Jan 01 2002

The Economics of Payday Lending

Report  
Number  
81

This report examines operations of payday lenders, who uses payday loans and why they choose to do so, and the extent to which customers become frequent users of these loans. It also discusses how credit unions might respond to the rise of the payday loan industry.

John P. Caskey
Swarthmore College
Report Number 81

Executive Summary

This paper analyzes payday lending. A payday loan is an uncollateralized closed-end loan intended to help a person meet financial needs prior to the borrower’s next payday. Payday lenders commonly advance $100 to $500 that borrowers agree to repay within about two weeks or on their next payday. Annualized interest rates on these loans are typically 400 percent or more.

Payday lending deserves scrutiny for several reasons. The industry first became formalized in the early 1990s and has grown explosively since that time. The business is highly contentious. Advocates argue that it provides an important source of short-term emergency liquidity for people with no better alternatives. Critics charge that it entraps modest income households in a series of high-cost debts. Not surprisingly, in recent years there has been much litigation related to the business, bitter fights over whether the business should be legal and, in cases where it is legal, how it should be regulated.

What is the research about?

There have been previous studies of payday lending. While several are high quality, they are almost all by groups that take strong advocacy positions either in favor of the industry or in opposition. This paper does not seek to make a case in support of, or in opposition to, payday lending. Instead, it uses available data to establish what we know about the operations of payday lenders, who uses payday loans and why they choose to do so, and the extent to which customers become frequent users of the loans. This paper also discusses how credit unions might respond to the rise of payday lending.

What are the credit union implications?

Although credit unions cannot prudently make loans to individuals beyond a particular credit-risk threshold, they can help these individuals in other ways. Credit unions can offer savings products designed to help members, especially those living paycheck to paycheck, build savings.

A second measure that credit unions can take is to promote consumer education initiatives that help people address credit problems, set savings goals, and adopt good personal financial management practices. Many credit unions already have programs in this area or work closely with groups that do. Credit unions that do not yet offer such services should investigate cost effective ways to do so.