A payday loan can best be described as a cash advance which will be issued against your next paycheck. Therefore, the money is typically advance for a relatively short period of time, it is often limited to just a few hundred dollars, and it must be repaid on a set date. A payday loan will generally need to be repaid within 2 to 4 weeks, although this will depend on whether you are paid fortnightly or monthly, and most lenders will not wish to issue a loan any greater than $1500.
The vast majority of lenders will either ask for a post-dated check or the borrower will need to authorize a direct payment from their bank account for repayment purposes. Therefore, it is advisable that a consumer only borrows money if you are sure they can repay it within the set period, and that they can easily budget for this.
Payday lending in general has received a lots of bad press over the years, and they are notorious for being extremely expensive. In fact, many borrowers are amazed by the hidden costs of payday lending when it comes to repaying the money that they have borrowed. The fees and charges that a borrower should be aware of will include a setup fee, which is often referred to as an application fee or brokerage fee.
This fee will vary depending on and term of the loan, and it is recommended that you check with your lender to ensure that you know exactly what these fees are beforehand. The most confusing aspect of payday lending is how interest rates are set, and this is typically what will cause a borrower the most problems. A prime example of this will be a lender offering a payday loan with an interest rate of 20% for the term. Now 20% isn’t the greatest deal for a loan, but it also isn’t the worst.
However, the 20% interest rate quoted will merely be for the actual term of the loan, and therefore if we were to calculate an equivalent annual percentage rate, the actual interest charges are a lot higher. Let’s imagine that a borrower takes out $1000 payday loan with an interest rate of 20% for the term of four weeks. As there are 52 weeks in a year, we would need to multiply the interest rate offered by 13 to produce an equivalent annual rate. Therefore, what originally seemed like a good deal is now actually pretty horrendous, as the annual percentage rate of this loan would be 260%.
You should also be aware that if you fail to repay the loan by the due date, you will typically be charged an extremely high default fee or even a very high rate of interest until you’re able to repay the loan in full. This, unfortunately, can become a vicious circle for many borrowers, as they find that by the time payment is due they are no longer able to repay the money. The payday loan will then effectively be “rolled over” and additional interest will be charged.
It is not unheard of for a borrower to continue rolling over their payday loan for an entire year, but this will eventually cost them 2 to 10 times the initial loan value, although this will depend on the interest rate being charged. Another practice that consumers should be aware of is payday lenders offering no interest payday loans. This is generally a very clever marketing ploy to entice customers who are in desperate need of cash.
If a payday lender is not going to charge any interest on a short-term loan, the likelihood is that they will charge a much higher upfront fee in place of the interest. This upfront fee could quite easily be far more than a very high interest rate being charged for a two or four week period, but the customer is taken in by the fact that they are told that their loan will have no interest charged.
Another practice that consumers should be aware of is a lender who appears to be extremely easy-going when it comes to repaying your loan. Rather than spelling out the obvious disadvantages of rolling over a payday loan, they will simply advise you to take out a new loan.
This will generally mean that the new loan will be made up of your previous balance plus interest charged, and therefore the second loan will usually be higher than the first. However, in addition to this you are likely to be charged yet another loan setup fee, which merely escalates the amount of fees and charges that you will have to repay.
It must be said that a payday loan can be an extremely convenient solution if you have a temporary cash flow problem. However, with that said, if you do not fully understand the fees, charges and interest rates that you’re being offered, you may find that you are even worse off financially once you have taken out a payday loan.