Why do payday lenders charge higher interest than a traditional bank or other lending institutions? Simply put: The risk to loan is higher. With payday lenders, the borrower has access to fast cash without going through a stream of paperwork and the hassle of a credit check. Banks and credit unions loan money on a long-term basis, collecting interest fees over a period of time. These institutions are pickier about who they loan to, usually approving only those who have good credit ratings, low debt-to-income ratios, and fall into a certain income bracket. This provides more security for the lending institution thus lowering the risk of the borrower defaulting on the loan.
Payday lenders, on the other hand, consider the applicant’s job, income, and direct deposit as their collateral, thus eliminating the need to ask for other proof of credibility. Credit checks are not run on the borrower so the lender does not know what kind of payment history the borrower brings to the “application table”. These lenders do require that applicants have no more than two other loans out at the time of application. They can verify this through a system called CL Verify. Essentially, the lender is taking more of a risk when they give a loan because they are not using the same criteria as traditional lending institutions. With the average of two out of three pay day loans not being paid back, lenders who offer online payday loans are taking a greater risk.
Something to remember when looking at the rates of payday lenders versus banks and credit unions is that interest is calculated on a short-term basis so it seems higher. For example: a bank may offer a loan that will take 12 months to pay off at an annual interest rate of 10%. That rate may seem much lower than a payday loan but that’s because the interest fees are being charged over a longer period of time. With a short-term loan, the interest is calculated based on the loan being paid back within 7-21 days on average. When you do the math, the interest rate will ultimately come out looking higher but you may end up paying more on the long term loan.
The bottom line is that choosing a loan and lender is at the discretion of the borrower. Researching lenders and interest rates is in the best interest of someone looking to take out a loan, whether short or long term. Payday lenders offer the advantage of a quick application process and funding time and don’t put the borrower through a grueling application process. It’s important to remember that these types of loans are meant to be short-term with repayment coming out of the borrower’s next paycheck.