To apply for a payday loan, a borrower needs to provide personal identification, paycheck stub, and bank statement. The borrower gives a postdated check to the lender for the amount of the loan plus the lender's fee. The lender holds the check until the borrower's next payday. At that time, the borrower has the option of (1) redeeming the original check with cash, (2) allowing the lender deposit the check, or (3) renewing or rolling over the loan, if the consumer is unable to repay it, by paying another fee.
Example of Payday Loan
Assume you want to borrow $200 until you get your next paycheck in two weeks. You write a postdated check to a payday lender for $230 (15% of $200 = $30 lender's fee + $200 loan amount = $230) and get $200 cash in return. The $30 interest you pay on the loan calculates to an Annual Percentage Rate (APR) of 391%. The payday lender may also charge you an additional one-time fee to set up an account.
If you are unable to repay the loan after the agreed-upon 14 days have elapsed, you may elect to extend the loan for another two weeks by paying an additional $30. If you choose to roll over the loan, you will have paid $60 in lender's fees for a one-month loan of $200. It is easy to see how quickly these fees can add up - if you extend the loan for a total of six months, you will end up paying $360 in fees, without having paid back any of the principal (the original $200).
While payday lending is not illegal in Massachusetts, the Massachusetts Small Loan Act prohibits anyone from making or brokering loans of $6,000 or less without a license from the Division of Banks. This law also caps annual interest rates on these loans at 23% and limits other fees to $20. Accordingly, a payday loan of less than $6,000 would trigger the licensing requirements and usury cap within the Small Loan Act. Currently, there are no companies licensed with the Division of Bank to engage in payday lending in Massachusetts. However, there are increasingly unlicensed companies that are offering payday loans to Massachusetts consumers over the internet.
Internet Payday Lending
Many unlicensed payday lenders offer their services using the internet. Upon completion of an internet payday loan application, a payday lender will electronically transfer funds into a consumer's checking account. At the close of the term, usually following the deposit of the consumer's next payroll check, the payday lender will automatically deduct the loan amount and interest charged from that account.
State and federal truth-in-lending statutes require lenders to disclose the true cost of credit in the form of an Annual Percentage Rate (APR) prior to the actual extension of credit. However, internet payday lenders typically advertise fees as a dollar amount rather than an APR. This may be misleading to consumers in determining the actual cost of the payday loan. The Division's survey of internet payday lenders found that APRs typically ranged from 300% to 500% and in one instance as high as 3,042%!
The Division of Banks strongly urges potential internet payday loan customers to educate themselves about the risks and responsibilities involved in these types of loans. Many internet payday lenders provide little or no identifying information about themselves. Because these companies are not licensed by the Division, they are subject to little or no regulation. Unlike a bank, credit union, or a Massachusetts licensed lender, consumers may have little or no recourse should they run into trouble while doing business with an unlicensed internet payday lender.
Alternatives to Payday Lending
- Ask your employer for an advance on your paycheck.
- Ask to borrow money from a friend or relative.
- Find out if you can delay paying a non-interest bill such as a utility bill and make payment arrangements with the utility company.
- Ask your creditor for more time to pay your bills. Find out what they will charge for this service - a late charge, an additional finance charge or a higher interest rate.
- Find out if your bank or credit union or a mainstream financial firm provides short-term credit products.
How do you plan for the future?
- Make a realistic budget and figure your monthly and daily expenditures.
- Build some savings to avoid borrowing for emergencies or unexpected expenses.
- Contact your local consumer credit counseling service if you need help developing a monthly budget or working out a debt repayment plan with creditors. There are non-profit groups that offer credit guidance to consumers.