A free market operates free of government intervention, where business transactions are mutually agreed upon by sellers and buyers. Though payday loan companies continue to thrive due to a steady market for their services, many argue that a payday loan company isn’t consistent with the free market due to its predatory lending practices.
Ultimately, however, every customer does business with a payday loan company willingly, knowing how they will be charged and understanding that they must pay back their short term loan on payday with interest. Most who utilize the service complete pay back the loan on payday without significant adverse effects on their finances, and both parties walk away from the deal reasonably satisfied.
Public backlash stems mainly from the high interest charges, though these are necessary for a payday loan company to operate. Payday loans make money from consumers who need quick cash between paychecks, by offering them a loan for needed cash at an obscenely high amount of interest (usually around the 300-400% annual range) in exchange. The idea is that you pay them back a few days later on payday, and they make a few bucks for the trouble.
If they charged a more normal interest rate, in the 10-30% range, they wouldn’t make any money since a 10-30% APR on a few hundred dollars over 3-5 days isn’t very much money. For example, a $300 loan, a typical amount for a payday loan, given at 10% interest would only accrue $0.25 in interest over 3 days. The suggested rate by many legislators, 39%, would yield a whopping $0.96 for the loan company’s trouble.
There’s no way a payday loan company could remain viable with such a return. The higher interest is in effect a daily fee for providing the service of the needed loan, and that discounts the fact that a payday loan company offers a unique service.
Regular banks would never offer payday loans to outside consumers, due to the risk involved with unknown customers (though some will allow payday cash advances for some loyal customers). And if regular banks ever did decide to roll out payday loans to the general public, they would charge a similarly high interest rate due to the risk of giving large sums of money to unknown customers, and to leverage the consumer into paying back such a loan as soon as possible.
Anyone who objects to the practice of payday loan companies may simply choose not to use them, and anyone who regularly faces situations where they need to use them needs to improve their budget management. Many consumers use payday loans in rare, absolute necessary cases, and understand that the high charges are a byproduct of the unique service. Those who don’t understand why payday loans cost so much don’t understand how such a mutual transaction fits the give and take nature of the free market, which belies their claims that a payday loan service isn’t consistent with a free market.