Monday, July 09, 2007

A Payday Loan Dilemma

A few days ago I was contacted by a payday loan company that was interested in advertising on this blog. The payday loan industry has recently come under a lot of fire from both personal finance bloggers and from less respectable institutions, such as Congress. Given the request, I did some thinking and crystallized my position on the payday loan industry more fully.

First, for my international readers and for the benefit of my American readers who have never watched late night cable channels, a brief explanation of the concept of payday loans. Payday loans are basically a short term loan given by private lenders, which you are expected to pay back out of your next pay check. The interest rates on these loans are incredibly high, and can reach several hundred percent per year or more. For example, one payday loan company I found online (by clicking on their ad) charges its customers $18.62 for $100 borrowed for a period of 7 to 14 days... 968% per year... by the way, that company bills its services as "Quick and affordable cash advances". Affordable, no less.

My opinion on this industry is twofold. My gut reaction is that this industry is an abomination and should be eliminated. This is loan sharking at its worst. I mean, this industry preys upon the financially weak and on the uneducated, driving them deeper and deeper into debt and poverty. As someone who has his financial house (mostly) in order, I view the existence of this industry as an abomination.

However, as readers of this blog know, I am a free market capitalist at heart. I believe that any business transaction between responsible adults, in which no market failure can be clearly demonstrated to exist, is no business of the government. The market should rule. If there was no need for this industry, if it did not provide a valuable service to its customers, it would not survive. The industry's very existence is proof enough that it should be allowed to exist. It is very easy to be sitting in my comfy chair in my office writing this post about the evil payday loan companies, but would I be feeling the same way if this industry was my only source for getting urgently needed cash? Probably not. As much as I hate it, payday loans are probably some people's only financial option.

My ambivalence leads me to the following conclusions:

1. Regulation - the payday loan industry should be tightly regulated. While I would not support setting maximum interest rate levels, I would certainly support such things as big, bright red letters informing people of their loan's APR; requiring a 24 hour mandatory waiting period before loans are funded, to prevent people from using this very expensive capital for such frivolous pursuits as gambling; and other measures to ensure that people are aware of exactly what it is that they are getting into. Very much like the tobacco industry, I would also favor bans on advertising of payday loans.

2. Education - people must be made aware not only of the tremendous costs payday loans carry, but also of the other options available to them. It is important that people view payday loans only as an absolute last financial resort, not as a first step to take at the first sign of financial difficulty. Practically any other source of cash is preferable to a payday loan: an advance from your employer would be ideal, a loan from a family member or a friend, renegotiating the terms of payment with your creditors. For other ways to avoid payday loans, check out this link from the FTC.

3. Preparation - there are some people that are no doubt forced into a situation where they must take a payday loan through no fault of their own. However, for the most part, the best way to avoid the need for a payday loan is to prepare for emergencies. Build an emergency cash fund; live below your means; insure against your biggest risks. For the most part such preparation will eliminate the need for a grotesquely expensive payday loan.

As a bottom line, yes I think that payday loans are bad. Yes, I think that they provide a service that is essential to some people at certain points in time. The payday loan industry must be tightly regulated and controlled, but there is no escaping the fact that there are some people for whom payday loans are the only option out of a bad situation.

In case you are wondering, I turned down the payday loan company's request to advertise on my blog. Here are portions of my e-mail response to their request:

"...As you may have guessed, my opinion of payday loans is quite negative. However, being strongly on the side of free markets, I am willing to concede that your industry fills a necessary economic niche, and provides a service that a certain portion of the population requires and greatly appreciates.

Despite this, I have decided to not accept your offer to advertise on my blog. I consider myself to be financially secure, and I am grateful that I have never needed the services that your industry offers. I feel that by accepting your offer of payment I would be taking advantage of those who are less fortunate economically, and who come to my blog in search of advice and information on how to improve their lot..."

Do you think that I have made the right decision? Do you agree with my take on the industry?


Angie Hartford said...

I'm glad you turned the gig down. Payday lenders tend to prey on low-income people who are already struggling just to make ends meet. Without an emergency fund, or credit cards, they don't have a lot of options.

The word usury comes to mind here.

Kevin said...

Not only was turning down the ad offer the right thing to do, but it was a prudent business decision.

For me, the perceived quality of a website is very much influenced by the ads. Nothing makes a site look unprofessional regardless of the actual content like having annoying or disreputable ads.

Good choice!

Shadox said...

Thanks for the support guys. Frankly, it was not a tough decision.

plonkee said...

As not a free market capitalist at heart I pretty much agree with your stance and I'm not surprised that it wasn't really a tough decision.

TFB said...

I think you are right for not taking their ads. I wouldn't. But surprisingly the payday loan companies don't make as much money as you would think. At least the one company I looked at didn't. It's the largest payday loan company in the U.S. but it only had 10% net profit margin. Banks usually make 30% profit. I'm guessing too much overhead relative to amount loaned and too much default cost.

ML said...

It is true that cash advances and payday loans are high risk loans – for both the borrower and the lender. However, sometimes, these types of payday loans are unavoidable. Some people are unable to set up there own emergency fund, and while responsible and making decent money, find themselves in a real bind from time to time. If these types of loans are understood and used for their intended purpose, they can be helpful and can give a person a “shot in the arm” financially to help keep up. Of course there are risks involved, which is why any borrower should always read through the site and loan agreement before taking the loan. Always ask questions. Additionally, if they do get the loan, it is best to pay it off in full or in as few payments as possible because of the interest rates.

payday loan said...
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