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Guide to Payday Loans

What is a payday loan?

Payday loans, also known as "cash advance", "check cashing", "payroll advance" or "deferred deposit" loans, are designed to help you get emergency cash when your paycheck runs out but you still have expenses to cover. The idea is that you will pay the loan back as soon as you get your next paycheck.

Payday loans don't require a credit check since they rarely exceed $1,000. However, the lender usually requires a pre-dated check or debit authorization to help secure their chances of getting paid back. This means the borrower needs to have a checking account.

How do payday loans work?

If you want to obtain a payday loan, find out how much you need and how much the lender is willing to loan you. When you've established the amount, you write a post-dated check for that amount, plus the set finance fee, to the lender. The lender will then advance you the check amount (less the finance fee) for a certain amount of time, typically 2 weeks to 30 days, depending on when your next paycheck comes. At the end of the period you pay the lender the amount on the post-dated check by authorizing them to cash it. If you do not pay the debt in full at the end of the time period, you will be charged additional finance charges and fees.

Some lenders, especially those on-line, only do electronic transactions. You give them electronic access to your bank account. That's a whole other issue.

What are the pros and cons of payday loans?

If you don't have money saved, credit cards or access to cash from other sources, then a payday loan could be your saving grace in the event of an emergency. If it is a one-time deal and you are able to pay the loan back without incurring huge finance charges, then this type of loan could help get you out of a bind. But, it is crucial to get the loan paid off by the end of the set period.

The problem is, most borrowers don't. They simply don't have enough from their next paycheck to make regular monthly expenses in addition to paying off a high interest loan. This is where payday loans get dangerous. The more time that passes, the more the borrower will be paying in interest and other charges. Interest rates on payday loans are also much higher than other loans or forms of credit. When you look at annual rates, payday loans are in the 3 digits. In fact, the average payday loan carries an APR of 400%. Compare that to a credit card where the standard rate is 7%; even higher rates of 20% are still no comparison to payday loan rates.

This is how payday lenders stay in business. They know how difficult it is for borrowers to pay back these loans; which continues a cycle of re-borrowing month after month while incurring astronomical fees.

Shouldn't this be illegal?

Due to, what is considered, such a high rate of abuse in the payday loan industry, some states ban these types of loans all together. Other sates have very specific laws that regulate the amount the lender can lend and the fees assessed. Federal agencies are cracking down on pay lenders by imposing tougher standards. One area that is being more closely monitored is proving the borrowers ability to repay the loan.

You still need to be careful as many payday lenders find ways to get around these regulations by partnering with banks in other states that don't have as many restrictions. You can research your own states usury laws and learn your consumer rights.

Alternatives to payday loans

Payday loans truly should be avoided much like loans from the mafia. Consider these other options before signing with a payday lender:

  • Negotiate with your creditor. Ask to either delay payment or work out an affordable payment plan. You could even try asking for a reduced amount.
  • Use a credit card (if you have one). You could also use the cash advance option on your card.
  • Ask your employer for an advance.
  • Obtain a line of credit from an FDIC approved lender
  • Apply for a small personal loan.
  • Borrow money from a friend or relative.
  • Rob a bank, go to prison, pay restitution (it's cheaper, takes less time and money)
  • Have a trusted friend beat you on the head until the feeling passes
  • Sell one of your internal organs on the black market
  • (Okay, the previous 3 items were jokes, but you get the point, right?)

If you have exhausted all other options and you have to go with the payday loan, be sure you completely understand all of the terms and what it will cost you before you apply. Shop around for a reputable lender who offers lower rates and fees. Borrow only what you absolutely need and what you know you can pay back with your next paycheck. As soon as you get paid, make paying back the loan your first priority.