As we know there’s been rather a campaign against payday loans. The cries from the feeble minded about the excessive, totally outrageous I tell ya’, interest rates charged on them. Hundreds of percent when expressed as an APR. So, they’re being regulated out of existence. Wonga has already gone and most of the rest will follow.
As a part of the Federal Reserve has noted:
Except for the ten to twelve million people who use them every year, just about everybody hates payday loans.
Apparently for the people who actually use them the interest rates aren’t outrageous.
The essential economic problem here being that lending small sums of money for short periods of time simply is expensive. Someone, somewhere, has to process the documentation, take the decision upon whether to lend or not and that simply is some measurable amount of time, human labour and cost. There was an attempt by a part of Goodwill to do this on a non-profit basis. Their APR was still well over 200%.
The APR calculation insisting that such fees be counted as part of the interest rate being charged. And if money is being lent for a week then we must include 52 instances of the fee to give us the APR. Which is how we do get to those thousands of percent interest rates when so measured.
As the Fed goes on to point out:
Even though payday loan fees seem competitive, many reformers have advocated price caps. The Center for Responsible Lending (CRL), a nonprofit created by a credit union and a staunch foe of payday lending, has recommended capping annual rates at 36 percent “to spring the (debt) trap.” The CRL is technically correct, but only because a 36 percent cap eliminates payday loans altogether. If payday lenders earn normal profits when they charge $15 per $100 per two weeks, as the evidence suggests, they must surely lose money at $1.38 per $100 (equivalent to a 36 percent APR.)
Which is how Wonga has been regulated out of business.
So, is there a solution to this? One company is trying:
A London start-up that lets employees draw down their wages early without having to resort to risky payday loans has secured £20m from investors, including the backers of collapsed payday lender Wonga.
OK, so, what’s the trick?
Wagestream enables companies to pay their employees their wages as they earn them, rather than in an end-of-month pay packet. Billed as a workplace benefit, staff can pay a flat fee of £1.75 to secure an early payment of a percentage of their salary.
So, the credit risk is on the company paying the wages, not the employee turning up to pay back the loan. That reduces the interest rate that must be charged. Sure, they say there is no interest here, simply a fee, but when we move to APR that distinction disappears, as above. Presumably there’s also some saving by doing this in volume terms – all employees of the company can be covered for the one set of investigation into the accounts.
Looks like a useful solution. Good luck to ’em.
Except it’s not actually a solution. Because this still – potentially at least – breaches the APR cap. Or, at least, that US one of 36% and more obviously any set lower than that.
A loan of £50 paying £1.75 in fees to borrow for one month is an APR of over 40%. And it’s grossly more than that if they borrow it only for the week at the end of the pay period – because that’s just how APR works.
The problem here is the measure being used, the APR, because it always, but always, shows vast interest rates on small sums for short periods of time even when there is in fact no interest charge at all. We’d probably do better to use a different calculation method……