A payday loan (also called a payday advance) is a small, short-term unsecured loan, "regardless of whether repayment of loans is linked to a borrower's payday." The loans are also sometimes referred to as "cash advances," though that term can also refer to cash provided against a prearranged line of credit such as a credit card. Payday advance loans rely on the consumer having previous payroll and employment records. Legislation regarding payday loans varies widely between different countries and, within the USA, between different states.
To prevent usury (unreasonable and excessive rates of interest), some jurisdictions limit the annual percentage rate (APR) that any lender, including payday lenders, can charge. Some jurisdictions outlaw payday lending entirely, and some have very few restrictions on payday lenders.
There are many different ways to calculate annual percentage rate of a loan. Depending on which method is used, the rate calculated may differ dramatically. E.g., for a $15 charge on a $100 14-day payday loan, it could be (from the borrower's perspective) anywhere from 391% to 3733%.
Payday loans carry substantial risk to the lender; they have a default rate of 10–20%,[dubious ] with other sources citing 5% per month. According to one study, defaults cost payday lenders around a quarter of their annual revenue.
- 1 The loan process
- 2 User demographics and reasons for borrowing
- 3 Criticism
- 4 Proponents' stance
- 5 Country specific
- 6 Variations and alternatives
- 7 See also
- 8 References
- 9 External links
The loan process
The basic loan process involves a lender providing a short-term unsecured loan to be repaid at the borrower's next payday. Typically, some verification of employment or income is involved (via pay stubs and bank statements), although according to one source, some payday lenders do not verify income or run credit checks. Individual companies and franchises have their own underwriting criteria.
In the traditional retail model, borrowers visit a payday lending store and secure a small cash loan, with payment due in full at the borrower's next paycheck. The borrower writes a postdated cheque to the lender in the full amount of the loan plus fees. On the maturity date, the borrower is expected to return to the store to repay the loan in person. If the borrower does not repay the loan in person, the lender may redeem the check. If the account is short on funds to cover the check, the borrower may now face a bounced check fee from their bank in addition to the costs of the loan, and the loan may incur additional fees or an increased interest rate (or both) as a result of the failure to pay.
In the more recent innovation of online payday loans, consumers complete the loan application online (or in some instances via fax, especially where documentation is required). The loan is then transferred by direct deposit to the borrower's account, and the loan repayment and/or the finance charge is electronically withdrawn on the borrower's next payday.
User demographics and reasons for borrowing
According to a study by the Pew Charitable Trusts, "Most payday loan borrowers are white, female, and are 25 to 44 years old. However, after controlling for other characteristics, there are five groups that have higher odds of having used a payday loan: those without a four-year college degree; home renters; African Americans; those earning below $40,000 annually; and those who are separated or divorced." Most borrowers use payday loans to cover ordinary living expenses over the course of months, not unexpected emergencies over the course of weeks. The average borrower is indebted about five months of the year.
Research for the Illinois Department of Financial and Professional Regulation found that a majority of Illinois payday loan borrowers earn $30,000 or less per year.  Texas' Office of the Consumer Credit Commissioner collected data on 2012 payday loan usage, and found that refinances accounted for $2.01 billion in loan volume, compared with $1.08 billion in initial loan volume. The report did not include information about annual indebtedness. A letter to the editor from an industry expert argued that other studies have found that consumers fare better when payday loans are available to them. Pew's reports have focused on how payday lending can be improved, but have not assessed whether consumers fare better with or without access to high-interest loans. Pew's demographic analysis was based on a random-digit-dialing (RDD) survey of 33,576 people, including 1,855 payday loan borrowers.
In another study, by Gregory Elliehausen, Division of Research of the Federal Reserve System and Financial Services Research Program at The GWU School of Business, 41% earn between $25,000 and $50,000, and 39% report incomes of $40,000 or more. 18% have an income below $25,000.
Draining money from low-income communities
Many people who use payday loans are low-to-middle income people with few assets. These individuals are least able to secure normal, lower-interest-rate forms of credit. Since payday lending operations charge higher interest-rates than traditional banks, they have the effect of depleting the assets of low-income communities.
However, a report from the Federal Reserve Bank of New York concluded that, "We...test whether payday lending fits our definition of predatory. We find that in states with higher payday loan limits, less educated households and households with uncertain income are less likely to be denied credit, but are not more likely to miss a debt payment. Absent higher delinquency, the extra credit from payday lenders does not fit our definition of predatory."
Aggressive UK advertising practices
In May 2008 the debt charity Credit Action made a complaint to the UK Office of Fair Trading (OFT) that payday lenders were placing advertising on the social network website Facebook, which violates advertising regulations. The main complaint was that the APR was either not displayed at all or not displayed prominently enough, which is clearly required by UK advertising standards.
Aggressive collection practices
In US law, a payday lender can use only the same industry standard collection practices used to collect other debts, specifically standards listed under the Fair Debt Collection Practices Act. The FDCPA prohibits debt collectors from using abusive, unfair, and deceptive practices to collect from debtors. Such practices include calling before 8 o'clock in the morning or after 9 o'clock at night, or calling debtors at work.
In many cases, borrowers write a post-dated check (check with a future date) to the lender; if the borrowers don't have enough money in their account, their check will bounce.
Payday lenders will attempt to collect on the consumer's obligation first by simply requesting payment. If internal collection fails, some payday lenders may outsource the debt collection, or sell the debt to a third party.
A small percentage of payday lenders have, in the past, threatened delinquent borrowers with criminal prosecution for check fraud. This practice is illegal in many jurisdictions and has been denounced by the CFSA, the industry's trade association.
Pricing structure of payday loans
Issuers of payday loans defend their higher interest rates by saying processing costs for payday loans are proportionally higher than other loans, including home mortgages. They argue that conventional interest rates for lower dollar amounts and shorter terms would not be profitable. For example, a $100 one-week loan, at a 20% APR (compounded weekly) would generate only 38 cents of interest, which would fail to match loan processing costs. Research shows that on average, payday loan prices moved upward, and that such moves were "consistent with implicit collusion facilitated by price focal points".
Charges are in line with costs
A study by the FDIC Center for Financial Research found that "operating costs are not that out of line with the size of advance fees" collected and that, after subtracting fixed operating costs and "unusually high rate of default losses," payday loans "may not necessarily yield extraordinary profits."
Based on the annual reports of publicly traded payday loan companies, loan losses can average 15% or more of loan revenue. Underwriters of payday loans must also deal with people presenting fraudulent checks as security, ordering a check stopped, or closing their account.
Annual reports of publicly traded payday loan companies demonstrate the net profit margins of payday lenders are in the 10–12% range.
Opponents of excessive government regulation of payday loan businesses argue that some individuals that require the use of payday loans have already exhausted other alternatives. Such consumers could potentially be forced to illegal sources if not for payday loans. Tom Lehman, an advocate of payday lending, said:
- "... payday lending services extend small amounts of uncollateralized credit to high-risk borrowers, and provide loans to poor households when other financial institutions will not. Throughout the past decade, this "democratization of credit" has made small loans available to mass sectors of the population, and particularly the poor, that would not have had access to credit of any kind in the past."
Household welfare increased
A staff report released by the Federal Reserve Bank of New York concluded that payday loans should not be categorized as "predatory" since they may improve household welfare. "Defining and Detecting Predatory Lending" reports "if payday lenders raise household welfare by relaxing credit constraints, anti-predatory legislation may lower it." The author of the report, Donald P. Morgan, defined predatory lending as "a welfare reducing provision of credit." However, he also noted that the loans are very expensive, and that they are likely to be made to under-educated households or households of uncertain income.
Petru Stelian Stoianovici, a researcher from Charles River Associates, and Michael T. Maloney, an economics professor from Clemson University, found "no empirical evidence that payday lending leads to more bankruptcy filings, which casts doubt on the debt trap argument against payday lending."
Aid in disaster areas
A 2009 study by University of Chicago Booth School of Business Professor Adair Morse found that in natural disaster areas where payday loans were readily available, consumers fared better than those in disaster zones where payday lending was not present. Not only were fewer foreclosures recorded, but such categories as birth rate were not affected adversely by comparison. Moreover, Morse's study found that fewer people in areas served by payday lenders were treated for drug and alcohol addiction.
Payday loans in Canada are governed by their individual provinces, for example in Ontario 562% APR($21 per $100, over 2 weeks). Bill C28 supersedes the Criminal Code of Canada for the purpose of exempting Payday loan companies from the law. In addition, the provinces of British Columbia and Saskatchewan have imposed specific regulations on payday loans, including lower interest rate caps.
Payday loans in the United Kingdom are a rapidly growing industry, with four times as many people using such loans in 2009 compared to 2006 – in 2009 1.2 million people took out 4.1 million loans, with total lending amounting to £1.2 billion. The average loan size is around £300, and two-thirds of borrowers have annual incomes below £25,000. There are no restrictions on the interest rates payday loan companies can charge, although they are required by law to state the effective annual percentage rate (APR).
Payday lending is legal and regulated in 37 states. In 13 states it is either illegal or not feasible, given state law. When not explicitly banned, laws that prohibit payday lending are usually in the form of usury limits: hard interest rate caps calculated strictly by annual percentage rate (APR).
As for federal regulation, the Dodd–Frank Wall Street Reform and Consumer Protection Act gave the Consumer Financial Protection Bureau specific authority to regulate all payday lenders, regardless of size. Also, the Military Lending Act imposes a 36% rate cap on tax refund loans and certain payday and auto title loans made to active duty armed forces members and their covered dependents, and prohibits certain terms in such loans.
Variations and alternatives
Alternatives to payday loans
Other options are available to most payday loan customers. These include pawnbrokers, credit union loans with lower interest and more stringent terms which take longer to gain approval, employee access to earned but unpaid wages, credit payment plans, paycheck cash advances from employers, auto pawn loans, bank overdraft protection, cash advances from credit cards, emergency community assistance plans, small consumer loans, installment loans and direct loans from family or friends.
If the consumer owns their own vehicle, an auto title loan would be an alternative for a payday loan, as auto title loans use the equity of the vehicle as the credit instead of payment history and employment history.
Payday lenders do not compare their interest rates to those of mainstream lenders. Instead, they compare their fees to the overdraft, late payment, penalty fees and other fees that will be incurred if the customer is unable to secure any credit whatsoever.
The lenders therefore list a different set of alternatives (costs expressed here as APRs for two-week terms):
- $100 payday advance with a $15 fee = 391% APR
- $100 bounced check with $54 NSF/merchant fees = 1,409% APR
- $100 credit card balance with a $37 late fee = 965% APR
- $100 utility bill with $46 late/reconnect fees = 1,203% APR
Other alternatives include the Pentagon Federal Credit Union Foundation (PenFed Foundation) Asset Recovery Kit (ARK) program. Through the ARK program, the foundation has helped nearly 4,000 military families with over $1.6 million worth of emergency loans and financial counseling from the highly regarded Consumer Credit Counseling Service.
Variations on payday lending
A minority of mainstream banks and TxtLoan companies lending short-term credit over mobile phone text messaging offer virtual credit advances for customers whose paychecks or other funds are deposited electronically into their accounts. The terms are similar to those of a payday loan; a customer receives a predetermined cash credit available for immediate withdrawal. The amount is deducted, along with a fee, usually about 10 percent of the amount borrowed, when the next direct deposit is posted to the customer's account. After the programs attracted regulatory attention, Wells Fargo called its fee "voluntary" and offered to waive it for any reason. It later scaled back the program in several states. Wells Fargo currently offers its version of a payday loan, called "Direct Deposit Advance," which charges 120% APR. Similarly, the BBC reported in 2010 that controversial TxtLoan charges 10% for 7-days advance which is available for approved customers instantly over a text message.
Income tax refund anticipation loans are not technically payday loans (because they are repayable upon receipt of the borrower's income tax refund, not at his next payday), but they have similar credit and cost characteristics. A car title loan is secured by the borrower's car, but are available only to borrowers who hold clear title (i.e., no other loans) to a vehicle. The maximum amount of the loan is some fraction of the resale value of the car. A similar credit facility seen in the UK is a logbook loan secured against a car's logbook, which the lender retains. These loans may be available on slightly better terms than an unsecured payday loan, since they are less risky to the lender. If the borrower defaults, then the lender can attempt to recover costs by repossessing and reselling the car.
- Alternative financial services
- Community Financial Services Association of America
- Loan shark
- Predatory lending
- Poverty industry
- Wage slavery
- Overdraft protection loans
- Refund anticipation loan
- Settlement (finance)
- Title loan
- Logbook loan
- Mortgage discrimination
- Debt bondage
- Debt of developing countries
- Michelle Hodson ,fdic.gov, 18 November 2009, How Payday Loans Work
- Whereas the borrower treats the whole $15 charge as an interest, while in reality some of it may be fees (e.g., processing or origination) which cover fixed costs and don't provide return on capital to the lender.
- $15 on $100 over 14 days is ratio of 15/100 = 0.15, so this is a 14-day rate. Over a year (365.25 days) this 14-day rate can aggregate to either 391% (assuming you carry the $100 loan for a year, and pay $15 every 14 days: 0.15 x (365.25/14) = 3.91, which converts to a percentage increase (interest rate) of: 3.91 x 100 = 391%) or 3733% (assuming you take out a new loan every 14 days that will cover your principal and "charge", and every new loan is taken at same 15% "charge" of the amount borrowed: (1 + 0.15)365.25/14 - 1 = 37.33, which converts to a percentage increase (interest rate) of: 37.33 x 100 = 3733%).
- Megan McArdle,theatlantic.com, 18 November 2009, On Poverty, Interest Rates, and Payday Loans
- Leland, John (2007-08-28). "Nonprofit Payday Loans? Yes, to Mixed Reviews". New York Times. Retrieved 2014-03-25. "Of the $9.90 that GoodMoney charges per $100 borrowed, nearly half goes to writing off bad loans"
- Paige Skiba and Jeremy Tobacman, 10 December 2007, : The Profitability of Payday Loans.
- Bachelor, Lisa (2008-05-29). "You can settle the loan on payday – but the APR could be more than 2,000 per cent". The Guardian (London).
- "Payday Lending in America: Who Borrows, Where They Borrow, and Why" Pew Charitable Trusts, July 18, 2012
- Elliehausen, Gregory. (2009) "An Analysis of Consumers' Use of Payday Loans" Financial Services Research Program. p27.
- HaworthPress.com: Howard Jacob Karger, "Scamming the Poor: The Modern Fringe Economy", The Social Policy Journal, pp. 39–54, 2004.
- : Donald P. Morgan, "Defining and Detecting Predatory Lending", Staff Report no. 273. January 2007
- "Facebook users warned about ads". BBC News. 2008-05-12. Retrieved 2008-06-10.
- Credit Action Campaigns on Facebook Debt Ads. Retrieved 2012-11-21.
- "Debt Collection". Federal Trade Commission.
- "Fast Cash Loans Charged by State Regulator" (PDF). Retrieved 2012-02-22.
- Federal Reserve Bank of Kansas City, Payday Loan Pricing, February 2009
- Mark Flannery; Katherine Samolyk (2005-06). "Payday Lending: Do the Costs Justify the Price?". Retrieved 2010-10-03.
- Lehman, Tom (September 2003). "In Defense of Payday Lending". The Free Market (The Mises Institute monthly) 23 (9). Ludwig von Mises Institute. Retrieved 2014-03-24.
- ""Defining and Detecting Predatory Lending", Federal Reserve Bank of New York Staff Reports, Number 273, January 2007". Newyorkfed.org. 2011-09-23. Retrieved 2012-02-22.
- Stoianovici, Petru Stelian; Maloney, Michael T. (28 October 2008). Restrictions on Credit: A Public Policy Analysis of Payday Lending. SSRN. Retrieved 10 August 2009.
- Morse, Adair (19 February 2009). Payday Lenders: Heroes or Villains?. SSRN. Retrieved 24 June 2011.
- "Interest rate cap, QLD". Fairtrading.qld.gov.au. 2011-11-18. Retrieved 2012-02-22.
- Annual percentage rates, NSW[dead link]
- Marie Burton, Consumer Focus, Keeping the plates spinning: Perceptions of payday loans in Great Britain
- "Payday lenders hope to return in Georgia, 3/18/07". Retrieved 2010-10-03.
- Times Dispatch: Other Options Exist[dead link]
- "Breaking the cycle of payday loan 'trap'", USA Today, September 19, 2006
- "Making Payday Flexible", New Jersey Business, December 2011
- "Persuading Small Employers to Advance Wages", Bloomberg Businessweek, July 19, 2011
- "With Payday Loans under Scrutiny, Startup FlexWage Offers Alternatives", American Banker, June 1, 2012
- "Testimony of Dr. Kimberly R. Manturuk, Center for Community Capital, University of North Carolina at Chapel Hill, Before the Subcommittee on Financial Institutions and Credit for Consumers, United States House of Representatives, Hearing on 'An Examination of the Availability of Credit for Consumers,'" Page 5, September 22, 2011
- "Hearing entitled 'An Examination of the Availability of Credit for Consumers'", The Committee on Financial Services, September 22, 2011
- "Cash from the Boss to Replace Payday Loans", Bloomberg Businessweek, October 20, 2011
- "Asset Recovery Kit (ARK) program". Pentagonfoundation.org. Retrieved 2012-02-22.
- "New FDIC guidelines allow payday lenders to ignore state laws" (PDF). Retrieved 2012-02-22.
- "Wells Fargo puts hold on direct deposit advance", bizjournal.com, June 2, 1997
- "The cost of convenience". BBC News. 2009-12-11.
- "Decision of the Trade Mark Registry over "Log Book Loans"" (PDF). UK Intellectual Property Office. 2003-11-26. p. page 2.
Media related to Payday loans at Wikimedia Commons