The Cost of Money and the Rise of Payday Loans

Increasingly marketed towards millennials as a heaps-cool way of boosting your finances in a time of need (possibly because a previous idea to prey on Centrelink recipients resulted in a $18 million fine), the term payday loans commonly refers to loans of up to a few thousand dollars with an “expectation” that the money (plus interest and fees), will be fully repaid from your next pay check.

In practice, many payday lenders seem to bank on you not paying them back, as their contracts become infinitely more profitable should you miss a payment. If you need further evidence of their wily ways, check out our 3 solid reasons to steer clear of payday lenders.

Who’s got two thumbs and most of your next pay check? This guy, that’s who!


Debt vs Interest


Debt in itself isn’t always a bad thing. Sometimes borrowing money is the lesser of two evils, or in the case of a business; a way to cover the start-up costs necessary to eventually turn a profit.

Interest however, is more like an STD you catch when borrowing money from strangers; best case, it clears up within a couple of months, worst case, you’re dealing with it for life.

Usually calculated over a yearly term, interest (from the Anglo-French interesse – “what one has a legal concern in”) is effectively the cost, excluding fees and charges, of borrowing money. This is particularly important because depending on who you are; the cost of money can vary wildly. Somewhat ironically, the more you need it, the more it’ll cost you.

For instance, banks can currently borrow money from the RBA, the Daddy bank of all other banks, for 2% (referred to as the “Cash Rate”), so were they to borrow $100, they would owe the RBA $2 every year they don’t repay the $100.

Compare that to say, the credit cards issued by those same banks that have an interest rate of anywhere from 10% to 25% per annum, and you quickly understand why in 2014, the big four banks pulled in combined record profits of $29 billion (obviously I’m simplifying things here, if it were this easy we probably wouldn’t stand for it.. and I’d be rich!).


Risk


Understandably, risk has a big impact on the cost of money. Would you lend $100 to someone you weren’t confident would pay you back, all for a $2 profit? Hopefully not.

Compared to lower interest loans such as mortgages or car finance, payday lenders have no house or car to quickly sell-off should the borrower vanish. To balance this risk, unsecured loans attract a higher interest rate (including your credit card).

Of course I have your money….

After the money-wizards conjured up the GFC (magically disappearing an estimated $15 trillion into thin air), in an attempt to avoid a repeat, regulators effectively doubled the amount of money banks were required to hold, relative to their lending portfolio (don’t worry, they can still lend over $10 for every $1 they actually hold).

According to Adam Mooney, CEO of the non-profit organisation Good Shepard Microfinance, this resulted in “a very rational response by financial services organisations to believe that people on low, or even middle incomes are not [their] target market anymore.”


Enter payday loans


If you were in the estimated 3 million people abandoned by the banks, payday lenders suddenly became much more attractive. Hence the industry’s huge growth over the last decade; from $100,000 million worth of loans, to over $1 billion today.

When you have a hole in your wallet and someone like Cash Converters (from the telly!) puts a contract in front of you, many people either assume the terms must be reasonable or lack the financial knowhow to understand the impact of their decision.

Unfortunately for these people, this trust may have been undeserved as evidenced by the $23 million in-principle settlement Cash Converters agreed to pay for, amongst other things, charging up to 633% (yes, you read that correctly) for cash loans.

So before borrowing money from a hipster in a rabbit suit, speak to a financial planner or visit the government website Money Smart for some free financial advice.

Disclaimer: The advice provided in this article is general advice only. It has been prepared without taking into account your objectives, financial situation or needs. Before acting on this advice you should consider the appropriateness of the advice, having regard to your own objectives, financial situation and needs.