Payday Loans - What Are They and Should I Use One to Fund My Small Business?
by sarahmillican, Community Moderator
- Created: November 10, 2010, 7:57 am
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
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
- 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
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.
savings: Entrepreneurs with very limited capital
can find start up funds by reaching into their pockets and pinching
together a mixture of supplemental income, credit cards, stock investments, revolving lines of credit, and 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
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.
- SBA loans, including the Microloan Program: Although the government does not lend money to
small businesses, it does provide guaranties to lenders. Government-backed
small business loans provide more security for lenders, making them
more likely to approve an application. The Microloan Program is designed
to provide small (up to $35,000) loans to as many small businesses as
possible. Because of its success, the program just received additional funding through the Recovery Act to
continue its efforts.
Visit the following
resources more information on obtaining government-backed loans or finding
general loan opportunities:
About the AuthorI'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.
Top Rated Articles
About This Blog
Loans, grants, taxes, and financial tips for your business.
- August 2014 (1)
- July 2014 (13)
- June 2014 (17)
- May 2014 (23)
- April 2014 (28)
- March 2014 (21)
- February 2014 (16)
- January 2014 (22)
- December 2013 (15)
- November 2013 (26)
- October 2013 (17)
- September 2013 (24)
- August 2013 (21)
- July 2013 (26)
- June 2013 (24)
- May 2013 (29)
- April 2013 (29)
- March 2013 (27)
- February 2013 (26)
- January 2013 (30)