Phantom Demand: Most Payday Loans are Churned

This just in from our good friend and colleague Leslie Parrish. Her new report reveals the large extent to which the payday loan industry relies on churned loans from repeat customers who get caught in a debt trap as opposed to ones that help borrowers meet unexpected needs.

She writes:

With payday lending stores sprouting up like weeds over the last ten years, you’d be excused for thinking there was an urgent and growing need for quick cash before payday. Because of the large number of loans originated each year, even some critics of the payday lending industry’s practices and 400%+ APR rates grudgingly consider these loans a “necessary evil,” filling a demand for short-term credit.

Well, it turns out the demand is not nearly what it’s made out to be. In a study released earlier this month, my colleagues and I at the Center for Responsible Lending found new evidence that much of the $27 billion in loans originated by industry storefronts each year are not taken to help with a financial emergency but instead are artificially generated by trapping borrowers in new loans, one payday after another.

Payday loans are small, short-term loans secured by a borrower’s personal check. Unlike most any other kind of loan, they are due in full on their next payday. Over 90% of these loans are repaid when they are due, but once most borrowers pay it off, they cannot meet their other expenses. So the customer takes out a new payday loan shortly after paying the previous one off, frequently within the first 24-48 hours.

Looking at detailed data from Oklahoma and Florida borrowers, we found that about half of new loans to repeat borrowers are taken at their first opportunity, and 87% are taken within two week’s time—the typical length between paychecks. Being unable to fully retire payday loan debt and instead having to take out a new loan each pay period appears to be the rule, rather than the exception.

We used this information to estimate the share of total loan volume that results from this “churning” of borrowers from one paycheck to the next, as opposed to loans taken to fill a borrower’s need for cash to address an unexpected expense. This churning accounts for three-quarters (76%) of total loan volume—or more than $20 billion—annually. This leaves just $6.6 billion in substantive credit that is actually being provided by the industry, which, to put into context, represents just three percent of the total credit provided through credit card cash advances.

What this means on a household level is that trapped borrowers lose $3.5 billion in fees each year paid on churned loans. This money could otherwise have been used to build up an emergency savings account, pay down debts, or purchase needed items.

We believe policymakers and regulators should protect borrowers from these loans, which are made inherently unaffordable by their short-term balloon payment. They should cap interest rates on small loan products, encourage responsible lending practices, and facilitate opportunities for low- and moderate-income families to save.

While the struggles that low-income families go through to make it from one payday to the next are very real, the idea that loans at 400% APR are an appropriate solution is nonsense. Most of the demand for these loans is self-generated by an industry that needs trapped borrowers to survive, and their impact on the people who are targeted is to make their needs even more urgent and their desperation even more dire.