Payday Loans - The Facts
You've probably seen the ad slogans from payday loan companies - "Get up to $500 before your next payday!" "Get up to $1,000 within minutes!" "No faxes or credit checks necessary!" Going beyond the slogans, there is a lot you need to know about payday loans to decide if one is right for you.
Whether they're called payday loans, post-dated check loans, deferred deposit check loans or cash or check advances, each of these are short-term high interest rate loans. These loans are designed for consumers with a Fair Isaac and Company (FICO) credit score below 620, which disqualifies them from most mainstream sources of credit or bank loans at competitive interest rates. These consumers fall into the subprime credit category and are considered more likely to default on a loan.
Before the subprime payday loan industry emerged, borrowers with poor credit or no credit often had nowhere to turn to get credit during a fiscal crunch. "Loan sharks" were some borrowers' only alternative, charging illegal and outrageous interest fees and using any means necessary to collect their debts. This often endangered much more than a borrower's finances.
See also our advice from the FTC on Payday loans.
Today, payday loans may be a subprime consumer's only realistic alternative in a cash crunch. Even if your credit is good, mainstream lenders may deny you credit in some circumstances. Payday loans may also be a resource for borrowers with very low or unreliable income, who possess little if any tangible assets.
As of 2005, there are close to 100 million payday loans issued every year. This explosion in subprime lending has resulted in more than 24,000 payday loan companies being established in stores, check cashing businesses and pawn shops throughout the U.S. Even people who don't fall into the subprime credit category use payday loans on occasion.
If used appropriately, payday loans are an extremely useful tool that can help you cope with short-term cash flow needs caused by unexpected emergencies that stretch your finances to the breaking point. Car repairs, illnesses requiring medical attention and money needed for an unexpected trip are all possibilities you may not have extra funds set aside for.
Even the possibility of bouncing a check or making a late credit card or utility bill payment could send you looking for a payday loan. One missed credit card payment could put a black mark on an otherwise excellent credit report and too many bounced checks could result in expensive penalty fees as well as your bank account being closed. A payday loan is a much better alternative.
Payday loan companies are very discrete and don't do credit checks or report with the top three national credit bureaus. Unfortunately, this means that successfully paying off your payday loan will not improve your credit rating. Some payday lenders utilize the TeleTrack reporting service to check if subprime borrowers have any outstanding debts from other payday loan companies.
Qualifying for a payday loan is usually very easy to do. Traditionally, payday lenders required you to mail or fax a blank check, most recent bank statement and your most recent pay stub from your employer. Some lenders also required a copy of your driver's license and telephone bill.
With many online payday loan companies you can find out if you're approved for a payday loan within a matter of minutes after your income and employment information is verified. Many of these lenders no longer require you to fax or mail in any forms. If you provide a payday loan company with your checking account number and a valid routing number you can have money wired into your account within an hour of approval. If your loan is approved after hours the money you need will be transferred the next business day.
Many payday lenders will approve you for anywhere from $100 to $1,500. It is important to take out no more than you need or you may end up paying a lot more in fees in the long run.
Loan fees usually cost $10 or more per $100 advanced. You should also take into consideration the Annual Percentage Rate (APR) and finance charges before getting a payday loan. As always, shopping around will get you the best rates.
Being an unsecured loan, payday loans often have very high APRs, which could potentially range anywhere from 390 to 780 percent. In some states, payday lenders issue loans with APRs above those allowed by state law. Since payday loans are intended for occasional short-term use, these companies are often exempt from these laws. It is a violation of the Federal Truth in Lending Act (TILA) for payday lenders not to disclose the APR of each payday loan they issue. You have a legal right to know how much you're paying for credit.
Payday loans are often to be paid back in two week increments. If you can pay off your payday loan at the end of this period you will save a lot of money that would have otherwise went toward expensive interest payments.
Payback almost always has to be arranged in advance. Some payday lenders will have you write a postdated check for the loan amount and all fees, for cashing on your next payday. Many payday lenders will electronically deduct the loan amount and fees from your bank account on your next payday. Many payday lenders will automatically charge you the refinance charge on your next payday unless you tell them to do otherwise.
If you can't afford to pay back the loan at the end of the loan period you'll have to rollover the loan. Rollovers take place when borrowers renew their loans for another loan period with additional fees tacked onto the price of the loan. If you don't have enough money to pay off your payday loan you could end up spending more than 10 times the amount of the payday loan by the time you finally pay it off.
Although payday loans are intended for occasional use when emergencies arise, many consumers who take out payday loans are not able to pay back the loans quickly, rolling over the loan several times or taking out more payday loans. This creates a dangerous cycle of debt that could bury you financially.
According to the Center for Responsible Lending, 91 percent of all payday loans are made to borrowers who take out five or more payday loans a year. Estimates at the standard rate of default for payday loans range from 20 to 25 percent.
If you default on your debt, you may end up owing much more than the original loan amount. You could also overdraw your bank account, which will likely result in overdraft fees or even lead to the closure of your account. If you don't want a payday lender to withdraw money from your bank account electronically don't give them access to the account. According to the Electronic Funds Transfer Act, giving a payday lender electronic access to your account is not legally a condition for being provided credit.
In some states, however, payday lenders can sue you if you default on your debt and your wages could end up being garnished until your payday loan is paid off. Some payday lenders have even filed criminal charges against borrowers who aren't able to repay their payday loans.
As with any type of loan, payday loans have their own unique pros and cons. If you use a payday loan wisely, you'll have an excellent source for emergency funds. If you use one poorly, you may ruin your credit and ending up in much worse financial shape. Weighing your options carefully will help you get the most bang for your buck out of a payday loan.
John Campbell is the writer and editor of CashBuzz, A financial portal for the rest of us. Check out http://www.cashbuzz.com for the latest articles on money management and tips and tricks that can help improve your finances.
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