Payday loans How Payday lending works
- I think most of us have a sense that payday loans are
- probably not the best source for a loan, that they probably
- charge a lot of money to those people who need that cash
- really badly.
- And what I want to do in this video is one, explain what
- they are but even more do a little bit of math to
- understand really how bad of an interest that they do
- So the way that works is let's say that I need to buy my wife
- a nice gift for her birthday that's tomorrow and I want to
- borrow $500.
- So I want to borrow $500.
- I would suspect that most people aren't borrowing it for
- some type of a gift, they're desperate to make the rent or
- pay the utilities or buy food or who knows what else, but
- whatever your reason, you need to borrow $500 and I would
- suspect that you have very little in your bank account,
- otherwise you wouldn't go to the payday lendor.
- And they say all right Sal, we're open to lending you $500
- and we're not going to do all of this deep research on how
- good of a credit you are and all of that, but we want a
- couple of things.
- One, we want to know your pay stub and your pay date.
- They're going to want to see your pay stub, they're going
- to they want to know when you're going to get paid, so I
- guess we call it your payday.
- And they might want some recent bank statements.
- And the whole reason why they want these things is they want
- to know you know even though your credit might be horrible,
- then you're going to get your salary or you're going to to
- get a payment from your employer probably in two weeks
- on your payday, and then you're going to be good to pay
- back to the $500.
- And to ensure this, so one they're going to make sure
- that you have a job, that in your pay stub maybe you make
- $1,000 every two weeks or maybe you make $2,000 every
- two weeks so that you're good for this.
- So maybe you maybe make $1,500 every two weeks, so they like
- to see that.
- Maybe your payday is two weeks from the day that you're
- borrowing it, borrowing the money.
- So two weeks from today.
- And then your bank statement shows that your bank kind of
- goes up $1,500 and you pay the rent and the food and then it
- goes back close to zero, then it goes up to $1,500 but they
- want to see that this $1,500 is hitting periodically.
- And they say, you know, we're going to give
- you the $500 today.
- You need to write us a check.
- We want you to write a check for not $500, for every $100
- you borrow, I want you to pay us back another $25.
- So $25 extra.
- And at first you might say, that's not bad, that's 25%
- interest. It's high, maybe it compares to some interest,
- some credit cards.
- But this isn't 25% a year, this is 25% for two weeks.
- And at the end of this video, we're going to do the map on
- what that actually turns into on an APR, or an
- effective APR basis.
- And these numbers are not crazy, these are actually very
- typical for payday loans.
- So if I'm borrowing $500, I have to give them back the
- $500 in two weeks plus $25 for every $100.
- So I'm borrowing $500, so I'm going to have to do plus five
- times 25 five or $125.
- So I'm going to write them a check for $500 plus a $125 so
- that's $625.
- I'm going to write a check, but obviously I don't have the
- money in my bank account right now, otherwise I wouldn't even
- be going to the payday loan.
- What I'm going to do on the date, I'm going to
- forward-date this check.
- I'm going to put the date, let's say this is the first of
- the month, instead of let's say, it's January 1, I'm going
- to put January 16 and whatever year I might be doing it.
- So I've forwarded it, this is two weeks from today.
- Two weeks in the future, and then I'm going to sign the
- check and I'll write it's for a payday loan and I'll write
- $625 etc. etc., then I have my little information here.
- And I'm going to give them this check and what they're
- going to say is we're not going to cash this, we're just
- going to keep this nice little check for us and when your
- payday hits you have an option.
- You can come back to us and give us $625 in cash and then
- we will give you back this check that is uncashed or if
- you don't show up, we are just going to cash this check.
- So one of these two things are going to happen.
- But effectively, if you didn't lie to them, they're going to
- essentially charge you $625 and you can imagine it is
- risky for the lender or because these are people with
- you know be maybe shady pay stubs and obviously they're
- desperate, so they weren't good at managing their
- finances, but they're doing their best to ensure that once
- that payday comes in, once that's that payment from the
- employer comes in, that they get first dibs was on the
- money before the person can pay their rent or their
- utilities or their food.
- And so that's the general idea behind it.
- Now we start off saying this probably not a good idea and
- you got a sense of that, because we're essentially
- paying 25% interest for every two weeks, not for every year.
- But let's think about what that is on an APR basis.
- So let's say we're paying $25 for every $100, that's really
- 25 per cent.
- When you say per cent, that root means hundred, right?
- Century, 100 years.
- So per cent, it literally means per 100.
- 25 per 100, so this is literally 25% interest or we
- could write it the traditional way, this is 25%
- interest per two weeks.
- So if we were just calculate a simple APR, a simple annual
- percentage interest rate, and you might want to watch the
- video on that to understand that that just takes your 25%
- and then multiplies by the number of periods in the year.
- So we have 52 weeks per year, but this is every two weeks,
- so instead of multiplying it by 52 weeks, we're going to
- multiply by there's 26 two-week periods in the year.
- So times 26 two-week periods per year.
- And this is 25% per two weeks.
- When you multiply this out, this is equal to-- let's get
- the calculator out-- I'll just multiply the numbers, I won't
- do the decimals.
- 25 times 26 equal to 650%.
- We're paying an APR of 650%.
- So if you thought the credit card companies were charging a
- lot of interest, charging you a mid teens interest rate or
- 20% rate, this is 650%.
- It's an one order of magnitude or to above what even credit
- cards charge.
- So this is a really, really, crazy annual percentage rate
- and this was just a simple annual percentage rate where
- we multiplied it by 26, this isn't the effective annual
- percentage rate, or the actual mathematically correct one.
- To do that, we would actually have to take-- and you might
- want to watch the video on this-- if you were to let that
- just compound, and you can imagine if you're the payday
- lender, you are essentially getting that compounding if
- you keep lending your money out and if you lend the
- interest you get from the last person, and you lend that out
- the same rate.
- To figure out that effective annual percent rate, you do
- 1.25, 25% plus 1 to the 26th power.
- We have 26 of these periods in a year.
- And what is that going to be equal to?
- So we have 1.25 to the 26th power.
- And then we get this crazy number, we're going to want to
- subtract a 1 from it, not that it's going to
- change much of our math.
- So minus 1, and we get, well let me be very clear--
- essentially this is 329 times our money.
- So this if this was a one here, that would be 100%.
- So let me just be clear, this number right here that number
- right there is such a high number it's hard to fathom.
- If you were to actually let money compound at this rate,
- and usually they would make you at least roll over the
- principal, so this may or may not be accurate but that
- actual payday lender, if they actually are able to roll over
- the money at this rate, they're going to have 329
- times their money.
- Or if you write it as a percent, it would
- literally be 32,987.
- Literally, 32,987%.
- Or after a year, you'll essentially have to pay
- roughly 330 times your money back to the payday lender.
- And obviously they don't let you compound like that, but
- this just gives you a sense of how ridiculous this
- interest rate is.
- I mean, you might have heard of the term usury.
- In the past, usury really meant any kind of interest,
- but now in our current cultural context we associate
- it with just an unreasonable level of interest and that
- threshold might be different for some people.
- Some people might say it's unreasonable to pay 20%, or
- 30% interest, or 40% annual interest. But I think everyone
- would agree that whether you look at 650% or 33,000%, these
- are usurious and reasonable interest rates.
- So you really, at all costs, unless your life depends on
- it, you want to avoid these payday loans.
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