Payday Loans: The Right Cost for the Right Product

Payday Loans Becoming More Popular

Payday loans are a fast, discreet means for consumers to obtain short-term credit in an emergency. Their popularity has increased significantly over the past decade, which may easily be attributable to credit-challenged borrowers’ need. Yet there are dogged parties (particularly banks and associated special interest groups like the Center for Responsible Lending) who argue that no matter what advantage payday loans grant consumers, the costs are “prohibitive.”

But this assumption is likely erroneous and an instrument of special interest group propaganda. Mark Flannery and Katherine Samolyk recently conducted a study for the authoritative Federal Deposit Insurance Corporation (FDIC) entitled “Payday Lending: Do the Costs Justify the Price?” Their findings answer the question very much in the affirmative; they indicate that “fixed operating costs and high loan loss rates justify a large part of the high APR charged on payday advance loans.” Moreover,   the authors do not find a supportable connection where loan rollovers or repeat borrowers produce excessive profits. In fact, they “do not affect store profits beyond their proportional contribution to total loan volume.”

Price, rightly justified

The media and anti-faxless payday loan groups continue to make claims that “runaway profits” and the “stink of poor and otherwise vulnerable consumers being exploited,” but they do so with what amounts at best to anecdotal evidence, based upon no factual, statistical study whatsoever. Flannery and Samolyk show via survey data from hundreds of payday loans stores over the course of three years that profits are not excessive but normal for a successful business. The Community Financial Services Association (CFSA) asserts that such relatively low profitability has driven many larger banks from the market for payday loans, leaving credit cards as their consumer credit offering of choice.

If payday loans aren’t excessive on grounds of profit, are they taking advantage of minorities who are unable to repay? Again, this assumption is disproven. The authors also show that economic and demographic conditions in neighborhoods where loan stores are located don’t support the  exploited minority claim that is the Center for Responsible Lending’s mantra.

How they prove that rates are right

Covering stores’ fixed operating costs and rate of default losses is essential to a faxless payday loan business being able to keep its doors open. Of the more mature businesses included in their study, the authors show profit of $1.89 per average dollar of loans outstanding. This is not excessive when the average of all stores is considered. The overall average for new stores, young stores and mature stores is $1.09 per average loan dollar outstanding. Does nine cents per dollar in profit sound excessive to you?

Payday loans are clearly a product whose time has come. Flannery and Samolyk close their study with a question for those who are calling for such loans to be outlawed: “Where will the people who use the product as intended go to fulfill their financial needs?”