Academic journal article Journal of the International Academy for Case Studies

Cashless at Payday: Financial and Ethical Dilemmas of Cash advances.(Instructor's Note)

Academic journal article Journal of the International Academy for Case Studies

Cashless at Payday: Financial and Ethical Dilemmas of Cash advances.(Instructor's Note)

Article excerpt

CASE DESCRIPTION

The primary subject matter of this case is payday loans, which are cash advances on a customer's next paycheck. Payday loans are a large segment of the subprime lending industry. Students examine the industry model, characteristics of payday loans and the people who use them, along with alternatives to payday loans while they calculate the benefits and costs of the various options. Secondary issues include the effect of a bad credit score on a person's ability to obtain credit and employment and along with reasons why people don't use banks. Finally, students discuss the ethical nature of bank fees and payday loan charges. The case has a difficulty level of three and is designed to be taught in one class period. The case should require one to two hours of outside preparation by students.

CASE SYNOPSIS

This case examines the process, costs and alternatives of payday loans. Payday loans are cash advances against the next paycheck. Payday loans constitute a $45 billion business and cater to individuals who are temporarily short on cash, such as college students. Many college students do not understand the true cost of payday loans while others believe it is their only option. The customer must have a checking account and a steady job. Typically, the individual does not have access to a credit card or other means for a cash advance. Students, in the role of Steve, examine the payday loan taken by Scott, Steve's brother. Steve also investigates the industry to learn how payday loans work along with an examination of the viability and cost of alternative sources of cash. During the evaluation process, students calculate the annual percentage rate of the loan and of alternative sources for the money. Furthermore, students discuss the ethical issues regarding payday loans and other alternative sources of quick cash including bank fees and credit cards.

INSTRUCTORS' NOTES

Recommendations for Teaching Approaches

1. What is the interest cost of Scott's payday loan, especially if he rolls it over for the entire year?

Scott pays $80 to borrow $400 for fourteen days. This is an interest cost of 20% ($80/$400) for the fourteen days. There are approximately 26.07 fourteen day time periods in a year (365/14). Thus, the loan could be rolled over 26.07 times in a year. The annual percentage rate is 20% times 26.07 or 521.43%. The 521.43% interest cost assumes that the borrower pays off the $80 in interest and any new rollover fees after each fourteen day period.

If the interest cost is also rolled over, the annual effective interest rate is 11,484.75%.

Effective interest rate = {[[1+ (5.2143/26)].sup.26]} - 1 = 11,484.75%

2: What are the dollar and interest rate costs of an overdraft on a checking account? Are there any ethical issues with the fees that banks charge for overdrafts?

There are two main costs to insufficient funds on a checking account. First, one's credit rating is damaged by the overdraft, which will affect one's ability to obtain future credit. The second cost of the insufficient funds is the cost of the various charges and fees associated with the overdraft.

For Scott, each overdraft costs $30 from the bank fee and another $25 to $35 from the merchant. The average would be $60 per overdraft. It the merchant turns the charge over to a collection agency, the additional fee of $35 would be added. The $60 charge is 15% interest ($60/$400).

Scott could have three overdrafts, the utilities bill, the telephone bill, and the car repair bill. This could add to $180 in fees, much larger than the payday loan charge.

Because the charge is the same whether the overdraft is $1 or $100, people who intentionally overdraft will overdraft one large amount instead of several small amounts to save on the fees. The students may find it unfair that a $1 Coke is charged a $60 insufficient funds charge. …

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