I think it would be helpful for legislators and policy makers if they got a glimpse into the real world of how a payday loan business runs, so this rate cap argument can be removed from abstraction.

Half the stores in America are owned by mom and pops. They are entrepreneurs. They’ve scraped together $25,000 to open a single store. On top of that, they’ve likely taken most of their life savings and borrowed from family, friends, and a bank. They’ll use that money to fund the $8000 monthly store overhead they have, to fund the loans they make, and to pay themselves just enough each week to feed their family.

That $8000 in overhead is lean for a store. It covers rent, utilities, maybe an employee, signage, advertising, payroll taxes, software, computers, office supplies, and a few other sundries.

Now they don’t just fling open their doors and start making $120,000 in loans each month. It takes about 18 months to reach that level – which is average for a payday loan store. That means they are not generating any profit during that first year and a half. They’ve gambled all they have on their business. Along the way, every two weeks, 6% of their loans won’t get paid back. That cuts into their revenues.

If they manage to build to a $60,000 loan portfolio at the end of their first year, they will break even in month 15.

But industry opponents never mention this, do they?

Now, let’s look at our operator once he’s managed to break even. This operator will now extend about $1.5 million in loans to customers per year. Let’s say he’s in a state that permits a fee of $15 per hundred borrowed.

Opponents ignore the fact that, on average, 6% of these loans will never be repaid despite collections efforts. That means $90,000 of that $1.5 million loaned is never returned. Thus, the lender will only earn money on $1.5 million of loans.

$1.5 million x 15% = $225,000 in total fees

An average store will cost about $8,000 a month to run. That includes paying employees, utilities, insurance, rent, and so on. Thus, total store costs for a year will be $96,000.

$225,000 total fees - $96,000 expenses = $129,000 in store profit.

But remember, that operator had to borrow from a lot of people to fund his losses for a year and to have money to lend out. That requires about $150,000 in total capital. Maybe they got lucky and got these loans before the credit crisis and are averaging a 10% APR interest rate, of $15,000 in interest payments.

$129,000 store profit - $15,000 interest = $114,000 in net profit

Say this owner will contribute $14,000 to his 401 (k) for retirement.

$114,000 net profit - $14,000 retirement = $100,000 in taxable income

Now he must pay federal and state income taxes. If this operator has a 4-person family to support, their federal and state taxes will be $16,000.

$100,000 taxable income - $16,000 = $84,000 in take home pay

In the final tally, $84,000 for a small business owner of one payday advance store is a very nice annual income, but hardly the level of wealth opponents claim that payday lenders achieve each year.

By the way, the owner probably won’t even take all that pay home. He’ll start saving it to open another store.

And what happens if a 36% rate cap goes into effect? That $15 per hundred fee becomes $1.38 per hundred borrowed. That’s a 91% revenue cut! So that $225,000 in total fees is now $20,000, not enough to cover defaults and overhead for even two months.

The results:

1) The lender is out of business.

2) The lender must declare bankruptcy

3) The lender’s investors have lost all their money.

4) The lender’s customers are forced to undesirable forms of credit

a. Bank overdraft and NSF fees – Three times more expensive

b. Internet payday loans – 70% to 100% more expensive and unregulated

c. Pawn something – Equally expensive, with risk of losing something of value if loan not repaid

I hope policy makers will take a long look at the consequences of passing what sounds like a good idea. The truth is, it will harm the very people they think they are helping.