Pawnshops make money by providing personal loans, reselling retail items and offering auxiliary services, such as money transfers or cellphone activation. Earning interest on loans and profits on retail sales are the principal income sources for the standard business model for a pawnshop. Pawnshops typically aim to generate overall net profit margins of at least 15 to 25%.
Providing Personal Loans
The first revenue source for a pawnshop is income derived from making loans and earning interest on the loan balances. A pawnshop makes a loan to an individual who turns over custody of an item, such as a television or a computer, that serves as collateral for the loan. The amount a pawnshop is willing to lend is based primarily on the value of the item, but it can also be substantially affected by the pawnshop's current inventory at the time of the loan. For example, if a person is looking to borrow money using a television as collateral and the pawnshop's inventory is already overflowing with similar televisions, it will generally offer to lend considerably less money than if it were low on inventory for televisions.
Pawnshops make loans at substantially higher interest rates than banks typically charge for personal loans. The risk of loan default is much higher, and many individuals seeking loans from pawnshop cannot qualify for traditional bank loans. Interest rates charged by pawnshops generally vary between 5% and 25%. State law governs the amount of interest that a pawnshop is allowed to charge, and regulations vary widely from state to state.
Loans are generally made on a monthly or 30-day basis. By the end of the month, to avoid forfeiting the property he has put up as collateral, the individual must either pay back the loan in full, plus the interest charge or simply pay the monthly interest charge, which allows him to extend the loan for another month. Pawnshops are generally willing to extend loans indefinitely as long as the interest is being paid, as they may eventually collect more in interest charges than the amount of the loan itself, while still holding the loan collateral against default.
As far as how much a person can borrow against an item, pawnshops typically look to lend no more than 40% to 50% of the projected resale value of the item pledged as collateral. The pawnshop owner also has to factor in potential costs of storage, cleaning, repair, and advertising, as well as covering general overhead expenses.
The second primary source income for a pawnshop is retail sales. Merchandise includes items that the pawnshop has purchased outright from individuals and items that were pledged as collateral by loan customers who then subsequently defaulted on their loans, thereby forfeiting the pledged collateral property to the pawn shop.
Pawnshops offer a bit more money to outright purchase items than they offer to lend against the items – perhaps 10% to 15% more – because they know that they will have the items available for immediate resale and can more accurately project their likely profit margins on reselling the items. Items that the shop eventually acquires through loan defaults may offer them higher or lower profits in the end, depending on the items and the length of time the loans were carried prior to default. If a loan was maintained for a lengthy period of time, the pawnshop may have already made a profit just from collecting the interest payments made prior to default. However, the length of time may also mean that the item has deteriorated in value to the point where it has little or no resale value.
Pawnshops commonly supplement their income by offering auxiliary services for which the shops charge fees. Typical extra services offered by pawnshops include check cashing, cell phone activation, Western Union or other money transfer services, and bill payment services. Some pawn shops also act as shipping locations for UPS or FedEx.