By special request. One of my readers recently asked my opinion on SC legislation winding its way through committee on payday loans. I offered a teaser about this last week and generated some other interest. Then I recalled that another reader's state (Ohio) was also working
on legislation, so I traded a few emails and got even more information. David's blog can be found at this site. I don't always agree with him, but he provides some good information on matters of politics and an alternative view. So with three people interested, I knew it was important.
This is the first in a three-part post on payday lending. I hate doing this as a series, but I honestly think that this is best for all of us. I feel obligated to present the facts about the business along with facts about the legislation. Only after I've presented the facts on both sides, will I present my opinion.
The timing of this is also important. Someone close to me recently got into some tight financial times and took out their first payday loan. They needed money to pay rent and were told that the late fee was $50 per day (I haven't been able to verify this). So, they walked down to
Cash Advance (or a similar store), wrote a post dated check for $345, got $300 in cash and paid the rent. They knew they had money coming in a few days. (I still have to follow-up to confirm they paid it back).
To describe payday loans, the FDIC says they "are small-dollar, short-term, unsecured loans that borrowers promise to repay out of their next paycheck or regular income payment (such as a social security check). Payday loans are usually priced at a fixed dollar fee, which represents
the finance charge to the borrower. Because these loans have such short terms to maturity, the cost of borrowing, expressed as an annual percentage rate (APR), is very high. Borrowers who obtain payday loans generally have cash flow difficulties, and few, if any, lower-cost borrowing alternatives." (see here)
Payday lending varies by state and not all states allow the practice. Generally, it works like this. You walk into one of these places and write a check (limits are typically about 1/4 of your monthly pay or $500-$600) with a future date on it and you walk out with cash. Fees
vary from state to state, for SC it's typically 15%, in ND (one state I checked at random) it's 20%. This can help you avoid late fees and returned check charges.
Critics are quick to point out that 15% over two weeks turns into 390% over a year. Using almost any definition you can find, that's usury. However, this business has a lot of risk involved. A few years back, I had the privilege of sitting next to a person from Advance America on an outbound flight. He and several co-workers were headed to a convention. We talked a bit about his business and he confided that they rarely cash the checks that people leave behind. Frankly, he told me "those people aren't likely to have money in the bank". According to MSN
Money they recently increased "the provision for doubtful accounts as a percent of total revenues for the quarter ended March 31, 2008 was 12.6%."
Payday lending can be seen as a product with strong demand. "Consumer demand for the traditional payday loan product remains strong." (MSN Money) In other words, people want (or need) payday loans.
With over 12% expected loss rate, you have to expect these companies to charge high rates. In fact, a quick analysis of Advance America's Income Statement in the MSN Money article shows a Net Income of only 9% of first quarter revenue (down from 13% last year). This is not what
I would consider a high rate of return for a business. By contrast, IBM's income was 9% for first quarter and Microsoft was a whopping 30%. 9% for a very high risk business sounds low in this light.
As mentioned earlier, some states don't allow this type business. Many states (SC & Ohio for example) are looking at legislation to restrict them. Regarding the legislation, Christian Science Monitor (which I believe is neither Christian nor Science) has an article titled "Ban
payday loans? Big mistake." It says that the idea smacks of "paternalism – the idea
that government must take care of adults because they aren't able to do so themselves." It goes on to say that this "is the ideology behind the wave of politicians determined to limit how much and how often Americans can borrow money."
Government making decisions for individuals? Something only a progressive could promote. Limiting business? Hardly conservative. Sure, some people are hurt by the practices, but should that exclude other borrowers? And shouldn't the individual be responsible for his/her own
actions (an idea I often promote).
Advance America has advice on their website for borrowers who might be hurting. "We at Advance America recommend that you evaluate the costs and benefits of all alternatives before obtaining an advance." I encourage you to check it out at their website.
My next post will be on what some states are trying to do to payday lending and then my third post will give my opinion. Hopefully, I haven't tipped my hand too much here. Please add comments as you see fit. Also, I have MUCH more reference material I'll gladly share and I'll also be glad to debate this via email or my blog.