Educational Consumer Tips

Pay Day Loans

Author: Better Business Bureau
Category: Finance

According to the Federal Trade Commission (FTC), check cashers, finance companies, and others are making small, short-term, high-rate loans that go by a variety of names: payday loans, car title loans, cash advance loans, check advance loans, post-dated check loans or deferred deposit check loans.

With payday loans, a consumer writes a check payable to the lender for the amount he or she wishes to borrow, plus a fee. The lender gives the borrower the amount of the check minus the fee. The lender holds the check until the borrower's next payday, when he or she can do one of three things: allow the check to be cashed, redeem it by paying cash to recover the loan plus a fee, or roll it over by paying the fee to extend the loan for two or more weeks.

With car title loans, companies offer short-term loans in exchange for the borrower's car title. In this situation, the consumer may find that if he or she is unable to pay the loan back when it comes due, the car becomes the property of the loan company. The car is often sold before the consumer can accumulate the funds necessary to get the title back.

Legislation enacted by the 2002 Virginia General Assembly authorizes payday lenders to transact business in Virginia. The legislation became effective July 1, 2002.

At the same time, the SCC approved regulations for payday lending in Virginia. The rules establish certain requirements and consumer protections applicable to licensed payday lenders and the loans they make payable on the borrower's next payday.

The Bureau of Financial Institutions licenses payday lenders. Licensed payday lenders are required to provide prospective borrowers with a pamphlet and notice that explain the borrower's rights and responsibilities regarding payday loans. The notice must include the following warning -- "Payday loans are not intended to meet long-term or recurring financial needs. It is recommended that you use a payday loan only to meet occasional or unusual short-term cash needs."

Payday lenders must clearly post in their offices a schedule of fees and the applicable interest rate. These charges must be stated not only as a dollar amount, but also as an annual percentage rate. By law, a lender is permitted to charge up to 15% for each $100 of the loan amount. For example, a $300 loan for 14 days carries a fee of $45 which is an annual percentage rate of 391%. Borrowers are allowed to prepay a payday loan in full or as partial payments. Doing so reduces the total interest rate, and a lender cannot impose an extra charge for prepayment.

The Better Business Bureau, along with the FTC, advises consumers to consider other possibilities before deciding on a payday loan:

- If you need credit, shop carefully. Consider a small loan from your credit union or a small loan company, an advance on pay from your employer, or a loan from family or friends.
- Ask your creditors for more time to pay your bills. Find out what they will charge for that service - as a late charge, an additional finance charge or a higher interest rate.
- Make a realistic budget, and figure your monthly and daily expenditures. Build some savings - even small deposits can help - to avoid borrowing for emergencies, unexpected expenses or other items.
- If you need help working out a debt repayment plan with creditors or developing a budget, contact your local consumer credit counseling service. There are non-profit groups that offer credit guidance to consumers for little or no cost.
- If you decide you must use a payday loan, borrow only as much as you can afford to pay with your next paycheck and still have enough funds to make it to the next payday.