A pay day loan is a short-term borrowing process where an individual can borrow a small amount of money but at a very high rate of interest. The borrower generally writes a post-dated personal check in the amount they wish to borrow besides a fee in exchange for cash. The lender usually holds onto the check and cashes it on the mentioned date which usually turns out to be the borrower’s next payday. These loans are also known as cash advance loans or check advance loans.
Deconstructing the ‘Pay day Loan’
Payday lenders are supposed to disclose their finance charges, but everything is not above board about these establishments and they have earned themselves a bad reputation for their unfavorable lending practices. Most borrowers banking on pay day loans have a disreputable credit and abysmally low incomes. They also may not have credit cards in their possessions and are almost forced to utilize the service of a pay day loan company. Even if the borrower is inclined to believe that the fee to be paid is fair, but the reality is that the amount translates into a rate to be more than 900% on an annualized basis. Most loans are for a period of 30 days or less and can then be rolled over for additional finance charges.
The Market for Payday
The pay day loan market in India is burgeoning and estimated to be at $10.27 billion (that amounts to Rs 70,000 crore), with estimates that it will touch almost $14 billion by year-end 2017. There are almost a hundred of startups in the payday space, and the surprising thing is as many as 30 of them were started in 2016, this just goes to show that there is a rising demand for this kind of loans. They usually use a kind of disruptive technology to reduce costs and attract customers in the process and many of them are actually funded.
Demonetization has given this market a further boost. The sudden cash crunch forced individuals to seek help from these start-ups to solve their personal emergencies. Inquiries for such loans have also risen dramatically.
While a few lenders are known to be front-end technology providers to big non-banking finance companies (NBFCs), many small companies have acquired the NBFC licenses themselves from the Reserve Bank.
Why Pay Day Loans Work?
Is there any valid reason for you to choose a digital lender? The one reason that prompts individuals to lend money from these companies are, Banks hardly lend people money for just a few days. So, it does not prove to be cost-effective for them to service small ticket loans which range from Rs 15,000-20,000.
Even if you seek for alternatives, credit cards, are the first thing that comes to mind but they are saddled with high-interest rates. Youngsters, especially seek this kind of loans to help them cater to their diverse needs such as education, travel and so on.
And how much can a youngster get? It all depends on the salary of the individual. The average loan-seeker can usually seek a loan between Rs 5,000 and Rs 50,000. Some loan companies can also provide a loan up to Rs 1 lakh or the amount that equals to 40% of the salary, but for that, the tenure stretches to a 90-day period. But for loans which have a tenure of 15 to 30 days, the cut off is Rs 50,000.
What separates the Payday lenders from the ordinary lender? They offer speed and convenience, which otherwise the borrowers do not get from other sources. At some platforms, the loan approval process is completely automated. If the applicant caters to the lender’s algorithms and finds the applicant creditworthy, loans are finalized and granted in a few minutes. But if some more details are required, then the process could get delayed and could take 24 hours if it requires manual intervention.
The algorithms to identify borrowed risk are many and varied, there are traditional ways such as IT returns, credit scores, bank statements and so on. But nowadays there are other algorithms to identify borrower risk such as social media, GPS locations, mobile usage patterns, SMS alerts and so on.
This model of banking has been very successful. The only concern is that the flat interest rate, which can almost burn a hole in the borrower’s pocket if he does not pay heed. The payday lending markets in different parts of the world such as the US and UK can be regarded as predatory, and provide debt traps for the naive borrower.
Regulators are shutting down on usurious rates which are charged by pay lenders in those countries. It can affect India too if some go overboard. The thing to note is that disruptive technological innovation should not lead to indiscriminate lending. Borrowers should bear it in their minds and forge ahead with extreme caution.
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