score matters so little that the majority of payday lenders don’t even run credit checks on their applicants.
Instead, the most important factors to qualifying for a payday loan are:
- A steady flow of income
- A bank account
- Being 18+ years old
One must have an income source, such as from a job, benefits, or social security, in order to ensure a lender that they can afford to repay a cash advance.
Regarding access to a bank, since so many instant loans are originated online, lenders require borrowers to have a valid checking account so that money can be deposited directly into a borrower’s account.
This is beneficial for both lenders and borrowers because it expedites the money delivery process. If you apply and qualify for a payday loan online, you can often get money deposited directly into your account within a few hours.
Finally, all qualified signature loan applicants must be 18 years old or older in order to avoid any legal questions of entering into a financially binding contract.
Since payday loans are so easy to qualify for, it’s not difficult to see one of their strongest benefits: accessibility.
Consider this: each year, 12 million American adults make use of payday loans. The reason why there is such a demand for this product is because it is so easy to obtain.
When somebody is in need of money, but they have bad credit, traditional bank and credit union lenders will deny their application. Credit card companies will not approve of them for a card, and family and friends can usually only financially help someone so much. Even though the supply is lacking, the demand still exists. These people with bad credit still need money, and that’s where payday lenders step in.
In addition to this ease-of-access, there are other very practical benefits to these instant loans:
- No credit checks are required — Those with poor credit, low credit, or no credit at all are not discriminated against
- Cash is usually delivered within 24 hours — This makes cash advances perfect for those enduring emergency situations that call for immediate financing
- You don’t need a job — It’s possible for unemployed applicants and those on benefits to still be approved
- The process is private — your borrowing activity will remain anonymous and secure
- Your protection is guaranteed — Payday loans are regulated by the Consumer Financial Protection Bureau (CFPB), so licensed lenders are watched by the federal government
Contrary to popular belief, payday loans aren’t exclusively used by the poor. In fact, a study associated with the Jefferson Institute found that middle class parents and families who make between $25,000 and $50,000 a year are the most common demographic to use short-term loans.
Reason being, so many people have low credit scores (especially due to the consequences of the recent recession), and this type of financing does not require a credit check.
Additionally, the uses for bad credit loans are so wide and unrestricted.
Unlike auto loans, which must be used for purchasing vehicles, and mortgages, which must be used for purchasing property, payday loans can be used for virtually anything.
According to a study done in 2012, 69 percent of cash advance borrowers used the money for:
- Credit card bills
- Food costs
Another 16 percent were reported to use the money for more unexpected expenses, such as:
- vehicle repair
- medical bills
Prospective applicants will find that there are two primary sources for payday loans: online websites and brick-and-mortar storefront locations. Both of these sources provide identical products, so choosing which one to use is entirely up to the applicant.
When choosing a short-term loan lender, review their website or location, compare their offers to others, and select the source that you feel most comfortable using.
But before finalizing that decision, consider the pros and cons associated with each option.
Applying for a payday loan online is the most efficient way to access quick cash today. Websites never close, there’s never a line, and they can be accessed from the comforts of your own home.
In the past, online short-term lenders required applicants to fax documents with proof of employment and bank membership. Today, however, faxless payday loans are the norm. Since technology has increased, by simply typing your information into online forms, there is no need to scan or fax documents to a lender.
When inputting sensitive information on any website, financing related or not, it’s important to verify legitimacy. To make sure your lender’s website is secure and legitimate, check for the following credentials:
- A Better Business Bureau profile
- A secure website certificate
- Terms of agreement
- Proper disclosures and disclaimers
- A live telephone number
- A physical address
Storefront payday loan lenders were the original dispensaries of legal short-term cash.
While they’re still very prevalent in locations where payday loans are permitted, they’re not necessarily as efficient as their online counterparts.
There are a few reasons for this:
Physical storefronts sometimes require applicants to bring in documentation to validate their information. That proof is usually expected to verify one’s employment, bank accounts, and direct deposit status.
In the past, it was common for websites to require documentation as well, and applicants would fax that information into lenders. But nowadays, the vast majority of online applications are faxless, removing the need of scanning or faxing anything in.
Another extra step that some brick-and-mortar locations require borrowers is a written post-dated check as security for any borrowed money. That post-dated check is written on the agreement that the lender will deposit it after two weeks when the cash advance is due. Online lenders bypass this step by requiring applicants to have a checking account in which cash can be deposited into and withdrawn from on the agreed upon dates.
For all the good they do, payday loans still carry a significant amount of risk. That risk has, in turn, stirred up a lot of controversy which is why cash advances and high-interest bad credit loans are constantly talked about in the media.
Since these loans carry significant fees and since borrowers have the option to roll them over when repayment is not possible, some find themselves falling into a financial trap of perpetual debt.
Some of the more common terms used to describe these traps include:
- Debt treadmills
- Cycles of debt
- Debt traps
- Financial quicksand
Each of these flowery terms illustrates the possible situation of a payday loan’s balance growing larger with each successive rollover.
For instance, if one takes out a $100 payday loan at a $15 fee, and the roll it over one time, they will owe $130 come the expiration of their agreement’s term. But if that loan is rolled over again, the borrower would owe $145. That balance grows by $15 with every rollover, which paves way for an out-of-control spiral of debt.
To curb this risk, many states have passed legislation restricting payday loans. These payday loan laws often include:
- Zoning restrictions
- Interest rate caps
- Rollover limitations
- Complete bans of the product
If you live in one of the states that prohibit payday loans, your application will not be approved, even if submitted to an out-of-state online website.
Military Payday Loans
While these state-specific laws govern what happens inside states’ individual borders, the federal government has stepped in to specifically protect the military from predatory lenders as well. The Military Lending Act was created in 2007 in order to reduce the number of payday loan storefronts that were proliferating around military bases and installments.
Members of the military may have a difficult time finding a payday loan, but some lenders will accommodate them. This accommodation is usually done by providing military applicants with lower interest and longer duration loans that more closely resemble unsecured personal loans than payday loans.
Given the debate over payday loans, some consumers with bad credit wish to avoid them, but still find themselves needing money. There are some alternatives to cash advances, but not all of them will fit everybody’s needs.
Some of the most common payday loan alternatives include:
- Car title loans
- Installment loans
- Bank or credit union short-term loans
Car title loans are short-term loans that do not require credit checks. But unlike typical cash advances, title loans require borrowers to put up a vehicle as collateral. In the event that a borrower defaults on their financing, an auto title lender can then repossess the collateralized vehicle and sell it to reclaim their money. The risk associated with car title loans is large, but if a borrower knows they can repay their loan, then securing money with a vehicle is a great alternative to borrowing a payday loan.
Installment loans are another form of high-interest financing, but they’re typically taken out for longer durations and for larger amounts. Then repayment is done in the form of regular and fixed “installments.” These act a lot like typical personal loans, but they are harder to qualify for than a typical paycheck advance is.
Finally, banks and credit unions are now offering short-term loans that act almost identically to payday loans. While they claim their products are different, those differences are miniscule at best. Additionally, applicants are typically required to be a member of the specific bank or credit union that is offering the financing, so these products are not available to everybody.
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