Independent, Fee-Only Financial Advisor

Independent, Fee-Only Financial Advisor

Friday, March 21, 2014

Payday Lenders and The Post Office

Did you know that the average rate on a payday loan is around 600%!?!

Payday lenders and pawnshops both fit into the category of financial intermediaries. They are just as much a part of the financial system as your bank on the corner. Like banks, both make money by lending money. Unlike banks, they don't have depositors. Instead, their lendable cash comes from investors.

Pawnshops make loans that require collateral-- take in Grandma's wedding ring and get some ready cash based on its value. The buyback will be more than their purchase price, meaning your interest charges are built into the transaction. Of course, if you default on the loan, they sell the ring! A win-win for the pawnshop guys.

Payday lenders don't require collateral, only a post-dated check. Because there is no collateral, the implicit interest rate on these loans is, generally, higher than the pawnshop. Both are designed to be short-term loans.

Each state sets the rules for payday lenders operating within their borders. Four states don't allow payday lending: Arizona, Arkansas, Georgia, and North Carolina (interesting that 3 of the 4 are southern states). One state, South Dakota, has a no holds barred policy on these institutions.

In Mississippi, the limit on the total anyone can have at any one time in a payday loan is $500. Average cost for this cash advance loan is around $20 per $100 borrowed. Write a check for $500 and get $410 in cash. Later, the lender puts the check through to collect the full $500 ($410 for the loan and $90 for interest).

The small dollar amounts make them seem trivial, but the short-term nature makes this an expensive way to go. Do the math on the dollar fee and the term of the loan, and you'll see how you can get to 600%!

Lenders will time deposit of the post-dated check to match your next payroll cycle. If it bounces, they are only allowed to charge one $30 NSF fee.

Is this predatory lending? Well, they serve a purpose in the marketplace. There are folks who need money but have no access to banks or credit cards. The problem is that many become serial borrowers and get caught in a never-ending cycle of high interest loans. Payday lenders justify the high rate by pointing to the risk and high default rates among this population. What's the answer?

There is a proposal to go back to the old Post Office banks to serve this segment of the public. These would be government-sponsored banks that would offer loans to high-risk customers at more reasonable rates than the payday lenders. For an ailing P.O., this could be a win-win!