Payday lenders make small, very short term consumer loans through a network of storefront shops or Internet sites. Consumer demand for this product appears to be very strong, and the industry has grown dramatically over the past decade. Yet many observers view the industry with suspicion because of the fees on the loans convert to very high annualized rates of interest. The media and some advocates feel that these fees are simply profiteering on society lowest social economic groups.
We know that payday lending is a viable service or the industry would not have gained the market share it has. But what about the fees they charge, and does the business need borrowers to keep renewing their loans to remain profitable. These are after all financial institutions with many of the same business hurdles that traditional financial institutions have, including labor, overhead, and loan defaults.
Studies have shown that there is a relatively high average cost of originating payday loans. Default rates have substantially exceed the customary credit losses at mainstream financial institutions. And like many new businesses the first few years generate negative or low profits before becoming fully profitable.
The question becomes does the payday loan industry need its borrowers to continually renew their loans for a payday loan storefront to remain profitable? The business relies heavily on maximizing on the number of loans made at each store, all of which operate with relatively fixed costs. It is also true that for stores that have been open for over four years, more than one forth of their customers each obtained more than 12 payday advances during the year.
Conclusions of the studies have shown that overall loan volume is the largest predictor of profitability, not the share of those renewing loans. In other words, this evidence does not necessarily imply that high frequency borrowers are more profitable than other borrowers, but only that more lending adds to store profits. While repeat borrowers are not more profitable on a per loan basis than infrequent borrowers, high frequency borrowers do generate store profits by contributing to overall loan volume.
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