Jason’s last post kicked off a bit of debate about payday lending. Is payday lending something libertarians should defend? Is it exploitative? Should it be illegal or, at the very least, heavily regulated?

There certainly seems to be something wrong with payday lending. Payday lenders target poor, vulnerable populations with little in the way of financial sophistication or alternative sources of credit. And the fees they charge can be enormous – the equivalent of over a 400% APR (my mortgage, by way of contrast, has an APR of just four percent).

But when it comes to payday lending, what is seen and what is unseen can be two very different things. Here are five of the most important points I’ve found to bear in mind when thinking about the morality of payday loans.

1. If payday lending is so profitable, why isn’t everybody doing it? This is a good question to ask yourself anytime you hear a story about some company earning unusually high profits off the back of a vulnerable population. If investors could earn a 200% rate of return by investing in new payday lending operations, why are smart investors wasting their time and money with anything else? Perhaps there’s something more to the picture that we’re not seeing?
2. Payday lending is not that profitable. Well, we don’t have to guess. People have studied this. And according to one study, the average profit earned by payday lenders was just 7.63%. By way of comparison, the same study reports that the average Starbucks franchise earns about 9% profit. So, if that 400% APR isn’t translating into sky-high profits for payday lenders, where exactly is it going?
3. Payday loans are short term loans. An Uber ride from downtown San Diego to La Jolla costs about $25. I think that’s a pretty reasonable price. But suppose I told you that the rate Uber charges to drive you 12.5 miles in San Diego would translate into a $6,000 trip from San Diego to Boston! Outrageous! Exploitative! Except, nobody uses Uber that way. And almost nobody uses payday lenders to take out loans that are appropriately characterized by an annual percentage rate. Payday loans are short term loans. They’re like an Uber ride to your local pub. Thinking about their fees in the same terms you’d use to think about the 30 year mortgage on your home gives us a very misleading picture of how much revenue payday lenders are bringing in.
4. Being a payday lender is expensive. So payday lenders aren’t earning as much as we think. But they’re also spending a lot more than we think. Payday lenders, unlike banks, keep long hours. That costs money. They also have a relatively high store density. That costs money, too. Finally, think about this. Payday lenders are lending to people who have a hard time getting credit elsewhere. Why do they have a hard time getting credit elsewhere? Because they have very bad credit. What does that mean for payday lenders? It means that sizeable portion of the loans they extend are going to default. And that costs money.
5. Bans on “usury” only make things worse. So, at the end of the day, payday lenders charge a high rate to their customers because that’s what it takes to cover their costs. That means if we try to artificially lower their rates by legal bans on “usury,” we’re going to make it impossible for them to cover their costs. And when businesses can’t cover their costs, they shut down. Question: who does that help? The who were forced by poverty and desperate circumstances to utilize the services of payday lenders are still poor, and still desperate. All you’ve done is taken away from them the least bad option they had. It’s a good thing to be concerned with the plight of the poor. It’s a good thing to want to do something to help. But it’s important to make sure that the thing you’re doing actually helps, rather than hurts.

I say a bit more about payday lending in this paper on the topic here. But a lot of the issues are the same ones that come up in discussions of price gouging, so you might find my papers on that topic (here and here) to be relevant as well.