The Rationale for Payday Loans
Posted on Jan 16 2013 at 10:05:29 AM in Money
Does anyone want to be in a position that requires them to seek a payday loan?
Of course not..PERIOD. But, there is a HUGE problem in this country:
1. 46 million people are considered living in poverty
2. 2/3 of Americans are living paycheck to paycheck
3. 25% of Americans are tapping their retirement funds to pay ordinary living expenses: YOU SHOULD NEVER TAP YOUR 401k for a loan...NEVER!
4. Older households carried an average credit card balance of $8,278 in 2012. For those under 50, credit card debt averaged $6,258.
These are TERRIBLE numbers and it is really an epidemic. And, therein lies the need for solutions. Clearly, the two main solutions are job creating and higher paying jobs and financial education to help people manage their money (expenses, investments, etc.). Job creating and higher paying jobs would certainly help a lot of people. But, a lot of people try to keep up with the Joneses and get themselves into trouble even if they have family incomes in excess of $100,000. So, when people are in dire need of cash and don't have any resources, who are they going to turn to if they don't have family members who can help them out, they don't qualify for government aid, banks wont help them, and they have an absolute emergency (car repair to get to work, medical expense, etc.).
This is why the payday loan industry emerged as a solution. All the consumer advocate groups complain, the state and city legislators complain, and yet they have NO solutions to help those who are in need of $200, 300, 500 or $1,000 to payoff an emergency expense (or sometimes an ordinary expense due to their own mistake spending too much money). So, why are
the annualized loan rates so high? This is VERY simple. Would you lend money to a stranger today; say $500? Most likely you would not. So, if you WOULD consider doing that, then you need to look at the business model to make sure that it makes sense. First, how are you going to reach these people who need these short-term loans or bad credit quick cash loans or payday loans? You need to set up an infrastructure. Second, how are you going to get paid back? These prospective customers are coming to you because they have NO COLLATERAL other than their paycheck and more than likely they have BAD CREDIT. So, ideally, you would set the model so that you will be able to get the money back via direct withdrawal. But, you can't guaranteed that the money will be there; what if the customer closes that account down during the loan period. It happens. The default rate is quite high in the payday loan industry, so you need to take that into consideration into the business model.
Let's take the example of a venture capital company (say one that invested in Facebook). When they invest, they EXPECT that if the investment pays off they will make 100x their money, because they are taking a HUGE risk on a company with NO ASSETS. Maybe this isn't apples to apples, but the fact is that when you make a loan or investment and there is NO COLLATERAL, meaning that there is a big risk that you won't get paid back, then you need to structure the deal so that if you do get paid back you make a high enough interest rate to compensate for all of your operating expenses to make other loans or investments that go bad and get a good return for taking on the risk. There are plenty of other business loans that are structured with interest, options, percentage of sales, etc. to companies in dire need of cash that end up in 300-500% returns. Do you see the state legislators complaining?
If you want to compare this to the mortgage fiasco, DON'T. Yes, banks took advantage of people by not disclosing the true terms and conditions, but the people buying the homes and seeking mortgages did not NEED those homes or mortgages. In this case, people are DESPERATE for short term or emergency cash; they need the money tomorrow and there are no other sources available. So, they have to expect to pay a very high interest rate. What is most important is that if you are in this position, you have a lender that is very TRANSPARENT. You need to understand the terms and conditions, and you need to know the interest rate, late fees and/or how does it work if you are not able to payoff the loan on time.