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<strong>Small</strong>-<strong>Dollar</strong> <strong>Loans</strong><br />

Products and Policies for Alternative Credit<br />

Nick Bourke<br />

November 7, 2012


The Pew Charitable Trusts<br />

Safe <strong>Small</strong>‐<strong>Dollar</strong> <strong>Loans</strong><br />

• pewtrusts.org/small‐loans<br />

Other Consumer Financial<br />

Security Projects at Pew:<br />

• Checking, debit and overdraft<br />

• Prepaid cards<br />

• Credit cards<br />

www.pewtrusts.org/small-loans 2


Agenda<br />

• Brief overview of existing payday loan research<br />

• Payday loan market: Who borrows, where, and why<br />

• Borrower choices and the decision to borrow<br />

• Online payday lending & the impacts of regulation<br />

• Policy Considerations<br />

• Q & A<br />

www.pewtrusts.org/small-loans 3


How Payday and Deposit Advance <strong>Loans</strong> Work<br />

• Borrower has an income source and checking account<br />

– Post‐dated check or electronic authorization to debit account<br />

• Lump‐sum repayment (usually, entire loan due in 2 weeks)<br />

– If cannot repay entire loan, pays fee to renew or borrows again<br />

– Some variations exist, e.g. VA requires min term of 2 pay cycles<br />

• Fees range by state law and product channel<br />

– $10 per $100 (261% APR) to $20 per $100 (521% APR) in storefronts<br />

– $25 per $100 online (652% APR)<br />

– Some variation for bank Deposit Advance Products (DAPs)<br />

www.pewtrusts.org/small-loans 4


Existing Research –Payday Lending<br />

www.pewtrusts.org/small-loans 5


Bounced Checks/Overdraft<br />

• Bretton Woods data analyzed by Center for Responsible Lending<br />

(2009): States with and without payday loans had similar levels of<br />

household income spent on NSF fees.<br />

• Campbell et al (2008): Counties with access to payday loans had<br />

higher rates of involuntary bank account closures (which are mostly<br />

due to excessive overdrafts) than counties without access to payday<br />

loans.<br />

• Morgan & Strain (2008): After payday left states, bounced checks<br />

went up in Georgia, but not in North Carolina, compared to other<br />

states that still had payday loans.<br />

• Zinman (2008): After Oregon law change resulting in fewer payday<br />

lenders, no significant change in bounced checks relative to<br />

Washington.<br />

A majority of payday borrowers said they overdrafted in past year<br />

www.pewtrusts.org/small-loans 6


Impact on Well‐Being<br />

• Zinman (2008): After Oregon law change, households report worse<br />

financial outlook, increased unemployment.<br />

• Melzer (2009): In states prohibiting payday loans, those living near a<br />

border of a payday state report delaying health care, moving due to<br />

financial problems, and more trouble paying bills.<br />

• Bhutta et al (forthcoming): Compares those narrowly approved to those<br />

narrowly denied a payday loan. Finds that credit scores of both are<br />

persistently low, and remain similar for both groups irrespective of<br />

whether they are granted a payday loan.<br />

• Wilson et al (2010): In a lab experiment, participants with access to<br />

payday loans fare better in a budget simulation game than those<br />

without, but those who use the loans heavily fare worst.<br />

“I'm no better off than I was when I first applied, I'm actually worse off,<br />

because I'm deeper in debt than I was when I first started.”<br />

www.pewtrusts.org/small-loans 7


Motivations | Expectations vs. Reality<br />

• California Department of Corporations (2008): Borrowers use loans<br />

mostly for bills and regular expenses, and are aware of fees.<br />

• CFSI (2012): Borrowers use loans for regular bills (b/c bills due before<br />

paycheck or consistently more than income, or unexpected expense<br />

or drop in income). 40% said loan cost more than expected.<br />

• Elliehausen & Lawrence (2001); also Cypress (2004): Borrowers aware<br />

of fees, but not APR.<br />

• Morse & Bertrand (2010): Borrowers dramatically underestimate APR,<br />

cost of over three months, expect to pay loan back in about a month.<br />

• Mann (forthcoming): Comparing survey responses to lender data, may<br />

find closer correlation between borrower expectations and actual<br />

length of repayment???<br />

www.pewtrusts.org/small-loans 8


Pricing & Profitability<br />

• DeYoung & Phillips (FRBKC)(2009): Payday lenders in Colorado<br />

charged the ceiling permitted by law over time.<br />

• Stegman & Faris (2003), DeYoung & Phillips (2009): Payday lenders’<br />

profitability is dependent upon borrowers chronically using loans.<br />

• Stephens, Inc. (2011): Storefront customers only become profitable<br />

once they have borrowed four or five times.<br />

• Ernst & Young (2009): Payday lenders earn $1.37 for each $100 lent,<br />

and do not earn excessive returns.<br />

• Avery & Samolyk (forthcoming): Access to credit is not affected by fee<br />

caps (at least as low as $10 per $100), with volume per store lower in<br />

higher‐cap states and higher in lower‐cap states.<br />

Avg. payday loan is $375. Avg. fee is $55 (storefront) or $95 (online)<br />

www.pewtrusts.org/small-loans 9


Debt Trap Issues<br />

• Parrish & King (2009): 76% of loans are re‐borrows within two weeks<br />

of paying back a previous loan, suggesting most payday demand is<br />

generated by shortfalls caused by previous loans.<br />

• Caskey (2002): Similar findings, but points out plausibility of both<br />

sides’ arguments.<br />

• Fusaro & Cirillo (2011): Randomly assign borrowers to either<br />

regularly‐priced or free payday loans. Both groups need 8 loans (7<br />

renewals/re‐borrows) to retire debt. Authors interpret this as high<br />

interest rates not causing cycle of debt.<br />

• Mayer (2012): Historical evidence that single‐repayment loans have<br />

been understood to inherently lead to long periods of indebtedness.<br />

<strong>Loans</strong> with repayment periods that are too short and payments that<br />

are too high encourage repeat borrowing, creating an “annuity” for<br />

the lender.<br />

www.pewtrusts.org/small-loans 10


Repeat Borrowing<br />

Administrative data overwhelmingly shows that<br />

people use payday loans heavily :<br />

• Average borrower in debt five months during year.<br />

• 80% of borrowers use 3+ loans per year (97% of all loans).<br />

• 63% of all loans go to people using 12+ per year.<br />

• More borrowers use 17+ loans per year than just one.<br />

• Each year (CRL):<br />

– 13% of loans are borrower’s first that year;<br />

– 76% are renewals or re‐borrows w/in one pay period.<br />

– 11% are new loans more than one pay period later.<br />

www.pewtrusts.org/small-loans<br />

11


Payday Lending: Who Borrows,<br />

Where They Borrow and Why<br />

+ Effects of Regulation<br />

www.pewtrusts.org/small-loans 12


Methodology –Pew Survey Research<br />

• First‐of‐its‐kind survey of American payday loan borrowers<br />

– Random Digit Dialing, including cell phones, Spanish, minimum of<br />

six attempts per phone number<br />

Two‐part survey:<br />

• Omnibus (49,684 total screens)<br />

– Demographic and usage findings based on first 33,576 screens<br />

– Margin of error +/‐0.2 percentage points<br />

• Follow‐up survey with 451 storefront payday borrowers<br />

– Margin of error +/‐4.6 percentage points<br />

• 10 two‐hour borrower focus groups in five cities<br />

www.pewtrusts.org/small-loans 13


www.pewtrusts.org/small-loans 14


1. Who Uses Payday <strong>Loans</strong>?<br />

www.pewtrusts.org/small-loans 15


1. Who Uses Payday <strong>Loans</strong>?<br />

For more information,<br />

see Pew report at<br />

Appendix A<br />

www.pewtrusts.org/small-loans 16


Odds of Borrowing<br />

The odds of using a payday loan are:<br />

• 57 percent higher for renters than for homeowners<br />

• 62 percent higher for those earning less than $40,000<br />

annually than for those earning more<br />

• 82 percent higher for those with some college education<br />

or less than for those with a four‐year degree or more<br />

• 103 percent higher for those who are separated or<br />

divorced than for those of all other marital statuses<br />

(single, living with a partner, married, or widowed)<br />

• 105 percent higher for African Americans than for other<br />

races/ethnicities<br />

www.pewtrusts.org/small-loans 17


1. Who Uses Payday <strong>Loans</strong>?<br />

www.pewtrusts.org/small-loans 18


1. Who Uses Payday <strong>Loans</strong>?<br />

www.pewtrusts.org/small-loans 19


www.pewtrusts.org/small-loans 20


2. Why Do Borrowers Use Payday <strong>Loans</strong>?<br />

www.pewtrusts.org/small-loans<br />

“Thinking back now to<br />

(that FIRST / the) time<br />

you took out a payday<br />

loan, which of the<br />

following best<br />

describes what<br />

specifically you needed<br />

the money for?<br />

21


Packaging vs. Experience<br />

• Short‐term loan<br />

• To cover small, often unexpected expenses<br />

• Designed to solve temporary cash‐flow problems<br />

• Not intended for long‐term use<br />

Average Borrower:<br />

8 loans per year<br />

$375 loan, $520 in fees ($895 total paid)<br />

Indebted five months during the year<br />

22


2. Why Do Borrowers Use Payday <strong>Loans</strong>?<br />

www.pewtrusts.org/small-loans<br />

How did you find out about bank<br />

deposit advances?<br />

“I found out about it because when<br />

you do the online banking there is<br />

this thing, I hadn’t heard about it, and<br />

it just says that I can do a direct<br />

deposit advance. And I clicked on it,<br />

like ‘Oh! Really?’ And then, well, it’s<br />

very quick and easy….”<br />

23


Borrowers of Bank Payday <strong>Loans</strong><br />

How do you know if deposit advances from banks are safe?<br />

“I think so because they are through the bank and the bank is FDIC Insurance. I<br />

don’t know. I am just assuming that. I would assume so.”<br />

“Well they got usury laws, don’t they? I think probably the payday loans aren’t<br />

subject to usury laws, but the banks because they’re chartered by federals, they<br />

got a lot of pressure on them to stay within the usury laws.”<br />

“Yes, government pressure about usury laws or something like that whereas<br />

payday loans are probably not regulated strongly.”<br />

“For the banks, on the door it says FDIC so you know it’s governed.”<br />

www.pewtrusts.org/small-loans<br />

24


www.pewtrusts.org/small-loans 25


3. What Would Borrowers Do Without Payday <strong>Loans</strong>?<br />

… and maybe savings?<br />

www.pewtrusts.org/small-loans 26


Alternative Forms of Credit<br />

And now what do you do for credit?<br />

“My direct deposit now goes to the credit union because it’s just a better<br />

deal…. [T]hey ask me if I want to pay $100.00 in increments or pay $50.00<br />

increments, do I want to pay in three months…. I can stretch it out for five<br />

months. I can pay $50.00 a month, for five months. Or $100.00 a month for<br />

two months. I get to choose how I wanted to pay it back. How<br />

much I wanted to pay, so it was a whole lot better.”<br />

www.pewtrusts.org/small-loans 27


The Importance of Having Options<br />

www.pewtrusts.org/small-loans 28


Options… for Credit<br />

Payday,<br />

Auto Title<br />

Loan<br />

Credit Options<br />

? X X<br />

etc.<br />

Alt.<br />

Installment<br />

Credit<br />

Card<br />

Mortgage<br />

/ HELOC<br />

www.pewtrusts.org/small-loans 29


Options… for Managing Finances<br />

Budget /<br />

Cut Back<br />

81%<br />

Non‐Credit Options<br />

Delay<br />

Paying<br />

Bills<br />

62%<br />

57%<br />

Percentage of payday borrowers who would use<br />

these options if payday loans did not exist<br />

Use<br />

Savings?<br />

Family /<br />

Friends<br />

57%<br />

Sell /<br />

Pawn<br />

Payday,<br />

Auto Title<br />

Loan<br />

12 Million<br />

Americans use<br />

payday loans<br />

each year, paying<br />

$7.4 billion in<br />

finance charges<br />

Alt.<br />

Installment<br />

etc.<br />

A small<br />

market –<br />

not well<br />

understood<br />

Credit Options<br />

Credit<br />

Card<br />

60%<br />

Payday<br />

applicants<br />

have a credit<br />

card –nearly<br />

all maxed out<br />

Mortgage<br />

/ HELOC<br />

41%<br />

Payday<br />

borrowers<br />

own a home<br />

www.pewtrusts.org/small-loans 30


What is the Payday Loan Experience Like?<br />

Not Short‐Term<br />

www.pewtrusts.org/small-loans 31


What is the Payday Loan Experience Like?<br />

Convenient / Accessible<br />

– Top two factors: How quickly, whether I can qualify<br />

– About 80% of first‐time applicants approved<br />

Customer service drives good feeling<br />

“They always…speak to you by first name and say, hello, how you doing when<br />

you first come in the store, and they’re good with remembering your name<br />

and your face.”<br />

Fast relief, but…<br />

“I do like payday loans… (but) they do take advantage because, you know, they<br />

do know that you need the money, and they know that they got you.”<br />

www.pewtrusts.org/small-loans 32


How Do Borrowers Repay?<br />

“That’s what happens: You wind up short the next, the<br />

following week, so you have to do it again…. I just was short for<br />

a while. Then I finally caught up on my own without doing that. I<br />

went to the pawn shop with one thing. Sometimes I’d find<br />

things at the flea market that I could take to pawn shops and I<br />

could sell them. I would see an antique at a flea market, and I<br />

could take it to an antique shop. I do things like that if I can.”<br />

www.pewtrusts.org/small-loans<br />

33


How Do Borrowers Repay?<br />

• Timely payment – but frequent renewal / quick re‐borrow<br />

– Can afford the $50+ renewal fee<br />

– Generally cannot afford the $400+ lump sum repayment<br />

– Helps explain why payday loss rates are low (3 percent),<br />

and re‐borrow rates are high (76% of loans renewals or quick re‐borrows)<br />

• To eliminate payday loan debt, many borrowers turn to the same<br />

options they originally chose not to use:<br />

– Help from family / friends, sell or pawn possessions, delay paying some<br />

bills, and change budgets / cut expenses. Savings?<br />

• Use windfall such as a tax refund<br />

www.pewtrusts.org/small-loans 34


Outcomes –Help or Harm?<br />

Data shows that for perhaps 1 in 5 borrowers, there is some time<br />

shifting / consumption smoothing occurring.<br />

…But they represent only 3% of loan volume.<br />

What about the 4 in 5 who use 3+ loans annually / 97% of volume?<br />

Or the subgroup who use 12+ loans annually / 63% of volume?<br />

• Credit scores remain tarnished, overdrafts continue<br />

• Average 5 months in debt, $520 in finance charges per year<br />

• Often turn to other options anyway<br />

www.pewtrusts.org/small-loans 35


So Why Do People Choose<br />

to Use Payday <strong>Loans</strong>?<br />

www.pewtrusts.org/small-loans 36


Why – The Underlying Need<br />

• Persistently weak credit profiles,<br />

permanent cash‐flow shortfalls<br />

• Not simply responding to short‐term<br />

shocks<br />

www.pewtrusts.org/small-loans 37


Why – The Choice to Borrow<br />

Budget /<br />

Cut Back<br />

Non‐Credit Options Credit Options<br />

Delay<br />

Paying<br />

Bills<br />

Family /<br />

Friends<br />

Sell /<br />

Pawn<br />

Payday,<br />

Auto Title<br />

Loan<br />

Alt.<br />

Installment<br />

etc.<br />

Credit<br />

Card<br />

Mortgage<br />

/ HELOC<br />

www.pewtrusts.org/small-loans 38


Why – The Choice to Borrow: Possible Frameworks<br />

• Desperation<br />

– Credit scores ~510, 4x delinquencies and 3x new inquiries past 12 months<br />

– About 1/3 of borrowers would accept a loan on any terms<br />

• Reliance on the lender<br />

– Packaging suggests the loan will be short‐term and affordable<br />

– Comfortable customer service relationships<br />

• Perception<br />

– Payday / DAP / SDC is “not another bill”<br />

– Focus on the fee, rather than the whole repayment<br />

– Confusion (e.g. 15% payday loan fee vs. 15% APR)<br />

www.pewtrusts.org/small-loans 39


What About Overdraft?<br />

• Median bank overdraft fee is $35<br />

• But:<br />

– APRs of 5,000 percent or more!<br />

– Overdraft is not an alternative option,<br />

– Nor a replacement for other options<br />

www.pewtrusts.org/small-loans 40


Overdraft Activity –Past Year<br />

Source: Pew Safe Checking in the Electronic Age Project, Nationally Representative Survey, 2012<br />

www.pewtrusts.org/small-loans 41


Overdraft<br />

www.pewtrusts.org/small-loans 42


Overdraft – Usually Charged as Penalty Fees<br />

www.pewtrusts.org/small-loans 43


Overdraft<br />

www.pewtrusts.org/small-loans<br />

44


Overdraft<br />

www.pewtrusts.org/small-loans<br />

45


Overdraft<br />

www.pewtrusts.org/small-loans 46


Overdraft Is Not “Alternative Credit”<br />

Median bank fee is $35<br />

• APRs of 5,000 percent or more!<br />

But:<br />

• Overdrafting generally is done by mistake<br />

– Intentional use of overdraft as credit is rare<br />

And Besides:<br />

• Most payday borrowers also overdraft anyway<br />

Overdraft is a function of tight budgets, limited information<br />

and lender policies. It is not an “alternative choice”<br />

www.pewtrusts.org/small-loans 47


www.pewtrusts.org/small-loans 48


Where Do Borrowers Get Payday <strong>Loans</strong>?<br />

49


Payday Lending Regulation Is Not Leading<br />

to Increased Online Borrowing<br />

• Permissive states are the least<br />

regulated and allow initial fees<br />

of 15 percent of the borrowed<br />

principal or higher<br />

• Hybrid states have relatively<br />

more exacting requirements<br />

than permissive states<br />

• Restrictive states either do not<br />

permit payday lending or have<br />

price caps low enough to<br />

eliminate payday lending in the<br />

state<br />

www.pewtrusts.org/small-loans<br />

50


Payday Lending Regulation Is Not Leading<br />

to Increased Online Borrowing<br />

51


Payday Lending Regulation Is Not Leading<br />

to Increased Online Borrowing<br />

www.pewtrusts.org/small-loans 52


Many Reject Online as an Alternative<br />

www.pewtrusts.org/small-loans<br />

53


Key Concerns with Online Payday Lending<br />

• Dissemination of personal information<br />

– “. . . I want to know how they got all my information. I mean, these loan<br />

companies are supposed to have some type of security . . . .”<br />

• Harassment or fraud<br />

– “They had all my information . . . my routing, my numbers, my banking account, my<br />

e‐mail address, my job. It . . . was like the biggest mistake . . . [Y]esterday I had 15<br />

missed calls from Officer John Marshall. He called me from five different numbers,<br />

a 911 emergency number. I was frantic. I thought something happened to my wife<br />

and kids, and it was Officer John Marshall. He called me from a 718 number, a 616<br />

number. He's telling me why are you ignoring my phone calls? You can't run away<br />

from this.”<br />

• Withdrawals and obstacles to repayment<br />

– “[T]hey tell you the only way that you can pay an additional principal is to go online<br />

but they can't send me the website, they don't know how I can log in, they don't<br />

have any information.”<br />

www.pewtrusts.org/small-loans 54


Payday Lending Regulation Is Not Leading<br />

to Increased Online Borrowing<br />

55


Key Takeaways & Policy Considerations<br />

www.pewtrusts.org/small-loans 56


Key Takeaways<br />

• Payday loan usage is across the demographic spectrum<br />

• Payday loans are for ordinary living expenses –not<br />

unexpected emergencies<br />

• Packaging diverges widely from actual consumer experience<br />

• “Options” include non‐credit as well as credit choices<br />

– Payday loans often fail as a substitute for non‐credit / overdraft<br />

– Choice to borrow: A function of desperation, reliance, perception?<br />

• State laws that restrict payday lending have an impact<br />

– Borrowers not being driven online (it’s not seen as a substitute)<br />

– Hybrid policies not decreasing usage, but are decreasing cost<br />

www.pewtrusts.org/small-loans 57


A Few Policy Considerations<br />

Task is to eliminate harms and pave the way for a functional<br />

small‐dollar loan marketplace<br />

• Consumer Financial Protection Bureau<br />

– Authorized to regulate Unfair, Deceptive or Abusive Acts or Practices<br />

in the payday lending market. But not “rate caps.”<br />

• OCC, FDIC, FTC remain important – especially for bank<br />

Deposit Advance Products (DAP)<br />

• State law continues to matter<br />

– States have the power to influence cost, usage<br />

– Online is a particular challenge, but some strategies exist<br />

www.pewtrusts.org/small-loans 58


Additional Online Resources<br />

www.pewtrusts.org/small-loans<br />

Quiz<br />

Report &<br />

Exec Sum<br />

State Data<br />

Interactive<br />

Collected<br />

Resources<br />

Summary<br />

Infographic<br />

59


Media:<br />

Samantha Lasky<br />

202.540.6390<br />

slasky@pewtrusts.org<br />

www.pewtrusts.org/small-loans<br />

Project Director:<br />

Nick Bourke<br />

202.552.2123<br />

nbourke@pewtrusts.org<br />

Research Methodology:<br />

Alex Horowitz<br />

202.540.6315<br />

ahorowitz@pewtrusts.org


Online Borrowers Are Different<br />

Online borrowers are more likely:<br />

• To earn $50,000 or more<br />

• To have a college degree<br />

• To be 18‐39<br />

And are less likely:<br />

• To be retired<br />

• To be disabled<br />

• To be 60 years of age or older<br />

61

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