Pay day lending – a little easy math to show how perilous this is for a person in need

I wrote the following about ten years ago, but the example remains pertinent.

I am quite certain my fellow bloggers are inundated by spammers who love your blog or post without commenting on anything specific. One of the more popular spammers comes from various pay-day lending groups. When we talk about bad types of capitalism, pay-day lending ranks close to the top. It is the worst form of usury as people in need get preyed upon by these folks. The pay-day borrowers do not realize they are paying an interest rate north of 200% as it is so easy to do.

Yet, what happens are the people in need set themselves up for a death spiral that is hard to pull out from. They begin a journey of paying more and more interest to pay off the use of funds a few weeks before their pay check. These lenders were outlawed in NC, which just meant they moved across the border to do more sales. I have heard people who say they provide a useful purpose, yet in essence they don’t. People are getting immediate money for a need coverable by their pay check. Yet, end up paying more than double or triple the amount they borrowed. And, it does not stop. You are beholden to the pay-day lenders for a long duration.

The lenders used to set up shop just off the military bases. This is unfortunate as they would prey on married couples who are separated by an ocean with one distracted  by war. The one at home needed the money and did not have the counsel of two heads asking is this the right path forward. In the volunteer charity work I do with homeless families, quite often the families are paying interest rates of 23% on a car loan. This type of car payment puts a huge bind on their budget and we help them get away from this loan and into a better one. Yet, for the pay-day lending, you have to multiply the 23% loan interest rate by a factor of 10 or more.

If you do not believe me, let’s do a simple exercise. If I have bi-monthly take home pay of $1,100 and need to get it now, the pay-day lender will give me $1,000. That will likely include a processing fee of some sort, but let’s say it is $0 and the rest due is interest plus the loan. So, the next pay-day, the lender takes my $1,100 payment to settle the loan. That is a 10% interest for a 1/2 month time period. Since there are 24 such time periods in a year, using simple interest, that is a 240% annual rate of interest.

If that is not bad enough, come the end of the 15 day period, I find I need my paycheck, so I reborrow it. So, I give them my paycheck, they take out another an extra $100 (I am rounding to make the math easier) on the interest I owe and they loan me $900 rather than $1,100 in take home pay. So, now I owe $2,200 on the use of $1,900. Assuming I could pay it back in 15 days, that would be a 1/2 month loan rate annualized to the tune of 379% per annum. However, I cannot pay the full loan back as my next pay check is only $1,100. So, I borrow yet again. The take out $200 more in interest due on top of the next $100, so I get $800. So, now I owe $3,300 on the use of $2,700.

I used a fictitious interest rate for the ease of the math. Yet, I also did not factor in a processing fee either. Yet, the purpose of the illustration is to show how fast you can get in over your head. Even if you did not borrow against a portion of your paycheck, you can soon end up owing the entire amount. A key problem is the people in need are the least likely to run the numbers. They just need the cash.

I am presuming the audience reading this is fairly astute, much more so than the average Joe’s and Josephine’s. If you have friends or relatives who are going down this path or who are considering it, help them look at other options. There are an increasing number of microloan possibilities whose lenders do not prey upon the borrowers. There are some other financial assistance programs that go under varying names. There may be some co-lending options as well. The dilemma is the pay-day lending is a vicious cycle that is difficult to break. So, help people avoid that cycle and try to get out of it if they can.

I do not begrudge anyone making a reasonable profit. Yet, I do find fault with people making an excessive profit off the backs of people who can least afford it. If you have a story about pay-day lending, please feel free to share it. Others need to see how this death spiral can affect people.