A payday loan is a not secured, short-term type of loan. The lender only requires employment records that accurately show previous payrolls. These types of loans are sometimes called cash advance loans and they have become increasingly popular amongst the lower income communities. Payday loans are convenient for lower sums as they offer a quick way to borrow money without dealing with the bank. For the people who do not have a good credit history, this is an excellent alternative and serves a purpose of having a financial lifeline. The downside is that proportionally to the amount borrowed, the interest can be quite high.
How does it work?
The lender is relying on previous records of the borrower’s employment and payroll history. The borrower usually posts a check dated a day or two after the expected payroll, and the amount is increased by a lender’s fee. Payday loans usually go from $100 to $2000 and a typical fee for a 14-day $100 loan would be around $10-15. Although this might sound fair to the borrower, this is actually a much higher fee than a bank would charge. But for the people taking these loans, this might be the only available option. And the risk of the loan completely falls on the lender, since there is nothing securing that the loan would be returned.
Payday loans are legislated in most of the states, but there are major differences that determine how viable this industry is. Some of the states limit the annual percentage rate that payday lenders can charge. There are a couple of states that specifically legislated short-term lending with strictly defined terms, but in most of the states, this is governed by the Uniform Small Loan Laws.
A couple of studies conducted by the Security and Exchange Commission showed that despite the risk involved in a single non-secured loan is high, the long-term risk for both sides is not higher than with any other types of loans or credit. There were some issues with predatory loan companies targeting low-income communities, but these are rare and have little to no effect to the legality of the industry.
Supply and Demand
This is not a new thing in the lending industry. Payday loans have been around for a while, but they had a bad reputation and not many people used them in fears of being ripped off. The recent economic downfall and the crash of the housing market in 2008 raised the demand for payday loans. The trust in banks decreased substantially, especially in the communities that were suffering the biggest consequences of the financial crisis. Lending companies recognized the opportunity and they started offering their services even outside the lower income communities. The competition in the industry resulted in better conditions for the borrowers and many people switched their credit cards for this type of loans. The number of payday loans has been on a steady rise since the start of the century and shows no signs of slowing down.