You've heard of stupidity taxes. They come in the form of state lotteries and junked slot machines that are rigged to pay out far less than they take in. The naive line up to gamble what starts out as spare change, but the upside to this is that -- every so often -- someone will beat the odds and strike it rich.
Not so for payday loans. This practice isn't quite as addictive as scratch-off tickets and one-armed bandits, but it's actually worse in one sense. In this game, the house always wins.
The Center for Responsible Lending estimates that predatory payday lending costs 5 million Americans a sum of $3.4 billion a year. Imagine the kind of person so desperate for money that they're willing to give up such a generous chunk of their upcoming paycheck. Those 5 million people are probably the ones most in need of that extra $3.4 billion. In some upside-down Robin Hood farce, payday lending roughly translates into the rich stealing from the poor.
"No way, hippie," you say. These companies are providing a welcome service for cash-strapped customers, aren't they? Let's see about that.
A payday loan arrangement typically has no problem forwarding you the funds of a paycheck that is two weeks away in exchange for at least a 15-cent nibble out of every dollar. It seems perfectly harmless until you realize that you're charging someone a 15% penalty for a mere two-week outlay of capital. Annualize that sum, and you'll arrive at a whopping 400% APR.
Before you start claiming that payday lending institutions are taking on great risks here -- especially with folks living paycheck-to-paycheck (or border-to-border) -- you should realize that the ultimate default rate is closer to about 2%.
It's easy to see why the FDIC set out to crack down on the practice earlier this year, and why some consumer-friendly credit unions have rolled out similar products with more reasonable fee schedules.
The fact that the payday loan sharks found a way to circumvent the FDIC speaks more to their predatory nature than the logical will to survive. Last month, my dueling buddy Lawrence explained that a typical Advance America
The sort of customers payday lending affects may explain why it isn't riling up the media ranks. Most consumers feel as if the disruptive lending practice can't touch them. Payday lending is a foreign experience to Jane Average. She's never set foot in a First Cash Financial
It's not right. These are payday loans we're talking about, here. Victims are working hard for the money that they will never fully see.
Lawrence may take me to task for calling a payday loan company "predatory," or its client base "victims." In truth, I would warm up to the practice if the fees weren't so out of whack with reality, and if the industry wasn't taking advantage of one particular group in this modern-day financial fiefdom.
Then again, even if the terms were fair, I'd still be bothered by a system that inspires folks to start spending a future paycheck -- no matter the fraction -- today.
As an investor, I would shy away from these payday loan providers. Yes, their stocks have been roughed up a bit lately, but that doesn't make them cheap. If the only thing separating you from your eventual margin-collapsed obsolescence is consumer education, it's a war that you will eventually lose -- and lose badly.
You're not done. This is just one part of a four-part Duel! Don't miss Lawrence Meyers' bull argument, Rick's rebuttal, and Lawrence's last word. When you're done, you're still not done. You can vote and let us know who you think won this Duel.
Longtime Fool contributor Rick Munarriz knew it would upset the mix even more if he made the distinction that loan sharks were cold-blooded creatures. He does not own any of the shares mentioned in this argument. The Fool has a disclosure policy. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early.