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Payday Loans - Do High Fees Imply High Profits?

Written By krismonnyont4 on Saturday, October 26, 2013 | 11:12 AM

Payday Loans - Do High Fees Imply High Profits?
Whether a company earns too much or too little cannot be analyzed only by multiplying the fees they charge with the amount of products they sell. The costs of the production, distribution, etc. need also to be taken into account. The same happens when it comes to analyzing payday loan lenders' profits...

Every company wants to obtain a profit and no one that is acting commercially will lend money out of the goodness of his heart. Yet, lenders dealing with low risk clients and offering regular personal loans with the proper credit verification processes for approval charge lower interests or fees. Thus, there must be a justifiable reason for the high fees charged by payday loan lenders.

What Kind Of Customer Requires Payday Loans?

This is an important question because the niche that lenders address with payday loans is a very particular gap of the financial market which is not filled by other financial products. Payday loans are meant to help those who run into an emergency situation and need the funds to cope with it. They are short term loans, carry small amounts and high fees as explained.

The problem is that those who need financial assistance for such emergencies obviously do not have the savings that they would need to face it. And though it is possible that some unexpected situation may cause that lack of savings, chances are that the one seeking a payday loan for such purposes has a null savings capacity and consequently either a low income or high expenses (or most commonly both).

The Risks Involved In The Transaction

So, what is to be expected of such customers? Truth is that the market analyses show a very high default ratio. Thus, simple math rules that high fees are needed to ensure any kind of profit. If I charge $1 every $100 (12% APR) I would get $1000 in profits every 100 customers borrowing $1000. But if 10% of the borrowers default on the loan, I would be losing $9000.

Instead, payday loan lenders may charge $10 every $100. With the above example and a 10% default rate, they would still make no profit at all. Yet, payday loan lenders have more customers, charge additional fees and make use of different methods to reduce the default ratio to a minimum. They do what every company does: minimize loses and maximize revenues.

Payday Loan Lenders Are Not The Devil

Now that we have de-demonized payday loan lenders, we should explain how payday loans are correctly used because if there is a devil and it is not the lender, it surely is the misuse of payday loans.

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