Whilst regulation of the payday loan industry increases, especially in the US, research and academic comment on its effect on consumer behaviour and financial planning has been limited.
A recent academic study from Cornell University entitled “Consumer Borrowing After Payday Loan Bans” (Bhutta, Goldin, Homonoff; 2016) aims to address the gap in literature surrounding payday loans, alternative finance and the restrictive regulations being enacted in certain US states. Below we will summarise the key findings from the paper, which can be read in full here.
Using new data from the Federal Deposit Insurance Corporation’s “National Survey of Unbanked and Underbanked Households” in conjunction with data on traditional credit product usage from the Federal Reserve Bank of New York and Equifax, analysis found the following in US states that prohibited the use of payday loans:
- The use of other forms of high interest credit and pawnshop loans increased with no effect on borrowers’ use of credit card debt or consumer finance loans;
- An increase in involuntary cheque account closures, suggesting borrowers become more likely to bounce cheques or go into potentially costly overdrafts on their bank accounts, which can be substantially more expensive than borrowing payday loans (see report from Which?);
- The fraction of individuals taking out alternative loans remained largely unchanged;
- While bans may be ineffective at reducing the total use of high interest credit products, such policies may reduce high interest borrowing among the lowest income users of such products;
- If policymakers concluded that payday loans were equal to or better than the available alternatives, restricting borrowers’ access to them may end up being counter-productive;
- Demand for alternative borrowing as a source of financial help is fuelled by a general desire for short-term credit rather than because of the way payday loans are marketed;
Essentially, the demand and need from consumers for credit does not diminish following prohibition of payday loans.
Therefore policy makers must consider what other forms of borrowing are available to consumers and whether the available “payday loans” are better or worse than the alternatives before tabling suggestions about bans.
There are some notable caveats to this research including that, other types of “unofficial” borrowing (from relatives or loan sharks) are not covered in the data set and so the wider effect of a payday loan ban on these forms of borrowing cannot be measured. The data also does not cover the number of loans the borrower takes out or for how much.
Further empirical research on the effects of payday loans, alternative financial services in other territories is key to informing businesses, decision makers and future policy in the short-term credit arena.
As part of your financial planning and to make sure you are borrowing from a regulated source please refer to the list of licensed providers on our website and the “evaluate your lender” information.
“Consumer Borrowing After Payday Loan Bans” http://www.human.cornell.edu/pam/people/upload/Bhutta_Goldin_Homonoff7-13-2016.pdf
“Overdraft charges more expensive than payday loans”