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A payday loan
(also called a paycheck advance or payday advance) is a
small, short-term
loan
that is intended to cover a borrower's expenses until his or her next
payday. Typical loans are between $100 and $500, on a two-week term and
have interest rates in the range of 390 percent to 780 percent (APR)[1].
The loans are also sometimes referred to as cash advances, though
that term can also refer to cash provided against a prearranged line of
credit such as a
credit card.
Though payday lending
is primarily regulated at the state level, the
United States
Congress passed a law in October 2006 becoming
effective on Oct. 1, 2007 that caps lending to military personnel at 36%
APR as defined by the
Secretary of
Defense.[2]
The
Defense
Department called payday lending practices "predatory",
and military officers cited concerns that payday lending exacerbated
soldiers' financial challenges, jeopardized security clearances, and
even interfered with deployment schedules to Iraq.
[3]
Some federal banking
regulators and legislators seek to restrict or prohibit the loans not
just for military personnel, but for all borrowers,[4]
because the high costs are viewed as an unnecessary financial drain on
the lower and lower-middle class populations who are the primary
borrowers.
Lenders say these loans
are often the only option available to consumers with bad credit or who
cannot get a bank loan, credit card, or other lower-interest
alternatives. Critics counter most borrowers find themselves in a worse
position when the loan is due than they were when they took the loan,
with many getting trapped in a cycle of debt.
The industry's
fast-paced growth indicates a highly profitable business model.
Statistics compiled by the
Center for
Responsible Lending show that the majority of the
industry's profit comes from repeat borrowers who are unable to repay
loans on the due date and instead repeatedly renew their loans, paying
fees each time.[5]
Many believe that
payday loans are the only option for consumers with bad credit, but
other options do exist and most financial counselors would direct people
to explore the alternatives.[18]
Other options are available to most payday loan customers.[19]
These include pawn shops, credit union loans with lower interest and
more stringent terms[20],
credit payment plans, paycheck cash advances from employers, bank
overdraft protection, cash advances from credit cards, emergency
community assistance plans, small consumer loans and direct loans from
family or friends.
Payday lenders do not
compare their
interest rates
to those of mainstream lenders. Instead, they compare their
fees
to the
overdraft,
late payment, and penalty fees that will be incurred if the customer is
unable to secure any credit whatsoever.
The lenders therefore
list a different set of alternatives (costs expressed here as APRs for
two-week terms):[citation
needed]
-
$100 payday advance
with $15 fee = 391% APR;
-
$100 bounced check
with $48 NSF/merchant fees = 1,251% APR;
-
$100 credit card
balance with $26 late fee = 678% APR;
-
$100 utility bill
with $50 late/reconnect fees = 1,304% APR.
Variations on payday lending
A minority of
mainstream
banks
offer advances for customers whose paychecks or other funds are
deposited electronically into their accounts. The terms are similar to
those of a payday loan; a customer receives a predetermined cash credit
available for immediate withdrawal. The amount is deducted, along with a
fee, usually about 10 percent of the amount borrowed, when the next
direct deposit is posted to the customer's account. After the programs
attracted regulatory attention[21][22],
Wells Fargo called its fee "voluntary" and offered to waive it for any
reason. It later scaled back the program in several states.
Income tax
refund
anticipation loans are not technically payday loans
(because they are repayable upon receipt of the borrower's income tax
refund, not at his next payday), but they have similar credit and cost
characteristics. A car
title loan
is secured by the borrower's car, but are available only to borrowers
who hold clear title (i.e., no other loans) to a vehicle. The maximum
amount of the loan is some fraction of the resale value of the car.
These loans may be available on slightly better terms than an unsecured
payday loan, since they are less risky to the lender. If the borrower
defaults, then the lender can attempt to recover costs by
repossessing
and reselling the car.
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