If you were asked to lend someone you knew was unqualified for a traditional bank loan $200 for a week, and you had to fill out paperwork, create a record, etc., how much would you want them to give back? If they gave you $205 ($5 for your trouble) you’d be roughly charging 130% APR and you wouldn’t cover your costs, let alone the risk. You can extrapolate 400% from this example.

Understanding how short duration, risk and operational overhead affects the rate is key to effective regulation in this industry.

Curious, but do you work in banking? I'm just wondering what else could potentially be motivating someone into thinking 400% interest on a short term loan that is by definition meant to be paid off on the next payday (anywhere from a week to fifteen days, or in some cases a month for individuals on a monthly/State-employee payroll) is anything but exploitative.

BANKS don't even give out personal loans at such absurd rates.

I used to work for a credit union that had a branch in a very troubled low income area. We worked really hard to get people to consider us as a cheaper, more transparent and ethical alternative to payday lending. So I know a lot about it as competition. Nowhere I’ve said it’s not exploitative. However, exploitative doesn’t mean that a high interest rate is extremely profitable as is popularly believed.

To clarify, payday lenders exploit people by a) encouraging loans for bad reasons, b) hiding details from financially illiterate people, c) trying to keep competition out of their market, d) not publishing comparable rates. But the actual business margins are not as good as 50-400% sounds due to the high volume/short duration/default risk.

Okay, then

You can extrapolate 400% from this example.

Consider me obscenely interested in understanding the math to break down measuring risk such that you end up with 400% annualized interest on a, say $1000 loan.

Again, even traditional banks don't hit applicants with poor credit this hard. Personally, I paid off a personal loan with my credit union down in Texas, only financial institution that would give me one with my credit. 18%.

I have yet to find anyone who can provide a convincing argument for why such a high interest rate is warranted compared to traditional lending sources who will have the exact same concerns and risks but charge demonstrably less.

Sure, if you loan someone $1000 and they have to pay you $1,080 in a week, your APR is roughly 400%. It’s just an extrapolation of the $200/$205 example. The risk would depend on the likelihood that the person would return with $1080, how many other loans you had to absorb the loss, your available capital, etc. I may not have understood your question, though.

Edit: in response to your edits, I think your credit union example is a good one. That is exactly why credit unions are valuable; they have a local/regional reach similar to payday, but they are cheaper, and they will lend to people that Bank of America, Chase, etc. won’t touch.

In my experience, credit unions have stricter lending rules. Mine does offer an overdraft protection, which is essentially the same as a payday loan, for $30; no matter the amount. I could go $2 over and bam, $30. This also applies to each transaction.

They do allow me to keep cash in my savings and still pull from this "credit", so for example I can transfer everything to savings and let my rent hit this "credit line", but if I'm not careful this is way more expensive then a payday loan.

Yes, there is an incongruence between use of a punitive fee to discourage behavior and the fact that fee revenue subsidizes low interest rates at many credit unions. The saving grace is that they are much more likely to refund the fee than a bank, but they don’t do it proactively let alone based on member profiling for financial illiteracy (low average balance, history of overdrafts, etc.) I think the approach could be much better.

Here’s a startup I really like that I think solves this overdraft problem effectively. They charge something like $1/mo for their service which likely isn’t sustainable standalone, but could work as a standard account feature at a bank/CU. https://www.dave.com

I have both a bank account and a credit union account (for various reasons, I actually have accounts with several local credit unions). My bank (USAA) will refund nearly any fee if you ask. My credit union will tell me to pound sand. I otherwise like them, but they are super strict. My bank also has zero-fee overdraft protection as well. But I have a credit card with them, so that probably is why.

If you think you could do it for less, why don't you? 200% returns would be yours for the taking!

Because I would not enjoy it and life isn't all about maximizing your income.