Payday Loan Facts

Practical Issues

Who are the industry's opponents?

Opponents of the Payday Lending industry fall into four main categories: The Uneducated Activist, The Philosophical Opponent, The Lobbyist, and The Media.

The Uneducated Activist

We believe the vast majority of opponents fall into this category. They often appear in the form of an activist organization. They do not understand, nor have they made an attempt to understand, how the product works or the economics of the business. Consequently, they believe lenders are "predatory" and out to "exploit the poor". Their arguments are emotionally-based, and have neither logic nor fact to support them. They believe payday loans should be banned, or have their fees capped by government intervention.

The Philosophical Opponent

Although some of these opponents are also uneducated about the product, some have studied it. They simply believe the fees are too high and that government should regulate the industry.

The Lobbyist

This opponent is paid, usually by an activist organization, to attack payday lenders. Their interests are purely mercenary, taking advantage of the naivete of the Uneducated Activist, and they do not care how their actions harm the lenders and their customers.

The Media

This opponent is also self-serving. 99% of all newspaper articles on payday loans are negative. This is because a story about how a consumer got "trapped by a loan shark" makes for a better story than how someone was helped by a payday loan.

Who are Payday Lenders?

Of the 22,000 stores in the United States, two-thirds are independently owned and operated. They are the small businesspeople of our country -- average American entrepreneurs who have invested their own money or gotten a bank loan to build a business.

They are young couples in their 30's. They are Southern businessmen in their 50's. They are ex-military with families to support. They are black, white, Asian, and Hispanic.

They are, for the most part, NOT fat-cats who make several million dollars a year.

How Much Money Do Payday Lenders Really Make?

The media and opponents of the industry spend a lot of time talking about the fees associated with payday loans. But they never spend any time talking about the costs of running such a business.

Here is a real-world example:

A moderately successful payday loan store that has been open for a year will have extended about $2 million in loans to customers. Let's say they're in a state that permits a fee of $15 per hundred borrowed.

Opponents ignore the fact that, on average, 5% of these loans will never be repaid despite collections efforts. That means $100,000 of that $2 million loaned is never returned. Thus, the lender will only earn money on $1.9 million of loans.

$1.9 million x 15% = $285,000 in total fees

An average store will cost about $10,000 a month to run. That includes paying employees, utilities, insurance, rent, and so on. Thus, total store costs for a year will be $120,000.

$285,000 total fees - $120,000 expenses = $165,000 in store profit.

But where do you think a payday lender comes up with $2 million to loan out to people? Where do you think they get the money to cover their expenses? Many of them take out a loan. Many would be lucky to get a $500,000 loan at 8%. That means they are paying $40,000 in interest on that loan per year.

$165,000 store profit - $40,000 interest = $125,000 in net profit

This owner will likely contribute up to $25,000 to his 401 (k) for retirement.

$125,000 net profit - $25,000 retirement = $100,000 in taxable income

Now they must pay federal and state income taxes. If this operator has a 4-person family to support, their taxes will be $15,000.

$100,000 taxable income - $15,000 = $85,000 in take home pay

In the final tally, $85,000 for a small business owner of one payday advance store is a very nice annual income, but hardly the level of wealth opponents claim that payday lenders achieve each year.

Are payday advance fees "too high"?

Opponents often translate a payday advance fee into an Annual Percentage Rate because 1) the law requires lenders to do so, and 2) it makes the lender look like they deserve the label "loan shark".

But let's examine how a change in fees affects a payday lender's business. This is the kind of analysis the Uneducated Activist has never performed. They look at the fee and then make a judgment, forgetting that every business has expenses.

Let's use our single-store example from above. Keep the default rate the same at 5%. If we lower the fee from $15 per hundred borrowed to $14, this will decrease the lenders revenue by about 7%. Net profit will decrease 15%. But take home pay will decrease 44% to $48,000.

Many activists want to see fees cut to $10 per hundred borrowed, or even lower! In that case, our store owner would be left with a store profit of $20,000. He can't survive on this, so he's out of business. Recently, the activist group OurOregon pressured the state legislature to cut fees to $6.50 per hundred borrowed.

This will put Oregon payday lenders out of business, despite the activist group's claims that this legislation allows payday lenders a "fair profit".

What will happen if payday lenders are put out of business?

Opponents would like you to believe that consumers would be better off without having access to payday loans. Yet if payday lenders are run out of business, these same activists never offer alternatives. Just because payday lenders vanish from a state does not mean that the demand for short-term emergency cash loans will vanish as well.

Here are the facts about what will happen if payday lenders are forced out of business:

1) Lenders may find another way to offer loans.

In Texas, payday lending was essentially outlawed by FDIC restrictions. The lenders now offer loans under a different section of the state's Finance Code. Before the FDIC got involved, consumers were charged about $16 per hundred borrowed. Now, they are charged $20.

Pennsylvania outlawed payday loans. Now lenders offer a new product under a different section of the state's laws. This product is more expensive for consumers, costing $30 per hundred borrowed.

2) Consumers will get their loans from the internet

A few websites offer low rates for first-time customers. However, after the initial loan, the fees approach $30 per hundred borrowed. There is also the added risk of identity theft, because consumers don't really know who they're dealing with. They may also have no recourse if the lender is in another state or is an offshore entity.

3) Consumers will return to bouncing checks, which is what they did before the payday loan era.

Consumers will write a bad check for each bill they owe, hoping to pay them off for real when they get their next paycheck. Unfortunately, each bad check will generate an NSF fee of $25-30 from the bank, and $15-25 from the merchant. That's a $40-55 charge per bill. As most payday loan consumers have regular bills that are small in denomination, bouncing checks will be far more expensive than a single payday loan.

Do payday loans "trap" people in cycles of debt?

Opponents that do not believe in personal responsibility make this statement. They believe merchants should bear the burden of protecting customers from the use of the product they sell which, of course, is impossible. The only person who can control how someone uses a product is the consumer himself.

Thus, a consumer may trap himself in a cycle of debt by using a payday loan irresponsibly.

Can you define "irresponsibly"?

The responsible use of a payday loan means using it to make up for a sudden shortfall of cash. Sometimes that shortfall may last several weeks. But a payday loan is like any other product -- it can be used irresponsibly.

Driving while intoxicated is irresponsible. If there is an accident, what caused it?
The car or the drunk driver?

A parent giving a 3-year-old a toy intended for an 8-year-old is irresponsible. If the 3-year-old is injured, is it the toy's fault, or the parent's?

Eating fast food every day is irresponsible. If you become obese, is it the food's fault, or your fault?

A consumer is using a payday loan irresponsibly if:
1) They aren't sure they can pay it back.
2) They do not alter their budget so they can
pay it back on time.
3) They take out multiple loans.
4) They do not seek alternative ways of meeting
a cash shortfall.

A payday loan does not trap anyone. A consumer traps himself by using the product irresponsibly.

Do payday lenders "target" or "prey" on specific demographics or neighborhoods?

The Uneducated Activist does not understand that all businesses want to be in neighborhoods where they have the best chance of attracting customers. The Lobbyist uses this statement to portray lenders as "predatory".

The word "target" is used to make it seem like lenders have singled out a group of people to attack. The reason is that activists have already judged payday loans to be "bad", thus lenders must be "targeting" people.

Here is a quiz. Which of the following businesses has chosen the right location to do business in?

A BMW dealership in a low-income neighborhood.
A Saks Fifth Avenue in a low-income neighborhood.
An ice cube stand in Alaska.
A Payday Loan store in Beverly Hills.

Answer: None.

Payday lenders will place themselves where their product is more likely to be needed. The people who use payday loans generally make $20,000 - $60,000 in gross annual income, so they will set up shop in those neighborhoods.

What about loans to the military?

Military personnel enjoy discounts from businesses such as Southwest Airlines. We would prefer it if payday lenders could find ways of making loans available to military personnel at a substantial discount. Unfortunately, military default rates are no different than civilian rates, and that makes discounts difficult to offer and still allow a lender to stay in business.

Pending legislation in California and the U.S. Congress will cap military rates at 36% APR. On the surface, this is great for the military. Unfortunately, storefronts that do a majority of their business near military bases will not be able to make a profit. They will vanish. Military personnel will be forced onto the internet to obtain loans, where they will likely face higher fees.

It is, regrettably, a "Catch-22" with no obvious remedy in practical terms.

We have expressed our concerns about low military pay to our representatives in Congress.

We are also exploring ways of offering an inexpensive, alternative loan product to military personnel via the internet.

Are there "bad" payday lenders?

Yes, but every business has its share of unscrupulous vendors. Consumers must shop around to find the best proprietors.

We believe that all shop owners should run a business honestly. An honest businessman can generate more than enough revenue to be profitable.

Do payday lenders use harassment to collect on defaults?

Some do and some don't. We support lenders that abide by state and federal guidelines regarding reasonable collection efforts. Remember, most payday lenders have a vested interest in keeping their customers. Overzealous collection efforts are more likely to result in a loss of a customer than getting one to visit the store again.

Academic Issues

Do payday lenders charge usurious interest rates?

The most common attack on payday lenders is that they are "legal loan sharks" that charge interest rates "in the hundreds of percent".

Translating the fee for a short-term loan into an APR is not an accurate way to judge the relative value of the product. The only reason APR's are even used is because the law requires it. Few customers consider what the APR of a loan is when making a decision whether or not to take out a payday loan.

The Fee - APR Argument

Dr. Thomas Lehman, in his article "In Defense of Payday Lending" notes that customers utilize what is known as "subjective value" when using a payday advance. Although an APR disclosure is required, its value is irrelevant to customers. "The real price signal to which the borrower responds is the flat fee that is charged to hold the postdated check. There is no such thing as an "excessively high" fee. It is entirely subjective to each voluntary participant in the transaction."

The decision of whether or not to take out a payday loan is no different than walking into a retail store and deciding whether or not to purchase a product based on how much it costs.

The Double Standard

If one is to insist on using an APR basis, then one must be consistent in its application to other transactions. Payday loan APR is calculated thusly:

(Fee / Amt. of transaction) x (2 weeks x 26)

If I go to an ATM that's not affiliated with my bank and withdraw $20, I get hit with as much as a $3.50 fee. On an APR basis, that's 455%. If I bounce a $100 check, I get hit with an NSF fee of $30 by my bank. The APR is 650%. If I pay my $100 credit card balance late, the company charges me a $28 fee. The APR is 728%. These percentages are actually deceptively low because I extrapolate each transaction over two weeks. In fact, all of these transactions are instantaneous, making their effective APR's infinity.

But do activists attack these outrageous APR's? They do not. Why? Because they have a double standard, driven by a bias against payday loans.

Are payday loan fees "too high"?

Payday lending establishments are dealing with a high-risk clientele. The way our banking system works is that the more credit-worthy a person is, the lower interest rate that person can get for a loan. The effective APR's charged on these types of small loans are going to be considerably higher because of the high-risk clientele. The entrepreneurs in this high-risk industry must find a way to recover their investment and earn a positive rate of return.

Dr. Lehman points out that these entrepreneurs "are drawing scarce financial resources out of some other line of investment, and committing these resources to a high-risk venture in making unsecured loans to borrowers, the large majority of whom have poor credit histories. Because the risk is relatively higher, the risk premium on the loan will naturally be higher.

Additionally, the fixed labor and capital costs associated with offering and underwriting a small loan are the same as offering and underwriting a larger loan. With a larger loan principle, the lender can cover costs and earn a profit by charging a lower annual percentage rate over a lengthier period of time. Small principle short-term loans, while costing roughly the same to supply, cannot charge equally low rates of interest and expect to cover costs. They must, therefore, charge higher rates of interest over short payback periods in order to be profitably offered. Thus, by their very nature and quite apart from the risk associated with them, small-balance short-term payday loans must charge a higher effective annual interest rate to induce profit-seeking entrepreneurs to provide them. You cannot offer a product for sale if you don't profit from it."

Do payday lenders "trap" people in cycles of debt?

Dr. Lehman reminds us that "this allegation ignores the old adage that "correlation does not equal causation." Payday loans appeal to a clientele who face numerous financial difficulties (many of them self-induced), quite independent of the payday lending industry itself. Most of these households have failed to establish good credit, have poor credit histories, are not known for their timely bill-paying habits, frequently bounce checks, frequently change jobs, and may relocate often. In short, they are the type of people who are going to be frequently short of cash and who will borrow "chronically" when given the opportunity. Because payday lending institutions provide them with this opportunity to borrow when other institutions will not does not mean that payday lenders cause this behavior. They simply provide an opportunity for this behavior to be exhibited more often than otherwise.

A payday advance is a product. Like all products, it is possible to use them irresponsibly. Yet how a product is used is not the responsibility of its manufacturer. Who can forget the lawsuit against McDonald's by a client who claimed the food made him obese?

How many times have you, while driving a car, rolled through a stop sign? Have you ever failed to stop for a pedestrian? Is this the car's fault, or the driver's?

It is possible to watch too much TV, drink too much coffee, eat too much bad food, and give toys to a 3-year-old when the package says "For ages 5 and up". But the buck stops with the consumer.

It is not the liquor store's job to identify alcoholics and refuse a sale. It is not a tobacco shop's responsibility to ask customers if they have a predisposition to cancer. It is not a car dealer's job to ask if a customer is a bad driver.

In fact, we argue that liquor stores and tobacco shops directly harm society and individuals by selling their products to irresponsible clients. Their products promote death, disease, and huge economic burdens on the state.

The Nobel Prize-winning economist Milton Friedman, in his landmark treatise "Free to Choose", states that people can look after themselves because they know the most about themselves, and they will flourish if you let them.

We thus believe that consumer activist energies are misplaced in focusing on payday loans, and that government intervention does more harm than good.

Should the government regulate fees?

Opponents think so. We disagree.

Let the free market take care of itself

What other business has their profits artificially capped by government, save public utilities? None. This is America, a country founded on free enterprise. Yet opponents want to see fees capped on payday loans, without understanding the economic realities behind the business.

In fact, we have already seen how the free market regulates fees, without government interference. Several states do not have payday loan fee caps. In those states, fees did not spiral out of control. In Oregon, for example, the going rate for a loan settled in at $20 per hundred borrowed. The same has happened in Texas.

Why? Because the "correct" price for a product is whatever the market will bear. This is Economics 101, and the market has proven that a product's cost will be determined by what a consumer with freedom of choice is willing to pay for it.

Overzealous regulation harms consumers

In Section 1, we discussed how excessive legislation limits consumer choice, and therefore increases the cost of the payday advance product.

Dr. Lehman tells us, "Government regulations in the form of price caps on payday loan fees are "solutions" in search of a problem that does not exist. Further, they would create adverse unintended consequences by distorting the market process. Indeed, these types of government interventions into consumer lending markets have unwittingly been partially responsible for the rise and popularity of the niche payday lending market.

The Uniform Consumer Credit Code adopted by most states already sets maximum interest rates that may be legally charged on consumer loans of varying amounts. This legal rate ceiling disrupts pricing signals emerging from supply and demand conditions and creates a shortage of loans to low-income recipients. The binding rate ceiling, contrary to its intended purpose, prevents these low-income borrowers from establishing or re-establishing credit, and restricts the availability of credit to less risky applicants, again proving that the laws of supply and demand cannot be overridden by the laws of politics.

Enter payday lending firms. By charging a flat fee for a "loan" on a postdated check, most of these types of firms are exempt from state usury laws and mandated rate ceilings. In other words, these payday lending firms have emerged to fill the gap left between supply and demand caused by government regulations that create an artificial shortage of conventional lending to high-risk borrowers.

In a twisted irony that only a collectivist could love, payday lending firms have cropped up, in part, as a response to government regulations that have distorted conventional consumer lending markets, and are now under attack from the very same political class that pressed for these regulations."

Are customers of payday lenders "victims" of the product?

As discussed in Section 1, any product can be used irresponsibly. However, opponents of payday loans place the blame on the lender and not where it belongs -- on the irresponsible consumer.

Consumer advocacy groups such as OurOregon believe that they know better than payday lending customers. This elitist snobbery demonstrates a mentality that is unhealthy for the lower and middle classes. It supports the concept of a "victocracy" -- where one group defines itself (or is defined by another) as being "victims".

Instead of nurturing this unhealthy sociological phenomenon, we believe in encouraging personal responsibility. Opponents of payday loans subscribe to a political ideology that people are not responsible for their own actions, that corporations are to blame for society's ills, and that only government knows what's best for people.

Opponents of payday loans define customers as being "unsophisticated" because they do not understand they are paying "outrageous interest rates", without ever acknowledging that APR's are not relevant in the customer's decision-making process.

Opponents believe payday loan customers must be "protected from themselves".

Opponents do not believe that customers are capable of deciding for themselves whether or not to take out a loan and if the fee is acceptable.

Opponents refuse to believe that payday lenders have a vested interest in working with an irresponsible consumer so that they can recover their principal.

Is it just a coincidence that over 22,000 payday loan locations exist in the USA? Could an estimated 12 million Americans be so "unsophisticated" that they have all been duped by these "predators"?

Have opponents considered that the enormous demand for this product exists because people need it, want it and understand it?

Ironically, by insisting that payday loan consumers are victims, and that payday loans should be banned, these opponents directly harm (what happens if loans are banned) the people they purport to help.

Why don't opponents suggest alternatives to payday loans?

A few of them suggest other ways to meet short-term needs, but most people either do not have access to those alternatives or choose not to use them.

The reason opponents don't offer other solutions for consumers is because there are no other solutions. However, rather than address the underlying problems as to why society doesn't offer low-income individuals emergency cash options, they instead attack the one solution those folks do have!

Rather than find ways of encouraging banks to attract the payday lending customer by offering them products they need, opponents instead assault the one service that has not abandoned these people.

When a person is in need of quick and convenient cash, where can they get it? What other business allows a total stranger to walk into their store, leave them a bad check and a promise to pay up in two weeks -- with no form of collateral whatsoever?

Would the opponents of payday loans offer a total stranger money under those circumstances? They would not. We see that as an elitist, hypocritical, and arrogant attitude.

©2006 Payday Loan Capital, LLC.