The Inclusive Economy
New Research Dispelling Payday Lending Myths
By Ethan Geiling on 07/27/2012 @ 02:30 PM
Twelve million adults, or about 5.5% of Americans, use payday loans, according to new research from Pew. Payday loans are short-term loans (usually two weeks) of a few hundred dollars with average fees and interest the equivalent of an annual percentage rate (APR) of around 400%. Predatory payday lending strips wealth from financially vulnerable families and leaves them with fewer resources to devote to building assets and climbing the economic ladder.
Certain demographic groups are more likely to use payday loans than others. For example, the odds of using a payday loan are:
- 57% higher for renters than for homeowners
- 62% higher for people earning less than $40,000 than for those earning more
- 82% higher for people without a college degree than for those with a four-year degree or higher
- 105% higher for blacks than for other races/ethnicities
Most of this is not surprising. But one data point stood out in particular: 8% of renters earning between $40,000 and $100,000 have used payday loans, compared with 6% of homeowners earning between $15,000 and $40,000. Homeownership was an even more powerful predictor of payday loan usage than income
In statehouses across the country, the payday loan industry has been butting heads with consumer advocates over questions of whether these loans need to be more strictly regulated. The industry argues that payday loans are a short-term lifeline that helps cash-strapped families weather unexpected emergencies. Consumer advocates say that the outlandish fees and interest rates on these loans are unfair and predatory, and that consumers often wind up with debilitating debt.
Pew’s research helps dispel some of the myths that the payday loan industry has tried to push over the years. Pew surveyed 33,576 adults in 48 states and the District of Columbia – the first-ever nationally representative in-depth telephone survey with payday borrowers about their loan usage.
Myth 1: Consumers use payday loans just to cover emergencies
Payday loans are marketed as short-term loans intended only for unexpected emergencies, like a car repair or an unforeseen medical expense. However, in reality, only 16% of borrowers use payday loans for unexpected and emergency expenses. More than two-thirds of payday borrowers use loans for recurring expenses, such as mortgage or rent, food and groceries, utilities, car payment, or credit card bill payments.
The average borrower takes out eight loans of $375 each per year and spends $520 on interest, meaning the average borrower is in debt for five months per year. This is an incredibly expensive and inefficient way to finance regular expenses.
Myth 2: Consumers are worse off without payday loans and have no other options
The payday loan industry often argues that without access to payday loans, low-income consumers would have nowhere else to turn for short-term credit needs. To test this, Pew asked payday loan users what they would do they were unable to use a payday loan. More than 80% of borrowers said they would cut back on expenses. Many also said they would delay paying some bills, borrow from friends and family, or use other credit options like loans from banks/credit unions or credit cards.
Interestingly, many borrowers do not realize that financing debt on a credit card is much less expensive than using a payday loan. Borrowers in focus groups often believed that a 15% APR credit card interest rate is the same as $15 for a $100 payday loan (which is 391% APR).
The takeaway is that, despite what the payday loan industry says, borrowers have a variety of options besides payday loans to handle cash shortfalls.
Myth 3: Banning storefront payday lenders leads to increased online payday loan usage
Many states regulate payday lenders, although these regulations offer varying degrees of protection. Fifteen states do not allow payday loan storefronts at all or cap rates at 36% APR or less, eight states have payday loan storefronts but provide some level of regulation, and 28 states essentially offer no protections at all.
One of the key issues often discussed in state legislators is whether banning payday loan storefronts leads borrowers to obtain loans from online payday lenders. The payday loan industry says that it does, consumer advocates say that it doesn’t.
Pew’s research found that restricting payday loan storefronts does not result in substantial online payday loan usage. In fact, in states where storefronts are prohibited, 95% of would-be borrowers choose not to use payday loans at all.
The graph below shows payday loan usage in 31 states (sample size was not large enough in the other 19 states). The graph also indicates which states have restrictive (red), somewhat restrictive (orange) and permissive laws (green). As would be expected, there are far fewer borrowers in states where storefront lending is banned than in states where it’s allowed. The takeaway is that borrowers are not flocking to online payday loans when storefront loans are unavailable.
Pew’s research comes at a key moment when payday lenders are pushing for a federal bill that would exempt them from state payday lending oversight. If passed, this bill would undermine all current state legislation regulate lenders, and would undo years of work by consumer advocates. It’s unclear whether this bill will gain any traction.