Payday loan lenders are open at times when most banks are closed and will usually issue payday loans with only a paycheck stub and photo ID, instead of the pile of financial documents and identification often needed for a bank loan. It is also true that few payday loans require a credit check, in the traditional sense. In fact, some companies target their loans specifically to consumers with troubled credit histories. Whether they will cover your unexpected expense, however, depends a great deal on how much you earn and how much you must use the loan to pay. How can lenders afford to extend these loans without credit checks? The answer begins with an understanding of the payday loan process.
The Life Cycle of a Payday Loan
A consumer has an emergency--perhaps the water heater sprung a leak or a rambunctious child broke a window. The consumer has already spent all the money from the last paycheck, but payday is still three days away. The consumer decides to get a payday loan to cover the cost of the repairs.
The consumer takes her most recent pay stub and her photo I.D. to her local payday lender. (There are ways to get payday loans by phone or online, but the basic concept is generally the same). The payday lender checks that the photo on the ID matches the consumer and that the name on the ID is the same as the employee's name on the pay stub. Remember that claim that no credit check is necessary. This essentially a credit check. The pay stub proves to the lender that the consumer is employed and is (theoretically) able to pay back the money borrowed.
- The consumer writes a post-dated check to the lender for the amount the consumer wants to borrow, plus the interest the payday loan will accrue before the consumer is expected to pay it back. In addition, the lender may add a processing fee to that total.
- The lender and consumer sign a contract agreeing to the terms of the loan.
- The lender gives the consumer cash or deposits the money into the consumer's bank account.
- The consumer uses the cash to cover the unexpected expense.
- The lender holds the check until the agreed-upon date, then deposits it.
- The check is processed by the lender's bank and the consumer's bank, transferring the funds from the consumer's checking account to the lender's checking account.
Lenders can afford to make payday loans primarily because of the fees and interest charges. The high interest rates usually cover the risk to the lender of check forgeries. Because the principal of the loan is relatively small and the loan is intended to be short-term, there may be a small convenience fee. This is for a consumer who wants to be assured that they will have the money to spare in their account by the time the check clears the bank.