What is a Payday Loan? Debunking the Myths
If you search for payday loans online, you might find contradictory articles about whether payday loans are bad or useful. In actuality, what you want to stay clear from when searching for a payday loan is indirect lenders, not payday loans themselves.
There are many payday loan myths out there that make it hard to answer the question, "are payday loans bad or not?" We hope to clear up these misconceptions and better explain what payday loans really are and how they work.
What is a Payday Loan?
Payday loans are small loans that borrowers take out usually for a few hundred dollars. Payday loans are also short-term loans that usually get repaid in full in a few weeks.
The purpose behind the design of a payday loan is to help borrowers who need smaller loans than other lenders typically provide. Those arguing that payday loans are bad, don't understand that payday loans are simply small, short-term loans.
Payday Loan Definition
Payday loans are consumer loans, small loans, and short-term loans. They are primarily designed to help borrowers get to their next paycheck.
Payday loans are not unsecured loans. They are secured loans that are secured with a post dated check that is scheduled to be deposited on the borrower's next paycheck.
Payday loans are also known for being high interest loans. Payday lending often comes with high Annual Percentage Rates (APR) because these lenders take on more risks and because borrowers don't repay the loan over several years.
How Do Payday Loans Work?
Payday loans work very simply. Many payday lenders even offer payday loans online now.
Here's how payday loans work:
- When someone decides they want a payday loan, they can go online or to a payday loan store.
- Then they'll fill out an application with some basic information.
- Next, the payday lenders will overview their application and determine whether their application can be approved or not.
- Once the application is approved, the borrower can write a post dated check for the amount of the payday loan. The date on the check will be scheduled for the day the small loan is due. This date is usually on the borrower's next scheduled pay date.
- Now the borrower can get their payday loan funds and rest assured that their loan payment is already automatically set up to be taken care of.
Reasons People Use Payday Loans
Payday loans, like all loan types, exist for a reason. Since payday loans are smaller, they can help borrowers with smaller, short-term financial needs.
Here's a deeper look into the many reasons why people choose to take out a payday loan:
Unexpected expenses can take many forms. Your car could break down, your water pipes could burst, or your basement could flood.
About 28% of US adults can't afford to put enough money aside for an emergency fund. About 59% of US adults say they are living paycheck to paycheck.
This demographic of people need somewhere to turn when they suddenly need to pay $300+ to fix their car so they can keep going to work.
Help with Expected Expenses
When you are living paycheck to paycheck, budget overlap occurs more frequently.
You can be the strictest budgeter, but when your budget is tight, there are bound to be times when you'll need a little extra help getting to that next paycheck.
After all, it can cost up to $300 a week just to get groceries to feed a family of four.
Avoid Paying Fees
Fees can really upset your monthly budget if you aren't careful. There are late fees for credit card payments, bounced check fees, and overdraft fees to be aware of, just to name a few.
Some late and overdraft fees can cost up to $30, which adds up quickly with each accidental overdraft transaction.
Avoid Utility Disconnections
Being late on bills, rent, and utility payments can also stack up high fees. Fees to reconnect your utilities after they've been disconnected can cost over $100.
Payday Loan Myths
Why are payday loans bad? There are a lot of payday loan myths, misconceptions, and controversies around whether payday loans are bad or not, what they are, what their purpose is, and how they work.
Payday loan misconceptions are important to understand because they sometimes create regulations and judgements against payday loans that make it harder for borrowers to get the small, short-term loans they need that they can't get anywhere else.
Here are a few of the major payday myths and misconceptions about payday loans:
Myth 1: "Payday loans target people of low-income households and minorities."
Many people have the idea that payday loan lenders are a predatory type of lender. This means that they are lenders who are unfairly targeting a certain demographic or taking advantage of vulnerable people or people in need.
They think payday loans are designed to take advantage of people in the lower income brackets or that payday lenders don't fully disclose their payday loan terms.
The truth is, payday loans and payday loan lenders are some of the most regulated loans and lenders in the country in order to ensure no one is taking advantage of anyone.
Payday loan lenders still have to be licensed and registered in order to operate, meaning they must comply with strict guidelines and regulations that keep borrowers safe.
Payday loan lenders even have rules and requirements that may not apply to other lenders who offer bigger loans, like verbally disclosing loan term agreements so borrowers understand exactly what loan terms they are signing up for.
Myth 2: "Payday lenders are dishonest and hide fees."
Some people try and say that payday lenders charge hidden fees. But just like any lender, licensed lenders like Check City aren't allowed to hide their fees.
Just like any other loan lender, licensed payday lenders outline all of their fees in the loan terms and even go over them verbally with customers taking out a payday loan.
This helps payday loan customers always understand exactly what they are paying.
Myth 3: "Payday loan interest rates are inflated to gouge the borrower and make huge profit for the lender."
Another major concern people have about payday loans is that they are expensive and have high rates and fees.
It's true that payday loans have high APRs, but what people don't realize is how APRs are calculated. APR measures interest for a whole year, but payday loan customers don't usually pay more than 10 weeks of interest on a loan.
Payday loans aren't supposed to be paid back over the course of an entire year but over the course of a few weeks or until your next pay date. Measuring payday loan interest rates with APRs is similar to measuring hotel room rates or car rental rates by year instead of by day.
For example, the average hotel room costs about $180 a night, not $65,700 a year. Likewise, a car rental typically costs $45 a day, not $16,425 a year.
Payday loans are only supposed to be used for short-term purposes and not as long-term financial solutions.
When used accordingly, payday loans can keep borrowers from incurring other types of fees (like returned check or late rent fees) and avoid potential negative marks on their credit score. For some borrowers, obtaining a short-term payday loan is a quick and easy solution to an unexpected expense.
Myth 4: "Payday loans are impossible to pay back."
Payday loans are much smaller than other traditional loans. A typical personal loan can range anywhere from $1,000 to $50,000 depending on the lender.
Other loans also come with longer payment terms that can sometimes span years instead of a few weeks or a few months.
Because payday loans are a much smaller amount (ranging closer to a few hundred dollars than a few thousand) and are paid back in a shorter amount of time, payday loans are arguably easier to pay back than other traditional loans.
Myth 5: "Payday loans trap people in a cycle of debt."
Many people think that payday loan borrowers end up in a financially destructive debt cycle because of payday loans. But this isn't actually possible.
Check City won't lend to a customer who already has a debt. Plus, the vast majority of Check City customers pay their short-term loans back on time, on their next payday.
Myth 6: "It costs less to pay overdraft fees than to choose a payday loan."
Many payday loan borrowers use payday loans to avoid paying late and overdraft fees. This is because fees add up quickly and can cause incredible havoc on a person's financial wellbeing.
For example, credit cards have an average late fee of $36.34, an average returned payment fee of $34.01, and an average penalty APR of 27.54%. If you're late paying rent you could be charged up to $50 a day or evicted from your home. If you're late paying the utility bills you get your heat, water, or power shut off and get charged late fees along with high reconnection fees that can be up to $100 on top of everything else.
Late fees, overdraft fees, and bounced check fees might not be too expensive by themselves, but when you have nothing else left in the budget until the next payday arrives, and your next payday isn't for another week or two, those fees can add up quickly.
Myth 7: "Good credit is required to get a payday loan."
Most lenders will have some credit score requirements. But payday lenders are typically more lenient on the credit scores they accept in their applications in order to make their loans more accessible.
The Truth About Payday Loans
If you really want to know the truth about payday loans and whether payday loans are bad or not, take a look at these fundamental truths about payday loans.
Payday loans are an essential credit option in times of need.
People who are against payday loans often think payday loans prey on people who are in tight circumstances. In fact, the opposite is true.
Payday loan lenders are some of the only financing options many people in tight spots can turn to for emergency credit. Payday loan lenders are some of the only loans that offer instant funds with short wait times when you have a sudden financial emergency and need funds quickly. Payday loan lenders also don't have the heavier requirements that borrowers have to meet at banks.
Other lenders and banks simply don't offer loans as small as payday loan lenders. But sometimes borrowers only need a few hundred dollars, not a few thousand. Some borrowers don't want to have to take out a giant loan they'll spend their whole life paying off. They just want to take out a few hundred dollars to take care of an emergency need.
In fact, 96% of payday loan borrowers believe that payday loans are useful and that they understood the finance charges outlined in the payday loan terms. 94% of payday loan borrowers believe payday loans are a sensible option when unexpected expenses arise.
The average payday loan is $388.
Payday loan lenders adhere to many compliance regulations in order to be responsible lenders and protect their customers. Here are some of the many things payday lenders go through with each customer:
- Require a checking account
- Rescind a loan at no cost within 24 hours
- Require a steady source of income
- Allow loan repayment over two months with no additional fees or interest
- Verify consumer’s ability to repay before approving their application
- Stop the interest on one payday loan annually
- Verbally disclose terms and conditions
- Only pay interest for actual duration of loan if repaid before due date
- Present extended payment plan option in bolded font in loan paperwork
Payday loan lenders also use information from credit bureaus to make sure their borrowers won't be overextended. Credit bureaus are able to see an applicant's financial debts, loans, and obligations so payday loan lenders can deny and approve applicants accordingly.
The truth is, payday lenders have many things in place to help payday loan borrowers pay off their small, short-term loans successfully.
Payday loan lenders often provide many other essential financial services to their community.
Many payday loan customers are also a part of the unbanked, underbanked, or cash-only demographics. They need a secure and accessible place to cash their checks quickly so they can pay bills and stay on top of their monthly budget.
So are payday loans bad? In actuality, payday loans don't deserve many of the negative preconceived notions they have. Payday loan lenders are some of the only lenders who offer smaller loans in the $300 range for people who only need a small, short-term loan.
Payday lenders also offer many other important financial services to members of their community. Cashing checks and sending money orders are just a few of the many services payday lenders like Check City provide.
Visit your local Check City today to experience our fast and convenient financial services for yourself!