Questioning the Payday Loan Industry’s Annual Percentage Rates and Fees
Lender matching services like Personal Money Store and lenders that offer payday loans online and in storefronts advertise small, short-term loans as a quick fix to temporary financial difficulties. After a short request procedure, approved consumers are able to receive the money inside of the store within a few hours or have it deposited into their bank account within a day.
Not only do critics of the payday lending industry object to the easy accessibility of these loans, they also object to the associated fees and percentage. A typical two-week payday loan in the amount of $100 can incur a fee of $15, which translates into an annual percentage rate of 391%. This common payday loan rate, which adheres to the appropriate state and federal laws, has been criticized. Detractors support capping the annual percentage rates so they fall within the range of conventional interest rates, a policy that payday loan proponents say would ensure zero profit and eliminate their business.
While there is no dispute that payday lending fees and annual percentage rates are high when compared to the more conventional fees and rates of traditional lending institutions, it is necessary to understand the reasons why it is an industry-wide trend. Are the high fees and rates that are hallmarks of payday loans being used to guarantee an extravagant profit, or are they a necessary part of operating a payday lending business?
Taking into Account the Costs of Providing Lending Services for Payday Loans
There are costs associated with the operation of any business, and payday lenders are no different. Regardless of whether they are lending payday loans from online or through brick-and-mortar stores, payday lenders incur costs that include:
• Loan loss rates from defaulted loans
• Fixed operating costs, such as overhead, insurance and technology
• Variable operating costs, such as payroll and utilities
The question is, how much more expensive is it for payday lenders to provide short-term, small-money loans than their more traditional lending counterparts? According to a study conducted by the Federal Deposit Insurance Corporation, or the FDIC, lenders assume a significant risk in lending payday loans; the default rates for payday loans far exceed the credit losses suffered by traditional banking institutions. The study also showed that there was a high average cost for originating payday loans.
Taking a Closer Look at Exactly What Makes a Payday Loan Business Profitable
If lending payday loans results in high fixed costs and rates of defaulted loans, how exactly does a payday lender make a profit? Critics of the payday industry point to the borrowing habits of two types of payday loan consumers:
• The repeat borrower
• The borrower who continually renews or rolls over their existing loan account
The borrowing habits of the second type of consumer are of particular concern. A report released by the Consumer Financial Protection Bureau, or CFPB, showed that 80 percent of payday loans are rolled over within 14 days, resulting in a balance comprised of more fees than the principal.
The previously mentioned FDIC study supports this assertion – up to a point. Repeat borrowers and borrowers who continually roll over their balances do indicate the profitability of a payday lender but only because they add to the lender’s volume of processed loans. In fact, the study showed that the amount of loans that are processed is the true determining factor of a lender’s profitability and that the borrowers who use the service most frequently make up the largest portion of a lender’s number of loans and profits.
The Fees and Percentage Rates Are Required for Payday Lending Profitability
The payday loan lender has to be able to make a profit while operating a business that incurs high operating costs and undertakes a large amount of risk. This can only be accomplished if the fees and annual percentage rates are high enough to cover those amounts. Capping off the rates of interest would only ensure that there would be no funds to cover the cost of processing the loan or to make a profit.