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Are Companies that Make Payday Loans Bad?

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There's a lot of negative talk in the personal space about pay day loans. In general this talk is justified as many people get trapped in loans with high interest rates. The rates are so high that sometimes people can only pay the interest on the loans. They can't pay the principle and get themselves out of the loan.

It is with this thought in mind that I thought, "Why not open up a pay day loan company of my own?" Excusing the ethics of such a thing for a second, wouldn't it seem like a fantastic way to get rich quick and easy. There's the rub. It turns out that it's not quite that easy. If it were really easy, there would be tons of entrepreneurs entering the field and undercutting them by a few percentage points to grab all the business for themselves.

Of course that doesn't happen because numerous payday loan companies exist still charging tremendously high rates. I believe they need to charge these rates because a large number of their clients never repay their debt or interest at all. It may sound like conjecture on my part and in some ways it is. However, I've had a little experience lending money on Prosper. From that experience, it is necessary to charge an outstandingly high price to some people with lower grades. I have lost money when I lent money to people of grade D or E at 29%. I can't imagine the rate I'd have to charge to make money on what Prosper deems high risk or no credit borrowers. Well I can, and it's about the rate that payday loans charge.

I can't recommend that people get payday loans. When you compare payday loans, it's too easy to get trapped into a hole you can't dig out of. Still, I think that payday loan companies aren't nearly as predatory as they are made out to be. I think they are just charging what needs to be charged. If people were more responsible they wouldn't need to charge such high rates. It's up to the consumer to educate themselves.

Last updated on April 25, 2012.

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28 Responses to “Are Companies that Make Payday Loans Bad?”

  1. J2R says:

    I do have a bit of knowledge on payday loans (the online companies).
    I was surprised to learn from them that 40% of their loans automatically default. That’s a pretty high rate, and that explains why the rates are so high. Also, most of the users that apply for these loans, apply for multiple ones (if they’re going to be in a hole, why not just dig a deeper hole?)

    Not to say these paydayloans are charity works. They do make a LOT of money on interest, but I’m just saying it’s a high risk business if you decide to do it on your own.

  2. jeremiah johnson says:

    bummer, so i guess my according-to-prosper HighRisk credit, and 17% DTI ratio won’t get me a loan that is cheaper than my current credit cards, which i’m trying to pay off.

    what’s so great about prosper, then?

  3. Lazy Man says:

    Prosper doesn’t assign the “high risk”, it’s based on your Experian (one of the major credit companies) profile.

    Prosper is not for everyone. Before taking Prosper, you should consult your financial adviser. If you should experience the following symptons, you should stop taking Prosper immediately… On a serious note, Prosper can’t help everyone. This kind of question is like asking what good is aspirin if you’ve got Cancer. You need to fix your credit rating and earn some trust from lenders. Once you have that trust, Prosper can lower that 17% interest rate significantly. That’s part of what is so great about Prosper.

  4. Joseph Sangl says:

    Payday loan joints are just proof that people will remain poor until they think about the decision they are making.

    I personally think that 379.99% annualized interest is entirely reasonable and non-predatory. NOT!!!

  5. Would you really lend money to somebody that can’t wait to get his pay cheque ? This individual only show serious credit problems that will lead within days (if it’s not hours!) to default.

    On another note, I’m still wondering how somebody that is rated A or AA on Proper is actually borrowing money at 10-11-12% when he/she can walk into the next door’s branch and get a loan at 8%… it doesn’t make sense to me.

    Cheers,
    FB.

  6. aschmuck says:

    Sure if have a home you can get rates that low with a home equity loan. For unsecured loans even AA and A would pay 10-13% (that is if the bank would make the loan at all).

  7. dong says:

    I wonder though why the AA and A credit folks don’t just borrow via secured avenues. I mean if I only needed to borrow 5k, I would look at home equity line first rather than trying to borrow it unsecured.

  8. MossySF says:

    First, not everybody is a homeowner. Second, not all homeowners have equity to borrow against. Third, why put your home at risk if you can get an unsecured loan. If times are tough, a home equity loan is extremely risky — lose your job, LOSE YOUR HOME!

  9. Minimum Wage says:

    So if my credit is in the tank (health/hospital/unable to work for a year thus no income, tons of fees followed by chargeoffs) and I can’t get it out of the tank on my pathetic income (I can pay the rent on time and keep food on the table but I have two credit problems which won’t drop off my report until resolved) then I’m doomed forever to outrageous terms and rates?

  10. Lazy Man says:

    MW: Yep more or less. Of course the other option is to not have any credit options at all. People want the payday to charge less – well they’ll just go out of business as it will no longer be profitable for them. So would you rather have high rates on no option at all? Unfortunately, that’s your only choice with the payday loan companies.

    I have a friend who shuts down hospitals that don’t meet certain health standards. I always wonder if it’s better to have a bad hospital or no hospital at all.

  11. MossySF says:

    Typical payday deal is something like $30 interest on a 2-week $200 loan. That calcs out to a 378% APY. To drop the interest down to a credit card-like 29%, the interest charged would be $2.30 which would be totally unfeasible for anybody to lend out. So the problem is the size of the loan — there are fixed costs for rent/salaries/paper-pushing/etc whether you borrow $200 or $200,000. Obviously, borrowing more money would prorate the fixed costs over a larger amount which decreases the interest charged.

    Let’s do some further math based on the 40% default number for payday loans. That means a lender who has absolutely no overhead at all (no rent, no employees, no internet, nada), interest charged has to be 75% at the minimum to meet the typical 5% online bank return. Add in basic business costs and now it’s 125% rate. Add in minor business profit (otherwise, just leave it in stocks bonds savings) and you have 150%.

    If you want to borrow money at better rates, you need to improve your credit score where people stop grouping you with the 40% defaulters.

  12. Minimum Wage says:

    Let me repeat: I cannot improve my credit score on my pathetic income because I can’t resolve two credit issues on said income. It’s not as if I have been frivolously spending money.

    My credit collapsed due to a specific (if prolonged) event. Am I somehow a greater risk now – earning min wage, without credit, and therefore not spending beyond my means – than is a person who is overspending?

    One thing I learned is not to volunteer a tax liability you can’t pay if you can get away with it – all it does is unnecessarily wreck your credit. Report the income and pay the tax later when you can, but don’t dig yourself a hole now you can’t get out of.

    And I don’t believe there is a 40% default rate. We’ve had newspaper articles here on payday loans and they say a lot of people roll over the loans several times and only a few ultimately default. And all those rollovers (on which the interest is paid) add up to a nicely profitable bottom line.

  13. Minimum Wage says:

    This seems a good place to ask a question I’ve had about borrowing:

    I have managed to buy a small amount of US silver coins for appreciation and hedging (I have been bullish on silver and gold, and can’t afford gold).

    I have learned that a person can walk into a pawn shop with an overpriced piece of jewelry (retail markups are enormous) and get a loan, but if you walk into a pawn shop with good old US silver coins – hard money – they’re not interested.

    What’s up with that?

  14. Lazy Man says:

    I found this article that calculates a payday loan company’s profit at around 10% in comparison to a bank’s which is around 30%. I meant to work that article into the article, but I lost it.

    If a 10% profit margin a nicely profitable bottom line, then something is missing.

    I’d say that yes, earning min. wage, without credit, and having credit problems (which I’m assuming is in the form of a debt) translates to a great risk to me. Is it bigger that someone overspending? I’m not sure about that, but then again, I don’t know how a company is going to quantify your spending habits.

  15. Minimum Wage says:

    I have a tax lien (from foolishly reporting a modest amount of income I could have gotten away with not reporting) and a creditor judgement from when I had no income and couldn’t pay (lots of padded fees and costs in there).

    So I guess reporting your income is a big mistake if you can avoid it.

    Which leads to another question: why should my honesty (in reporting my income) make me a greater risk than a dishonest person who avoids a tax lien by not reporting income?

  16. They are evil and more and more of them are owned by the big banks. Wells Fargo owns Cash America!

    Evil, stay away. I don’t know how these people live with themselves.

    Peace
    DT
    http://www.debtingthomas.com

  17. MossySF says:

    I’m not saying you don’t have good reasons for your current credit problems but look at it from a lender’s perspective. Every story they hear is “I’m different from others due to X, Y and Z”. If every story is unique/special/high priority, then no stories are unique. How can a 3rd party lender quantify repayment ability and willingness? All they can do is look at the numbers.

    Only people who know you in person can have confidence in criteria beyond numbers. The best way to build credit is through a personal network — someone who trusts you either cosigns a loan with you or loans you money via prosper/circlelending/etc so your repayments show up on credit reports. Or give you a small amount of money for you to deposit at a credit union to get a secured loan. Or add you as an authorized user on their CCs (but not give you a card) and then take you off 3 months later leaving their repayments on your file.

  18. Joey says:

    Very simply put, payday loan businesses exist because there is a demand, and the majority of consumers are happy with the service and the cost.

    Also, for many people, a payday loan is the best and most economical choice they have. For example, when comparing the cost of a $200 payday loan ““ approximately $30 ““ to the cost of a late credit card payment (approximately $37) or a bounced check (NSF plus merchants fee average around $54), a payday advance is the best alternative. Also take into consideration that the average bank overdraft charge is $26.90 per check, regardless of the amount of the overdraft. And, isn’t an overdraft really just a short term loan from the bank?

    When consumers need short term financial assistance, they should be allowed to look at all of their options and make the choice that is best for them.

  19. Minimum Wage says:

    I can’t get a secured loan because of the tax lien; i.e. nothing can really be “secured” when the IRS has first crack at it if it wants it. So I guess I’ll never be able to get conventional credit, and even bankruptcy won’t help.

    So at least I learned a lesson: never report income unnecessarily if you can’t pay the tax, especially if it’s a small and non-obvious amount.

    There was some mortgage lender which advertised that you are more than your credit score. I guess I’m not more than my credit score.

  20. Lynz says:

    I just stumbled upon this site and am impressed with the thoughtful debate. I actually read through all of the comments. Really like the analogy about whether it’s better to have a bad hospital or no hospital at all. I know there are efforts being made to ban payday lenders by putting into law rate caps that make the product unfeasible and you gotta wonder, what happens to the millions of people who have turned to payday loans to get them through to their next paycheck? Payday lenders are forced to close their doors…but then what? People are still occasionally going to find themselves in need a few hundred dollars. Seems like the unintended consequenses may be the worst option for consumers.

  21. jaymore says:

    Just to add to Lynz’ point, removing payday lenders from the marketplace won’t do away with the demand for them; that’s been proven in states where payday lenders have been banned, like Georgia. It’s seems a no-brainer that allowing regulated lenders that obey the laws is far better than closing all of them and then leaving consumers to fend for themselves. That’s when folks go “underground” and will resort to any means to get money, perhaps even criminal activity.

  22. TFB says:

    I’m glad we agreed on this one. MossySF also correctly pinned it down to the high fixed cost relative to the small amount borrowed. If you attach a fixed cost for each of your Prosper loan, you will probably turn a profitable Prosper portfolio into a loss.

  23. I Love Vogel says:

    Lazy Man, why do you have “Payday Loan” and ” Cash Advance” links on your site? I always believed these organizations to be legalized “loan sharks.”

    These lenders prey upon borrowers who are down on their luck. These businesses know that majority of their customers get in a vicious cycle of borrowing they can’t get out of.

    I’d would remove these links from your site. That is unless, you are really a MLMer that is looking to create a community of financially desperate people seeking solutions. I see your angle.

  24. Lazy Man says:

    ILV,

    Payday loans are not the topic of discussion. I suggest you continue it on my post where I ask are companies that make payday loans bad? I’ll be happy to continue it in it’s rightful place. It doesn’t advance the discussion of MonaVie (unless of course you can’t discuss that anymore).

    The key word you used was “legalized.” They are legit businesses and don’t “prey upon borrowers.”

    Regarding MLMs, you may have missed comment #88, “I’m not against MLM businesses for things that can be measured objectively (Tupperware, Mary Kay, etc.).”

    You caught me, I’ve really spent years writing things like How To Save Money (there are links to dozens of ways to save money that I have written).

  25. J. Money says:

    i just think it’s funny that every adsense on this page shows payday loans now :) like, you could say “PayDay Loans SUCK BIG” and they’d still pop up! haha…

  26. Doughball says:

    In general, we should all avoid payday loans. Common sense — if you can at all help it, don’t do it.

    But if you absolutely must, avoid doing business with Check Into Cash and the owner of Check Into Cash, Mr. W. Allan Jones. This company is the absolute epitome of greed and ignorance.

    Check out the following article written by Gary Rivkin entitled, “Portrait of A Sub-Prime Lender.” This article pretty much tells the shameful truth about W. Allan Jones and Check Into Cash:

    http://www.huffingtonpost.com/gary-rivlin/portrait-of-a-subprime-le_b_602182.html

  27. […] Nine years ago (almost exactly to the day), I asked the question, “Are Companies that Make Payday Loans Bad?“ […]

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