How Payday Loans Work

A payday loan is a service to solve your short-term financial emergencies. Payday loans are granted based solely on the borrower's identification check, which is held for a future deposit or electronic access to the bank account of the borrower. In order to obtain a payday loan an individual should write a check for the total amount of the loan plus the finance charge. On settling of these commitments the borrower is provided cash. Sometimes, borrowers sign over the right for the lender to electronically access their bank accounts in order to receive and pay off the money for payday loans. The moneylender holds the check until the customer's next payday, when the loan and the fees must be fully paid. Borrowers chooses whether to allow the lender to deposit the check, redeem it for a cash payment, or pay the finance charge and roll the loan balance over to another pay period.

Payday Loan Cost

State law outlines the maximum amount that you can borrow as well as the repayment schedule. For example, Montana limits cash advance takeouts to $300, while Illinois has a higher cap at $1000. These loans are typically given for a two-week period. Interest rates vary from about 390% to 780%, with 470% being the average annual interest rate. This amounts to fees per $100 of $10 to $30, in most cases. Remember that the shorter the terms of the loan are the more you have to pay.

If compared to other cash loans, payday loans are considerably more expensive. For example, a $300 cash advance from an average credit card has a finance charge of $13.99 for one month, which amounts to an annual interest rate of about 57%. A payday loan for the same amount costs $17.50 for each $100, or $105 if renewed one time. This can add up to 426% annual interest.

How to Obtain a Payday Loan

To get a payday loan all you need to do is to fill out a form. Obtaining this sort of loan does not involve credit check. The loan is approved based on the belief that you have valid bank account, a reliable source of regular funding and proper identification.

Payday Loan Lenders

There are a great number of companies which provide payday loans such as payday loan stores, pawnshops, and check cashers. Some rent-to-own products companies also make payday loans. Nowadays the internet has become another large source of payday loans. Sometimes they are marketed through toll-free phone numbers.

According to CLR report the United States accounted for around 25,000 payday loan outlets in 2006. The total annual loan volume came up to at least $28 billion. The loan fees, in turn, reached as much as $5 billion.

Legal Status for Payday Lending

Payday lending is currently regulated or authorized in thirty-six states and the District of Columbia. After passing this type of legislation on June 1, 2006, Michigan has become the most recent state to have licensed loans. Licensed loan lenders are allowed to award payday loans in two other states.

There are two territories and twelve states, which have not passed the laws to authorize loans. Maine does not have industry legislation at this time. However, supervised lenders in Maine can choose to use a fee structure that allows some payday lending.

How to Avoid State Small Loan and Usury Laws

There are shady dealers who conceal loans through sham tactics, such as, for instance, Internet access with rebate schemes. In Texas there are many loan lenders or so-called "Credit Service Organizations" which are unregulated. Such organizations can evade the limits set by the Texas Finance Commission and the state's small loan laws. The Federal Deposit Insurance Corporation is striving to stop many banks from "renting" charters to help payday lenders work in states where it is not legal to do so.

Borrowing Cycle

Payday loans can trap a borrower into a repeat borrower cycle. This may happen because payday loans have an extremely high cost, short tern for repayment and strict and serious consequences in case the borrower fails to make duly repayment. The average amount of loans that consumers make with the same lender varies between eight and thirteen. One state has nearly 60% of all its loans made as same day renewals, or new loans that are obtained as soon as the borrower has repaid the previous loan.

Checks Cost and Risk

The checks written by a borrower to secure a payday loan are not covered by any funds in his bank accounts. This means that these checks bounce when the customer does not pay, resulting in fees from the borrower's bank and the lender. Moreover, returned checks have a negative impact on the consumer's credit card history. If there are too many bounced checks recorded on the account (especially if they were used to get payday loans), borrowers can even lose their personal bank accounts.

Coercive Collection

As lenders have consumers' personal checks to secure loans, some of them may use coercive collection tactics. Sometimes criminal penalties are threatened for those who cannot make good on checks. Military personnel may be threatened with a court martial in case they do not pay their payday loan checks. In some states lenders are allowed to sue for multiple damages for bad checks.

Payday Lending over the Internet

Though internet is a very convenient method to apply for a loan, it adds the risk of security breaches and fraud. When a borrower takes the payday loan over the internet, he or she fill out a form online and then the money is remitted directly to his or her account electronically. They are also electronically withdrawn on the following payday. Many Internet payday loans renew automatically each payday, and the lender automatically withdraws the finance charge from the borrower's account electronically.