Small-Dollar Loans Products and Policies for Alternative Credit Nick Bourke November 7, 2012
The Pew Charitable Trusts Safe Small ‐ Dollar Loans • pewtrusts.org/ small ‐ loans Other Consumer Financial Security Projects at Pew: • Checking, debit and overdraft • Prepaid cards • Credit cards www.pewtrusts.org/small-loans 2
Agenda • Brief overview of existing payday loan research • Payday loan market: Who borrows, where, and why • Borrower choices and the decision to borrow • Online payday lending & the impacts of regulation • Policy Considerations • Q & A www.pewtrusts.org/small-loans 3
How Payday and Deposit Advance Loans Work • Borrower has an income source and checking account – Post ‐ dated check or electronic authorization to debit account • Lump ‐ sum repayment (usually, entire loan due in 2 weeks) – If cannot repay entire loan, pays fee to renew or borrows again – Some variations exist, e.g. VA requires min term of 2 pay cycles • Fees range by state law and product channel – $10 per $100 (261% APR) to $20 per $100 (521% APR) in storefronts – $25 per $100 online (652% APR) – Some variation for bank Deposit Advance Products (DAPs) www.pewtrusts.org/small-loans 4
Existing Research – Payday Lending www.pewtrusts.org/small-loans 5
Bounced Checks/Overdraft • Bretton Woods data analyzed by Center for Responsible Lending (2009): States with and without payday loans had similar levels of household 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 said they overdrafted in past year www.pewtrusts.org/small-loans 6
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 (forthcoming): 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 7
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 (b/c bills due before paycheck or consistently more than income, or unexpected expense or drop in income). 40% said loan cost more than expected. • Elliehausen & Lawrence (2001); also Cypress (2004): Borrowers aware of fees, but not APR. • Morse & Bertrand (2010): Borrowers dramatically underestimate APR, cost of over three months, expect to pay loan back in about a month. • Mann (forthcoming): Comparing survey responses to lender data, may find closer correlation between borrower expectations and actual length of repayment??? www.pewtrusts.org/small-loans 8
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 (forthcoming): 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. Avg. payday loan is $375. Avg. fee is $55 (storefront) or $95 (online) www.pewtrusts.org/small-loans 9
Debt Trap 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. • Fusaro & Cirillo (2011): Randomly assign borrowers to either regularly ‐ priced or free payday loans. Both groups need 8 loans (7 renewals/re ‐ borrows) to retire debt. Authors interpret this as high interest rates not causing cycle of debt. • 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 10
Repeat Borrowing Administrative data overwhelmingly shows that people use payday loans heavily : • Average borrower in debt five months during year. • 80% of borrowers use 3+ loans per year (97% of all loans). • 63% of all loans go to people using 12+ per year. • More borrowers use 17+ loans per year than just one. • Each year (CRL): – 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 Lending: Who Borrows, Where They Borrow and Why + Effects of Regulation www.pewtrusts.org/small-loans 12
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 survey with 451 storefront payday borrowers – Margin of error +/ ‐ 4.6 percentage points • 10 two ‐ hour borrower focus groups in five cities www.pewtrusts.org/small-loans 13
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1. Who Uses Payday Loans? www.pewtrusts.org/small-loans 15
1. Who Uses Payday Loans? For more information, see Pew report at Appendix A www.pewtrusts.org/small-loans 16
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 17
1. Who Uses Payday Loans? www.pewtrusts.org/small-loans 18
1. Who Uses Payday Loans? www.pewtrusts.org/small-loans 19
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2. Why Do Borrowers Use Payday Loans? “Thinking back now to (that FIRST / the) time you took out a payday loan, which of the following best describes what specifically you needed the money for? 21 www.pewtrusts.org/small-loans
Packaging vs. Experience • Short ‐ term loan • To cover small, often unexpected expenses • Designed to solve temporary cash ‐ flow problems • Not intended for long ‐ term use Average Borrower: 8 loans per year $375 loan, $520 in fees ($895 total paid) Indebted five months during the year 22
2. Why Do Borrowers Use Payday Loans? How did you find out about bank deposit advances? “I found out about it because when you do the online banking there is this thing, I hadn’t heard about it, and it just says that I can do a direct deposit advance. And I clicked on it, like ‘Oh! Really?’ And then, well, it’s very quick and easy….” 23 www.pewtrusts.org/small-loans
Borrowers of Bank Payday Loans How do you know if deposit advances from banks are safe? “I think so because they are through the bank and the bank is FDIC Insurance. I don’t know. I am just assuming that. I would assume so.” “Well they got usury laws, don’t they? I think probably the payday loans aren’t subject to usury laws, but the banks because they’re chartered by federals, they got a lot of pressure on them to stay within the usury laws.” “Yes, government pressure about usury laws or something like that whereas payday loans are probably not regulated strongly.” “For the banks, on the door it says FDIC so you know it’s governed.” 24 www.pewtrusts.org/small-loans
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3. What Would Borrowers Do Without Payday Loans? … and maybe savings? www.pewtrusts.org/small-loans 26
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