What Is A Payday Loan?

Payday loans are short-term loans offered in small dollar amounts.  The term of the loans is around 14 days, give or take, because the due date is when the customer receives their next paycheck.  Loans are usually for less than $500.

A person might need a payday loan because they are living paycheck-to-paycheck and some kind of emergency arises.  Perhaps their car breaks down, as has happened to me.  Maybe they have a large doctor’s bill to pay.  Maybe they need some funds to throw a birthday party for their child.  Maybe it isn’t an emergency at all.  Maybe they just need the loan to make ends meet during a particularly expensive month.  Think of all the things that might cost a few hundred bucks that, if it happened, you might not have the money for.  That’s why payday loans exist.

You walk into a payday lender, fill out an application with basic information about yourself, your employer, when you are next paid, and provide your bank account information.  You cannot get a payday loan unless you have both a job and a bank account.  I repeat – you must have a job to get a payday loan!

You receive loan disclosure paperwork required by the federal government and by the state you live in.  This explains the terms of the loan in clear language.

Let’s say you need $300 to fix your car.  You will leave a post-dated check with your payday lender for $300, plus the fee for the loan.  That fee depends on the state you live in, but it’s usually around $15 per hundred borrowed.  So you leave a check for $345.  You take your $300, get your car fixed, pay your mechanic, and when you get your next paycheck, you either return to the payday lender and pay the $345, or you call the lender and tell him to deposit the check you left behind.  In some states, you can renew the loan by just paying another $45, although not all states permit this.  Even in those states, some lenders do not permit it as a matter of policy, and the industry appears to be moving towards requiring some kind of principal paydown.

If you don’t pay back the loan, and cannot renew it, the smart thing to do is simply ask for a payment plan. Most lenders are happy to do this for you because they want their money back!  Only as a last resort will they send you to collections, or sell your account to a collection agency, or take you to court to get their money back.  Even if they did – hey, it’s your fault you didn’t pay back that loan!

That’s how simple it is.  So, you have to wonder why it creates so much controversy.  Stay tuned and I’ll examine all the angles.

History Of Payday Loans

Up until 1990 or so, there were a lot of what I call “family lenders”.  These were companies like Avco, which would extend small credit lines to families.  Gradually, these family lenders were gobbled up by large banks that didn’t see the value in this kind of loan product, so they slowly disappeared.

Well, just because a product vanishes doesn’t mean the demand vanishes along with it.  There weren’t any real alternatives for folks who needed small, short-term loans.  Plus, banks started charging increasing fees for bounced checks.  They could collect up to $30 every time you bounced a check, and since one bounced check might trigger a whole cascade of bounced checks, those fees could add up very quickly and would be even more profitable than offering short term cash loans.  In addition, if you bounced a check, the merchant would hit you with a fee.  Bouncing checks became very expensive for the consumer and very profitable for the banks.

Fortunately, America is about entrepreneurship.  When a need occurs in a market, someone steps in to fill the gap.  Some Midwestern businesspeople realized that a payday loan was a better way for consumers to meet short-term cash needs because it was cheaper than bouncing a check, which might cost them as much as $55-$60 each time.  At a price of $15 per hundred, someone could borrow as much as $400 and pay the same as they would if they bounced one check.  But since one bounce would often trigger others, it would end up being less expensive.  In addition, if they borrowed only $200 or $300, the fee would be $30-45, still less than a single bounced check.

Payday loans involved a single charge, unlike other products that required collateral, origination and administration fees, prepayment penalties and charges for other services such as credit life insurance, interest payments and additional charges. Bounced checks and late bill payments could have negative credit consequences whereas defaulting on a payday loan had no credit consequences. Basically, a payday loan would be a simple, quick and confidential way to meet short-term cash needs between paydays while avoiding the potentially higher costs and negative credit consequences of other products.

So throughout the 1990’s, payday loans caught on very quickly.  Why wouldn’t they?  They solved a problem, which is what all great products do.  Millions of people have used them over the past twenty years, and they return to use the loans whenever they have need of them.

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