Payday Advances
One of the most disturbing trends in “financial services” is the proliferation of Deferred Presentment services, or what most of us call payday loans. The basic idea is this: you are having a temporary cashflow problem. You need extra cash in this period to cover extra expenses, and you anticipate that you will have excess cash in the next period, so you take an advance from future earnings, plus a fee, and use it to cover current expenses. America has gone from living from paycheck to paycheck, to now living from next month’s paycheck to the next month’s.
The problems with this system seem obvious. If you have a cash flow problem in this period, what’s going to ensure that you won’t have a cashflow problem in the next period, especially with the reduced income caused by the payday advance fees? The Community Financial Services Association of America [CFSA] supposedly dispels these myths on their website under the fact or fiction section.
Now, economically speaking, these institutions have a place in the marketplace. The demand is such that these companies can charge exorbitant finance charges and people will still come to them for financial relief. They have no other access to the cash they need, and so they have to turn to the only one who will take on the risk of loaning them money. If they had good credit they would take out a bank loan–even the worst rates at any bank will be far better than the annualized rates on these payday advances. They probably have poor credit from mismanagement of their money in the past; therefore, why would a company realistically, or ethically think that these are short-term cashflow problems, and that advancing future earnings won’t send the customer into an inescapable cycle of debt? The only way these institutions are willing to assume the added risk of loaning to these individuals Is to charge exorbitant fees to mitigate that risk. And thus the cycle continues…
One way they get away with it is by charging a flat fee on the loan, as opposed to interest, but still require it to be paid off within two weeks. The fee ranges anywhere from $15-20 for every $100 advanced. They are required to report the cost of taking the loan, both in terms of dollars, and APR. The annualized APR of a two-week payroll advance with a $15 fee, for example, would be 391%! With a $17 fee it would be 443%! Basically any other type of loan would be a much lower rate than this.
My argument, then, against this industry is that it is simply unethical. Despite the claims of the CFSA or any other specific company, this industry preys on the ignorant and irresponsible, and makes them pay through the nose because of it. Mortgaging future earnings for “short-term” cashflow problems is hardly a way to help these people out. The economic model becomes distorted, because these companies seek to increase the asymmety of information by publishing distorted reports and statistics, painting a picture of normality and peace of mind, without disclosing the risks and possible consequences.
Now, for the consumer, the first way to avoid falling into this trap is to manage your money carefully. If you spend less than you make, and increase your savings, then if you do come to a point where you have a legitimate short-term need, you can pull money from past earnings (that has been actually been earning interest, rather than paying it) to cover your expenses. The second most important thing to do, is to maintain a good credit rating. This happens by opening up one or two credit accounts, using them, and always making the payments on time. It sounds so simple, and yet avoiding those two things are what force people into sleazy payday advance places.
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