Payday Loans Introduction

Money tends to burn a hole in everyone's pockets. But for people who are cash-strapped, those dollars seem to burn even faster. Where can someone turn when he runs low on money? Unfortunately, many look to the payday loan, a financial product that's like gasoline to that incendiary cash.

A little too convenient
There's little doubt that the payday loan fills a need in society. Many people are desperate for cash, but don't qualify for a loan or a credit card. They have no choice but to turn to payday loan storefronts that are providing easy access to cash. Easy, but costly.

Here's how the loan works: Borrower X needs money on Tuesday, but won't get his paycheck until Friday. He goes to the payday loan company and signs a post-dated personal check for the amount he needs, plus a fee. In return, the company gives the person the cash, minus the fee. When Friday rolls around and Borrower X gets his paycheck, the lender either cashes the check or tears it up in exchange for cash. Borrower X also has the option of rolling the loan over for a longer period of time, in exchange for more fees.

Killer fees
The payday loan includes extremely high finance charges. If a borrower writes a personal check of $115 to borrow $100 for two weeks, that $15 fee equals a finance charge of 391 percent on an annual basis. That's an exorbitant amount of interest! What's worse…it's usually levied against lower income people who really can't afford to pay the price.

Lenders may argue that, for the borrower who can't get a credit card or a bank loan, the payday loan is the only place he can turn for quick access to money. But the most profitable customers for these loan operations are not people who use the service once or twice; it's the repeat customers who've fallen in a debt spiral from which they don't know how to escape.

Debt's domino reaction
The reverberations of these debt spirals are felt throughout society. Payday loans, for example, were found to be creating serious financial problems for members of the U.S. military, leading the Department of Defense to label payday lenders as "predatory." In October of 2006, Congress passed a law that would cap lending to military personnel at 36 percent APR (annual percentage rate).

This is great news for the military, but it leaves questions unanswered for the market as a whole. Barring further intervention by the government, payday loans will continue to thrive. There are alternatives, but many people are simply too cash-strapped to take advantage of them. If payday loans continue to spread like wildfires, they'll leave scorched consumers in their paths.