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. Theyâ€™ve scraped together $25,000 to open a single store. On top of that, theyâ€™ve likely taken most of their life savings and borrowed from family, friends, and a bank. Theyâ€™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 donâ€™t just fling open their doors and start making $120,000 in loans each month. It takes about 18 months to reach that level â€“ which is average for a payday loan store. That means they are not generating any profit during that first year and a half. Theyâ€™ve gambled all they have on their business. Along the way, every two weeks, 6% of their loans wonâ€™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, letâ€™s look at our operator once heâ€™s managed to break even. This operator will now extend about $1.5 million in loans to customers per year. Let’s say heâ€™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 wonâ€™t even take all that pay home. Heâ€™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. Thatâ€™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.
1) The lender is out of business.
2) The lender must declare bankruptcy
3) The lenderâ€™s investors have lost all their money.
4) The lenderâ€™s customers are forced to undesirable forms of credit
a. Bank overdraft and NSF fees â€“ Three times more expensive
b. Internet payday loans â€“ 70% to 100% more expensive and unregulated
c. Pawn something â€“ 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.