How Payday Loans Work

During a routine car check-up, a service attendant announces to you that it will take $500 to repair your car. Normally, this cost wouldn't be a big deal, but this month you had to pay your income taxes, and you took a hit. To make matters worse, you're supposed to go on a road trip in a week. Where are you going to get $500 in time to get the car fixed?

You decide to head down to the place on the corner that advertises "Quick Cash Now." You've walked by it a hundred times but never had cause to go inside. You decide to give it a try. It's so easy! You're out the door in 15 minutes, and $500 will be deposited in your account sometime the next day. Sure, it cost you $50 in fees, but nothing beats that convenience, right?

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We could all use a little extra money. A payday loan could provide that money -- but it'll cost you.

That convenience is a $40 billion-per-year industry in the United States [source: Kirchoff]. This is the industry ofpayday lending, and it's served by more than 22,000 locations nationwide.

Booming Industry

In 2000, quick-cash companies in Washington State issued 1.8 million loans totaling $580 million. In 2004, with a large increase in the number of lending companies and locations, these numbers grew to 3.3 million loans totaling $1.2 billion [source: State of Washington].

In this article, we'll learn about the purpose of payday loans, as well as the drawbacks of these quick-cash offers.

The Purpose of Payday Loans

Payday loans are designed for people who need a quick injection of money before their next paycheck. The purpose of a payday loan is fast, easy money to take care of life's little emergencies.

A payday loan is a short-term, high-interest loan. The usual amount of the loan is between $50 and $500. You obtain one of these loans from a payday lender, a company that often offers other convenient financial services, such as foreign currency exchange, utility bill paying and license processing.

The process is actually quite simple. Here's the recipe:

• 
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  Payday lenders take advantage of banks' disadvantages.
  Visit a payday lender. These companies often have stores, but you can also apply by phone or online. Some lenders do their business strictly online.
• This is a no bank loan application. Usually the application consists of your contact information, banking information and employment information. The lender may ask you for the contact information of a few friends and family. The lender would call these references were you to not pay back your loan.
• Write a check to the lender for the amount you want to borrow, or, if applying online, pledge to pay the borrowed amount by a certain date. The lender will add the finance charge, or fee. Usually lenders express their fees in $100s. Paying $15 per $100 of loan is fairly common.
• The lender deposits the money in your bank account or gives you a check for the amount.
• The lender holds the check you wrote for the term of the loan, usually two weeks.
• When the term is up, the company cashes the check or debits your bank account. This pays back your loan and pays the lender's fee.
• Rollover: If you can't afford for that check to be cashed, you can roll the loan over into another term (usually another 14 days). The lender will tack on another fee.

Ease and convenience fuel the allure of payday loans. One of the biggest advantages that payday lenders have over banks is their flexibility. Payday lenders have more locations and longer hours than most banks. Some lenders, such as some Currency Exchange locations in Illinois, are open 24 hours a day. And when was the last time you saw a bank open on Sunday?

Bad Credit? No Worries

Payday lenders rarely check your credit. Coupled with the privacy and expediency of the process, this open-mindedness makes payday lenders very attractive to people with poor credit.

In addition, the loan application process is fast. You can usually be out the door, off the phone or away from your keyboard in less than half an hour. Furthermore, you get the money in no time -- if the lender doesn't hand you a check when you apply, the money is usually electronically deposited in your account within a day.