Payday Lending Math is Bad on All Sides

Jason linked to this piece on payday lending in the UK, and I was struck right away by math being poor on all sides of the debate. I’m not the type of libertarian to defend payday lending to the death, as I think it’s usually kind of dumb…but then again, I’d rather have the option to keep heat going in the winter if I didn’t have cash-flushed friends and family or an understanding bank willing to do business with the type of guy who was about to lose his heat for non-payment. But generally, yes, it’s spectacularly bad from a financial perspective. (Then again, the same people clucking are often the same yuppies who got ARMs based on the asset bubble of house prices, so…)

Still, this piece was pretty bad in conflating various “percents,” as was its source material. Here it quotes Times Online:

Payday UK said that the typical annual percentage rate (APR) for its deals was 1,355 per cent. The typical rate for a credit card is 20 per cent, while a high street bank charges about 18 per cent on an overdraft.

Well, “APR” and a “charge” are very different things. Both are percents, but the comparison ends there.

Payday lenders, such as Payday UK, Express Finance and Pounds Till Payday, offer loans of up to £1,000. Payday UK demands that £125 be repaid for a £100 loan, or £937.50 for a £700 loan. The loan is usually paid off within a couple of days, as soon as the borrower’s wages are paid into their account.

Well, if you get 100 but have to pay back 125, and you do so in a few days, that’s 25%, not 1,335%. If you carried the loan the full year, you’d be talking that kind of rate–but you don’t. So if a bank overdraft is 18%, I’m imagining they don’t let you carry that 18% over a whole year. They charge it immediately. So the relevant numbers are 18 versus 25. This works in the bank overdraft’s favor, but not so dramatically as 18 versus 1,335. That’s a deceptive comparison…ironically, the same sort of comparison used to get people to get a payday loan.

Of course, getting bank overdraft protection on this side of the pond requires a decent-sized deposit, an annual fee, and a credit check. I’m guessing most customers of payday loans don’t do that well on credit checks, don’t have tons of cash to make the bank feel happy that they’ll get paid back, and can’t afford an extra $100/year just to know they won’t have to go to a payday lender. And while the poor may be able to wallpaper their apartments in credit card applications, the reality of getting credit sufficient to pay off an electric bill is not necessarily so rosy.

So yes, if you’re a yuppie, you’re an idiot to get a payday loan, and the guys with the soft helmets will look at you and mutter, “retard.” But maybe you should think about the consequences of making the last refuge of the desperate job-holder illegal.

Speaking of, let’s deal with the rhetorical coup-de-grace:

I was recently on an NPR show on consumer debt, and a caller said his uncle, a former loan shark who did 15 years in prison, was mystified by payday lending, particularly since he had charged only 17%.

Wow, what a deal…now was that 17% accrued over an entire year, or was it due in a month or less?

Nah, I’m kidding. The real ludicrousness of this comparison is that payday lending companies tend not to break your legs when you default.

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