A payday loan is a short-term loan for a small amount of money. The loan is given in cash and typically paid back via electronic withdrawal from the debtor's checking account.

Payday loans have been criticized for their interest rates. However, defenders of high interest rates on payday loans note that, due to processing costs on such small loan amounts, conventional interest rates would not be profitable. For example, a $100 one-week loan, at a 20% APR (compounded weekly) would only generate 38 cents of interest, which would fail to match loan processing fees. Also, the interest on payday loans is less than the costs associated with bounced checks or late credit card payments, and banks will not typically give out these types of loans that are needed by many people.

California PayDay Loan Law

Many check cashing businesses in California offer small sum, short-term, high-rate, unsecured personal loans. These loans go by many names, including "payday loans," "cash advance loans," "post-dated check loans" or "deferred deposits."

In a payday loan transaction, the borrower will provide to the lender items such as a paycheck stub, photo identification and a recent bank statement. The borrower writes a check to the lender for the amount of the loan and the lender's fee. Under California law, the lender's fee cannot exceed 15 percent of the loan amount and the total face value of the check may not be more than $300. The lender agrees to hold the check until the customer's next payday, up to 30 days. At that time, the borrower may redeem the check with cash, allow the lender to deposit the check or roll over the loan by paying another fee.

Payday lenders advertise their services as a way to cover unexpected expenses like car repairs and avoid bounced check fees and late payment penalties

PayDay Loan Example

Let's say 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 a one-time fee of $10 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's easy to see how these fees can quickly add up - if you extend the loan for a total of six months, you'll end up paying $360 in fees, without having paid back any of the principal (the original $200).

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