The is no doubt that payday lenders have a bad name, they probably rank right around used car sales people when it comes to trustworthiness and believability but don’t strike me with lightning when I say, there is a place for payday lenders.
I admit I was a payday lender at one time. Back in the early 1970s when my family was facing a tough economic time, my parents on several occasions asked me for permission to raid my piggy bank to get some cash for milk and bread until payday. When they paid me back they gave me more than they borrowed for that short-term loan. The annual interest rate I got from they was amazing.
Essentially that is the essence of what a payday loan is. It should be a bridge loan, like wealthier people use to fund the construction of their home and then replace it with a permanent mortgage.
A payday loan should be used to help you over a gap until you receive your money and can repay the amount borrowed.
The car needs repairs for you to get to work and you don’t have the cash for it now but can pay it off when you get paid next, possibly a good candidate for a payday loan.
The hot water heater goes, you need medications and the pet needs surgery; all good reasons that someone without credit might need a payday loan.
If you haven’t done it I urge you to go drive around those sections of your town that have the most payday lenders. Go see the other side of the tracks. Go count the number of Main Street banks you find, it won’t be many.
Disadvantaged consumers are typically serviced by higher priced merchants and services because unless a substantial profit can be made, why bother. Opponents of the payday industry cry out that payday loans victimize consumers and all payday loans should banned.
Are people screwed over by payday loans, absolutely they are. The worst examples are those people that go and get one payday loan to payback another and just snowball their debt to a point where they can never pay it back. But wait a minute, doesn’t that sound suspiciously like the mess going on with Wall Street banks and what they did to American consumers by feeding them mortgages they could not afford?
Are payday loans expensive: Yes
Do payday lenders profit: Yes
Is their a substantial risk in making the loans: Yes
Will eliminating payday lenders reduce consumer financial risk: No
Rather than block or kill payday lenders, instead we should look at ways to restrain fees to a reasonable amount based on administrative time, risk, actual collections and profit.
The average payday loan nationally is $325. This is a loan until next payday. So what would we consider worth the time for a high risk lender to get involved and serve these customers? Did you say $50, please, that would not even begin to cover fees and profit. How about more like $200, getting closer I’m sure.
So what would Bank of America say if you walked into a branch and asked for a two week loan for $325. They would tell you they don’t do such a thing, would encourage you to apply for a credit card and as you walked out they would laugh at you as being a waste of their time.
The credit card might be a good option but that would imply that you had good credit to begin with, and you don’t because if you did you wouldn’t be hunting down a payday loan.
So let’s look at the following credit card designed for people with poor credit.
This card is issued by First Bank of Delaware, an FDIC insured Main Street bank.
The card comes in two types, a $300 limit card with an APR of 24.5% or a $70 limit card with an APR of 19.5%.
Since the average payday loan is for $325, I’ll just focus on the $300 card terms here.
Cash Advance Rate: 30.5%
Delinquency APR for Purchases: 30.5%
Delinquency APR for Cash Advances: 36.5%
Variable Rate Calculation: Prime rate plus 18.5% but no lower than 24.5%, could be higher.
Annual Fee: $150
Account Maintenance Fee: $9.95 per month
Cash Advance Fee: 5% of the amount of the cash advance
Late Payment Fee: $35
Overlimit Fee: $35
So what would it actually cost you to for the bank to give you this card so you could borrow $325 for two weeks.
Let’s see.
Annual Fee: $150.00
Monthly Fee: $9.95
Overlimit Fee: $35
Cash Advance Fee: $16.25
Interest Charge for One Billing Cycle: $10
Total Cost of Loan: $221.20
So to get the $325 that you need in cash and pay it all back in two weeks it would cost you a total of $546.20.
Bad News: According to the terms on this card you’d have to wait at least a month to get your money, and even then, you probably would not be able to borrow the $325 in cash that you need. Here is what the terms say: If you are approved for the $300 Card, your credit line will be $300 and your Annual Fee of $150 will appear on your first statement. Your initial minimum payment of $30 must be received, cleared and posted on your credit card account before you can activate your card and use your credit card account. Your initial available credit will be $180. You will be billed an Account Maintenance Fee of $9.95 per month (total of $119.40 per year), beginning after you make your first purchase or cash advance.
What Does History Tell Us About Payday Lenders?
Payday lenders and finance companies have always served a niche in our capitalistic society. They provide access to cash and credit for people that would otherwise not be served. And this is not a new condition. Let’s look back into American history.
Today, when we think about the neighborhood finance company, it usually carries a negative connotation. Storefront lending is now the place you go when the bank won’t touch you, or so many believe.
Personal finance companies played an important part in accelerating the consumption of credit in America. Ironically, that was not their intention.
In the 1920s, if you wanted a small loan, your choice of supplier was usually limited to the “loan shark.” In order to help people avoid such unscrupulous borrowing, small-loan offices appeared. These offices wanted to assist workers with budget advice and affordable loans for emergency situations and were viewed as bastions of social welfare and of charitable purpose.
The intention of finance companies was to provide advice to workers and restore them to the path of financial control, Victorian thrift and self-discipline. The finance companies felt if they could only help people make out a budget and provide some advice, the financial troubles of the applicants would be eased. It did not take very long for the plan to explode in their faces as people came to them to borrow more and more. Finally, finance companies stopped counseling people, consumers just wanted the loans. Some finance companies, having overachieved on their objectives and unsatisfied with their inability to achieve their philanthropic objectives, closed their doors.
Early usury laws did more to hurt workers’ abilities to gain access to borrowed money. A tremendous amount of argument raged in written works of the time both for and against usury laws.
The unintended effect of usury laws was a growing underground of illegal lending. While it is true that throughout the ages some lending could be characterized as unconscionable, when legislatures set a maximum interest rate, it prevented many lenders from extending credit to those who, some might argue, needed it most.
Interest rates are determined by a number of factors: cost of funds, quality of the collateral and risk of return. When the usury rates were determined, they did not account for the ability of lenders to make loans to the more financially challenged members of our society. This unreasonable control of the free market value of funds created an artificial ceiling on available cash and made lending so unprofitable as to cause many lenders to close.
You can see natural market values of interest rates in operation today. While a new vehicle loan may cost 8.75 percent for 36 months, the same lender may charge 9.25 percent for a 72-month loan. And an unsecured personal loan may be at the rate of 16 percent.
Usury laws extend back to Jewish Mosaic laws that prohibited the charging of interest on loans. In modern times, usury laws determine the maximum amount of interest, which can legally be charged. Loans above the maximum legal rate are called usurious.
Finance companies labored under restrictive usury laws and limited the ability of consumers to obtain small loans. While it was popular opinion that there should be controls placed upon interest rates, consider the following facts:
- Finance companies did not have access to cheap funds from depositors like a bank. They either lent their own money or had to borrow.
- Finance companies made riskier loans so a higher return had to be made from those that did repay to compensate for those that did not, in spite of collection efforts.
- Finance company loans were generally for low dollar amounts but required the same administrative costs of origination and administration as loans 10 times the amount.
Oklahoma City, 1937
It is interesting to read about the history of Arthur Ham, a graduate student of Columbia University, who, in the early 1900s, studied small-loan lenders in detail.
Ham first concluded that finance companies of the day were causing a hardship on workers by charging high rates of interest.
However, after he led the campaign to pass usury laws to limit the amount of interest that could be charged, Ham completely reversed his position.
He originally felt, as do many people then and today, that high interest rates were an indication of shameless profit. However, as he became better acquainted with the loan industry, he discovered how interest rates for these loans were determined and why they were necessary.
Since the new lower, “protective” interest rates enacted were too low for small finance companies and philanthropic lenders to take on the risk of low-dollar borrowers, people had no place to turn for these small loans. After realizing what was happening, Ham moderated his views and worked with lender organizations to find a way for small finance companies to exist while eliminating the undesirable “loan shark” element.
Source: The History of Credit and Debt
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“Are payday loans expensive: Yes
Do payday lenders profit: Yes
Is their a substantial risk in making the loans: Yes
Will eliminating payday lenders reduce consumer financial risk: No”
Very well said. Payday loans are not right for everyone in every situation, but they are a useful financial tool for those that use them responsibly. Many times payday loans are a less costly alternative to overdraft fees, bounced check fees, late payment fees or utility reinstatement costs. It’s about taking control of your finances with the financial tools that work for you.
This is an excellent article. Extremely informative. I too am a payday lender and prior to buying a franchise I worked in the lending world for almost 30 years. I also worked for a well know finance company for 26 of those years. I watched as their business model changed away from small personal loans of any kind to mortgages. Leaving the consumer with even the smallest blemish on his credit with no where to turn to get a loan. If the politicians and the press would wake up and study this business they would find that we arent loan sharks but people trying to help others get the loan that they cant otherwise obtain. We dont cater to the poor as so often stated our customers on average make over 30k per year and many of them make over 75k. If the loan is used correctly it can be extremely beneficial to get and far cheaper than many of the alternatives.