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Payday Loans - What Are They and Should I Use One to Fund My Small Business?

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Payday Loans - What Are They and Should I Use One to Fund My Small Business?

Published: November 10, 2010

What is a payday loan?

Payday loans are typically small, short-term loans intended to cover a borrower's expenses until his or he;s next payday. Payday loans vary by lenders, but the majority use the borrower's next paycheck as collateral while charging an interest and fee for the loan. While the most common name is-payday loan- they can also be referred to as cash advance loans, check advance loans, post-dated check loans, or deferred deposit loans.

As the saying goes, if it seems too good to be true, it probably is. The Federal Trade Commission says that'regardless of their name, these small, short-term, high-rate loans by check cashers, finance companies and others all come at a very high price' Read on to learn more about payday loans.

Understanding the Payday Advance Market

The payday advance industry became popular during the 1990s by catering to an unfulfilled demand for small, short-term consumer loans, according to a study by the Federal Deposit and Insurance Corporation (FDIC) and Georgetown University's McDonough School of Business. Payday advances are single payment loans and their underwriting process normally does not involve a credit investigation. Because of the limited amount of documentation and credit required for the loan, it is not uncommon for a payday loan customer to have cash flow difficulties or a poor credit.

The study revealed that payday loan customers typically:

  • Use small and short term loans, typically $500 or less, as a bridge to their next paycheck;
  • Were recently turned down for other forms of credit or offered less credit than the amount they applied for;
  • Have consumer credit problems or a limited credit availability due to a bankruptcy filing in the past five years;
  • And/or have been 60 or more days late on a mortgage or consumer debt in the last year.

As a result of these characteristics, payday lending is generally characterized as a form of subprime lending.

How does a payday loan work?

The loan process can vary depending on lenders, but typically a payday loan starts with the borrower writing a personal check payable to a specific lender for the amount the person wants to borrow, plus interest and fees.

For example, in return for the small loan of $500, Joe provides a payday lender with a check or debit authorization for $500, plus interest and a finance charge. The lender agrees to hold the check until the Joe's next payday. At the next payday, Joe may redeem the check by paying the loan amount plus fees, or the lender may cash the check.

In some cases, a borrower may extend their loan by paying only the finance charge and writing a new check, essentially starting the process over with a new, higher balance.

Why are payday loans controversial?

Payday loans have been controversial over the years for a combination of reasons - questionable collection practices by lenders, high interest rates, and the many disputes occurring over evolving and sometimes complicated credit laws, to name a few. While the adjustable percentage rate (APR) for payday loans varies depending on the lender and how long the check is held before being deposited, expect the rates to be incredibly high.

According to the FDIC, payday loans typically range from $100 to $500, although some states permit payday loans up to $1,000. The finance charge applied to payday loans is typically between $15 and $20 per $100 borrowed and payday loans are often times renewed because the borrower cannot afford to pay off the principle, while also keeping up with the weekly fees they incur.

The bottom line, according to the Federal Trade Commission, is try to find an alternative to the payday loan. If you must use a payday loan, try to limit the amount and borrow only as much as you can afford to pay back with your next paycheck and still have enough to make it to next payday

What are some alternatives to payday loans?

If yo're looking to start a small business, you will want to consider all your financing options, but pay careful attention to the fine print associated with both traditional and nontraditional lending offers. Payday loans are generally not a popular choice for funding a business because the loan amounts are generally small and come at a high interest rate. The following options are popular alternatives to payday loans.

  • Small loan from a credit union or a small loan company: Some banks may offer short-term loans for small amounts at competitive rates. A local community-based organization may make small business loans to entrepreneurs In any case, shop first and compare all available offers. Read more about credit unions.

  • Low-cost credit offers: Compare the APR and the finance charge, which includes loan fees, interest and other credit costs. Military personnel have special protections against super-high fees or rates, and consumers in some states and the District of Columbia have some protections dealing with limits on rates. A cash advance on a credit card also may be possible, but it may have a higher interest rate than other sources of funds; find out the terms before you decide.


Related Resources

Visit the following resources more information on obtaining government-backed loans or finding general loan opportunities:

About the Author:

Sarah Millican
I'm a digital strategy consultant with ENC Strategy (www.encstrategy.com) and work full-time to support the Small Business Administration in growing and developing this online community to the best that it can be.

Comments:

Payday loans are basically a way to cover up an emergency expenditure. Payday loans are taken for a very short period of time. Unlike other regular loans from mainstream banks, no collateral is needed for these loans. The borrower’s next pay check is taken as the basis for the loan. Most people avail payday loans to tackle the emergency financial crisis. To fund a small business payday loan could be a good option because an entrepreneur who has just started a business will be more assured and comfortable to avail such kind of loans for its convenience, ease and speed. However this cannot be a source of investment for the long term of the business.
A cash advance payday loan is a type of short term loan that you get from a business that is not a bank, usually a short-term loan store. It is called a cash advance loan, because you generally borrow just enough to get through to your next pay day, upon which the money is due. Cash Advances business operates under a wide variety of titles, and may take postdated checks as collateral. Generally they charge a large amount fee for the loan, which puts the interest rate very high, some rates are as high as 400%.
Payday loans should be a last resort for an individual person, and rejected altogether by those looking for small business funds. One alternative is to establish credit by opening a separate checking account for your business and applying for a small loan.
I knew many information after reading the article. Payday loan's interest is high which writer has said in his article. I want to know why payday loan's interest is high? I hope writer will publish a article about it in the future.
I think we should use loan perfect work. It is applicable for all kinds of loan. Blog is nice but interest of payday loans are high. You should write interest of payday loans why high? Thanks.
Dear Sarah, although I am working in payday loan industry myself, nevertheless, your article still was able to help me to clarify certain things regarding the very process of getting a payday loan. I would like to add that there are certain states that allow payday loans and some that don't allow, still, many people from these states try to apply. Here is a list of states and available loan limits: http://www.ncsl.org/issues-research/banking/payday-lending-state-statutes.aspx This industry is very hard to compete in - there are literally tons of companies that can easily mislead consumers. That's why, if a consumer applies online they should double-check everything on the website - the SSL certificates, customer testimonials (if any), Privacy Policy, Terms of Use, etc. I would also like to add that nowadays, payday loans are available for people in Australia and the UK. The final advice I would like to give to anyone who plans to apply for a cash advance is: make sure you know what you are doing. You should have 100% control of your finances and will be able to pay the loan out in the given time period. This is very important. You don't want the loans to stack up, burying you in debts.
When you are borrowing money, you would like to make sure you are getting the best rates possible. This is much easier whenever you get your cash advance online. You only need a couple of minutes to fill out a couple of pieces of data, and the lenders will begin bidding for your business. This means you will get the most competitive rates possible. Learn more about Competition in payday industry at: personalmoneynetwork.com
I just build a pay day loans website. I am looking for an affilate offer.
Have you considered CPA offers? You have to go through an application/approval process, but the offers are well worth it. Otherwise (if ClickBank doesn't have anything), try going to sites that offer pay day loans and look for an "affiliates" link. Most should have some sort of affiliate program as it is one of the best forms of marketing.
A payday loan should really be the last thing people turn to for financial aid. It is also important that consumers are aware of the risks. "Payday addiction" is common among consumers who use payday loans to live cash advance to cash advance rather than paycheck to paycheck. This, of course, is a terrible financial choice.

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