Payday loan businesses are often maligned. For someone just looking at the raw numbers (well, certain raw numbers, anyways) payday lenders might seem predatory. After all, interest rates in the hundreds of percents can’t be ethical, can they?
The fact of the matter is, though, that payday loans have fees that are comparable to other types of credit, in terms of their dollar costs. The big difference, of course, is that you pay back a payday loan in a period of weeks rather than over the course of months or years.
Payday loans also fill a specific need. If you don’t have a traditional bank, or if your credit isn’t sufficient to qualify for other types of loans, a payday lender can meet a specific need. It’s estimated that as many as 60 million Americans do their daily financial business in places outside of the traditional banking arena. Payday loans are one part of how they do business. Rent-to-own businesses are another example of how these folks handle their finances.
These folks, often known as the “unbanked” or “underbanked” have traditionally been ignored by the banking establishment. Still a 2005 federal law states that the FDIC is responsible for monitoring the situation with such people, and encouraging the banking system to bring those people into the fold.
This law isn’t new, however. The Community Reinvestment Act of 1977 was designed to help address the credit shortage for low and moderate income neighborhoods. While the CRA may have helped with things like housing, it didn’t address traditional banking services such as things like savings accounts, money orders, check cashing and affordable small loans.
As you can imagine, many underbanked and unbanked households are on the lower side of the income scale. Around 71 percent of unbanked households have incomes under $30,000 per year. This is a problem that payday lenders have stepped in to address. While critics may not care for their methods, they have found a business model that both meets their financial needs and provides access to money for the unbanked and underbanked.
The real challenge is that banks have traditionally shied away from offering short-term loans. In addition, some banks face regulations that require them to charge much smaller interest rates, making the kinds of short-term loans offered by payday loans unprofitable at best.