Sara Routhier, Managing Editor and Outreach Director, has professional experience as an educator, SEO specialist, and content marketer. She has over five years of experience in the insurance industry. As a researcher, data nerd, writer, and editor she strives to curate educational, enlightening articles that provide you with the must-know facts and best-kept secrets within the overwhelming world o...

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Joel Ohman is the CEO of a private equity-backed digital media company. He is a CERTIFIED FINANCIAL PLANNER™, author, angel investor, and serial entrepreneur who loves creating new things, whether books or businesses. He has also previously served as the founder and resident CFP® of a national insurance agency, Real Time Health Quotes. He also has an MBA from the University of South Florida. ...

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Reviewed by Joel Ohman
Founder, CFP®

UPDATED: Dec 21, 2011

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After comparing the prices of payday loans, which usually hover around 15 percent, to other loans, often ranging from 3 to 10 percent, an obvious question is, “Why?” The short answer is because pay lenders have to price their loans that high in order to stay in business.

 

Lending requires more money than simply the amount handed over to customers. It’s a business, and like other businesses, payday lenders need to pay employee wages, property rent, and website domain fees. In addition to normal expenditures, payday loans suffer from a much higher default rate than other types of loans. That default rate hovers are 6 percent, according to an article done by Reuters. That high default rate hits payday lenders even harder since payday loans are not backed by any collateral, and thus can’t collect a car or property in return for their lost money.

 

If a payday loan borrower defaults and their check bounces, the payday lender must chalk that transaction up as a wash.

 

Let the numbers do the talking

 

Consider a payday lender who loans out several transactions totaling $1,000. At an average interest rate of 15 percent, he can expect to gain a total of $150. But over the course of those loans’ lifetimes, that lender can statistically expect to lose 6 percent, or $60. The profit margin on loaning $1,000 comes out to a grand total of $80—right around 8 percent.

 

A profit of 8 percent on short term financing is not usurious or condemning.

 

Another way of approaching a payday loan’s cost is by taking it on a day-by-day basis. Few would cry out in disgust if a borrower approached a friend and asked for $100, and the friend agreed claiming he’d like to be repaid an extra $1 per day that his money is gone. After two weeks that works out to be nearly exactly how much a payday loan lender charges. The only difference is this example is one between friends. The risk is slightly smaller given the relationship between the lender and borrower. With payday lenders, they loan cash out to complete strangers.

 

The fact of the matter is short term lending is risky and, therefore, not cheap.