Payday Loans

Many people think that payday loans always mean getting money at an enormous APR. While the rates of them may seem high, they still are far from usury. This kind of lending is targetted at the  bottom part of society. To recompensate high default rates, companies must charge high annual rates to remain profitable. In this article I will outline the overall characteristic of sub-prime lending industry. I will also show you how to avoid being trapped by a loan shark.

Payday loans are one of the least respected financial instruments. To put it short – people hate them. Yet they have their role and without them, the working poor would not be able to persevere when life gets really tough. There are occurences in lives of everyone, when we face shortage of cash. It can be a punctured tire, leaking roof, ill child. Every of this situation requires quick action. I’d like to ask every opposer of sub-prime lending – would you watch your child suffer if the only way to help them was through a payday loan?

I know that everyone should save money. The thing is, not everyone can. Modern economy is in a fragile state, people lose jobs. The menial, simple jobs are being transferred overseas. So those who were already not earning much, can’t find a source of income. This is precisely why so many people are on food stamps right now. Because they can’t afford even the basic needs.

The thing is, if someone has a low placement in social hierarchy, his or her family will probably be somewhere around here. So if she or he, can’t save money, their families can’t too.

So, since we know that people taking payday loans are almost always low-income, what is the probability they won’t be able to repay their debt in a month or two? It is quite big. Let’s say that one in every 10 people will default.

Now – how can lenders compensate for that? How can they remain profitable?

Obviously what they need to do is increase the interest. So those who pay on time will compensate for the defaulting people.

Yet some criticize those companies that the APR is still too high. What I want to tell such people is that if they think payday loans can be offered cheaper, why won’t they open their own lending company? Surely, people will invade their doors if they could offer APR twice lower?

Yet that doesn’t happen. The invisible arm of the market already pushed companies to fight each other. And the most effective way of doing it is through lowering of the APR.

Note: In reality, before payday loan is given out, companies run extensive and complicated credit checks. They employ highly-skilled statisticians and programmers. who in turn create a system able to seize every potential borrower in few seconds. The said system can look at your earnings, housing situation, age and marital matters and say with confidence:

This person has 24% probability of default. To remain profitable, we need to offer a loan with APR of 350%.

Another case:

Someone has a high income but the system looks at their credit history – It can see that said person haven’t repaid their previous loan.

This person has 76% probability of default. Do not lend them money, it is too risky.

And this is how the whole thing works. I hope that you enjoyed this article. The next one will be talking about payday loans industry in more detail.

See you soon,

Jake

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