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Wednesday, July 28, 2010

Thoughts after reading Broke, USA

One of my 'favorite' topics in business math: Payday lending.

Quick question: How many Payday lending stores are there within a 3 miles radius around DVC?
Answer: 9
Quick, what are you thinking?

Payday lending is a relatively new industry, started in the 1980s. Before that, if somebody needed a bit of quick cash for a short time until the next paycheck, one had to go to a local pawn shop. There, the pawn broker determined the price they could get when selling the item in their store, divide that by 3, and that was the dollar amount the customer could borrow. For example, if I were to take my mom's gold watch to the pawn broker and they determine that they can sell it for $300, then I can borrow $100.

If I then can pay the $100 (plus a fee!) back within an agreed-upon time, I get the watch back.
If I can't, then the watch gets sold by the pawn broker.

Bottom line: the pawn shop makes money whether I pay back the loan or not. But I digress - I really wanted to talk about payday loans.

No gold watch needed. In its place is a higher fee. Let's say I borrow the same $100, let's say for one week, since I just need to get a couple of tires for the car, and I have no cash or other resources to borrow from. No family, friends, credit card, etc., that could help tide me over. At the payday loan store, I would get the $100, cash, and agree to pay $115 back in a week.


It's good that it's there, since I had nowhere else to go, and I needed my car to go to work.
There is just one problem. In this scenario, the annual percentage rate of this loan comes to 391%. (Yes, we calculate that in class. But you can try if you want to check it out yourself.)

See the problem? This is called usury (Merriam-Webster: "an unconscionable or exorbitant rate or amount of interest; specifically : interest in excess of a legal rate charged to a borrower for the use of money.")

Before I forget: Most payday loan customers are repeat customers. This means that they either don't pay the original loan off, but rather take out a second loan to cover the first loan... you get the idea. Or that they use more than one payday loan company to take out loans. Or that they use payday loans on a somewhat regular basis. All to the tune of 391% APR.

Don't get me wrong: That there is a business that makes it possible for the 'un-banked' to get a short-term loan is a good thing.

That the business model is based on interest rates that would make the Mafia blush is a bad thing.

As Alan Greenspan said, "Of concern are abusive lending practices that target specific neighborhoods or vulnerable segments of the population and can result in unaffordable payments..." (March 2000)

Finally, in 2010, the financial reform package and its Consumer Financial Protection Agency to investigate abuse, was passed.

I love teaching business math. Experiencing the Aha! moments when the business world around them starts making more sense to students is the most rewarding feeling. Plus, an educated consumer is an empowered consumer.

Teaching is about empowering learners.

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