What Are Payday Loans?

Posted by Nick Niesen on November 8th, 2010

Payday loans are also called cash advances, and are relatively small (usually not for amounts exceeding $1,500), short-term loans that do not require credit checks. They are available to borrowers who are a little short on cash and are looking to bridge the gap between pay days. They are especially attractive to people who have immediate cash needs due to certain emergency situations, such as a car repair or necessary medication.

Cash is given to the borrower, who gives the lender a post-dated check for the loan principal plus a loan fee, along with any accrued interest. The maturity date on the loan will typically be the borrower?s next pay day, which is when the lender will process the check.

Payday loan lenders are normally found in small shops or franchises, but can also be found at large financial institutions who will offer variations of payday loans.

If a borrower takes out a payday loan for $100, they will write a post-dated personal check for $115, which includes the principal balance and the loan fee. The borrower will receive $100 in cash. The lender will hold this check for up to two weeks, at which time the borrower will be given the option to either redeem the initial check for $115 in cash or to roll-over or refinance the check by paying a fee that will extend the loan for another two weeks. If the borrower does not roll-over the loan, the lender will deposit the $115 check. If the borrower refinances the loan three more times, they will have to pay an additional $15 for each roll-over, or in other words, they will be paying $60 to borrow $100.

Payday loans are a sore subject for some, and have become a source of controversy. Critics say that these loans are targeted at people who do not understand the concept of the time value of money, and say that payday lenders are no different to loan sharks since the interest rates are excessively high. In most cases, the APR on these loans will exceed 250%. In the example above, the $15 fee is equivalent to a 391% APR.

Though payday loans are a convenient source of immediate cash for short-term needs, it goes without saying that potential borrowers should beware of making continuous roll-overs, and that the APRs they pay may be quite a bit higher than APRs they might be able to find on a common credit card.