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.