Payday Lending: Good Or Evil

There's been a lot of discussion on whether payday loans are good or evil. Most people (regardless of whether they actually use them or not) think they prey on weaker sections of society. The businesses, of course, claim they offer a service to under served communities.

According to a great research article written by the renowned economic institution, The Mises Institute, payday loans are definitely evil.

The Center for Responsible Lending concludes payday lending is a predatory business in that it lures borrowers into a "debt trap." The problem, the Center says, is this: borrowers take out short-term loans with high interest rates and transaction costs. The costs are so burdensome that borrowers soon find they need additional loans. This cycle traps borrowers in a situation of revolving high-priced, short-term credit. The Center’s study estimates conservatively that borrowers spend $3.4 billion dollars annually in lending fees.

However, they also suggest a solution:

Short of banning payday lending altogether, the Center advocates that payday lending companies be permitted to advance no more than 4 loans per customer per year and that these loans have 90-day terms (instead of 14-30 day terms). In this way, spendthrift borrowers are prevented from abusing the service and falling into the trap of revolving credit.

There you have it. Payday loans are evil and you should try and avoid them. But even though they are bad, there's a way to make them less bad. The article also explains why pay day loan businesses need to charge so much and once you realize this, you understand why they effectively make only a 30% return on their money.

You can read the entire article here.

What's your opinion on payday loans?

Are Payday Loan Customers Ignorant?

The common belief is that payday loan borrowers are somehow ignorant of the true costs of the loan. While their may be some truth that they belong to the economically dis-advantaged sections of society, they may not necessarily be completely dumb.

Most of them take out a loan to pay for emergencies. If you need your car repaired, without which you can't get to work, paying 50-250% an annual interest seems like a necessary expense. In fact, if its only $250, and you expect to be able to pay it off in a week, paying an extra $60 might even seem like a bargain. Especially if the borrower has the potential to work over-time to pay it off.

Borrowers get into trouble when they borrow more than they can afford to pay back within a short period of time. Thats when these cash advance loans can eat you alive.

In fact, there are hundreds of borrowers on Prosper.com who are willing to pay 30% interest, just to get out of 100-200% interest loans. For borrowers, this is particularly attractive. Where else can you earn a 30% return on your money?

Of course, the best investment is start a payday loan business, but that is incredibly capital intensive than lending money on Prosper.

How To Start A Payday Loan Business

While researching often used terms related to payday loans I came across the term "how to start a payday loan business". While its not very popular (its searched for roughly a dozen times a day), the search term returns nearly 9,000 pages on google!

While the first 2 links seem legitimate sites to the same company offering a $300 how-to manual (which seems pretty comprehensive and claim you can make 30% return on your money), the subsequent links are spam sites from California State University at San Marcos that have invisible text (white text and white background) and links to various other pay day loan sites. Amazing how they're the 3rd link. I imagine having a .edu domain has something to do with it.

Anyway, there are two ways to get into the payday loan business. One is to start from scratch, and the other is to buy an existing business or franchise. Startup costs can be pretty high and include setting up a retail shop, office furnishings, broadband Internet, a computer and a sizable amount of cash for lending. If an existing business is purchased, the advantage is the business has a client base. The client base is important, as many of these borrowers will be repeat customers for a surprisingly long number of months. They will pay off the loan and then come back in a few months and do it again. These customers usually have a very good source of funds like a pension or some sort of structured payout.

The returns can be pretty substantial, but they are not without risk. Since no credit check is performed, its wise to make sure the borrower doesn't already have a payday loan.

Its also advisable to be cognizant of the local lending laws since any breach of these could result in severe penalties. Collecting delinquent accounts is also part of the business and the success in this area will directly affect the profit of the company.

Referrals are a great way that existing customers can help to expand your business. Giving them a financial incentive to recommend you to their friends will make getting new customers an easier proposition.

Having a location in a high foot traffic area is beneficial since you're essentially in the retail lending business. If you don't have many other attractions nearby, you will have to do much more advertising to bring in new clients.

In conclusion, stating a payday loan or cash advance business can be a profitable business if proper steps are taken to maximize success.

Payday loans

Payday loans are a form of subprime lending, similar to high interest rate credit cards.

Opponents claim that payday lenders are usually situated near military bases or in low-income areas and target the young and the poor, who often may not understand the time value of money. Some even compare payday lenders to loan sharks due to high interest rates; typically 250% or more when annualized. There have also been incedents where payday lenders have pursued criminal bad check charges, despite the fact that they knew the check was bad at the time when it was written. Similarly, it is argued that the interest rates on payday lending (and on rent to own purchasing) unfairly disadvantage the poor, compared to the middle class who pay at most 25% or so on their credit cards.

Defenders of the higher interest rates note that payday loan processing costs do not differ much from their higher-principal, longer-term counterparts such as home mortgages. They argue that conventional interest rates at these lower dollar amounts and shorter terms would not be profitable. For example, a $100 one-week loan, at a 20% APR (compounded weekly) would only generate 38 cents of interest, which would fail to match loan processing costs. They also argue that the interest on a payday loan is less than the costs associated with bounced checks or late credit card payments. They also argue that the interest cost accurately reflects the increased risk of default, a concept known as risk based pricing.

The best alternative for those unfortunate to get sucked into these loans is tho pay them off as soon as possible. Prosper.com offers a solution by offering the lender alternate sources of funding at reasonable rates.

Of course, the best way to avoid payday loans is to create alternate streams of income so you're never in a tight spot. Particularly useful are ways of making money online,since they provide time and geographic independence. Like this blog!

How This Pay Day Loans Site Came About

This is an experiment to see how much traction I can gain from writing posts about Payday loans in terms of SEO ranking and Ad generation. In particular, I want to see how long it takes for this blog to achieve meaningful Google search engine ranking for payday-related search terms and organic traffic.

Payday loans are bad for people. If you stop to calculate how much percentage you pay on an annual basis for a short-term loan (usually 2 to 8 weeks in duration) it can come out to be well over 100%! They should be using micro-lending sites like Prosper.com instead.

As a lender on Prosper.com, I've lent out money to payday loan borrowers and have helped them escape the clutches of the preditary lending communities. It can be argued that the payday loan-sharks provide a valuable service to the lower section of society who are unable to get loans from any place else. However, charging upto 400% in annual interest is rather unethical and cannot be rationalized except under the pretext of pure greed.