A Radical Cure for the Ills of Payday Lending: Transparency

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There is no force greater than a reasonably free market economy, but it can only exist if:
  • Companies compete for your business. In other words, there is more than one choice. (No monopolies allowed.)
  • Consumers have the ability to compare, ditch and switch. They can, with a little effort, understand the true cost of competing products, make informed decisions, and change suppliers easily.
  • Companies producing products that no one wants to buy can fail. They will go out of business, and the people who invested in the business will lose their investments.
When consumers have choice and transparency, and when companies are never too big to fail, amazing things can happen. The market will be brutal to companies without a compelling product or value. And it will disproportionally reward those who create real value for consumers.

Unfortunately, the forces of the market usually don't reach consumer financial products. But, when true markets are created, the results can be dramatic.

Price Comparison Sites Work Amazingly Well in U.K.

In the United Kingdom, price comparison websites have revolutionized financial services, particularly auto insurance. If you want to buy auto insurance, you can visit a website, enter a few pieces of personal information and immediately see real personalized quotes from most major auto insurance companies. These are not estimates based upon public records or reverse-engineered guesses based upon the clever work of a computer scientist. The auto insurance companies share their pricing information with the price comparison websites.

Thus, all three conditions of the market are met. Consumers can go to one website and see the cost of the products being offered. It is very easy to compare, ditch and switch online. And no auto insurance company has a handout from the government. If they don't compete for business, they will fail.

Most importantly, the price comparison websites show the cheapest products first, not the products that pay the highest commissions. To be the top recommendation, you have to be offering the best price.

Auto Insurance Premiums Have Fallen 30 Percent -- Over There

And the result? Since 2011, auto insurance premiums have dropped by more than 30 percent. In the last 12 months, auto insurance premiums dropped a staggering 19.3 percent. How can prices keep going down? The pressure of the market is forcing companies to innovate. They are improving their underwriting models. They are investing in better fraud detection and claims handling processes. But they are doing all of this to lower premiums so that they can stay alive, not because they plan on making more money. The market is forcing them to compete. And it is brutal.

Compare the U.K. market to the U.S. auto insurance market, where insurance premiums are generally increasing. One website, www.leaky.com, tried to bring transparency to the auto insurance market. Not surprisingly, the auto insurance companies were not interested in transparency. In fact, the company received a cease-and-desist order every two months of its existence from insurance companies trying to stop it. Eventually, fighting the litigation became too much, and the startup had to shut down its product. Think about what that means to you: Big insurance companies sued a tiny company into oblivion solely because they don't want you to know how much their products cost.

And the auto insurance companies are still fighting hard to ensure that it remains difficult for consumers to compare, ditch and switch.

And Now Consider Payday Loans

Thanks to true price comparison websites, the U.K. consumer has enjoyed ever-reducing insurance premiums, ever-increasing low-rate balance-transfer durations (you can now borrow at 0 percent for 34 months in the U.K.) and ever-lower personal loan interest rates (with excellent credit, it is easy to get a 5.1 percent interest rate). Regulators there have taken note and would like to unleash the power of the market on one of the worst corners of financial services: Payday loans. As the Guardian reported last week, the competition regulator is going to force payday lenders to share their pricing information with price comparison websites.

Payday lenders offer short-term loans to consumers who have no other options. On average, payday lenders charge between $15 to $20 for every $100 that you borrow for 14 days. But the real money is made when borrowers roll over the loan. When the debt comes due in 14 days, the borrower has two choices. They can pay back the $100 borrowed or pay another $15 to $20 to extend the loan for another 14 days. According the Consumer Finance Protection Bureau, 80 percent of borrowers roll over their loans.

Hidden fees can often add up to far more than amount of the loan. Short-term loans turn into long-term loans, loaded with fees, generating annual percentage rates in excess of 1,000 percent.

Payday Lenders Scheme Around the Rules

Attempts to regulate payday lending have been a complete failure, on both sides of the Atlantic. Payday lenders are clever and find ways of getting around every rule designed to hem them in. In fact, a number of U.S. payday lenders are incorporated on Indian reservations to avoid regulatory oversight completely.

The payday loan model remains:
  • Hide the true cost of borrowing.
  • Don't share pricing up-front, making it difficult to compare.
  • Keep people in debt forever, by making it "cheaper" to extend, rather than pay off the loan.
But rather than trying to write new rules, which payday lenders will find their way around, we should consider unleashing the power of the market. Imagine if payday lenders had to share all of their pricing model with price comparison websites. Consumers who need cash could go to a single website and see how much it would actually cost to borrow the money until the loan is completely paid off.

Remember the most important part of a price comparison website: the person with the lowest price almost always wins. Financial services are a commodity. So, if payday lender A has a 1,000 percent APR, and lender B has a 990 percent APR, then all of the business would shift to lender B. Lender A would see a dramatic drop in business, and would have to respond.

Payday lenders could drop their prices by 90 percent and still make great profits. But they don't drop their prices because they don't have to. Forcing transparency on the payday lending market could drive real change.

Consumers Would Benefit on Other Products

The ability of the price comparison business model to transform financial services inspired me to leave the U.K. and move back to the U.S., where I created MagnifyMoney.com. I believe that complete price transparency quickly rewards companies with the best product, rather than the biggest marketing budget. For example, we have a balance transfer marketplace where PenFed (a credit union that anyone can join) usually takes the top spot. It is there because it has the best product (you can move your debt from other credit cards to PenFed and pay only 4.99 percent for 48 months, with no fee), not because it has the biggest marketing budget.

When banks that are too big to fail aren't forced to compete based upon price, consumers lose. We have a lot to learn from the dominance of easy-to-use price comparison websites in the U.K., and I look forward to the day when banks, payday lenders and insurers are racing to drop prices in an effort to survive.

Nick Clements is the co-founder of MagnifyMoney.com, a website that makes it easy to compare, ditch and switch financial products. He spent nearly 15 years in consumer banking, and most recently he ran the largest credit card business in the U.K.

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A Radical Cure for the Ills of Payday Lending: Transparency

Managed to get that raise or promotion? Fantastic -- now don't go out there and spend it all immediately. In classic "keeping up with the Joneses" fashion, too many of us see an increase in salary or a sudden windfall (like an inheritance) as an excuse to take our lifestyle up a notch. We buy bigger houses than we need, get the latest gadgets even though ours work just fine,and spring for fancy steak dinners just because we can.

​Instead, whenever your financial situation gets a boost, consider the best ways to put that money to work for you. The truly wealthy are those whose money continues to grow and earn them more, even when they're not actively doing anything with it.

The average American household that carries credit card debt holds a balance of around $15,000. If you're among those who have a credit card balance, you've probably seen the little chart on your monthly statement telling you how much you'll pay in interest over the next several years if you make only the minimum payment. (If you haven't, look at it.) The same chart will also compare that to a "suggested" payment that's slightly higher. 

​Our recommendation? Throw everything you can at paying your balances off as fast as possible. And make sure not to take on any additional debt in the future; if you can't pay for a consumer good out of pocket, don't finance it.
We don't demonize student loan debt the way we do credit card debt because we see an education as an investment -- and higher education often is the difference between one income bracket and another. Similarly, many people justify taking out a car loan by stating that they need a car to get to work.

​That said, debt is still debt, and the longer you take to pay it off, the more interest you'll pay. Once you've freed yourself of credit card debt, paying down your car and student loan balances should be next on your list.

Whether it's to handle an unexpected car repair, a sudden illness or a major plumbing problem, you should always have some money set aside to cover unforeseen expenses. Set up a regular monthly transfer from your checking to your savings account to earmark this money before you're tempted to touch it. If necessary, cut back in another budget category (like eating out or entertainment) to free up the funds to save more.

​Putting aside a little each month could prevent you from getting socked with a hefty bill you can't afford and then need to finance.

No matter your age, you should be adding to your retirement funds -- such as your 401(k) or individual retirement account -- each month. Just setting aside money sporadically won't cut it; you need to identify how much you'll need to live on once you stop working and monitor whether you're on track to reach that amount.

​Here's a quick-and-dirty rule of thumb: multiply your annual spending by 25. This is the amount you'll need in your retirement portfolio, if you assume that you'll withdraw 4 percent per year to live on during your retirement. In other words, you'd need $1 million in your portfolio to live on $40,000 annually. Creating a plan will help you make sure you're able to retire the way you envision.
A home is a big investment, and sometimes that investment doesn't wind up netting you the return you thought it would.

The biggest culprit is having too large a balance on your mortgage, which detracts from your own personal stake in the current market value for your home. The sooner you pay this amount down, the better your home equity will be.

​You also want to be careful when purchasing a new home. Buying in a neighborhood that's on the downward spiral or buying the most expensive home on the block, likely won't net you a good return when it's time to sell. Also take care to stay away from custom renovations (like turning the garage into a recreation room), which could negatively affect your resale value. 

Paying high investment fees eats away at your gains. And since your gains compound over time, this creates a domino effect that can really chip away at your wealth. Take a close look at your investment companies' fees and shop around to make sure they're not taking more of your money than they need to be.

If you don't have a long-term investment vision and are simply playing the market, you could seriously undermine your wealth-building potential. Stop paying attention to market fluctuations, media pundits and the stories of your friends and family. Instead, create your own long-term investment strategy that will maximize your overall returns. Resist the urge it play it ultra-conservative (or fall for get-rich-quick schemes) and educate yourself on the best way to make your dollars work for you.

​If you're having trouble making sense of your options or want a second opinion, seek the help of a trusted financial adviser.
Based on your experience and seniority level, education and industry, you should have a fairly good idea how much you ought to be making at your job. If you don't, check out a site like PayScale to get a ballpark figure.

If you're not making what you're worth, you're doing more than leaving money on the table; you're also losing all the compound growth and investment returns that money could be generating for you. Invest in yourself with professional development and continuing education, make the case for that raise or promotion, or seek out a company who will value you higher.

If you don't have proper insurance coverage, you're taking a very big risk that could come back to bite you. Too many people think the worst can't happen to them, but the hard truth is you can't predict the future, and scrimping on sufficient insurance is never a good idea.

Of all the things we're hesitate to part with our money for, adequate insurance coverage should not be one of them. No matter your age, everyone should be properly covered with:

  • Health insurance.
  • Disability insurance.
  • Homeowner's or renter's insurance.
  • Flood insurance (if you live in a flood-prone area).
  • Umbrella liability insurance (especially if you own a small business).

If a spouse or children relies on you for support, make sure you have a decent term life insurance policy, as well.

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