Understanding What A Payday Loan Really Is

And Deciding if it's the Right Option for You

Understanding What A Payday Loan Really Is
February 23, 2013

Payday Loan: It Could Be Just What You Need!

Our discussion today is about payday loans and some of the mysteries surrounding them. The odds are good that you’ve driven past a Money Tree or Checks 2 Cash, or even watched the commercials on TV for Money Mutual. The odds are equally good that you’ve viewed these places as being a last resort for people who can’t manage their money.

This is most certainly not the case. In fact, for many of you out there, this might be an option you haven’t considered but one that could help you out of a very troubling situation. At some point, we have all found ourselves short on cash due to one or more unexpected events (e.g., car repairs, medical bills, plumbing issues) and many others in this economy who have recently filed for bankruptcy may be short on options. Payday loan companies offer such individuals an excellent solution, but many are afraid to inquire due to the “stigma” that surrounds payday loan or short-term lending companies. Our goal here is to provide you with some information to make walking in their doors a little less scary if you find yourself in need of some short-term cash.

Each short-term lending company has its own rules, regulations, and policies. To cover what each one does in detail would lead to a very lengthy article, so let’s focus in on the generalities such as information requirements and how these types of loans work.

Short-term or Stop Gap

First, it must be stated that short-term loans are meant to be a “bridge” or a “stop gap” for the short term, merely providing smaller amounts that typically range from $100 to $500—although sometimes more, depending on the company. Every company offering these loans stresses that you must use them wisely.

Payday loan companies typically do NOT report to the credit bureaus. As such, they also don’t really care about your credit scores, but there is an approval process that identifies your ability to repay your loan. To get approval for a loan, it is necessary to bring in bank statements showing your deposits over the last few months (such as direct deposit for work or paychecks deposited). Several recent pay stubs are also required. To emphasize, payday/short-term loan companies expect that you will be able to repay a loan with your upcoming cash flow. Your bank statements, pay stubs, and any other expected forms of income are also scrutinized closely by these companies to mitigate their risk as much as possible, and everything must be documented.

If you bring sufficient documentation and information with you to demonstrate that you will have the ability to repay your loan with your future cash flow, the entire process is fairly straightforward and can be done fairly quickly right inside the store. Once you have been approved (usually for a smaller amount, like $100 or $200, until you build up a history), the cash is yours.

Repayment Options

You then have a variety of options for repayment. Some companies offer actual “payday” loans, meaning they will withdraw funds from your account when your next paycheck comes in. Other companies offer longer-term repayment options, even up to six months. You can make payments at the store, online, or via direct deposit from your account on the due dates.

However, as you can imagine, payday loan companies take a lot of risks. Even though auto-debits will be set up to withdraw the payments directly from a checking account, there are those who might choose to close an account; in such cases, the loan company ends up losing out on a bit of money. Due to this risk, payday loan companies charge “fees” that cover the risk rather than the “interest” you would get from a bank loan. This essentially allows them to receive several HUNDRED percent interest rates. You may think this sounds illegal, but since it is in the form of a “fee,” it is completely legal.

As an example, at one payday loan company, you may receive a $500 loan that can be paid back over a period of six months. There is an upfront fee of $75, a “maintenance fee” that is divided up among your payments, and an interest rate. Monthly payments for a $500 loan would typically be around $135 per month. Doing the simple math, if you pay it back over the entire six months your $500 loan is costing you nearly $800. Is this a scam or a rip off? Not at all, since the company is the one taking a risk by lending you the money. Keep in mind that if you’re in a situation where you are desperate for $500, then this will likely not be an issue for you. Of course, paying off the loan in a month or two drops the overall down to a $600 total “payoff” depending on when it’s complete.

As you can see, payday and short-term lending options are available for those finding themselves in a bind. When your credit cards are maxed or your savings account is depleted, you might need to take advantage of this option, although it’s not ideal from a “cost” perspective. However, from a “last resort” perspective, this might be exactly what you need. You certainly don’t want a short-term loan to go buy a new TV, but if your furnace just went out and it’s going to be freezing cold for the next week, one of these options may be the short-term solution you’re looking for.

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