by Ben Kritz

Created on: March 22, 2008   Last Updated: March 23, 2008

A free market is by definition one that is unregulated by any factors other than supply and demand, so in that sense, payday loans are indeed consistent with the free market. There is a demand for short-term loans that carry few credit restrictions; payday loan companies supply the loans to meet that demand. The implication of the question, however, is that "free market" is necessarily a good or desirable state, and that is not always the case. Things like illegal drugs and child pornography also are consistent with the free market, strictly speaking.

A payday loan is a very simple transaction. Usually, the only requirements are a job and a checking account. Once a loan-seeker's employment is confirmed, he then writes a check payable to the loan company, post-dated for the due date of the loan. The total amount of the check is for the loan amount and the interest, which is generally very high, 25 to 30 percent or more. In other words, for a post-dated check in the amount of $200, the borrower will typically receive $150 in cash. On the date the loan is due, the loan company deposits the borrower's check, and if everything has gone according to plan, the loan is automatically repaid when the check amount is deducted from the borrower's account and paid to the loan company's account.

There are obvious pitfalls in receiving a payday loan. If a person has already run short of funds between paydays, receiving an advance against the next paycheck will most likely only aggravate that deficit cycle. And even though they are loans, the manner in which payday loans are made puts them into a sort of legal gray area in case of default. The only way a payday loan can be defaulted is if there are insufficient funds in the borrower's checking account to honor the post-dated check when it is presented to the bank. From a legal standpoint, a bad check is a bad check regardless of the reason it was written. Depending on what state the loan company is doing business in, it has wide latitude in charging additional fees in pursuit of collection, and the borrower is usually subjected to additional penalty fees from his bank. Passing a bad check is also a criminal offense. Realistically, most jurisdictions will not pursue a case against an offender for a single incident, especially if it is likely that it was an honest mistake or the result of uncontrollable circumstances. But there is nothing to prevent them from doing so if they choose, and this can be a powerful threat to use

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