If Only Understood – Payday Loans

Ryan Kruger and Mike Catalano
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Posted: Dec 20, 2006 5:10 AM
If Only Understood – Payday Loans

Recent outcry for a ban on payday lenders made me wonder how many of those pointing fingers ever tried to open one of the doors they want to kick down. Have they listened to a customer describe what is on the other side? Payday lenders live behind our eyes and just outside our understanding. The tasteful accusation at fancy dinner parties is that they prey on the low income worker, trapping him into unsavory interest rates. The hosts need to ask the caterer or nanny used that same evening, for their opinions.

Up front, I must disclose a bias of my own. I know about preying on the uninformed – those who have sold me their shares of a publicly traded payday lender. I am a professional money manager and one of my favorite bets is on an extraordinary streak continuing – the mismatch of capitalism versus Congress.

Payday lenders are under severe scrutiny with potentially sweeping regulations from Congress and met with applause from pundits far more quoted than me. I wonder which one did the math on the $40 his daughter ATM’ed last weekend. More than $4 billion in ATM fees were paid last year. This “little” fee has not been going down like you may think. Bankrate.com found ATM surcharges have climbed 20% in the past two years alone. Why is paying a fee to get your own money less offensive than paying someone to borrow theirs? At least a payday lender is providing a service and capital not available elsewhere. Yet one rate is called usurious, the other is called a convenience fee.

Next time you run into your banker offer to bet him on the over-under for NSF fees, toward the bank’s profits. Let him set the line and then you take the over. The $25 Non-Sufficient Funds fee is not often described at the chamber luncheon as a 31.25% rate calculated on the $80 check written to your plumber before a deposit hits. Worry not about the plumber, he can easily be assessed late fees on his credit card while he waits to get paid. Why do payday loans on city street corners carry egregious costs but bouncing checks and cards in the suburbs is merely protection against a lack of sufficiency?

Accusing payday lenders recently, the executive director of a Poverty Law Center said, “They set it up so you have to pay the whole thing off in two weeks, and they know you can’t…the worst part is they trap you. They are taking advantage of poor people.” What’s better I’d ask the director, much more sophisticated (and less understood) interest-only-loans where your rich neighbors are paying nothing off? Regulators found that 85% of payday customers returned to the same store in the same year. Last time I checked, customers return to a business not a trap.

Politicians do not agree with me or with the free market growing for payday customers who need more choices (which bring costs down), not fewer. “It’s just wrong to charge 400%, no matter how severe the need is. These loans are inherently abusive…,” according to a director for the Consumer Federation of America. I would agree and the secret truth he avoided is that – so would the payday lenders and customers! The “help” this director argues for is no different than campaigning against taxi-cab rides across the country. The cost would be outrageous, and is precisely why nobody does it.

The most damaging claim, and consequently the most believed and quoted (as above), is that payday lenders charge an annual percentage yield (APY) of 390%. I have yet to read about the simple truth on the other side of that math. There is typically a $15 fee on a $100 loan to be paid back within two weeks. The APY’s calculation, however, assumes it is not paid back over any two weeks, until an annual (26 two-week periods x $15 per period = $390) percentage rate soars to 390%. Using that same math would reveal an average bank’s NSF’s APR is over 700%, and the average credit card late fee’s APR is over 850%.

What’s not quite as outrageous is the quiet fact that payday customers can and will pay their loans back which makes this APR calculation completely meaningless. But don’t take my word for it and you can even ignore the facts. Instead, just try to pay 390% and see what happens. Most payday lenders won’t allow it - or anything even close. Lenders and state laws typically limit rollovers to 4 weeks, and many allow none at all.

Capitalists solve more problems than Congress every day because they are paid to listen to what their customers need, not elected by telling them what they want. Customers are the best regulators, capable of exacting the harshest penalties because they vote with their feet.