Payday Loans: Short Term Money Fix, But Is It Really Worth It?

Due to the high cost of living in most cities, most people are finding it hard to make ends meet. Good credit is important also, and adults need to build a good credit rating to indicate financial trustworthiness. These are two of the reasons why people go to banks and lending institutions to get loans. A loan is a type of debt. It is money lent to a consumer to be returned with interest. Debt by definition, refers to goods, money or services owed by a person or entity from another person or entity.

There are two types of debts, long-term and short-term debt. Long term credit refers to the type of credit one would have with a mortgage, car loans, or other installment loans, which are repaid over months or years. Short term credit, on the other hand, is used to purchase items or services that are to be paid for in a single payment within a given period of time, usually with no interest charge. A paycheck advance or cash advance is a type of short term, unsecured credit. Private finance companies offer this type of loan for borrowers who run short of cash in between paydays, thus the term ‘payday loan.’ Borrowers can apply for a small loan, normally up to $1,500, and the amount borrowed plus interest will be paid by the borrower through a post-dated check to the lender.

The maturity date, or payment date will usually coincide with the borrower’s pay day, meaning that the lender will process the check on the on the borrower’s pay day. A borrower may also provide bank account details so the lender can do an electronic withdrawal on the agreed upon date of payment.

Below is an example of the cash advance process:

The borrower applies for a payday loan of $100. The lender agrees. The borrower submits a post-dated personal check for $115 to the lender, and receives an electronic deposit of $100 to his bank account. The lender will process the check 14 days after the receipt of the cash advance unless the borrower requests for a refinance. The borrower will have to pay a certain amount to extend paying the $115 for up to 2 weeks. Most lenders do not limit for the number of times that the borrower can request for a refinance or a “roll-over”.

Note though, that along with the original interest of $15, there will be a finance charge of $20 every time the borrower requests for a refinance, so if the borrower requests for a roll-over three times, the total finance charge will amount to $60. Add the original interest of $15, and in total, the borrower would have shelled out almost double the original amount that he borrowed.

Payday loans have become the subject of controversy. There are those who say lending institutions target those who do not understand the process of getting cash advances; they are those who are inexperienced or who are from low-income communities.

There are arguments that the lending institutions are to blame because they make it easy for borrowers to get loans. Most lending institutions require no more than a proof of a regular income, such as a pay stub, and a checking account; they do not check a borrower’s credit history or credit rating to see his ability to pay the loan. Aside from that, there are some lending institutions that process post-dated checks even when a notice from the borrower that he will not be able to pay the loan or the finance charge for a roll-over.

If the borrower has insufficient funds in his bank account, some institutions forward their information to collections agencies or underwriters. Some people say that payday lending companies are like loan sharks, with the astronomical interest rates that they command and the way that they prey on unsuspecting and cash-strapped victims.

In defense, lending institutions say that due to the nature of the loans they provide it is imperative that they require borrowers to pay higher interest rates. In general, short term loans do not yield the same profits as long term loans such as home mortgages. Operating and processing costs are taken from finance and interest charges that the companies are able to collect, provided they are able to collect them from their borrowers.