Uncovering ‘payday’ lending myths
A great deal of confusion and misunderstanding surrounds short-term lending. From outside the industry, critics see high Annual Percentage Rates (APR's) and deduce that short-term lenders profit abnormally from 'predatory' lending practices at the expense of consumer welfare.
How do short-term lenders justify having excessively high fees?
Understanding the rate cap vs. APR
The first thing to understand is the difference between a 'rate cap' and an annual percentage rate (APR).
There is a rate cap in place for all loans in the states of ACT, NSW, QLD and VIC, which is set at 48%. Depending on which state, the rate cap calculation takes into account the length of the loan, the amount of credit offered, and the length and amount of repayments. It ensures that lenders do not over-charge for loans. Cash Doctors provides cash advances under a ‘continuing credit contract’, which at all times operates under the 48% rate cap, just like all major banks.
APR represents the costs of a loan calculated over an annual period. Mortgage rates often don’t tell the whole story when it comes to the cost of a loan. APR takes into bank fees, points, pre-paid interest etc. If a mortgage has a rate of 6%, it’s APR may be 6.5%.
Because short-term lenders offer a product intended to be used for days or weeks, the APR is not an appropriate measure of the costs of a loan.
APR as a unit of comparison
Follow this example. If you’re travelling from Sydney to Brisbane you could pay for a plane ticket or a taxi. A plane ticket might cost $80 ( webjet.com.au ), while a taxi could charge $1850 ( www.taxifare.com.au ). You’re probably better off taking an aeroplane.
The APR of banks who offer larger loans over longer periods of time and have smaller business costs, is significantly less than that of short-term, small amount loans, which typically have higher business costs. The products are not on par and therefore comparing the products does produce a disproportionate comparison.
You will often see critics comparing the APR of a short-term, small amount loan to what mainstream credit providers charge (7-20%) and claim short-term credit providers are charging unaffordable, exorbitant interest rates and are profiting abnormally.
A more accurate way to compare the products is to look at the actual cost of taking out the loans. For example...
| Provider | Loan amount | Total Repayments | % repayment on top of loan |
| Bank loan | $400,000 | $711,000 | 77.75% extra |
| Personal loan | $8000 | $12,146 | 51.83% extra |
| Cash advance | $400 | $505 | 26.25% extra |
(Source: Average figures formulated from data collected from ANZ, Commonwealth Bank, NAB, Westpac, Aussie, GE Money, BOQ, Bank West, St. George, Suncorp, Cash Doctors as at 08/07/2011).
A bank may only charge you 15% interest on your loan but the ultimate repayment on a $8,000 personal loan is $12,146.
Short-term lenders charge a higher fee for their short-term product but it’s in exchange for convenience and instant service.
Long-term vs. short-term lenders
When a major bank offers a loan it can pass overhead costs on through a small interest rate over a long period of time. A short-term lender, in most cases, only has up to a 30 day period to pass on these costs. If Cash Doctors charged a mainstream unsecured loan interest rate of 12% APR on a $200 loan over an average loan period of 24 days, $1.58 of gross revenue would be generated. This doesn’t even cover the cost of transferring the advance to the customer.
Comparing a bank loan and short-term loan is like comparing...
| The long-term commitment option | Cost | The short-term commitment option | Cost |
| Soft drink in bulk from a wholesaler | $0.50 each | The same soft drink from 7/11 at 3am | $4.50 each |
| Renting a unit in the city on a 12-month lease | $57 per night | The same unit on a one off basis | $250 per night |
| Buy a car with a car loan | $10 per day | $505 | $66 per day |
| Home Internet connection | 9 cents per hour | Internet cafe | $6 per hour |
| Tea at home | 8 cents per tea bag | Tea in a cafe | $3.50 per tea bag |
| Home-made meal | $3 | The same ingredients in a drive-through meal | $8 |
The world is full of time vs. price scenarios. Do you need it urgently? Or do you have the financial flexibility to commit to a long-term outlay?
How does Cash Doctors justify being ‘expensive’?
Cash Doctors provides a fast, convenient and easy service. Up to $600 in your bank account in under an hour via an easy online application process. We are just like the 7/11, the hire car, the Internet cafe and the coffee shop down the road. We know we’re more expensive but we’re for people who need the money fast and hassle-free. Cash Doctors isn’t here to tie people down with debt, it’s a drive-through for funds - in one minute, out the next.
Cash Doctors criteria
Cash Doctors lends only to permanently employed Australians (receiving sick and holiday pay) who earn at least net $400/week. The average salary of a member is $38,000 net and the average age 31.
Cash Doctors does not lend to the unemployed, pensioners, bankrupts, contractors, self-employed or those on Government support (Centerlink).
Cash Doctors' member profile is quite different from the 2002 CLCV report1 ($24,500 average salary and many customers earning less than $401 per week) and the perception of many critics. Ordinary hard-working Australians use Cash Doctors. They usually work in administration, accounts, sales, education, IT, recruitment, insurance, customer service and health. Most Cash Doctors members have clear credit ratings and are eligible for mainstream finance - they just prefer this style of credit to manage their finances.
Cash Doctors performs credit checks to confirm the new member fits the lending criteria.
There are lenders who lend to people on Centrelink benefits – Cash Doctors do not, nor do they allow rollovers. Often other lenders don’t have any vested interest in improving the financial literacy of their customers like Cash Doctors do. The Cash Doctors blog, transparent application process and helpful customer service all aim to help the customer manage their finances.
It is in Cash Doctors’ best interest for people to repay on time.
Cash Doctors’ business model is built to encourage repayment. They rely on their members to pay on time - otherwise they cannot continue to provide their service. They genuinely don’t want people to miss repayments. Cash Doctors does not allow debt spirals to occur by halting fees at 45 days overdue.
What is the worst case scenario at Cash Doctors?
There are stories of people owing thousands of dollars on a $200 cash advance. This doesn’t happen at Cash Doctors. The worst case scenario at Cash Doctors is not unreasonable. If a member takes out a $600 cash advance, reschedules the maximum number of times (23 reschedules), the most they would have to repay is $1166.
For example A person is loaned $200 until their payday next week. They don’t meet their repayment of $275 the following week. If they are unable to repay the loan and it goes 45 days overdue, fees are halted. The loan then becomes a part of a collection process where a collaborative agreement is made to recover the amount at $100 per fortnight, which takes approximately 3 months to finalise. The absolute maximum amount they will have to pay on top of the $200 she borrowed is $425. There is no chance that they will fall into a debt spiral and have thousands to pay back over many months.
A predatory lender, who allows the interest to continue indefinitely, rather than halting interest when 45 days overdue as Cash Doctors does, may have a total repayment of $1000+ after 5 months. Taking into account the cost of recovering the $1000+ as well as the potential revenue gained through making additional loans, Cash Doctors is better off lending the same $200 a few times over those 5 months. Not only has the predatory lender created a negative experience, but he'll find it costly to recover the debt thereafter.
Any lender who continues to charge interest indefinitely and courts delinquency is very unlikely to collect and maintain viable cash flow as time progresses.
Operating in a responsible short-term lending market in Australia
What does it mean to be a responsible lender?
Cash Doctors’ business model encourages responsible business practices. A responsible lending model helps the lender provide credit to only those who can repay. Traditionally, short-term lenders would lend to financially unstable customers who attracted late fees that would grow exponentially. They had a short-term focus and attracted a lot of negative word-of-mouth. Responsible lenders have a long-term business view and an ethical focus. They don’t support chronic or habitual borrowing.
Australian customers
It is often thought that people using short-term lenders are on government support and can’t hold a permanent job. Cash Doctors customers are in fact the opposite:
- 42% are homeowners.
- 23.9% have a TAFE qualification, 24.3% have a university degree and 6.5% have postgraduate degrees.
- 100% have a steady income (permanent full-time or part-time employed) and an active bank account
A study conducted by the Consumer Law centre found most providers require the consumer to at least request a loan before disclosing cost and some only make the cost known when the consumer is in the very final stage of a three or four stage loan application process.2 This is not the case with Cash Doctors where they provide a costs calculator. The calculator shows people the exact cost of their loan. Also, once an applicant completes the online application, all costs are displayed onscreen. The applicant does not have to sign a contract until they have agreed to the costs schedule.
A Cash Doctors loan is a source of cash when you need it – and unlike a credit card, it’s not available when you don’t need it, allowing consumers to resist the urge to spend beyond their means.
References
- 1. Consumer Law Centre Victoria, 2002. “Payday Lending In Victoria: A Research Report”. Accessed 29.06.11 from http://www.consumer.vic.gov.au/CA256902000FE154/Lookup/CAV_Credit_Research/$file/payday.pdf
- 2. Gillam, Z and the Consumer Law Centre, 2010. “Payday Loans, Helping Hand or Quicksand?”
