A thread on Hacker News came up discussing payday loans moving online. I replied with my experience about meeting a guy who was looking into opening a payday loan shop -
The Center for Responsible Lending, which is frequently mentioned on ZestCash’s website at the time of this writing, supports a 36% annual interest rate cap.
I used to think this way until I met a guy who was doing research into opening a payday loan shop. Taking a bit of risk and being blunt, I said to him, "Hey dude, you know, I like finance. I get finance, it's good. I'm not a person who just bashes finance because I'm ignorant... but c'mon, aren't payday loans, like, totally fucking evil?"
He took it in a good spirit and answered. Here's his take:
The first thing he said is that payday loan shops don't charge a huge APR, they charge a flat fee for getting a payday loan, often $20 or $40 on a $500 loan.
That's 5% to 10% of the loan amount, however, if you average that to APR you get a crazy %, something in the low thousands, like 1000% or so.
So I said, "Well, dude, yeah, 1000% is evil. Right?"
He says, and I'll never forget this, "What do you think the default rate is on a payday loan?"
I said, "Well, jeez, I dunno..."
He said, "Okay. It's really high. Many of them don't get paid back. And it's a shitty business to be in, nobody likes selling payday loans. The price of a payday loan is what it is considering the default rate and the unenjoyableness of the business. If someone found a better system or enjoyed it, they could get in with lower rates. Traditionally banks don't want anything to do with it, since it's such a high risk and unpleasant business."
I said, "But... isn't that taking advantage of people?"
I won't forget his second quote either - "People only go get a payday loan when, for whatever reason, they can't get money anywhere else. If payday loan places didn't exist, there'd be no emergency credit for people. Mind you, these are the worst borrowers. These are people with no savings who no one trusts enough to lend them 500 bucks for two weeks. Do people abuse it to go drinking a week early? Yeah, sure, like anything else. People abuse eating fast food, drinking too much, tobacco, all sorts of things. I don't approve of that. But for other people, a payday loan is a lifeline. If you regulate it so you can only charge $5 for a $500 loan, there won't be payday loan shops any more. They won't exist. And that'll be bad for people who desperately need credit and can't get it elsewhere. The people that complain about this aren't doing anything to help people, they're not opening a shop to compete with more fair rates, because they'd go out of business. They just like to talk about how unfair it is, but haven't thought about what to do after they drive all these shops out of business with their regulation."
He explained some valid reasons for people to get a payday loan - car breaks down and they need to replace it, emergency expenses... he said under those conditions, it can make sense to get a payday loan. And with the huge default rates, the payday shops need to charge a large amount to stay in business. Later he went on to say that people really like making money by lending, so if they thought they could beat a CD or bond rate by lending for low amounts at payday shops, they would. The reason it doesn't happen is because of the default rate and how unpleasant the business is. (No prestige, in fact it's anti-prestigious, and not fun working conditions either)
Changed my view on the industry. Still don't like the business, would never go near it personally. But it puts it into context some.
I agree with the man that you speak of in this article. It's a high risk field, so of course the penalties are going to match. A payday loan can be a lifeline for some people. I find it interesting when the upper-middle class debates issues that they really have no understanding of. There are responsible people who do not have the luxury of falling back upon a quick loan from wealthy parents and may not have any other form of collateral when it is needed quickly.
A great article with interesting discussion points rather than the usual useless factually incorrect SEO writing that is so prominent in most articles discussing the subject.
I would like to thank you Sebastian for taking the time to understand it from both the lenders and customers point of view, and totally 100% agree that the loans should be avoided if it can be helped - more a last resort than a loan of convenience.
Some really interesting points, and a great analogy Michael G.R (comment).
If you make 36% on a loan, how can you not stay in business? If the borrower is crap do not lend him any money. You are doing him a favor. And you will be blessed.
People who get payday loans default ALL the time. Some run straight to the bank and try to put stop payments on it as soon as they leave the shop. Plus it's hard money lending.. These people have derogatory credit, shady income, or are straight up cashing stolen checks many times. It's an ugly business to be in.
That's a bit like people who are against buying clothes made in countries where workers aren't paid much compared to Western standards (I'm not talking about slavery or small kids being forced to work, just regular textile work in a poor region). When you ask them what's good about all these people losing their jobs and probably not being able to find as good a source of income elsewhere to support their families and send their kids to school, they hand-wave it away.
Some people are against things that they find unpleasant, without realizing that the alternatives are often even worse. What matters is that they feel good about the choice, not that the person who has to live with the decision is actually better off.
It's easy to make a choice between a good thing and a bad thing. But when the choice is between two relatively bad things, some people just want to wish the whole dilemma away, which is often counter-productive in the end.
My friend Chris gave me a copy of "Winning Through Intimidation" to read - wow. Just wow.
Title's misleading. It's actually about how not to be intimidated, and how to generally do good business by being prepared and ready. At least, I think that's what it is, I'm only halfway through.
Here's an excerpt from page 106-107. Bold added by me:
The lender went crazy. During the ensuing heated discussion he said two things that would ring in my ears for a long time to come and, consequently, help me to prepare for earning and receiving substantial money in the near future.
The first thing he said was: "You have a lot of nerve trying to earn $15,000 on one deal; why, you're only a broker."
I logged into my stock account the other day and realized that contrary to my previous claim/strategy of investing solely in Warren Buffet's Berkshire Hathaway, I had no Berkshire shares left. Time for an update, I reckon.
So what happened? Nothing against Berkshire, for sure. I sold almost all of my shares at a profit, and I still have full faith in the company. But sometimes opportunities come along that are too good to pass up, two of which I'm currently invested in.