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The Payday Loan Option | By Tom Johnson

In today’s financial climate it is nice to have options to get cash when you need it. Many people have friends or relatives who they can turn to when they get behind on bills, but others may not be so fortunate. The latter groups of people are those who find that payday loans are a viable option, an option that gives them the ability to access cash quickly and at a reasonable rate as compared to the alternatives of destroyed credit and outrageous bank fees.

I have been in the payday loan business for about five years, prior to that I had a good Federal job and was just two years away from being fully vested in my Federal retirement. My job was privatized and overnight, my Federal retirement was out the window. I had two options: to continue to work for the contractor 800 miles away for the same pay and no retirement benefits or to do something different. I started to look for something different. Luckily during my Federal career I had been steadily investing in small real estate projects and had some resources to work with. I looked at a large number of real estate based businesses but one day I came across an opportunity to buy into a payday loan corporation. At first I didn’t really understand the industry and couldn’t really understand why people used this type of business. My "ah-ha" moment came on the day when I got a call from my son who was in college at the time. He said he needed money because he had been overdrawn at the bank and didn’t know it. He had been using his debit card for a variety of small purchases like gas, slurpees, fast food, etc. The bank continued to allow his debit card to charge these items while charging $25.00 for each and every transaction for which he was "over drawn" resulting in "over draft fees". By the time he figured out what was going on, he was $275.00 in debt to the bank for fees on his 11 transactions. From this point on, I started to realize the fallout for a lot of Americans who fall behind on their bills and don’t have credit options available to them.

Here are some of the things that I have since learned about the payday loan industry. Payday loan stores started to spring up in the 1990s due to a number of factors taking place in the financial industry. Traditional banks were exiting small dollar, short term lending due to the high cost structure and high risk nature of this type of lending. In addition they saw the path of least resistance to higher profits as higher fees, higher NSF (non-sufficient funds check) fees and over draft protection fees. In short, the banks saw an opportunity in Americans' lack of access to short term credit. These factors combined created a demand for a source of short term credit. Good old American capitalism provided a solution, payday loans.

Detractors of the industry like to use APR (annual percentage rate) to describe why payday loans are expensive. An APR is the cost of borrowing money as if it were based on a 1 year loan. Payday loans are not one year loans; they are usually anywhere between 10 day and 30 day loans or up until your next payday. In the same way you would pay $35 for a 5 minute cab ride across town, you wouldn’t pay $7 per minute to rent or own a car. If you did your one day rental rate would be $10,008. For the sake of this argument, let’s play by the payday industry critics rules and use APRs.

So let’s compare costs of payday loans as compared to the alternative. We will look at 3 examples: a payday loan, a bounced check, and my son’s overdraft fee.

How a payday loan compares: $100 payday loan with a $15 fee for two weeks = 391% APR $100 bounce check with a $35 NSF and $20 merchant fee for 1 day = 20,231% APR $1.59 slurpee at C store with a $25.00 overdraft fee for 1 day = 583,770% APR

Now multiply the money the bank profited on their "overdraft protection" from my son on this transaction and multiply that by the 11 overdraft fees over the 7 days he used the card before he knew he was overdrawn. These are the simple truths about the industry that are often times glossed over by the industry critics.

The Evolution and Economics Behind Payday Loans | By Tom Johnson

Americans are increasingly being financially pinched in our modern profit driven economy. Don’t get me wrong, I believe the profit motive is a natural solution to many problems and that American capitalism has been a great engine that has lead our country to worldwide economic dominance over the past 100 years. Nothing is perfect, but the American model has been, in my opinion, as good as it gets. As we move away from an industrial base and towards a service based economy, and as farms and ranches consolidate and move into the hands of fewer but more economically strong people, and as business’ grow larger and have fewer competitors, the gap between the rich and the poor continues to grow.

In the financial industry this was the case as well, when I was growing up in the 60’s and 70’s I could go to a bank and get a short term loan. There were many banks and a lot of competition who served the large middle class. By the 1990’s, as the middle class shrunk and the lower-middle class grew, the traditional banks had moved away from small dollar, short term lending. This change was largely due to the high cost of servicing these loans as compared with profit made. The banks made a simple business decision to cease short term lending. At the same time the banks made another business decision to improve profits, after all isn’t that what capitalism is all about in the first place? The banks decided to greatly increase the cost of bounced checks, overdraft protection fees and late payment penalties. Instead of providing short term credit to Americans, they decided to profit from the lack of it. Today more than ever, a large percentage of bank profits are made through fees and penalties. Again, I can’t blame the banks for making the decisions they did, the decisions were based on the profit motive, and it is not necessarily the duty of banks to provide credit to everyone.

Every business I have ever associated with has a profit motive, most of them would be glad to charge you whatever the market will bear for their products or services. Luckily, American Capitalism is about supply, demand, and competition. So when a company starts to charge too much for a product, another company comes in and says we can make some good money providing that service for that same price or less, this is what has historically kept prices in check. When the traditional banks limited the availability of short term credit and increased fees and penalties, a demand was created for short term lending, One day in the early 1990’s the first payday loan business opened in response to that demand. There goes that free market again!

The payday loan industry is now regulated in most states; the state regulations limit the amount of the fees and many other aspects of how much or how often a customer can get a short term cash advance. These regulations are good because they protect the customer while at the same time preserving the customers’ access to short term credit. Critics of the payday loan industry tend to use APR’s (annual percentage rates) as a way to explain their position as to why they think payday loans are so expensive.

Here are some facts about Payday loans & APR’s:

An APR is the result of a formula used for computing an annualized interest rate or the cost of financing if a loan were paid off over 1 year:

Finance charge, divided by number of days, times 365 divided by amount financed

A typical payday loan does not exceed 2 weeks or 30 days, so the annualized interest rate becomes irrelevant. Payday fees are a reasonable alternative compared to standard bank fees and ATM charges when similarly annualized. The Annual Percentage Rate for a $35.00 NSF fee along with a $25 merchant fee is 1,278%, regardless of the check amount that bounced. A $47 late fee and reconnect fee for a utility has a corresponding APR of 1,225%. The $1.50 fee you are charged at an ATM machine, not belonging to your bank, correlates to an APR of 526% regardless of how much you withdraw. A payday advance for $100 will typically have a fee of $15 with an APR of 391%. This small loan will help prevent the consumer from experiencing some of the credit damaging effects mentioned above. A useful example of explaining the difference between traditional long term financing and quick cash advances is to use the taxi cab analogy. While you would think nothing of paying $30 for a five minute cab ride in NYC, you would never rent a car for $6 per minute. If you did your daily rate would be $8,640 per day. You are paying for the service and not having to use other less desirable alternatives.