Payday Loans: The Controversial Issue
A payday loan is a short-term loan with a high interest rate. Here's how a payday loan works:
A consumers writes a post-dated check to a payday lender and receives a cash loan. The lender makes money by adding a fee which is included in the total amount to be repaid when the borrower gets his or her next paycheck. The payday lender does not extend credit to the borrower.
Payday loans are also know as cash-advance loans, check-advance loans and post-dated check loans.
History of Payday Loans
Many states in the US have usury laws. These laws forbid interest rates from exceeding a certain APR (varies by state.)
Passed in July 1996, Senate Bill 1959 opened the door for payday loans. The justification was that there was a need for small emergency loans with no strings attached. Many banks were closing during this time due to merges, making it difficult for consumers to acquire bank services. Banks were not interested in originating $100 -$500 non-secured loans.
Payday loan companies have successfully gotten around usury laws in many states by establishing relationships with nationally charted banks based in payday-loan-friendly states where usury laws either don't exist, or exist but are lax.
The Center for Responsible Lending claims that 91% of payday loans are used by people fast-cash borrowing five or more times per year. In 1990, there were 12 payday loan companies in the US. By 2001, there were 14,000. In the United States, payday loan companies account for approximately $5 billion of economic activity each year, often at the expense of the financially vulnerable individuals and families.
Payday Loans: Positive Aspects
- Quick and Easy
The loan process consists of a short application with relatively easy qualifications. If money is needed to pay a bill today, a cash-strapped consumer can pay an important bill within minutes of walking through the doors of the payday lenders office (or, the case of an online application, cash is usually wired into the borrower's bank account and is accessible the next business day.)
Though payday lending is often vilified as legalized loansharking, many consumers who have exhauster all other options can get access to emergency cash from a payday lender, cash that can be used for food, life-saving drugs or a rent payment. Bottom line: it's easy to be a critic when you don't have an eviction notice on your door and your family is well fed.
The process of obtaining a payday loan only requires an active checking account, a job with a minimum monthly income, and proof of residence. A typical loan from a typical bank often involves hours of filling out long application forms, information verification and basing your creditworthiness on your credit score.
Some payday loan companies offer the convenience of applying online. The money can be deposited into your account the next day without any hassle or ever having to leave home. Compared to other financial transactions, like making credit card payments online, payday loans are actually quite secure.
In the event that financial constraints prevent a borrower from paying back the loan by his or her next payday, many payday lenders allow borrowers to extend the term of the loan. This is also called "rolling over" the loan.
Payday Loans: Negative Aspects
Payday loans are negative in the following ways:
- High APRs and Interest Rates
Interest rates on payday loans are invariably much higher than 100%. For example, a $100, two-week payday loan with a $15 charge will yield a 390% annual percentage rate (APR.) The APRs and interest rates associated with payday loans are typically much higher than loans offered
by traditional banks and credit unions.
A two week repayment period is typical for a payday loan; some offer a four week repayment term, so as to accommodate employers who pay on a monthly basis. If the borrower experiences financial hardship within the two or four week repayment window, or is simply an irresponsible borrower, he or she is still expected to repay the debt in full. Late fees can accumulate and make the loan double or triple the original loan amount. Unlike bank loans that offer several months to several years to pay back a loan, payday loans have short repayment times.
Payday loans are extremely convenient, easy to obtain and easy to rollover (rolling over is when a borrow extends or renews a payday loan.) It's easy for a borrower to get hooked on payday loans and get stuck in a virtually insurmountable debt trap. This can easily snowball into a mountain of high-interest debt.
Payday Loan Reform Act
The Payday Loan Reform Act was passes on February 26, 2009 to amend the Truth in Lending Act requiring additional disclosure requirements and other protections for consumers. The stipulations of the Payday Reform Act follow the last section of the Truth in Lending Act. Here are a few highlights:No lender can make a loan to a consumer unless:
Lawmakers believed that lenders were providing deceptive information to consumers. Congress felt that if consumers had a clear understanding of what they were getting into, they would not renew their loans.
New rules, as a part of the consumer protection agency currently being constituted by Congress, aim to protect families from predatory practices perpetrated by all types of financial institutions. The federal agency will protect individuals and families from financial abuse, and will investigates the financial marketplace on their behalf. If created, the new financial protection agency will be responsible for setting forth consumer-friendly terms, policies and language regarding mortgages, credit cards, auto loans, overdraft fees, financial literacy and alternative financial services. Proposed rules that would affect payday lenders include:
- limiting borrowers to 6 payday loans in a 12-month period,
Payday Lending Stats
Statistics indicate that payday loans target minorities. 51% of those who use payday loans make less than $10,000 per year. 53% of payday loan users are Blacks and Hispanics. The Southwest Center for Economic Integrity reported that 83% of payday loan companies are located less than one-fourth mile from high/medium stress areas as opposed to 69% of banks and 56% of credit unions.
The Bottom Line
There are an equal number of risks and benefits with payday loans. The important thing is to borrow responsibly if you have no other options. Before going to a payday lender for a loan, ask friends or family for help. Another option many overlook is getting assistance from their church, mosque or synagogue. Sell stuff on eBay or to a pawn shop.
Category: Payday loans