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Payday Lenders Place In The Society

June 11, 2012 | Comments: 0 | Views: 161

A payday loan is a short term loan given against the customer's next paycheck. Typically the fee is about $15 for $100 loan for 14 day period. Thus the loan carries an APR of 390% (15x26). The critics of such payday loan practices claim that this is usury, that the fees are excessive and unreasonably high. Critics also claim that the payday loan practice drains money from the low income community who are already short on money, thus creating additional burden on the people. Some have also said that this practice exploits financial hardships of low income families for profits and trap them in vicious debt cycle. So the question arises: Does the payday lending business have a place in society?

To understand this it is necessary to profile a payday loan customer. The salient characteristics of payday borrowers are a) they have little-to-no money in the bank b) they have moderate incomes and c) they are fairly severely credit constrained. So it is not unusual for someone who is low on cash and credit to default on his/her loan. The default rate in the payday loan business is 10-20% which is significantly higher than other sections of loan industry. According to a study conducted by Paige Skiba (Vanderbilt University Law School) and Jeremy Tobacman (University of Oxford) says that the loan defaults costs a lender about 25% of annual revenue. Since the risks are high, the lenders have to charge higher fees for the loans to mitigate the risk. For this reason, even the non-profit payday lenders charge about 250% APR.

Though the APR seems very high, in the absolute dollar terms, the fees paid are not that high. This is because the typical loan amount is not that high. As noted above, a common payday borrower has low to moderate income. The loan amount is thus low as well. As per the Skiba-Tobacman study a mean loan size is $283 and the median is $269. So a mean interest charge is $42.45 for 14 days. To run a retail payday operation, a store front is needed - thus the rent and operation cost. Employees have to be hired to run the operation - employment costs. Given the higher costs of running the business, lenders say that the higher fees are justified.

A typical payday loan borrower is at the lower end of the socio-economic ladder. Thus, from a profitability perspective, he/she is not a high priority for the banks to compete for their business. Also, the credit challenges have made them pariah for the credit card companies. So, there are not many avenues left for these low income families to fulfill their short term financing needs. Payday lenders are here to fill this gap in the loan industry.

To conclude, despite the higher costs for customers, the payday lenders do fill a need in the society. Some stronger consumer protection regulations can help protect low income consumers from getting into a debt pit.

Jack Mill is a financial blog writer for Payday Lenders Not Brokers. For more information about Jack or direct payday lenders visit his site.

Source: EzineArticles
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