Introduction
Loan is a debt from an individual, bank or banking institutions. In a loan transaction, the involved parties are a borrower, who borrows the money, and the lender, who provide the money, which is known as the 'principal'. As the lender would not lend money without seeing a reason to do so, an interest is charged on the principal – this is a sum of money calculated according to the amount of the principal and is the profit the lender makes.
History
A majority of loans are secured loans, which means that something valuable is pledged by the borrower to the lender, which the lender can sell to get back his money in case of default – that is, in case the borrower cannot find the money to pay the loan. A pay day loan is a type of secured loan where the security is the borrower's next pay cheque.
A pay day loan is also referred to as a cash advance, and it is usually for a small amount and has to paid after a short term of time. As the security is a pay cheque, the borrower has to have payroll and employment records before the loan is granted.
Different jurisdictions seem to view pay day loans in totally different ways. While some give pay day loans an illegal status, others have minimal restrictions placed them on them. Many jurisdictions, to prevent usury, have a cap on the rate of interest that can be charged from a borrower in a pay day loan transaction. This is because pay day loans usually come with a rate of interest higher than that of traditional loans. This is justified by lenders by saying that they run quite a risk in giving out pay day loans, because the default rate is rather high (10 – 20%) and many loans are never repaid.
Features
In fact, there is quite a debate about the ethics of pay day loan lenders.
It has been said by some that they drain income for those who earn low – these are the people who do not have other possessions as security to be eligible for traditional loans that charge lower interest rates. It has also been seen that pay day loans may end up trapping the borrower in a debt cycle – this means that they have to keep renewing the loan because of the high rates of interest till they can finally save a large enough amount to satisfy the loan.
Tips and comments
On the other hand, proponents of the system have said that pay day loans tend to result in an overall increase in family and community welfare. Also, the industry does not create a profit off the borrowers, and only tries to make up the losses it incurs through default in payment, which is pretty high. Studies have also showed that communities that have been hit by disaster, whether natural or man-made, have been able to deal with it in a better way and faster where there has been available an option of pay day loan.
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