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Objective, Third-Party Research on the Payday Advance Industry & Alternative Products

Academics, regulatory agency research personnel, financial services foundations and other interested parties have recently released studies related to the payday advance industry and alternative products. A summary of the most current research:

1. “Payday Holiday: How Households Fare after Payday Credit Bans,” by Donald P. Morgan and Michael R. Strain, Research Officers with the Federal Reserve Bank of New York – NOVEMBER 2007.
Households without access to payday loans are forced to use costlier credit products and suffer greater financial difficulties, according to this study from a Federal Reserve economist.
The study compares households in states with payday loans with households in both Georgia and North Carolina, states that eliminated payday loans in May 2004 and December 2005 respectively.
It concludes that payday loan bans result in increased credit problems for consumers.

Without access to payday loans, Georgians and North Carolinians bounced more checks, complained more about lenders and debt collectors, and filed for bankruptcy at a higher rate.

This negative correlation – reduced payday credit supply, increased credit problems – contradicts the “debt trap” critique of payday lending
Payday credit is preferable to substitutes such as the bounced-check “protection” sold by credit unions and banks or loans from pawnshops.
Located at: http://www.newyorkfed.org/research/staff_reports/sr309.html.

2. “Defining and Detecting Predatory Lending,” by Donald P. Morgan, Research Officer, Federal Reserve Bank of New York, and Samuel G. Hanson, Graduate Student, Harvard Business School. JANUARY 2007
Payday loans are not a predatory, “welfare-reducing” form of credit and – to the contrary – actually enhance the welfare of households by increasing the supply of credit, according to this study from a Federal Reserve Bank economist and a Harvard graduate student.

The study found:

Payday loans are not welfare-reducing, or “predatory”

  • By providing credit where otherwise there would be none, payday loans actually ENHANCE the welfare of customer households
  • Competition in the payday lending industry helps to control prices – restricting access to payday loans increases prices.
  • Payday lending represents a legitimate increase in the supply of credit, not a contrived increase in credit demand.

3. High-interest loans benefit borrowers, according to “Expanding Credit Access: Using Randomized Supply Decisions to Estimate the Impacts,” a July 2007 study by Dean Karlan, Yale University, and Jonathan Zinman, Dartmouth College.
The study assessed the impact of high-risk loans on consumers by expanding high interest credit to rejected applicants in South Africa. The lender used in the study shared many characteristics with the American payday loan industry by offering small, high-interest, short-term, cash loans.
Six to twelve months after taking the loan, borrowers experienced a wide range of beneficial outcomes. Individuals taking high interest loans were less likely to be in poverty, less likely to be hungry or malnourished and less likely to have lost their jobs.

The study found that:

  • Policies restricting access to credit are misguided
  • High-interest credit is beneficial to borrowers
  • Borrowers use credit wisely

4. “Contrasting Payday Loans to Bounced Check Fees,” Thomas E. Lehman, Ph.D., Associate Professor of Economics, Wesleyan University, prepared for the Consumer Credit Research Foundation, 2005.
Examines and contrasts payday loan and bounced check fees and their real costs to consumers.

  • “Although actual data regarding individual consumer usage of overdraft services require refinement, inferential data suggest that payday loans hold a cost advantage over overdraft services for the average consumer.”

Located at: http://www.inpolicy.org/index.php?option=com_content&task=view&id=211&Itemid=26

5. “Low-Cost Payday Loans: Opportunities and Obstacles,” Sheila Bair, Dean’s Professor of Financial Regulatory Policy, A Report by the Isenberg School of Management, University of Massachusetts at Amherst, prepared for the Annie E. Casey Foundation, June 2005.

Examines the potential of competition from banks and credit unions to lower the cost of payday loans:

  • “Though depository institutions have the means to offer low-cost payday loan alternatives, the proliferation of fee-based bounce protection programs represents a significant impediment to competition.”
  • “…fee-based bounce protection programs are functionally equivalent to payday loans when used by customers as a form of credit. When used on a recurring basis for small amounts, the annualized percentage rate for fee-based bounce protection far exceeds the APRs associated with payday loans.”
  • “Banks and credit unions benefiting from overdraft fee income may not want to cannibalize this income by offering their customers lower-cost, small dollar credit options.”

6. “Payday Lending: Do the costs justify the price?,” Mark J. Flannery, Co-director of the Center for Financial Research, Federal Deposit Insurance Corporation, Katherine Samolyk, Senior Financial Economist, Federal Deposit Insurance Corporation, Division of Insurance and Research, April 4, 2005.
Analyzes store-level data provided by payday advance firms, with the goal of contributing evidence about the viability of the payday advance product by providing a careful and objective picture of the performance and profitability of large mainstream firms in the industry.

  • “The payday advance product’s structure makes it costly to originate these short-term loans, whose default rates substantially exceed the customary credit losses at mainstream financial institutions.”
  • “We find that fixed operating costs and loan losses justify a large part of the high APR charged on payday advance loans…These operating costs lie in the range of [payday] advance fees, suggesting that payday loans may not necessarily yield extraordinary profits.”
  • “These APRs substantially exceed the rates associated with mainstream consumer credit products, although some mainstream services (e.g., overdraft protection fees or credit card late payment fees) might translate into similar APRs if providers were required to report such information.”