Are Payday Lenders Charging Too Much?
Payday lenders have quite a bad reputation for charging extremely high fees. But are these fees really as high as mainstream media would have you believe?
The reason payday loans appear expensive at first is because people try to compare payday loans with the same measurements as credit cards or traditional loans. When you look at it from a traditional lens, payday loans do indeed seem expensive.
However, payday loans are really a completely different animal from a credit card or personal loan. Here’s why.
The Payback Rate is Much Lower
In the traditional loan world, default rates are very, very low. In the single digits. In the payday loan world, the percentage is over 10%.
Remember that payday lenders need to make sure they’re profitable in the long run in order for them to support themselves, their employees and their customers.
In order for them to be able to continue to run a business, the profits from the customers that do pay back their loans need to cover the losses from customers who didn’t pay back the loan.
This is perhaps one of the largest “hidden” costs of payday loans. It’s not that they’re trying to charge exorbitant amounts of money to exploit customers. It’s just that their costs are a lot higher than a traditional loan, because they have to cover a lot more defaults.
Why Payday Loans Can’t Be Measured in APR
When mainstream media tries to point out how much payday loans are charging they typically try to point to an APR number.
For example, let’s say a payday lender is charging you 15%. If you borrow $100, you pay back $115.
If you looked at this from an APR point of view, you’re paying over 300% interest. That’s because APR statistics compound every month. In other words, month 1 you’re paying 15% interest on $100, but month 2 you’re paying 15% interest on $115, so on and so forth.
By the time you get to month 12, you’re paying interest on $535 a month from your initial $100 loan. No wonder the APR statistics look so high.
The reality is simply that payday loans are completely different than credit cards and loans. Nobody takes out a payday loan for a year. They’re meant to help you cover emergencies in a matter of days or weeks.
Competition Drives Prices Down
One final thing to remember is that payday loan prices are always being pushed down thanks to competition, especially with the internet.
If one lender is making 20%, another lender will be happy to take their customers by charging 15%. Another lender will come along who’s willing to take 13%. So on and so forth.
The prices of payday loan lenders really aren’t high when you look at the default rates they need to cover. Without measuring them against unfair metrics like APR, payday lenders are actually quite reasonably priced, especially in a highly competitive world like the internet.