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A payday loan or check cash advance is a small, short-term loan that is intended to cover a borrower's expenses until his or her next payday. Typical loans are between $100 and $1500, on a two-week term and have interest rates in the range of 390 percent to 900 percent (APR). The loans are also sometimes referred to as cash advances, fast cash advance, online cash advance, payday loans, deferred deposit. There are many other names but for the most part if you Googled, Yahoo’d or MSN’d these words, they would take you to the cash advance companies online that spend millions every day to make sure they are on the top of the results.
Lenders say these loans are often the only option available to consumers with bad credit or who cannot get a bank loan, credit card, or other lower-interest alternatives. Critics counter most borrowers find themselves in a worse position when the loan is due than they were when they took the loan, with many getting trapped in a cycle of debt. Payday loans aren’t the problem. It is the borrowers who abuse the system and outright have no intention of paying back the cash advance, payday loan. With the fees that are charged, a lender would have to rollover the fast cash advance, payday loan, online cash advance at least 6 times just to get the money back that the fraudster, or deadbeat customer took. That doesn’t include operating costs and advertising costs either. If you add those in, it may take up to 10-15 rollovers just to break even on that bad customer.
Borrowers visit a payday lending store and secure a small cash loan, usually in the range of $100 to $500 with payment in full due at the borrower's next paycheck (usually a two week term). Finance charges on payday loans, cash advances are typically in the range of $15 to $30 per $100 borrowed for the two-week period, which translates to rates ranging from 390 percent to 780 percent when expressed as an annual percentage rate (APR). The borrower writes a post-dated check to the lender in the full amount of the loan plus fees. On the maturity date, the borrower is expected to return to the store to repay the loan in person. If the borrower doesn't repay the loan in person, the lender may process the check traditionally or through electronic withdrawal from the borrower's checking account.
If the account is short on funds to cover the check, the borrower may now face a bounced check fee from their bank in addition to the costs of the loan, and the loan may incur additional fees and/or an increased interest rate as a result of the failure to pay. For customers who cannot pay back the loan when due, members of the national trade association are required to offer an extended payment plan at no additional cost. In states like Washington, extended payment plans are required by state law.
Payday lenders require the borrower to bring one or more recent pay stubs to prove that they have a steady source of income. They are also required to provide recent bank statements. Individual companies and franchises have their own underwriting criteria.
Internet lending
Online payday loans are marketed through e-mail, online search, paid ads, and referrals. Typically, a consumer fills out an online application form or faxes a completed application that requests personal information, bank account numbers, Social Security number and employer information. Borrowers fax copies of a check, a recent bank statement, and signed paperwork. The loan is direct deposited into the consumer's checking account and loan payment or the finance charge is electronically withdrawn on the borrower's next payday.
Examples
For example, a borrower seeking a payday loan may write a post-dated personal check for $460 to borrow $400 for up to 14 days. The payday lender agrees to hold the check until the borrower's next payday. At that time, the borrower has the option to redeem the check by paying $460 in cash, or renew the loan (a.k.a. "flip the loan") by paying off the $460 and then immediately taking an additional loan of $400, in effect extending the loan for another two weeks. In many states, "flipping" or "rolling over" the loan is not allowed. In states where there is an extended payment plan, the borrower could choose to opt into a payment plan. If the borrower does not refinance the loan, the lender may deposit the check. In this example, the cost of the initial loan is a $60 finance charge, or 390% percent APR.
Pricing structure of payday loans
Defenders of the higher interest rates say processing costs for payday loans do not differ much from other loans, including home mortgages. They argue that conventional interest rates for lower dollar amounts and shorter terms would not be profitable. For example, a $100 one-week loan, at a 20% APR would generate only 38 cents of interest, which would fail to match loan processing costs. The cost for operating a payday loan company is equal to that of other financial institutions. Cash advance, payday lending, fast cash advance, online cash advance are very expensive products to offer.
Critics say payday lenders' processing costs are significantly lower than costs for mortgages and other traditional loans. Payday lenders usually look at recent pay-stubs, whereas larger-loan lenders do full credit checks and making a determination about the borrower's ability to pay back the loan.
The Actual Profitability of Online payday lending is very small:
Ever company has operating expenses that must be covered. These costs lie in the range of advance fees” collected and that, after subtracting fixed operating costs and “unusually high rate of default losses,” payday loans “may not necessarily yield extraordinary profits.” Based on the annual reports of publicly traded payday loan companies, loan losses can average 36% or more of loan revenue. Underwriters of payday loans must also deal with people presenting fraudulent checks as security or making stop payments.
Critics concede that some borrowers may default on the loans, but point to the industry's pace of growth as an indication of its profitability. Consumer advocates condemn the practice as a whole, regardless of its profitability, because it "takes advantage of consumers who are already hard-pressed to pay their debts".
Proponents claim that cash advance loans provide a service that is not available from other sources. Many credit unions have attempted to offer similar products, but have been unable to do so without government subsidies or grants, a fact that many lenders and reports have highlighted. Furthermore, most of these programs offered by credit unions have ended due to the high default rates of lenders. No credit union in the country is going to show that they failed but I guarantee you there are a lot of credit union executives saying, “they are right to charge the rates they do, there is no way to make money on it or even break even without doing so.”
Alternatives to payday loans
Many believe that payday loans, cash advances, fast cash advances are the only option for consumers with bad credit, but other options do exist and most financial counselors would direct people to explore the alternatives. This story has two sides. Most customers who are borrowing from a payday lender and paying the rates they are paying for a payday loan, cash advance or online cash advance are doing so on their own volution. If a customer could walk over to a credit union and get $300 in 10 minutes, don’t you think they would be doing it? If they credit union was charging only 10% for a $300 payday loan or cash advance, they would not have any money left to lend because like payday lenders, cash advance companies, fast cash advance companies they would lose 50% of their revenue replacing bad loans. No bank or credit union in their right mind would try this product without the appropriate risk factored into the pricing of the cash advance or payday loan. There have been charity stories of a credit union in Alabama or New York that just received a grant of twenty million dollars to circumvent the payday lending, cash advance companies, fast cash advance companies or other types of payday lenders. They believe they have a better mouse trap and by offering these “short term” credit options with lower interest rates to consumers, it will keep these customers from getting payday loans.
This is wishful thinking. Customers of payday loan, cash advances, are typically not good customers for low interest loans because they like to spend money. Cash advance companies, payday loan companies, online cash advance companies offer a service, high interest credit for those who cannot get a loan anywhere else. These customers choose on there own recognizance to purchase this credit at that price. Consumer advocacy groups are taking a page out of Michael Creighton’s book. They are looking for money that follows an issue. The don’t have an issue that will bring in the money. These customers want this product. Georgia banned payday lending, cash advance companies from their state. Do you think this stopped Georgia customers from spending money in this fashion?
Other options are available to most payday loan customers. These include credit union loans with lower interest and more stringent terms edit payment plans, paycheck cash advances from employers, bank overdraft protection, cash advances from credit cards, emergency community assistance plans, small consumer loans and direct loans from family or friends.
Payday lenders do not compare their interest rates to those of mainstream lenders. Instead, they compare their fees to the overdraft, late payment, and penalty fees that will be incurred if the customer is unable to secure any credit whatsoever.
The lenders therefore list a different set of alternatives (costs expressed here as APRs for two-week terms):
- $100 payday advance with $15 fee = 391% APR;
- $100 bounced check with $48 NSF/merchant fees = 1,251% APR;
- $100 credit card balance with $26 late fee = 678% APR;
- $100 utility bill with $50 late/reconnect fees = 1,304% APR.
Other types of payday lending
A minority of mainstream banks offer advances for customers whose paychecks or other funds are deposited electronically into their accounts. The terms are similar to those of a payday loan; a customer receives a predetermined cash advance for credit available for immediate withdrawal. The amount is deducted, along with a fee, usually about 10 percent of the amount borrowed, when the next direct deposit is posted to the customer's account. After the programs attracted regulatory attention, Wells Fargo called its fee "voluntary" and offered to waive it for any reason. It later scaled back the program in several states. Wells Fargo and Bank of America are two of the biggest gainers for cash advances and payday loans in America. They just don’t call them cash advances or payday loans. Wells Fargo has been charging 8-10% for many years now. That is 8-10% for 1 day or 14 days. That could be an APR of 2400% or 240%. They haven’t scaled back in California. It is still quite a product there. |
