When you’re strapped for cash and need money fast, what do you do? Some people turn to a payday lending service. You can find these businesses in many cities across the nation, but how do they operate? And how do you decide which one to use?
We answer these questions and more in our payday lending services shopping guide. At BestReviews, we’re keenly aware that citizens today are inundated with products, deals, and other special offers. In a sea of consumer options, it can be hard to wade through the gimmicks and jargon to find what’s right for you.
That’s why we put together this shopping guide: to help you figure out what payday loans are all about and how to proceed if you would like to apply for one.
If you’re thinking about taking out a payday loan, here are the steps you can expect to follow.
You provide some basic financial and personal information to the lender. This could include pay stubs, proof of address, references, etc.
The lender determines the maximum amount of a potential loan. The limit is based on the amount of an average paycheck.
You write a post-dated check for the amount of the loan plus any applicable fees. The check is cashable to the lender on the date of your next payday.
You receive cash from the lender.
You now have two choices. You can repay your debt by the next payday or request an extension. If you ask for an extension, the lender can legally add a second fee to the original balance. This additional fee is known as a rollover; it’s a major source of income for payday lenders.
Here’s a potential scenario. A borrower proves to a lender that he or she earns $400 every week. The lender determines that the borrower is eligible for a $200 loan plus an additional $15 service fee. The borrower writes a postdated check for $215 to the lender and receives $200 in cash.
A payday loan can be a lifesaver, but if you don’t do it right, it can bog you down financially. Theoretically, payday loans are supposed to be short-term emergency loans for nominal cash amounts. For example, a customer may need $150 to replace a damaged tire or $250 to pay an unexpected traffic ticket.
Ideally, the total amount of any payday loan is repayable with one paycheck. But because many people have fixed living expenses like rent, they may not be in a financial position to repay the loan in a timely manner. Left unpaid, a payday loan rolls over, and the debt grows higher.
This is why many financial experts discourage the use of payday loans unless the situation is truly an emergency.
The post-dated check you provide the lender cannot be cashed by the lender until your next pay date. On that day, you can choose to pay your debt in full or request an extension. But buyer beware: when you ask for an extension, you accrue more fees.
We researched the best consumer practices when it comes to obtaining a payday loan from a lending company. Here is what we found.
You should definitely shop around for the best terms and rates. The payday loan industry is very competitive, and businesses are eager to attract and retain new clients. Before settling on a lender, visit several stores and websites on a fact-finding mission. Federal and state governments may impose some rate limits on payday lenders, but marketplace competition dictates that some businesses will offer you a better rate than others.
It’s wise to seek referrals from co-workers, friends, or neighbors. Many regular payday lending customers develop brand loyalty based on their positive or negative experiences with a local lender. Before committing to a specific lending institution, seek advice from people who have actually been through the experience. Consulting online reviews from both satisfied and dissatisfied customers is also a good idea.
Extension fees may continue to accumulate until you have paid off your loan in full. Rollover fees are a major source of income for payday lenders.
It can’t hurt to explore your other loan options, too. While a payday loan may sound painless when compared to borrowing from “Mom and Dad Savings and Loan,” the repayment terms can be draconian. Consider your other options. A sympathetic employer may agree to an emergency cash advance. Friends or relatives could be in a position to loan money. An online appeal on social media or crowdfunding websites may generate enough donations to pay the debt. Even selling an item or two at a pawn shop may be preferable to the terms of a payday loan.
You may be able to work with creditors to reduce your debt. Instead of borrowing $250 from a payday lending service, consider negotiating directly with your creditors for better repayment terms. They may be willing to extend a payment deadline, accept lower payments with interest, or accept services in trade.
If you’re a first-time borrower, you may not know exactly which documents to bring to a payday lending institution. Generally speaking, a loan representative will want to see proof of steady income (pay stubs, bank statements), photo ID, and possibly proof of residency (utility bill, personal letter). Some lenders may also ask for a list of personal references.
What most payday lenders will NOT do is run an official credit check on applicants. Remember, this is not a loan based on your ability to pay. Rather, it’s a loan based on the lender's ability to collect the debt.
If a borrower fails to repay the entire amount of the loan plus fees within one or two paycheck cycles, the rollover can become significant. When expressed as an annual percentage rate (APR), some payday loans can carry interest rates as high as 9,000%.
Contrary to popular belief, most payday loan institutions do not automatically approve every applicant who walks through the door. Successful loan applicants are usually full-time employees who meet the company's minimum income criteria.
Once the lender processes your information, he or she will explain your options. This means spelling out the exact terms of the loan, from the maximum amount available to the repayment terms and fees. If you agree to the amount and terms of the loan, the lender will ask for a post-dated check for the total cost of the loan and service fees.
Traditional banks lost some of their ability to generate small personal loans after a series of failures and federal interventions during the 1980s and 1990s. The Glass Steagall Act created even more federal restrictions on the banking industry's lending practices. This led directly to the rise of private lending companies not regulated by Glass Steagall or the FDIC. These lending institutions could make small personal loans using anything from the borrower's paychecks to a car title as collateral.
Since that time, the payday loan industry has continued to blossom.
Federal and state regulations may restrict the maximum interest a lender can charge, but competition in the marketplace determines the final cost of a payday loan to customers.
Payday loans are not home mortgages or small business loans, which are backed by federal agencies and have regulated interest rates. Payday loans can have exorbitant interest rates when calculated as an Annual Percentage Rate (APR).
The check-cashing services provided by alternative lending institutions address an important need for people who, for whatever reason, do not have their own bank account.
Very few people who earn $350 a week can afford to repay a $215 personal loan all at once without sacrificing other critical expenses. Many payday loans accumulate rollover fees at least once, and payday lenders know this.
The practice of offering immediate loans with no credit checks is very appealing to low-income workers who need emergency cash. Critics of the payday loan industry condemn this easy access to high-interest loans as “predatory lending.”
Many lending institutions will not extend credit to someone without steady, full-time work. If an applicant's income fluctuates widely from week to week, it can be hard for a lender to determine a maximum loan qualification.
Many payday lenders strongly disagree with the negative assessments they hear from critics. They believe they are addressing the financial needs of an underserved demographic: low-income workers who cannot qualify for traditional bank loans or other emergency aid.
And the fact is, many customers do repay the entire loan on time, so the so-called “predatory” rollover fees and exorbitant APRs don’t affect them.
Because customers walk out of the lender's office with cash in hand, they can usually address the issue that necessitated the loan in the first place. The traffic ticket is paid in full, the bad tire is replaced, the dentist bill is paid off.
The last obligation between a borrower and his/her payday lending company is (hopefully) on the borrower’s next payday. The lender should still possess the post-dated check, and the borrower should have the full amount of the loan in cash. This should be a simple one-to-one exchange, the check for the cash. However, if there is a balance remaining on the original loan, the lender may offer an extension for an additional fee.
It’s illegal for payday lenders to loan more than the amount of an applicant's anticipated paycheck, and borrowers are strongly discouraged from holding more than one payday loan at a time.
Some payday loan professionals offer their clientele check-cashing services. In this scenario, the lender cashes a personal or commercial check for a small fee.
Many people who do not have traditional bank accounts prefer this convenience. To their way of thinking, cashing a check with a payday loan company is preferable to the overdraft fees and other charges traditional banks mandate from customers who are overdrawn.
U.S. military personnel are discouraged from obtaining private payday loans, because the military already provides programs for short-term emergency loans.
1. According to a Pew Charitable Trust study, an average payday loan customer will take out eight loans of $375 in his or her lifetime and pay at least $520 in interest before paying off the original principle.
2. Military payday loan customers are protected by laws which cap interest rates at 36%.
3. A Consumer Federation of America study found that 80% of payday borrowers rolled over or borrowed new loans within 30 days.
4. Payday lending is forbidden in 14 states, including much of the northeast and Washington, D.C.
5. Borrowers who default on payday loans cannot be arrested, and these personal loans do fall under bankruptcy laws if the borrower files for such protection.
6. According to a Milken Institute report, the calculated annual percentage rate (APR) on payday loans in the U.S. runs from a low of 196% in Minnesota to a high of 574% in Mississippi and Wisconsin.