May 30, 2009

In Defense of the Payday Loan Industry

NOTE: SHORT TERMS LOANS PROVIDE THE CASH NEEDED TO MEET IMMEDIATE SHORT-TERM CASH FLOW PROBLEMS. THEY ARE NOT A SOLUTION FOR LONGER TERM FINANCIAL PROBLEMS FOR WHICH OTHER KINDS OF FINANCING (SUCH AS CREDIT CARDS, AN OVERDRAFT LOAN OR A LOAN FROM FRIENDS OR FAMILY) MAY BE MORE APPROPRIATE AND AFFORDABLE. YOU MAY WANT TO DISCUSS YOUR FINANCIAL SITUATION WITH A NONPROFIT CREDIT COUNSELING SERVICE AVAILABLE TO CONSUMERS EXPERIENCING FINANCIAL PROBLEMS IN YOUR COMMUNITY.

I've spent about 25% of my adult life working in the payday loan industry and am pretty much used to it by now: "So what do you do for a living?...oh, well, uh, hope you feel good about that." I hear it from my own coworkers fairly frequently: "I can't believe these people don't realize how much we're screwing them over." Yes, that is me, I take advantage of poor people who are lured in by the promise of quick cash and then are overwhelmed with 700%, 800%, 900% interest. I'm a loan shark. I'm a terrible person. I should probably switch to something more moral, like dealing heroin.

Anyway, I'd like to set the record straight for anyone out there judging me (yes, President Obama, that includes you and your support of the proposed 36% APR interest cap...since you totally read my blog...):

Let's consider, for a moment, a man named Harold. Harold works hard to feed/shelter/entertain himself and his family, and is generally able to do so, but rarely has anything left over by the next paycheck. Harold runs into some sort of financial emergency: an unexpected medical bill, a car repair bill, a check deposited from a while ago that he had forgotten he wrote. Whatever the case my be, he needs money immediately and won't have anything until his next paycheck, 12 days from now. He doesn't have any friends or family members who can afford to loan him the money. He only needs $200-$500 to get him through, and banks don't really give out loans that small. What is he supposed to do?

Whatever the case may be, thousands, if not millions, of Americans live paycheck to paycheck like Harold, and most run into financial emergencies at some point. For some it's their own fault, for others it's not, but the fact of the matter is they are there and and no increase in minimum wage or other government intervention I can think of will ever change that fact. What are these people supposed to do?

Now, let's go to a company called Hip Hip Hurray Early Payday (you would not believe how many hypothetical company names I made up before finding one that didn't turn out to already be a real company). This company has acquired some money and decided to divide it up into $300 lumps to give out small payday loans. The goal is to make money for the company, but not charge too much that they don't have any customers. The costs of marketing, credit checks and manual underwriting that goes into each loan before it is ever funded is about $60 (the amount varies somewhat from company to company on this, depending on how careful they are about who to fund loans to and how large the company is, but from my experience and research, $60 is fairly typical). So to be breaking even on a $300 loan for two weeks, the APR would need to be 520% ($60 times 26 two-week periods in a year divided by $300). A little higher than 36%, yes?

Except there is another factor: payday loans are high risk loans. A rather high percentage (it would be compromising to share statistics from the companies I've worked for, and I'm not really sure what industry average is, but let's just say you would likely be surprised at how high it is) of the loans that Hip Hip Hurray gives out never pay back even the full $300. So, unfair as it may be, in order to provide the service they do, the people who do pay back the loans have to cover the funds lost from the people who don't pay. So the APR would need to be higher than the 520% we already calculated to be breaking even. And obviously to be making a profit, it would need to go up from there.

Granted, many people don't pay off the loan in full on their first payday and pay more interest as they extend the loan, so Hip Hip Hurray can perhaps afford to go a little lower on the fees there. Some people think it's wrong to count on people not being able to pay off their loan in time in order to make any profit, but that's how the majority of financial institutions in this world work (banks, credit card companies, etc.) so Hip Hip Hurray is not too torn up about it. Virtually nobody takes a full year to pay off a payday loan, so for those who think that 800% APR means that someone getting a $300 loan is paying back $2400, that's just ridiculous. We're really not that terrible.

If our pal Harold decides to get a payday loan to make ends meet and has been smart about planning how quickly he will pay it off, it is quite likely that he will end up being charged less from Hip Hip Hurray Early Payday than he would be from his bank if his financial emergency causes a few NSF charges (not to mention it looks better for his credit to have received a loan and paid it off rather than to have gone in the hole with his bank). And it's entirely possible that his payday loan has saved him from future financial trouble that would be worse than the interest he will pay. I've heard many stories from people I'm funding loans to (because of the stigma attached to the deal, I think a lot of people feel like they need to justify why they're doing it to the company they're getting a loan from) about how they would loose their job if they can't pay to fix their car to get to work or how they would have to pay an insanely high re-turn-on charge if their utilities get turned off because they couldn't pay the bill...that sort of thing. It can be worth your money to get the loan in a number of situations.

So basically moral of the story: I'm not destroying peoples lives constantly at my job. I'm providing a unique service and charging what I feel are reasonable rates for it. If you still have a problem with it, I'd actually love to hear what you think, as I'd hopefully have an answer and can add another bit to my "payday loans aren't pure evil" speech that I give from time to time to friends and coworkers. And if I don't have an answer for it and discover the error of my ways...so be it. It'll be easy to find another, more fulfilling job right? Right?

2 comments:

Trapper said...

The math makes perfect sense. One question, though: just as my car payment requires a payment each month, what is the minimum rate of payment on these sort of loans?

Another issue I have with these is purely from a moral standpoint. I don't feel as though it is a worthwhile service. You gave an example of whatever-his-face was which is realistic. But which party feels good about the situation? I couldn't imagine the loan company in this situation is like "I am so glad I could help you out!". They are there to make a buck and if there is one thing I hate, it is money.

Lis @ Ace Cash Express said...

A payday loan has never been a long-term solution to a financial problem. A payday loan is typically a more expensive type of credit because it is for a short-term and there is a higher risk of default so you cannot compare it to other types of loans which requires so much scrutiny from the lender.