Payday loans are single-payment, short-term loans that are made in return for delayed deposit of a borrower's personal check. These loans go by a variety of names that indicate that borrowers are receiving cash in advance of a future paycheck, including: cash advance loans, check advance loans, post-dated check loans, deferred deposit check loans, and quick cash loans.
Payday loans are technically illegal in New Jersey. According to state statutes, a check cashing licensee cannot cash or advance money on a postdated check (i.e., a check with a future date on it). However many payday lenders operate on the Internet, sometimes from foreign countries, and state residents can access their services. Therefore, it is important to understand how payday loans are structured and how much they cost.
Here's how payday loans work. A borrower writes a postdated personal check to the lender, typically for a sum between $100 and $500. Payday loan fees can seem "cheap" at first but, in reality, they are a very expensive way to borrow money when the amount of the fee is considered in relation to the short two-week length of the loan.
To fully understand the high cost of payday loans, in relation to other forms of borrowing (e.g., credit cards, bank loans), it is necessary to cover the cost into an annual percentage rate or APR. An APR is the simple percentage cost of all finance charges over the life of a loan on an annual basis. The annual percentage rate for paying $15 to borrow $100 for two weeks is 390% (15% biweekly x 26 biweekly periods in a year = a 390% APR).
What happens after two weeks? Depending on the lender, options at this time are to "redeem" the postdated check with $115 cash or to have the lender simply deposit it (this assumes that there are adequate funds in the borrower's checking account, of course). Unfortunately, many borrowers don't have enough money to repay the lender after two weeks. Perhaps they were behind on other bills or had some type of emergency. Their second option is to extend the payday loan with another fee (e.g., another $15 for the same $100 loan).
After a few roll-overs, the fee charged for payday loans can actually exceed the amount borrowed. Many people don't pay off these loans for months and, therefore, dig themselves deep into debt. If you extend a $100 loan three times (i.e., three more bi-weekly periods), you will have paid $60 to borrow $100: the original $15 fee plus $45 for three more extensions ($15 x 3). After six roll-overs the finance charge (fees) will be greater than the amount borrowed.
The word "interest" is generally not used in payday lending agreements. Instead, payday lenders call their charges "fees." This way, they reason, they don't violate state usury laws which cap the amount of interest that can be charged on loans. In some states, lawmakers exempt payday lenders from limits on interest rates. Payday loan fees are exactly like interest charged on a credit card, except much higher. With all types of loans or credit, consumers pay a price to borrow money.
A 1997 study of payday lenders by the Consumer Federation of America found effective annual interest rates (APRs) ranging from 261% to 1,820%. While some states have passed rate caps and/or limits on loan roll-overs, payday lenders operating offshore from places like Grenada are often beyond the reach of U.S. laws.