Payday lending is a big company. The Community Financial Services Association of America (CFSA) has more than 20,000 member locations – more than Starbucks or McDonald’s. Around 19 million American households (nearly one in six in the country) have taken out a payday loan at some point.
How Payday Loans works
Payday loans get their name because they usually appear on the borrower’s next payday. They differ from ordinary bank loans in different ways:
- Smaller amounts . In most states where payday loans are legal, there is a limit to how much you can borrow this way. This limit ranges from $ 300 to $ 1,000, with $ 500 being the most common amount. The Pew report says the average size of a payday loan is $ 375.
- Shorter conditions . A payday loan must be repaid when you receive your next salary. In most cases this means that the loan period is two weeks, although it can sometimes be a month.
- No time limits . With a normal bank loan you pay back the money bit by bit in installments. For example, if you borrow $ 1,000 for 5% for a year, you pay $ 85, 61 a month – $ 2, 28 for interest and the remainder for principal. But with a payday loan you have to pay the entire sum – interest and principal – all at once. This is often impossible for a borrower with a limited budget.
- High interest . When you borrow money from a bank, the interest you pay depends on your creditworthiness and the type of loan you receive. A borrower with excellent creditworthiness can take out a mortgage loan with an annual interest rate (APR) of 3% or less. On the other hand, someone with bad credit who takes out an unsecured personal loan would pay 25% or more. But payday loans charge all borrowers the same rate – usually around $ 15 per borrowed $ 100. So if you borrow $ 500, for example, you pay $ 75 in interest. That doesn’t sound so bad until you remember that the loan period is only two weeks. On an annual basis this comes out at an April of 391%.
- No voucher . Banks check your credit before you provide a loan to find out how much you have to pay. If your credit is very bad, you probably cannot get a loan at all. But you don’t need a good credit – or a credit – to get a payday loan. All you need is a bank account, a proof of income (such as a payment slip) and proof of identity that you are at least 18 years old. You can walk outside with your money within an hour – an important reason why these loans appeal to financially desperate people.
- Automatic refund . When you take out a payday loan, you issue a signed check or other document that gives the lender permission to withdraw money from your bank account. If you do not show up to repay your loan as planned, the lender will either win the check or withdraw the money from your account.
- Simple extensions . If you know you can’t afford to pay off your loan on time, you can come in before it comes and extend it. You pay a fee equal to the interest you owe and you give yourself another two weeks to repay your loan – with a different interest payment. Or, in countries where this is not allowed, you can immediately take out a second loan to cover what you owe to the first. That’s how many users end up taking months to pay for what started as a two-week loan.