How Payday Loans Work- Know how can you apply for it and the cost involved

Payday loans- How do they work

The payday loans are fast cash for people who though have income but with bad credit and these loans are for typically small or less than $500. But payday loans are the most expensive way to borrow money. If the loan isn’t repaid in full on the first payday, a new finance charge is added and the cycle repeats. Within a few months, borrowers can end up owing more in interest than the original loan amount.

Because short-term lending is subject to a patchwork of state and federal laws, these loans look different in nearly every state. They may go by names such as cash advance, deferred deposit, deferred presentment, or credit access business.

Payday lending is legal in 27 US states, with 9 others allowing some form of short term storefront lending with restrictions. The remaining 14 and the District of Columbia forbid the practice.  

Some states have laws limiting the number of loans a borrower can take at a single time. This is currently being accomplished by single, statewide real time databases. These systems are required in Florida, Michigan, Illinois, Indiana, North Dakota, New Mexico, Oklahoma, South Carolina, and Virginia States Statues. These systems require all licensed lenders to conduct a real time verification of the customer’s eligibility to receive a loan before conducting a loan. Reports published by state regulators in these states indicate that this system enforces all of the provisions of the state’s statutes. Some states also cap the number of loans per borrower per year (Virginia, Washington), or require that after a fixed number of loan renewals, the lender must offer a lower interest loan with a longer term, so that the borrower can eventually get out of the debt cycle by following some steps. Borrowers can circumvent these laws by taking loans from more than one lender if there is not an enforcement mechanism in place by the state. Some states allow that a consumer can have more than one loan outstanding (Oklahoma). Currently, the states with the most payday lenders per capital are Alabama, Mississippi, Louisiana, South Carolina and Oklahoma.

States which have prohibited payday lending have reported lower rates of bankruptcy, a smaller volume of complaints regarding collection tactics, and the development of new lending services from banks and credit unions.

In the US, the Truth in Lending Act requires various disclosures, including all fees and payment terms. Payday lenders say their business gives millions of hardworking Americans access to desperately needed cash in an emergency. Consumer advocates point out that payday lenders only really profit when borrowers can’t repay their loan on time, a fact that motivates lenders to overextend credit, sinking borrowers into an escalating and dangerous spiral of debt.

For this reason, financial experts caution people to steer clear of payday loans, particularly if there’s any chance they can’t repay the loan immediately, and to seek out one of the many alternative lending sources available instead.

How do payday loans work?

Payday Loans- How do they work

According to consumer federation of America Payday loans are short-term cash loans based on the borrower’s personal check held for future deposit or on electronic access to the borrower’s bank account. Borrowers write a personal check for the amount borrowed plus the finance charge and receive cash. In some cases, borrowers sign over electronic access to their bank accounts to receive and repay payday loans.

Lenders hold the checks until the borrower’s next payday when loans and the finance charge must be paid in one lump sum. To pay a loan, borrowers can redeem the check by paying the loan with cash, allow the check to be deposited at the bank, or just pay the finance charge to roll the loan over for another pay period. Some payday lenders also offer longer-term payday instalment loans and request authorization to electronically withdraw multiple payments from the borrower’s bank account, typically due on each pay date.

Payday loans range in size from $100 to $1,000, depending on state legal maximums. The average loan term is about two weeks. Loans typically cost 400% annual interest (APR) or more. The finance charge ranges from $15 to $30 to borrow $100. For two-week loans, these finance charges result in interest rates from 390 to 780% APR. Shorter term loans have even higher APRs.  Rates are higher in states that do not cap the maximum cost.

What you need to get a Payday Loan?

To get a payday loan you need an open bank account in relatively good standing, a steady source of income, and ID proof. Lenders do not conduct a full credit check or ask questions to determine if a borrower can afford to repay the loan.  Since loans are made based on the lender’s ability to collect, not the borrower’s ability to repay while meeting other financial obligations, payday loans create a debt trap.

CFPB found that 80 percent of payday borrowers tracked over ten months rolled over or reborrowed loans within 30 days.  Borrowers default on one in five payday loans.  Online borrowers fare worse.  CFPB found that more than half of all online payday instalment loan sequences default.

  • You must be at least 18.
  • Lenders check a specialized consumer reporting agency to ensure that you don’t have outstanding payday loans, a wage garnishment or other judgment against you, or a history of bad checks or bankruptcy.
  • You can be rejected for a payday loan, despite having income and a bank account, for several reasons like if you don’t make enough money. Some lenders require as little as $500 monthly net income; some require more or you don’t meet their repayment requirements or you already have an outstanding loan or you are active-duty military. Federal law prevents payday lenders from making short-term loans at more than 36% APR to military members. Some lenders find ways around the law’s limits, but others exclude them as customers.
  • Also your loan may be rejected if you have a recent bankruptcy, recent bounced checks, have not been employed long enough or your bank account has been opened too recently.

Who offers Payday loan?

The Payday lenders offer these loans and are available by payday loan stores,  or at stores that sell other financial services, such as check cashing, title loans, rent-to-own and pawn, depending on state licensing requirements. Loans are made via online sites and cell phones.  CFPB found 15,766 payday loan stores operating  in 2015.

High cost payday lending is authorized by state laws or regulations in thirty-two states. Fifteen states and the District of Columbia protect their borrowers from high-cost payday lending with reasonable small loan rate caps or other prohibitions. Three states set lower rate caps or longer terms for somewhat less expensive loans.  Online payday lenders are generally subject to the state licensing laws and rate caps of the state where the borrower receives the loan.

Thirty-two states allow payday lending. Four states Maine, Utah, Wisconsin and Wyoming  cap the maximum loan amount. The highest cap is $1,000, in Delaware, Idaho and Illinois; the lowest cap is $300, in California and Montana. The most common cap is $500. A few states also limit each payday loan to no more than 25% of a borrower’s gross monthly income, if that’s less. Nevada and New Mexico cap each loans at 25% of the borrower’s gross monthly income rather than a fixed dollar amount. Details on state limits can be found here.

This doesn’t mean you’ll be approved for the highest amount allowed by law. A payday lender will consider your income, expenses and payday lending history to determine how much you can reasonably be expected to pay back. The industry has calculated that the average payday loan is $350 to be repaid in two weeks.

The cost of payday loan

Payday Loan- Cost

 

The cost to take out a loan varies by state and by lender. States that allow payday loans typically cap the maximum allowable interest at between $10 and $30 per $100 borrowed. The cost of a loan from a storefront payday lender is typically $15 for every $100 borrowed, according to research from the federal Consumer Financial Protection Bureau.

At that rate, a $350 loan the amount of the median storefront loan costs $52.50. When it’s time to repay, usually in two weeks, the total amount owed is $402.50. Online payday lenders tend to charge higher rates and often claim exemption from state rate caps. The CFPB found the median online payday loan cost $23.53 per $100 borrowed.

However, most loans are extended. Nineteen of the states that authorize payday lending allow lenders to roll over a loan, in which case the borrower pays only the interest fee and extends the loan for two weeks. He then gets a new, second interest fee tacked on. The remaining states don’t prohibit a borrower from taking out back-to-back loans, which has the same effect.

Most consumer loans are clearly labeled by annual percentage rate, which includes the total cost of fees and interest over a year. That $15 per $100 fee for a two-week loan effectively is a 391% APR. Annual percentage rate (APR) is meant to give you a way to compare the costs of any loans. It includes not just interest but any other required costs, such as origination fees or insurance.

The affect of payday loan on your credit

Payday Loan Infographic

Most payday lenders don’t check a borrower’s credit history or credit score with the big three credit bureaus TransUnion, Equifax and Experianto decide who gets a loan. Nor do they report on-time payments to the bureaus so that your credit scores improve.

So if you fail to pay the loan, the credit bureaus will likely hear about it and your credit score will be damaged. While the payday lender might not report a defaulted loan to the credit bureaus, the collections agency to whom the lender sells the defaulted loan could.

If the collections agency calculates there’s only a very small chance of the loan getting repaid, it may cut its losses and report the default to the credit bureaus immediately. If the agency has a shot at getting paid, it would likely hold off on reporting a missed payment to use it as leverage.

If  you cannot repay a payday loan, both storefront and online payday lenders will do their best to collect the money themselves first, because when they sell debts to collections agencies they get only a few pennies for each dollar of debt. The effort will happen on two fronts: Lenders will continue to try to withdraw money from your account, sometimes breaking amounts into smaller chunks to increase the chance the payment will go through. Each failed attempt can trigger bank fees against you.

Also the payday lenders will start calling you, sending letters from their lawyers, and even calling your personal references. Also lender may try to negotiate a settlement with you for some part of the money owed. Or can outsource the loan to a debt collector, a step that can happen in as little as 30 days. A debt collector, also known as a collections agency, will report to the credit bureaus and could file a civil suit, if the amount is large enough to warrant the expenditure. A court judgment against you remains public for seven years and can lead to seizure of your assets or a garnishment of wages.

Therefore always think twice before you opt to take a payday loan. If it’s extreme financial crunch then only go for such loan and also before you decide to take out a payday loan do consider some other alternatives to solve your money issues.

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