Why are payday loans so expensive?
Apply for a Loan
Secured with SHA-256 Encryption
UPDATED: Dec 21, 2011
Advertiser Disclosure: We strive to help you make confident loan decisions. Comparison shopping should be easy. We are not affiliated with any one loan provider and cannot guarantee quotes from any single provider. Our partnerships don’t influence our content. Our opinions are our own. To compare quotes from many different companies please enter your ZIP code on this page to use the free quote tool. The more quotes you compare, the more chances to save.
Editorial Guidelines: We are a free online resource for anyone interested in learning more about loans. Our goal is to be an objective, third-party resource for everything loan related. We update our site regularly, and all content is reviewed by experts.
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.