Payday loan are small, short-term loans (typically up to $1500) without a credit check that is intended to bridge the borrower's cash flow gap between pay days. Note, however, that the term payday loans can also mean cash provided against a prearranged line of credit such as a credit card.
The loans are typically given in cash and secured by the borrower's post-dated check that includes the original loan principal and accrued interest. The maturity date usually coincides with the borrower's next pay day. On the maturity date the lender processes the check traditionally or through electronic withdrawal from the borrower's checking account.
Lenders of payday loans typically operate small stores or franchises, but large financial service providers also offer variations on the payday loans advance. Some mainstream banks offer a "direct deposit advance" for customers whose paychecks are deposited electronically. Some income tax preparation firms partner with lenders to offer "refund anticipation loans" to filers.
As of 2001, lending of payday loans is legal in Canada and in twenty-five of the United States . Elsewhere in the US, a payday loans lender may affiliate with an out-of-state chartered bank to conduct business.
For example, borrowers seeking payday loans may write a post-dated personal check for $115 to borrow $100 for up to 14 days. The check casher or lender of payday loans agrees to hold the check until the borrower's next payday. At that time, the borrower has the option to redeem the check by paying $115 in cash, or refinance ("roll-over") the check by paying a fee to extend the loans for another two weeks. If the borrower does not refinance the loans, the lender deposits the check. In this example, the costs of the initial loans are a $15 finance charge, or 391 percent APR. If the borrower chooses to roll-over the loans three times, the finance charge would climb to $60 to borrow $100.
As a form of sub-prime lending, such as high interest rate credit cards, lending of payday loans is the subject of controversy. Some critics claim that payday loans target the young and the poor, near military bases and in low-income communities, who may not understand the time value of money. Others go further, comparing payday loans to loan sharks due to high interest rates-- typically 250% or more when annualized. There have been reported cases in which lenders of payday loans have pursued criminal bad check charges, despite the fact that they (presumably) knew the check was bad at the time when it was written. Likewise, it is argued that the interest rates on payday loans lending (and on rent to own) unfairly disadvantage the poor, compared to the middle class who pay at most 25% or so on their credit cards.
Defenders of the higher interest rates note that payday loans processing costs do not differ much from their higher-principal, longer-term counterparts such as home mortgages. They argue that conventional interest rates at these lower dollar amounts and shorter terms would not be profitable. For example, one-week loans for $100, at a 20% APR (compounded weekly) would only generate 38 cents of interest, which would fail to match processing costs for the loans. They also argue the interest on payday loans are less than the costs associated with bounced checks or late credit card payments. They also argue that the interest cost accurately reflects the increased risk of default, a concept known as risk based pricing.
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