Payday Lending Basics

  1. What is a payday loan?
  2. Who uses payday loans?
  3. What is required to get a payday loan?
  4. How much does a payday loan cost?
  5. How big is the payday lending industry?
  6. Who makes payday loans?
  7. How are payday lenders regulated?

1. What is a payday loan?
Payday loans are small cash advances, usually of $500 or less. To get a loan, a borrower gives a payday lender a postdated personal check or an authorization for automatic withdrawal from the borrower’s bank account. In return, he receives cash, minus the lender's fees. For example, with a $300 payday loan, a consumer might pay $45 in fees and get $255 in cash.

The lender holds the check or electronic debit authorization for a week or two (usually until the borrower's next payday). At that time, the borrower has the option of (1) paying back the $300 in exchange for the original check, (2) letting the lender deposit the check for $300, or (3) renewing or rolling over the loan, if he is unable to repay it. Some lenders accomplish the same effect with "back-to-back transactions," having the borrower write a check for a new advance, and using these funds to repay the prior loan. In renewal and back-to-back transactions, the borrower gets no "new" money, but pays another $45 in fees.

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2. Who uses payday loans?
The payday industry advertises these loans as quick and easy ways to get cash, and targets low-income working consumers, including welfare-to-work women, military personnel, and others who have little to no savings and live paycheck to paycheck. Most cash-strapped borrowers who get payday loans are not able to repay the whole loan within two weeks, and end up rolling over their loan and paying renewal fees multiple times. Trapped on this "debt treadmill", consumers typically pay much more in fees than the amount they originally borrowed.

Although payday loans are marketed as one-time assistance during a financial emergency, a 2003 study (PDF) by the Center for Responsible Lending found that 91% of all payday loans are made to borrowers with five or more payday loans per year. Borrowers, on average, receive 8 to 13 payday loans from a single payday lender per year. And, most payday borrowers go to more than one lender, dramatically increasing their total number of payday loans per year. Only one percent (1%) of all payday loans are made to one-time emergency borrowers.

Read stories about payday lending victims.

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3. What is required to get a payday loan?
To get a payday loan, most consumers only need to show personal identification, have a personal checking account, and provide proof of income from employment or government benefits, such as Social Security or disability payments. Unlike conventional lenders, payday lenders do not look at a borrower's monthly expenses or her ability to repay the requested loan.

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4. What are the costs of a payday loan?
For a two-week payday advance, a borrower will pay at least fifteen dollars for every $100 borrowed. But with such a short duration these loan fees are equal to roughly a 400% annual percentage rate (APR). And as the chart below shows, consumers who renew their loans often end up paying more in fees than they have borrowed!

For borrowers with five, ten, or even twenty repeat loans per year, payday lending functions as chronic debt, instead of helpful credit. These borrowers pay additional loan fees for no new money each time the loan is renewed. CRL estimates that predatory payday lending costs five million Americans $3.4 billion annually.

The societal costs are also great. Since the payday lender is holding a “live check” as collateral, borrowers struggle to renew their payday loans every two weeks while falling behind on other bills, like rent, mortgage, electricity, and even groceries. As borrowers slide deeper and deeper into trouble, payday lenders get paid while other merchants and lenders do not. Social service agencies and faith-based groups pick up the tab for families in trouble.

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5. How big is the payday lending industry?
Payday lending grew rapidly through the first half of the past decade, leveling off in recent years. In 2000, the industry consisted of 7,000 to 10,000 payday loan offices, rising to a peak of about 24,000 storefronts in 2006. Industry growth has slowed recently, with about 22,000 payday locations currently located in 35 states, which originate an estimated $27 billion in annual loan volume.

The great majority of payday loans are originated shortly after a previous loan is paid back, with half of new loans opened at the borrower’s first opportunity, and 87 percent opened within two weeks. This borrower churn inflates payday loan volume by over $20 billion, each year, with three of every four loans generated by the debt trap. The churning of loans to borrowers each pay period costs these households $3.5 billion in extra fees each year.

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6. Who makes payday loans?
In the early 1990s, payday loans were made by small independent shops that primarily offered check-cashing services. Today, the industry is dominated by large regional or national "monoline" lenders that provide only payday loans, and multi-service lenders that offer an array of fringe banking services such as check cashing, money orders, and bill paying services.

Banks are also becoming more active in this industry, by providing capital to payday lenders and entering into partnerships to originate payday loans in states that prohibit stand-alone payday lending (called "rent-a-charter" deals.)

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7. How are payday lenders regulated?
State laws generally govern whether payday lending is permitted in a state. Currently, some 36 states allow payday lending. However, several large payday lenders are using brokering arrangements or rent-a-charter agreements with commercial banks to circumvent state bans and limits. In these cases, payday lenders evade state laws by invoking federal preemption through the Federal Deposit Insurance Act.

This practice is now under attack by some federal regulators and state attorneys general. For example, in Georgia and in Maryland, legislation has been enacted to prevent this kind of arrangement.

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