A payday loan is a short-term loan without a credit check that is intended to bridge the borrower's cashflow gap between paydays. Typically, a payday loan may be for $500 or so. A payday loan allows customers to get cash for a short time period against their next paycheck. A customer with an active checking account, direct deposit and a job can receive funds in their account within a short time. The loan is typically given in cash and is secured by the borrower's post-dated check that includes the original loan principal and accrued interest. The maturity date usually coincides with the borrower's next payday. On the maturity date, the lender processes the check traditionally or through electronic withdrawal from the borrower's checking account. Payday lenders typically operate small stores or franchises, but large financial service providers also offer variations on the payday advance. Payday lending is the subject of controversy, due to its high interest rate. Some critics claim that payday lenders target the young and the poor, those near military bases and in low-income communities, who may not understand the time value of money. Others go further, comparing payday lenders to loan sharks due to high interest rates-- typically 250% or more when annualized. It is argued that the interest rates on payday lending unfairly hurts the poor, compared to the middle class who pay at most 25% or so on their credit cards. Defenders of the higher interest rates note that payday loan processing costs do not differ much from their higher-principal, longer-term counterparts such as home mortgages. They argue that conventional interest rates at these lower dollar amounts and shorter terms would not be profitable. They also argue that the interest on a payday loan is less than the costs associated with bounced checks or late credit card payments. They also argue that the interest cost accurately reflects the increased risk of default, a concept known as risk-based pricing. |
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