High-cost consumer credit has proliferated in the past two decades, raising regulatory scrutiny. We match administrative data from a payday lender with nationally representative credit bureau files to examine the choices of payday loan applicants and assess whether payday loans help or harm borrowers. We find consumers apply for payday loans when they have limited access to mainstream credit. In addition, the weakness of payday applicants’ credit histories is severe and longstanding. Based on regression discontinuity estimates, we show that the effects of payday borrowing on credit scores and other measures of financial well-being are close to zero. We test the robustness of these null effects to many factors, including features of the local market structure.
The availability of payday loans is often implicated in financial distress. We test this hypothesis by analyzing delinquencies on revolving, retail, and installment credit in Georgia, North Carolina, and Oregon. These states have restricted the formerly easy availability of payday loans by either banning them outright or capping the fees charged by payday lenders. The results, based on difference-in-difference methodology, suggest that this legislation has had small, mostly positive, effects on delinquencies. The results do not support the debt trap hypothesis that payday loans exacerbate borrowers’ financial difficulties. With more states considering further restrictions on payday lending, our findings have policy implications.
High-interest payday loans have proliferated in recent years. Using new data from the
Current Population Survey, we exploit state-time variation in payday lending laws to study the effect of payday loan restrictions on consumer borrowing. We find that although such policies are effective at reducing payday lending, consumers respond by shifting to other forms of high-interest short-term credit such as pawn shop loans. This result sheds light on the mechanisms by which payday loan access affects borrowers' financial well-being and suggests that legislative efforts to address payday lending in isolation may not reduce the extent to which consumers rely on short-term high-interest credit products. Finally, we present evidence that those who switch to pawn loans after payday loan bans do so because they lack access to small bank loans.
This essay compares the results from a survey administered to payday loan borrowers at the time of their loans to subsequent borrowing and repayment behavior. It thus presents the first direct evidence of the accuracy of payday loan borrowers’ understanding of how the product will be used. The data show, among other things, that about 60% of borrowers accurately predict how long it will take them finally to repay their payday loans. The evidence directly contradicts the oft-stated view that substantially all extended use of payday loans is the product of lender misrepresentation or borrower self-deception about how the product will be used. It thus has direct implications for the proper scope of effective regulation of the product, a topic of active concern for state and federal regulators.
It is estimated that payday lenders made $40 billion of loans in 2010. But these loans are controversial, with one of the politically charged claims being that the high interest rates on payday loans trap consumers in a “cycle of debt.” We test this claim by conducting a field experiment whereby a random sample of borrowers are given interest-free payday loans. We then track these loans and find no difference in loan repayment rates between this treatment group and a control group of borrowers who paid conventional payday-loan interest rates. This result forms strong evidence that high interest rates on payday loans are not the cause
of a “cycle of debt.”
Payday loans are widely condemned as a “predatory debt trap.” We test that claim by
researching how households in Georgia and North Carolina have fared since those states banned payday loans in May 2004 and December 2005. Compared with households in states where payday lending is permitted, households in Georgia have bounced more checks, complained more to the Federal Trade Commission about lenders and debt collectors, and filed for Chapter 7 bankruptcy protection at a higher rate. North Carolina households have fared about the same. This negative correlation—reduced payday credit supply, increased credit problems—contradicts the debt trap critique of payday lending, but is consistent with the hypothesis that payday credit is preferable to substitutes such as the bounced-check “protection” sold by credit unions and banks or loans from pawnshops.