Payday Loans, Anybody?

No, I’m not talking about borrowing a payday loan. We all know it’s very expensive for the borrowers. If you treat the fee as an interest charge, the rate often reaches several hundred percent APR. You know, what’s bad for the borrowers must be a good deal for the lenders, right? What about owning a piece of the action? Wouldn’t it beat lending on Prosper ten times over?

Before you accuse me of being a cold blooded capitalist lack of morality or ethics, let me get this straight. Payday lending is a legit business regulated by the states. There are payday loan companies publicly traded on the stock market. Chances are you already own them through your mutual funds. For example a company called Advance America, Cash Advance Centers, Inc. (ticker symbol AEA) operates 2,900 payday loan centers in 36 states. The company is traded on the NYSE and it’s worth more than $1 billion. Vanguard is a top institutional shareholder of that company.

Second, payday loan transactions are completely voluntary. The lenders provide a service which the customers use by their own choice. If there is a cheaper, better service, the customers will use that instead. If the customers don’t seek out the best deals for themselves, it’s not the vendor’s fault, is it? The value of a product or service is in the eyes of the customers. I may not think a particular pair of shoes is worth $300, or a car is worth $40,000, but a lot of other people apparently disagree. The same goes for payday loans. The customers think the service is worth the price or else the lenders wouldn’t be in business.

Are payday loan companies making a lot of money? Not necessarily. You see the mind boggling 600% APR on the revenue side but that 600% APR is on a very small sum for a very short term. Earning 600% APR is impressive but not if it’s on $100 for one week. Then you are only talking about $3 and change. To really make money, you will have to pull in a lot of customers into your door. And you don’t see the cost side of the equation. After the costs of doing business are taken out, the profit is nowhere close to what you’d imagine. Take again Advance America for example, according to Yahoo! Finance, its revenue in 2006 was $673 million. After expenses were taken out, the net income was only $70 million, for a profit margin of 10.4%. By comparison, the profit margin for banks is usually around 30%. I just picked a random bank First Midwest Bank (FMBI) in Illinois. On $345 million revenue in 2006, it made $117 million profit, for a profit margin of 34%. Now, who’s making the big money?

The reason I wrote this post is not to defend the payday loan lenders. I think the society is better off without them. But then again the society is better off if people don’t live barely paycheck to paycheck and don’t need payday loans.

What I’m trying to show is that you have to look at any issue more closely and not jump to a conclusion based on what you read in the newspaper (or this blog, for that mater). The mass media pull on people’s emotions. They create sensational headlines to attract eyeballs and ad dollars. If you read the mass media, you get the impression that payday lenders exploit their customers to the n-th degree (some do), and by logical extension, owners of payday lending companies are making obscene profits. Except they don’t.

Be careful with what you read, and that includes what I write as well, because I may be wrong.

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  1. Lazy Man and Money says

    Nicely written. It seems the majority of people are against the rates that PayDay loans charge, but they aren’t bringing it that much money. With all the defaults they need to charge those rates to run the business and make a little profit. The alternative of course is to say they can’t lend money at all, and I’m not sure that solves the problem.

  2. Ted Valentine says

    Yeah, nicely written straw man. I must have missed the $100 limit sign. These businesses are just legal loan sharks and they have enslaved a lot of people with their rates. Somehow you skipped right over that part. Note that just because something is legal doesn’t mean it is the right thing to do.

  3. Personal Finance says

    I think the reason why people raise issues with payday lenders is that the customers that use their services are not sophisticated as you (or most people who read these blogs) so as to fully understand how much the service is costing them. If someone took time to explain to them the real cost of using the service (similar to how you have explained it in this blog), then they may indeed seek alternative areas for finance.

  4. Arizona says

    The fact of the matter is that banks will not service this segment, and parents, cousins, and friends no longer will loan the cash. Pawn shops have been in business since the dawn of time…

  5. ECW says

    However, the usefulness of such payday loans highly depends on the applicant needs. For a person in emergency who expect can payback in due date, such loans may help. The condition of loan lender is important too. Very high interests are a drawback, but some companies are more customer oriented and even accept bad credit persons.

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