Payday loans are short-term loans for small amounts granted to credit-poor borrowers. Borrowers need to be employed, own a checking account, and borrow an amount that they will be able to repay within one pay cycle.
In the typical payday loan, a borrower will receive $100 immediately after applying. The borrower is free to use the money without restriction. Within one pay cycle (generally two weeks in the U.S.), the borrower will repay $115 to the lender. Because payday loans are granted for small amounts and short durations, lenders can make loans to borrowers who have no credit history.
Payday loans are the easiest form of consumer financing and for many borrowers, payday loans represent the only method of obtaining consumer credit. The payday loan market operates as a separate operation from more traditional lending markets like credit cards an bank loans. Since the payday loan industry offers loans to any employed citizens with a checking account, a substantial minority of the working poor rely on payday lenders for short-term liquidity.
Payday loans are frequently criticized because they are offered at exorbitant interest rates that would be illegal under usury laws covering traditional loans. The typical payday lender charges an effective annual percentage rate of several thousand percent. As a comparison, average credit cards would fall in the 20-30% range and prime credit borrowers could obtain no-collateral signature guarantee loans from a bank at 8-10%.
Historically, payday loans have not been covered under state-specific usury laws regulating the maximum interest charged by lenders because of the method of calculating an interest rate. Usury laws are framed in terms of annual percentage rates: the percentage of interest charged on the loan on a per year basis. The typical payday loan lasts one-to-two weeks, making it difficult to normalize the interest charge to a standard annual rate. 13 U.S. states have made payday lending illegal or extremely difficult in practice. In these states (Arkansas, Connecticut, Georgia, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, North Carolina, Pennsylvania, Vermont, West Virginia), payday loans are virtually non-existent.
Where they are legal, payday loans are generally offered by small, retail fronts located in strip malls or mixed-use commercial districts. Some payday lenders operate websites, but state-specific regulations require these operations to tailor or restrict their lending by geography.
Defenders of the payday loan industry note that payday borrowers are not served by any main-stream consumer credit products. These borrowers are not eligible to obtain credit cards, cannot get mortgages or bank lines of credit, and are essentially blocked from participating in the traditional financial system. Payday lenders describe their business as a safety net that enables borrowers to survive short-term liquidity problems.
Payday loans can best be described as a financing vehicle of last resort for people who have no other option. With their enormous effective interest rate and shaky-legal standing, it remains to be seen whether payday loans will exist in the future. If you are looking for a payday loan, be sure to read your contract carefully and include all fees in your calculation of the best availablerate.