Safe Small-Dollar Loans Research Financial Literacy Seminar Series May 16, 2013 www.pewtrusts.org/small-loans
Pew’s Consumer Financial Security Work Safe Small-Dollar Loans • pewtrusts.org/ small-loans www.pewtrusts.org/money • Checking, debit and overdraft • Prepaid cards • Credit cards www.pewtrusts.org/small-loans 2
Existing Research – Payday Lending www.pewtrusts.org/small-loans 3
Motivations | Expectations vs. Reality • California Department of Corporations (2008): Borrowers use loans mostly for bills and regular expenses, and are aware of fees. • CFSI (2012): Borrowers use loans for regular bills. 40% said loan cost more than expected. • Morse & Bertrand (2010): Borrowers dramatically underestimate APR, cost of loan; expect to pay loan back in about a month. • Lusardi & Scheresberg (working paper): Most high-cost borrowers show low levels of financial literacy; this is a driver of usage. www.pewtrusts.org/small-loans
Impact on Well-Being • Zinman (2008): After Oregon law change, households report worse financial outlook, increased unemployment. • Melzer (2009): In states prohibiting payday loans, those living near a border of a payday state report delaying health care, moving due to financial problems, and more trouble paying bills. • Bhutta et al (working paper): Compares those narrowly approved to those narrowly denied a payday loan. Finds that credit scores of both are persistently low, and remain similar for both groups irrespective of whether they are granted a payday loan. • Wilson et al (2010): In a lab experiment, participants with access to payday loans fare better in a budget simulation game than those without, but those who use the loans heavily fare worst. “ I'm no better off than I was when I first applied, I'm actually worse off, because I'm deeper in debt than I was when I first started. ” www.pewtrusts.org/small-loans
Pricing & Profitability • DeYoung & Phillips (FRBKC)(2009): Payday lenders in Colorado charged the ceiling permitted by law over time. • Stegman & Faris (2003), DeYoung & Phillips (2009): Payday lenders’ profitability is dependent upon borrowers chronically using loans. • Stephens, Inc. (2011): Storefront customers only become profitable once they have borrowed four or five times. • Ernst & Young (2009): Payday lenders earn $1.37 for each $100 lent, and do not earn excessive returns. • Avery & Samolyk (draft): Access to credit is not affected by fee caps (at least as low as $10 per $100), with volume per store lower in higher-cap states and higher in lower-cap states. www.pewtrusts.org/small-loans
Bounced Checks/Overdraft • Bretton Woods data analyzed by CRL (2009): States with and w/o payday loans had similar levels of HH income spent on NSF fees. • Campbell et al (2008): Counties with access to payday loans had higher rates of involuntary bank account closures (which are mostly due to excessive overdrafts) than counties without access to payday loans. • Morgan & Strain (2008): After payday left states, bounced checks went up in Georgia, but not in North Carolina, compared to other states that still had payday loans. • Zinman (2008): After Oregon law change resulting in fewer payday lenders, no significant change in bounced checks relative to Washington. A majority of payday borrowers overdrafted in past year (CFPB, Pew) www.pewtrusts.org/small-loans
Cycle of Debt Issues • Parrish & King (2009): 76% of loans are re-borrows within two weeks of paying back a previous loan, suggesting most payday demand is generated by shortfalls caused by previous loans. • Caskey (2002): Similar findings, but points out plausibility of both sides’ arguments. • CFPB (2013): Confirms that long-term borrowing is norm in both conventional and bank payday. Two-thirds of payday borrowers had 7+ loans in a year (mostly w/in 14 days of previous loan). Bank deposit advance users took out a median of 14 advances over eight pay periods. • Mayer (2012): Historical evidence that single-repayment loans have been understood to inherently lead to long periods of indebtedness. Loans with repayment periods that are too short and payments that are too high encourage repeat borrowing, creating an “annuity” for the lender. www.pewtrusts.org/small-loans
The Fundamentals (Pew’s July 2012 Report) www.pewtrusts.org/small-loans 9
How Payday Loans Work • Packaged as “short - term” loan for “temporary needs” – Obtained from storefronts, online, some banks • Borrower has an income source and checking account – Writes a check, post-dated for next payday, or gives electronic authorization to debit account • Short repayment period, tied to borrower pay cycle – Conventional payday loan is 2 weeks w/ lump-sum repayment. – If borrower cannot pay that, pays fee to renew or borrows again • Average loan size $375 • Avg. fee per two weeks: $55 store, $95 online, ~$35 bank www.pewtrusts.org/small-loans 10
Repeat Borrowing is the Norm Administrative data overwhelmingly shows that people use payday loans heavily: • Avg. borrower in debt five months during year • 80% borrowers use 3+ loans per year (97% of all loans) • Loan volume heavily skewed toward frequent borrowers – 63% of all loans go to people using 12+ per year – More borrowers use 17+ loans per year than just one • Each year (CRL analysis of Veritec Oklahoma data): – 13 % of loans are borrower’s first that year – 76% are renewals or re-borrows w/in one pay period – 11% are new loans more than one pay period later www.pewtrusts.org/small-loans 11
Payday Loan Business Model • Nearly all loans go to repeat borrowers – 97% of loans go to those using 3+ per year – 63% of all loans go to people using 12+ per year • Consecutive usage is the norm – More than three quarters of loans originated before next pay period • The business model requires extended or repeat usage • Similar problems may arise in installment lending variations – Refinancing (“loan flipping”), add -on fees www.pewtrusts.org/small-loans 12
Report: www.pewtrusts.org/small-loans 13 See p.11
Bank Deposit Advance Loans (CFPB Data) • 18% of users or occasional users (median 2 pay periods/yr) – Account for only 3% of all transactions • More than half are heavy users (median 10+ pay periods/yr) – Account for 81% of all transactions – Very heavy users (median 19+ pay periods/yr) – 34% of transactions CFPB Data www.pewtrusts.org/small-loans 14
The Fundamentals (Pew’s July 2012 Report) www.pewtrusts.org/small-loans 15
Methodology – Pew Survey Research • First-of-its-kind survey of American payday loan borrowers – Random Digit Dialing, including cell phones, Spanish, minimum of six attempts per phone number Two-part survey: • Omnibus (49,684 total screens) – Demographic and usage findings based on first 33,576 screens – Margin of error +/-0.2 percentage points • Follow-up, in-depth survey with 451 to 703 borrowers – Margin of error +/- 4.2 to 4.6 percentage points • 10 two-hour borrower focus groups in five cities www.pewtrusts.org/small-loans 16
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1. Who Uses Payday Loans? www.pewtrusts.org/small-loans 19
1. Who Uses Payday Loans? For more information, see Pew July 2012 report at Appendix A www.pewtrusts.org/small-loans 20
Odds of Borrowing The odds of using a payday loan are: • 57 percent higher for renters than for homeowners • 62 percent higher for those earning less than $40,000 annually than for those earning more • 82 percent higher for those with some college education or less than for those with a four-year degree or more • 103 percent higher for those who are separated or divorced than for those of all other marital statuses (single, living with a partner, married, or widowed) • 105 percent higher for African Americans than for other races/ethnicities www.pewtrusts.org/small-loans 21
1. Who Uses Payday Loans? www.pewtrusts.org/small-loans 22
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2. Why Do Borrowers Use Payday Loans? www.pewtrusts.org/small-loans 24
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3. What Would Borrowers Do Without Payday Loans? www.pewtrusts.org/small-loans 27
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Payday Lending Regulation Is Not Leading to Increased Online Borrowing www.pewtrusts.org/small-loans 31
Payday Lending Regulation Is Not Leading to Increased Online Borrowing www.pewtrusts.org/small-loans 32
How Borrowers Choose and Repay (Pew’s February 2013 Report) www.pewtrusts.org/small-loans 33
Payday loans are unaffordable “If you can’t pay that money back when you…agreed to, they let you just pay the interest, and then it gets easier and easier for you to renew that loan, because you’re saying, well, I need to do this with this money, and I can pay this $17.50 or $35 and go ahead on.” — Storefront borrower, Birmingham, AL www.pewtrusts.org/small-loans 34
Most Use Payday Loans for Recurring Expenses Report: www.pewtrusts.org/small-loans 35 See p.10
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