Payday Loans

Wednesday, November 3, 2010

A payday loan is a small, short-term, high-rate loan. Payday loans are not issued by banks. They are issued by businesses. These businesses can generally be found in poor neighborhoods and near military bases. The U. S. Federal Trade Commission is recommending consumers to avoid payday loans. They are not a good idea. Here is how they work…

A person who needs a payday loan writes a personal check payable to the lender. The amount of the check is the amount to be borrowed PLUS the borrowing fee set by the lender. The lender then gives the borrower the amount to be borrowed (not the amount on the check). The check is not cashed until the agreed upon date. This date is usually the borrowers next payday which is in two weeks. This can be set up electronically if the borrower prefers.

If the borrower has the amount due in their checking account on the set date, then the loan is closed out. However, if the money is not in the account then begins the trouble. If the borrower’s bank allows overdrafts the check is cashed and the loan is closed. But now the borrower is overdrawn and may need another loan!

If the borrower’s bank does not allow overdrafts then one of two things will happen:
1) The borrower may ask the lender to extend the loan and not cash the check. The new amount due is the amount borrowed PLUS TWO borrowing fees.
2) The check bounces and there is now the bank fee for the borrower. In this case there is the check bounce fee and the new amount due is the amount borrowed PLUS TWO borrowing fees.

Now…there is a second chance to pay off this loan. The new date for collection is the borrower’s next payday. If the borrower has the new amount due in their checking account on this new date, then the loan is closed out.

However, if the money is not in the account the trouble grows. One of two things will happen:
1) The borrower may ask the lender to extend the loan and not cash the check. The new amount due is the amount borrowed PLUS THREE borrowing fees.
2) The check bounces and there is another bank fee for the borrower. In this case there is another check bounce fee and the new amount due is the amount borrowed PLUS THREE borrowing fees.

This can continue for quite some time. It is a vicious cycle. It is a cycle that is happening every day to regular people. It is a cycle that lenders are enjoying tremendously.

An example is that you borrow $100 with a $15 borrowing fee. This means you write a check, post dated to your next payday, for $115. You receive $100. That is 15% interest which is better than most credit cards. If you do not have $115 in your checking account by the set date and your bank will not allow overdrafts, then you ask to extend the loan. You now owe $130. That is 30% interest which is worse than most credit cards. If this happens a second time you will owe $145. That is 45% interest which is unheard of with any credit card. If you are paid every two weeks and this happens to you six times, which is less than three months, you owe $205. That means you are paying $105 in interest to borrow $100. This is not good.

Things happen and there are going to be times that you need cash fast. There are many steps you can take before you resort to a payday loan. Look into overdraft protection plans on your checking account. Get a pay advance form your employer. Borrow from a friend or family member. Check into a signature loan from your bank or credit union. Sell something. Get a second job. Find out about emergency hardship programs in your area.

The best thing you can do for yourself is have things in order before this becomes an issue. Build an emergency cash fund. Keep an open credit card for emergencies only. Above all build yourself a healthy credit score so that you can borrow at low rates when you really need it.