Payday Loans Explained in Simple Terms

Payday loans, sometimes also called paycheck advances or payday advances, are small, short-term loans that allow borrowers to cover expenses until he or she receives the next paycheck.This type of lending has come under a bit of scrutiny lately, as many unscrupulous individuals began taking advantage of borrowers. Because of this, some jurisdictions have imposed strict usury limits on the annual percentage rates that can be charged. Other jurisdictions have banned the practice of payday lending all together, while still others do not police the industry at all. Since the nature of payday loans is very short-term, there can be a significant difference between the annual percentage rate (APR), and the effective annual rate (EAR). This is due to the fact that EAR compounds the interest, which can cost a great deal more to repay.Payday loans are typically issued through a retail outlet. The money is issued immediately with no background or credit checks, and is due in full at the time of the borrower’s next paycheck (typically a term of no longer than two weeks). The finance charges on these loans are quite high and can be anywhere from fifteen to thirty percent of the amount borrowed for the two week period. This ends up calculating out to be an APR of anywhere from 390 to 780 percent. Terms are set in place by the borrower writing a postdated check to the lender for the full amount of the loan plus the applicable fees. When the loan is due to be repaid, the borrower is to return to the store to repay the loan in person, or else the lender will cash the postdated check.In the event that the person does not return to the store to pay, and the postdated check bounces, the borrower will face extra fees from their bank, extra fees and interest charges from the lender, on top of the original amount owed.Payday lenders take steps to minimize their risks, such as requiring the borrower to bring multiple pay stubs in as proof of steady income. Bank statements may also be required.In addition to retail locations, the internet is now one of the easiest places to seek a payday loan. In these cases, a borrower fills out an online application that provides personal information, employer information, and bank account numbers. Copies of paychecks, bank statements, and signed paperwork must also be faxed. Once completed, the loan is direct deposited into the borrower’s checking account and the loan amount along with finance charges is electronically withdrawn when the next payday occurs.To give you a better idea of how the process works, let’s take a look at an example. A borrower needs to borrow $500 for two weeks. The lender agrees to issue the funds as long as the borrower writes a postdated check for $575 (the $500 borrowed, plus $75 interest charge at a rate of 15%). The lender then agrees to hold the check until the borrower’s next payday or until two weeks has elapsed. When two weeks is up, the borrower must repay, have their postdated check cashed, or renew the loan. If you renew the loan the lender will add another fee to the loan amount outstanding and give you another two weeks to pay it.While it can be high, the pricing structure of payday loans is quite straightforward. Lenders often defend their high rates by providing the argument that processing costs for such loans are often much higher. Since most financial institutions do not offer conventional loans for such low dollar amounts, they must keep prices high in order to recoup their own loan processing costs.

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