What makes payday loans so expensive (3-part series)
Posted on: 16 October 2015
For the first mini-series at A Fig A Day, we'd like to break down what exactly makes a Payday loan cost so much. Lenders often claim that it's to cover the "risk" that people won't pay them back, but that's hardly the whole story. Lenders use fees to cover all the costs of their business, from keeping the lights on to hiring employees to paying for advertisements. Spoiler alert, a lot more goes to paying for advertisements than you might think. Over the next few posts, we will show you exactly how this works.
Part 1 -- You're paying for the ad!
Let’s start by breaking down how businesses work with two examples. A simple business spends money to make things, and then sells those things to customers for more money. A farmer buys $100 of seeds to grow watermelons. He then sells those watermelons at the market for $120. From the $120 he has earned, $100 covers the original cost of his seeds and the farmer keeps $20 for himself to provide for his family.
However, suppose the farmer lives far away from the market and he needs people to come to his farm to buy his watermelon. But how will people know his watermelon are ripe and ready to be purchased? The farmer needs to let people know, so he buys an advertisement in the local newspaper which costs him $10. Then, if the farmer still needs $20 to provide for his family and $100 for the seeds, he now needs to make an extra $10 on his watermelon to pay for the newspaper advertisement. To do this, he now sells his watermelons for $130, $10 more then in the original example. So we the buyers now pay an extra $10 for the farmer's watermelon.
It’s often not obvious to us customers, but the money we pay for things covers many different costs. In the case of the farmer, his customers ended up paying for his newspaper ad. In part 2, we will discuss how this applies to lenders.
To be continued...