If your bank account is overdrawn, a payday loan may seem like a great way to get your balance back in the black and avoid paying overdraft or non-sufficient funds fees. Such a loan doesn't involve credit checks and gets you cash quickly – in some cases, instantly. That doesn't necessarily mean it's a good idea, however, as your ultimate costs may exceed those associated with an overdrawn bank account.
Payday Loan Basics
Payday loans are designed to lend money to those with a steady job until the date of the employee's next paycheck, at which point both the balance and interest is due. Interest rates for these loans are generally high -- with amounts that translate to annual percentage rates of 390 percent or higher, according to the Federal Trade Commission -- reflecting both the presumed desperation of the borrower and the lender's risk that repayment won't be made on time. Banks, on the other hand, charge account holders fees against overdrawn accounts for each transaction that places or keeps the account in the red, whether they allow transactions to go through or reject them with a "non-sufficient funds" designation. As payday loan marketing materials often point out, the interest paid on a loan may be less than what a bank might assess for a series of fines.
Documentation Required
A payday loan doesn't require the paperwork of a conventional bank loan, but you'll have to prove that you're employed, that your housing situation is stable and that you'll be easy to contact if they need to. Loan operators will want to see your last couple of pay stubs, a bank statement and likely a utility bill or another indication of your permanent address. With the bank statement, they're looking less at the balance – negative or positive – than they are confirming you have an account and that your employer deposits regular paychecks in it. They'll want your contact information at work, at home and on your mobile device, and will ask for your work supervisor's name, spouse's name and perhaps additional references.
Repaying The Loan
When you take out the loan, you'll often get the proceeds in cash. The benefit is that the money gets credited against your overdrawn bank balance as soon as it is deposited, unlike the holding period some banks may place upon a check before fully crediting your funds. However, the payday lender typically demands collateral to increase the chances of repayment. Often this takes the form of a postdated check. Some lenders may simply deposit the check at the appropriate time, while others will want you to return with cash, retaining the check only as a backup. If you took out the loan over the Internet, the lender may make an automatic withdrawal through an electronic financial network.
Predatory Lending Concerns
The payday loan is a controversial topic in banking and financial circles, with increasing regulation and pressure to protect consumers against what may be considered to be predatory lending practices. Though payday lenders have historically been regulated on the state level, the Consumer Financial Protection Bureau has explored establishing federal regulations and oversight. Concerns are that many borrowers simply roll over the loans because they can't afford to repay them and are charged interest and applicable fees every time they do so. Even in states where interest rates are capped by usury laws, late fees or NSF fees ratchet up the balance. Such costs may quickly exceed the back overdraft fees you were trying to avoid.
Other Loan Possibilities
Because of the unsavory reputation of the payday loan industry, some businesses and organizations have stepped in to offer their own payday loan plans that can sidestep some of the fees and risks. Your employer may have policies governing payday advances in case of an emergency need. Nonprofits or other organizations may facilitate loans, with some deducting the repayments from the paycheck automatically.