The Exploitation and Ingenuity of the Payday Loan Industry
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The Exploitation and Ingenuity of the Payday Loan Industry
In the past 30 years, the payday loan industry has grown to an astounding $46 billion industry, and particularly in the US, and now becoming more of a phenomenon in UK, there are more payday loan stores than there are McDonalds, or Starbucks. So why has this industry garnered significant levels of scrutiny and support from opposing sides? And what are payday loans? Payday loans are small loans that can be taken out by any individual with little to no collateral at high rates of interest and must be repaid when the individual’s next paycheck is received. This report analyzes the aspects of the payday loan industry as to whether the payday loan industry exploits the poor and the uneducated, or whether it is a legitimate business in the eyes of economic welfare in a capitalistic society.
Like twelve million Americans each year who struggle to pay their bills and rent on time, many people take out a cash advance using the payday loans, and they make it past their billing period for another two weeks. However, unlike other types of consumer credit which allows borrowers to pay their principal back over time in exchange for lower rates, payday loans require all their payment at once. With an average payday loan of $375, a one-time fee of $55 must be paid. So in an average consumer’s standpoint, he/she can keep 85% of their money while making it through another two weeks. However, someone with financial knowledge will know that a $55 financing fee to a $375 loan is approximately 446% APR in interest and a bank line of credit can be maxed out at approximately 30% with periodic payments. According to Robert Mayer’s (2003) examination of exploitation, this is a classic example of bounded rationality – in which an individual’s decisions are based on their rationality, which is further limited by the amount of time and information they possess.
The payday loan industry, making an astonishing $9 billion in loans and interest in 2013 take advantage of those who do not take the time or necessary effort to compare fees across a multitude of different consumer credit offerings. Given by the fact that majority of payday loan participants are “rolling-over” (a term used to describe paying a fee to extend the payback period), individuals who are limited by deterring credit, or low on capital may be put in a continuous debt-cycle by rolling-over multiple times while increasing debt at unfairly high interest rates as mentioned previously. In a study conducted by Ernst & Yonge LLP in 2004, many Canadian payday loan firms rely on repeat customers for their growth. By increasing rates on borrowers or limiting the number of repeat borrowings, these payday loan firms are able to increase their profit margin while limiting risk. However, an even larger problem arises as borrowers use one firm’s loan to settle another’s debt. By doing so, it raises significant questions as to the nature of the payday loan industry. Such loans were intended as an emergency case-based usage, however, if regulars are borrowing numerous times a year, this suggests an extended-loan process, by which they being to be exploited by the industry’s carefully designed business model. As a result, many individuals pay in excess of 5-6x their original borrowed principal just to settle their initial debt. Payday loan firms further exploit their customers by limiting the amount of information provided during a loan inquiry process. In a 2007 study (Buckland, Carter, Simpson, Et Al, 2007), 58% of clerks said close to nothing about any borrow-related fees during the loan inquiry. Borrowers are never provided an annual percentage rate(APR) or effective interest rate(EAR) which would allow them to compare against other credit products, and close to 66% of clerks said nothing about the maximum or minimum loan amount. In