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Payday Loans vs. Invoice Financing

By Caron Beesley

“Get cash fast!” We’re all familiar with the ads and slogans that payday lenders use to lure cash-strapped consumers. They can be a viable option for some, but for most people, the short-term relief that these payday loans provide comes at a very high price.

Here are some straight answers about payday loans for small business owners (also known as cash advance loans), plus some alternative cash management and lending options to consider.

What is a Payday Loan?

Payday loans originated as a quick solution for overcoming short-term cash problems. Secured by a personal check or paid by electronic transfer, payday loans are essentially cash advances that tide you over until the next payday (hence the name). Funds are made available for a short time (the typical repayment period is two weeks) for a set fee based on the amount you borrow.

In the business world, payday loans or cash advance loans are marketed as a way to overcome shortfalls in cash caused by unexpected outgoings or insufficient incoming cash.

How Payday Loans Work

According to the Federal Trade Commission (FTC), payday loans work as follows:

“A borrower writes a personal check payable to the lender for the amount the person wants to borrow, plus the fee they must pay for borrowing. The company gives the borrower the amount of the check less the fee, and agrees to hold the check until the loan is due, usually the borrower’s next payday. Or, with the borrower’s permission, the company deposits the amount borrowed—less the fee—into the borrower’s checking account electronically. The loan amount is due to be debited the next payday.”

Payday Loans Have a Set Limit

In an effort to protect borrowers, most states have laws in place that limit the amount of money payday lenders can loan and cap the duration of the loan. Other states have even banned them outright. The limit is typically $500 but can be as low as $300.

Payday Loans Are Very Expensive

With fixed dollar fees and short-term durations, the cost of payday loans can be very high, especially if you can’t repay on time, when additional fees apply. Furthermore, annual percentage rates on payday debt can average 400% but can be as high as 5,000%!

Payday loans propagate a vicious cycle that can lead to larger financial problems. According to research by the government’s Consumer Financial Protection Bureau (CFPB), two-thirds of payday borrowers take out seven or more loans a year. Most are taken within 14 days of the original loan being repaid, some even on the same day.

The FTC is vehement in its caution against payday loans and cautions consumers to find an alternative. The Commission cites examples of escalating costs and the potential for a loan as low as $100 to incur fees of $60 if it’s rolled over three times.

Payday Loans Lead to Long-Term Debt

The average payday borrower is in debt for nearly 200 days, says the CFPB, and a quarter of all borrowers spends 83% of the year owing money to payday lenders. For an easy-to-read breakdown of the CFPB report and the true cost of payday loans, check out this article by Consumerist.com.

Even Google Has Banned Payday Loan Ads

In July of this year, Google bowed to pressure from consumer groups and took the unprecedented step to ban payday lenders from advertising their products using Google Ads (the ads that appear above search results).

When reviewing our policies, research has shown that these loans can result in unaffordable payment and high default rates for users so we will be updating our policies globally to reflect that. This change is designed to protect our users from deceptive or harmful financial products…” wrote David Graff, Director of Global Product Policy in a company blog.

Facebook also banned such ads in 2015.

Why Invoice Financing Can Be a Better Option for Business Owners

Payday loans can be useful if you are confident that you can repay the loan promptly. But for business owners with unpredictable cash flow and unexpected expenses, they can lock you deeper into long-term, expensive debt.

There are many preventative measures business owners can take to avoid cash flow issues, such as making a realistic budget, creating a cash flow forecast, and learning from your cash flow statement. But there are also financing alternatives that are less costly and more sustainable.

One option that’s rapidly gaining traction is invoice financing. Not to be confused with invoice factoring, invoice financing gives you instant access to the cash you’re owed by providing an advance on outstanding invoices.

The advances help optimize cash flow so that you can continue to successfully run your businesses while waiting for accounts receivable invoices to be paid. This enhancement in cash flow is intended to help companies maintain consistent operations and streamline capital for expenses like new equipment or payroll.

Fundbox, for example, provides invoice financing services that advance 100% of your owed invoice amount. You have 12 weeks to pay the amount back, plus a small clearing fee (if you repay early, the remainder of the fee is waived). There is no limit to the number of invoices you advance so long as you’re within your Fundbox Credit limit, as opposed to being restricted to state-regulated payday lending limits.

By providing next-day access to cash, keeping fees low, and essentially giving you access to money you’re owed (not borrowing), invoice financing is a useful alternative to risky and costly payday loans.

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