Payday loan facts for kids
A payday loan is a special kind of short-term loan. It's usually for a small amount of money and is meant to help people cover unexpected costs until their next payday. These loans often come with very high fees, which are like interest.
The name "payday loan" comes from the idea that you borrow money and promise to pay it back when you get your next paycheck. Sometimes, people write a check for a future date to the lender, and the lender gives them cash right away. Even if the loan isn't directly tied to your payday, it's still often called a cash advance. Rules about payday loans are different in various countries and even between states or provinces within a country. Some places have rules to stop very high fees, while others don't allow payday loans at all.
Payday loans have been linked to people having trouble paying back their debts.
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How Payday Loans Work
When someone gets a payday loan, a lender gives them a small amount of money. The borrower agrees to pay it all back on their next payday. Lenders usually check if the person has a job or steady income, often by looking at pay stubs or bank statements.
In a traditional payday loan store, a person goes in and gets cash. They write a check to the lender for the loan amount plus fees, dated for their next payday. On that future date, the person is expected to go back to the store and pay off the loan. If they don't, the lender can deposit the check. If there isn't enough money in the bank account, the borrower might get extra fees from their bank and the loan could become even more expensive.
Today, many payday loans are done online. People fill out an application on the internet. The money is then sent directly to their bank account. On their next payday, the loan amount and fees are taken out of their account automatically.
Who Uses Payday Loans and Why
Studies show that many people who use payday loans are white, female, and between 25 and 44 years old. However, certain groups are more likely to use them, such as people without a four-year college degree, those who rent their homes, African Americans, people earning less than $40,000 a year, and those who are separated or divorced.
Most people use these loans to cover regular living costs over several months, not just for sudden emergencies that last a few weeks. On average, a borrower might be in debt with these loans for about five months each year. Other studies have found that black and Hispanic families, new immigrants, and single parents are also more likely to use payday loans. They often use them for everyday bills, not just one-time expenses.
Are Payday Loans Profitable?
Some studies have looked at how much profit payday loan companies make. One study found that the average profit margin for payday lenders was around 3.57%. This is actually less than what many other traditional lenders, like credit unions and banks, usually make. For example, a coffee company might have a higher profit margin than a payday lender.
Some people argue that the fees charged by payday lenders are fair because of their costs. They say that after paying for their operations and dealing with people who don't pay back their loans, payday loans might not make huge profits. However, other research suggests that many payday loans are "rolled over" into new loans again and again. This means the borrower keeps paying fees without reducing the original amount they borrowed.
Arguments for Payday Loans
People who support payday loans say that they help individuals who can't get loans from regular banks. They argue that if payday loans didn't exist, some people might have to turn to illegal lenders. They believe that these loans make small amounts of credit available to people, especially those with lower incomes, who wouldn't otherwise have access to any loans.
However, others disagree. They point out that there's little proof that people turn to illegal lenders when payday loans aren't available. Also, since many borrowers roll over their loans, they often end up asking friends or family for help to pay off the payday loan. There's also no clear evidence that people in states where payday lending is banned or limited have trouble finding small loans.
Some research has suggested that payday loans might actually help families by giving them access to money when they need it. But other studies have found that the high costs of these loans can make a family's financial situation worse, making it harder to pay regular bills like rent or utilities.
Payday Loans Around the World
Australia
In Australia, rules for payday loans changed in 2009 and again in 2013. Now, there's a limit on how much interest and fees payday lenders can charge. For smaller loans (under $2,000), lenders can charge a 20% setup fee and a 4% monthly fee. For medium loans ($2,000-$5,000), they can charge a $400 setup fee plus a 48% annual interest rate. Lenders must also make sure borrowers can afford the loan.
Canada
In Canada, each province has its own rules for payday loans. For example, in Ontario, there's a maximum fee of $18 for every $100 borrowed over two weeks. Most provinces have laws about payday loans, except for Newfoundland and Labrador.
United Kingdom
The United Kingdom has a growing payday loan industry. In 2009, about 1.2 million people took out 4.1 million loans. By 2012, the market was worth £2.2 billion. Most borrowers earn less than £25,000 a year. While there were no limits on interest rates for a long time, lenders had to show the annual percentage rate (APR).
In 2014, big changes were made to how payday loans work in the UK. The main goals were to make sure lenders only lend to people who can afford it and to help borrowers understand the costs and risks. New rules were put in place:
- A maximum daily cost of 0.8% of the loan amount.
- Late payment fees capped at £15.
- The total cost of the loan (including fees and interest) can never be more than 100% of the original amount borrowed. This means if you borrow £100, you will never pay back more than £200 in total.
United States
In the United States, payday loans are legal in 27 states. Nine other states allow some form of short-term lending with rules. The remaining 14 states and Washington D.C. do not allow them. Some states also limit the number of loans a person can take at one time.
The Consumer Financial Protection Bureau (CFPB) is a government agency that helps protect consumers. It has the power to regulate all payday lenders. There are also rules to protect military members from very high interest rates on certain loans. The CFPB has taken action against lenders who break the rules, for example, by lending to military members when they shouldn't or using aggressive ways to collect money.
Some payday lenders have partnered with Native American tribes to offer loans online. This is because Native American reservations have their own laws. However, the Federal Trade Commission (FTC) is watching these lenders closely, as some might just be non-Native companies using the tribal connection to avoid state laws.
Other Options Instead of Payday Loans
Most people who consider payday loans have other choices. These can include:
- Pawn shops: You can get a loan by leaving something valuable as security.
- Credit union loans: These usually have lower interest rates, but it might take longer to get approved.
- Getting an advance from your employer: Some employers might let you get part of your paycheck early.
- Bank overdraft protection: This helps if you spend more money than you have in your bank account, but it can still have fees.
- Cash advances from credit cards: You can get cash from your credit card, but it often has high fees and interest.
- Help from family or friends: Asking people you know for a loan.
- Community assistance programs: Some local groups offer help for emergencies.
Sometimes, people take a payday loan to avoid these other options, but then end up using one of them to pay off the payday loan later. If someone owns a car, they might consider an auto title loan. With this, you use your car as security for the loan.
Payday lenders often compare their fees to other costs you might face if you don't have enough money, like bounced check fees or late payment fees on bills. They argue that their fees are similar to or even lower than these other charges.
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A shop window in Falls Church, Virginia, advertising payday loans.
