The American Payday Loan Industry
Payday loans entered the American market around the end of 2000. The early years for these types of loans carried a negative stigma, and many frowned upon the industry. Currently, it is not only a thriving industry, but the shadow that once plagued this market has somewhat dissipated.
The name of payday loans actually tells you exactly what they are. These loans are short-term cash loans that have minimal requirements. There is usually no credit check and normally these loans are not reported to a credit bureau, unless the borrower defaults. There are only three items needed to process an application: a valid checking account in the borrower’s name, a valid pay stub and valid identification.
If approved, the payday lender will then direct deposit the loan amount into the borrower’s checking account, sometimes even on the same day of application. The lender then debits the payments for the loans for bad credit on a bi-weekly or monthly basis from the checking account on the borrower’s payday, hence the name.
Payday lenders are not considered banks, but they serve a niche of people that need emergency cash quickly and are employed so that they can pay that loan back. Legally, they are labeled as Non-Depository Financial Institutions (NDFIs) and do not hold a banking license.
The major issue with these types of loans is that States do have usury laws which limit the amount of interest that can be charged to about 35%. Payday lenders charge up to 500% interest. Some states have decided to deregulate these micro signature loans and exempt payday lenders from the usury laws, which has allowed the industry to proliferate.
Since this entire loan process occurs online and lenders automatically debit, it is highly efficient and simple. And, since the interest rates are incredibly high, the margins for this business continue to impress. Some default rates in the industry are reported at 50%. Even at this level, the business is profitable because the interest amounts are so exorbitant. And, the lender can use a collection agency to secure the 50% that defaulted, so they make additional income on that end.
Micro signature loans can range from $300-$50,000. This appears to be a very wide range, but the lender has reviewed, verified and confirmed all banking and paycheck information, and as a result, they feel comfortable lending an amount commensurate with the borrower’s pay. In addition, in order for the borrower to stop the payments, they would actually need to close the bank account. And even at that point, the lender has the social security number of the borrower and can pursue collections using the social security number.
The future of this industry is continuing to digitize small loans into cellular phone applications. For example, there are micro loan cellular applications that actually allow you to apply and get approved for payday loans using only your cellular phone. What is interesting is that these applications are limited to a smaller loan amount, and they also carry a much lower interest rate. Rapidly changing, there is no retraction in this market, just increased need and many more options.