Payday Loan

A payday loan (also called a paycheck advance) is a small, short-term loan that is intended to cover a borrower's expenses until his or her next payday. The loans are also sometimes referred to as cash advances, though that term can also refer to cash provided against a prearranged line of credit such as a credit card (see cash advance). Legislation regarding payday loans varies widely between different countries and, within the USA, between different states.

The basic loan process is simply that a lender provides a short-term unsecured loan to be repaid at the borrower's next pay day. Typically, some verification of employment or income is involved (via pay stubs and bank statements), but some lenders may omit this. Individual companies and franchises have their own underwriting criteria.

In the traditional retail model, borrowers visit a payday lending store and secure a small cash loan, with payment due in full at the borrower's next paycheck. The borrower writes a postdated check to the lender in the full amount of the loan plus fees. On the maturity date, the borrower is expected to return to the store to repay the loan in person. If the borrower does not repay the loan in person, the lender may redeem the check. If the account is short on funds to cover the check, the borrower may now face a bounced check fee from their bank in addition to the costs of the loan, and the loan may incur additional fees and/or an increased interest rate as a result of the failure to pay.

Some jurisdictions impose strict usury limits, limiting the annual percentage rate (APR) that any lender, including payday lenders, can charge; some outlaw payday lending entirely; and some have very few restrictions on payday lenders. Due to the extremely short-term nature of payday loans, the difference between nominal APR and effective APR (EAR) can be substantial, because EAR takes compounding into account. For a $15 charge on a $100 2-week payday loan, the APR is 26 × 15% = 390% but the EAR is (1.15²⁶ − 1) × 100% = 3,685%.