Deferred Deposit Loan

Deferred Deposit Loan: A Quick Look

A deferred deposit loan is a short-term, high-cost loan where a borrower writes a post-dated check or authorizes an electronic withdrawal for a future date, usually their next payday. The lender gives the borrower the loan amount minus fees upfront.

What is a Deferred Deposit Loan?

Why are deferred deposit loans also called payday loans?

Deferred deposit loans are more commonly known as payday loans because the loan term is typically tied to the borrower’s next payday. These loans are designed to help people cover expenses until their next paycheck, but they come with significant risks.

Definition

A deferred deposit loan is a type of unsecured loan, typically for a small amount, that a borrower receives in exchange for a post-dated check or an electronic fund transfer authorization. The lender holds the check or authorization until the borrower’s payday, when the loan amount plus fees is due to be repaid.

Understanding Deferred Deposit Loans

Background and History

Deferred deposit lending has roots in informal lending practices that have existed for centuries. However, the modern payday loan industry began to gain traction in the United States in the early 1990s. Initially, these loans were intended as a short-term safety net for unexpected expenses. Over time, the industry grew, often operating in areas with less stringent regulation, leading to concerns about predatory lending practices and excessively high fees.

How Does a Deferred Deposit Loan Work?

The process is straightforward:

1. Application: A borrower in need of quick cash applies for a deferred deposit loan, usually at a storefront lender or online.
2. Check or Authorization: The borrower provides a post-dated check for the full loan amount plus fees, or authorizes an electronic withdrawal from their bank account on a specific future date (their payday).
3. Loan Disbursement: The lender gives the borrower the loan amount in cash or via direct deposit, minus the fees.
4. Repayment: On the due date (the borrower’s payday), the lender cashes the check or makes the electronic withdrawal. If the borrower doesn’t have sufficient funds, the check may bounce, incurring additional fees from both the lender and the bank.

Real-World Example

Let’s say Sarah needs $300 to fix her car before her payday, which is two weeks away. She goes to a payday loan store and gets a deferred deposit loan. She writes a check for $345 (the $300 loan plus a $45 fee). The lender gives her $300 in cash. On her payday, the lender attempts to cash the $345 check. If Sarah has the money in her account, the transaction is complete. If not, she could face bounced check fees and still owe the $345 plus potentially more fees if she rolls the loan over.

Who is Affected by Deferred Deposit Loans?

These loans often appeal to individuals with limited access to traditional credit, such as those with poor credit scores or who are unbanked or underbanked. They are frequently used by people living paycheck to paycheck who face unexpected expenses or cash flow shortages.

Tips and Strategies for Using Deferred Deposit Loans

Given the high costs, it’s generally advisable to avoid deferred deposit loans if possible. However, if you find yourself in an emergency situation:

• Understand the Fees: Calculate the Annual Percentage Rate (APR). For payday loans, this can often be 300% or more.
• Read the Contract Carefully: Know the exact repayment date and any fees for late payment or insufficient funds.
• Explore Alternatives: Before taking out a payday loan, consider options like:
  • Asking family or friends for a loan.
  • Negotiating a payment plan with creditors.
  • Checking with local charities or community assistance programs.
  • Seeking an advance from your employer.
  • Exploring credit union loans or small personal loans from banks, which typically have much lower rates.
• Budget Rigorously: If you do take out a payday loan, ensure you have the funds to repay it on the due date to avoid costly rollovers or further debt.

Common Misconceptions

• “It’s just a small fee.” While the fee might seem small ($15-$30 per $100 borrowed), when annualized, it translates to an extremely high APR.
• “It’s the only way to get fast cash.” As mentioned, many alternatives exist, though they may require more effort to secure.
• “Rolling over the loan is fine.” Repeatedly rolling over or “flipping” a loan means you only pay the fee and extend the repayment date, without reducing the principal. This can trap borrowers in a cycle of debt.

Sources

• Consumer Financial Protection Bureau (CFPB) – Payday Loans: https://www.consumerfinance.gov/consumer-tools/payday-loans/
• National Consumer Law Center – Payday Loans: https://www.nclc.org/issues/payday-predatory-lending.html
• Investopedia – Deferred Deposit Transaction: https://www.investopedia.com/terms/d/deferred-deposit-transaction.asp