I like to listen to Clark Howard. If you can get past the obnoxious campy “always-in-a-good” aspect of his delivery, the advice he gives is normally really strong. Good conservative kinda stuff.
However, every time he talks about payday loans I get all hot-n-bothered.
See, Clark thinks that the industry should be shut down or regulated. He feels that charging someone 10-20% on money for 1-3 weeks is out of the world crazy. And, I admit, that kinda rate, even if you call the loan a “1 month loan” is way high.
But look at the numbers. See what happens when you assume a 10% default rate:
| Number of Borrowers |
Amount Borrowed |
Default Rate |
| 100 |
$100.00 |
10.00% |
|
|
|
|
|
|
|
|
|
| Total Amount Lent |
$10,000.00 |
|
| Loans Unpayed |
10 |
|
| Money Lost |
$1,000.00 |
|
| Fee to Cover Money Lost |
$11.11 |
|
| Loan + Fee |
$111.11 |
|
| Repayment % |
11.11% |
|
| Effective Annual % Rate |
133.33% |
|
|
|
|
|
|
|
| Profit |
$0.00 |
|
If the lender accepts ZERO profit, the effective annual rate is 133.33%.
Now look what happens if the lender actually wants to realize a profit on his money:
| Number of Borrowers |
Amount Borrowed |
Default Rate |
| 100 |
$100.00 |
10.00% |
|
|
|
|
|
|
|
|
|
| Total Amount Lent |
$10,000.00 |
|
| Loans Unpayed |
10 |
|
| Money Lost |
$1,000.00 |
|
| Fee to Cover Money Lost |
$11.11 |
|
| Loan + Fee |
$111.11 |
|
| Repayment % |
11.11% |
|
| Effective Annual % Rate |
133.33% |
|
|
|
|
|
|
|
| Profit |
$0.00 |
|
|
|
|
| Desired Profit Margin |
1.00% |
|
| Profit |
$100.00 |
|
| Fee + Profit per good loan |
$12.22 |
|
| Loan + Fee + Profit |
$112.22 |
|
| Repayment % |
12.22% |
|
| Effective Annual % Rate |
146.67% |
|
The rate jumps to 146.67 for a 1% profit margin. Consider that; do you know anyone willing to risk 10k large in the hope of getting back $100.00? Me either.
So, let’s look at 5%:
| Desired Profit Margin |
5.00% |
| Profit |
$500.00 |
| Fee + Profit per good loan |
$16.67 |
| Loan + Fee + Profit |
$116.67 |
| Repayment % |
16.67% |
| Effective Annual % Rate |
200.00% |
Wow! If our lender would like to realize a 5% profit rate, he would have to charge an effective interest rate of 200%! But wait, what if the default rate isn’t 10%, what if it’s 15%?
| Desired Profit Margin |
5.00% |
| Profit |
$500.00 |
| Fee + Profit per good loan |
$23.53 |
| Loan + Fee + Profit |
$123.53 |
| Repayment % |
23.53% |
| Effective Annual % Rate |
282.35% |
The annual rate soars to 282%!
The problem isn’t the payday lender. Not at all. The problem is the borrower population. The rest is just numbers.
So, if Clark just asked the right questions he would walk away with a better understanding of the situation. And just think, this profit margin and annual rate assumes a PERFECT efficiency in administration costs. No labor, insurance, rent or processing. ALL of which add to the cost before profit that the borrower has to pay.
It looks bad, but a closer look reveals an industry that really isn’t as predatory as we like to think.
