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WERTH: So, what Fusaro did was he set up a randomized control trial where he gave one group of borrowers a traditional high-interest-rate payday loan and then he gave another group of borrowers no interest rate on their loans and then he compared the two and he found out that both groups were just as likely to roll over their loans again. And we should say, again, the research was funded by CCRF.
While the banks, which include giants like JPMorgan Chase, Bank of America and Wells Fargo, do not make the loans, they are a critical link for the lenders, enabling the lenders to withdraw payments automatically from borrowers’ bank accounts, even in states where the loans are banned entirely. In some cases, the banks allow lenders to tap checking accounts even after the customers have begged them to stop the withdrawals.
DEYOUNG: Studies that have looked at this have found that once you control for the demographics and income levels in these areas and these communities, the racial characteristics no longer drive the location decisions. As you might expect, business people don’t care what color their customers are, as long as their money’s green.
Fulmer says that payday-loan interest rates aren’t nearly as predatory as they seem, for two reasons. First: when you hear “400 percent on an annualized basis,” you might think that people are borrowing the money for a year. But these loans are designed to be held for just a few weeks, unless, of course, they get rolled over a bunch of times. And, reason number two: because payday loans are so small — the average loan is about $375— the fees need to be relatively high to make it worthwhile for the lender. For every $100 borrowed, Fulmer says, the lender gets about $15 in fees. So, capping the rate at an annualized 36 percent just wouldn’t work.
Consider a study that Zinman published a few years back. It looked at what happened in Oregon after that state capped interest rates on short-term loans from the usual 400 percent to 150 percent, which meant a payday lender could no longer charge the industry average of roughly $15 per $100 borrowed; now they could charge only about $6. As an economist might predict, if the financial incentive to sell a product is severely curtailed, people will stop selling the product.
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And yet it is surprisingly difficult to condemn the business wholesale. Emergency credit can be a lifeline, after all. And while stories about the payday-lending industry’s individual victims are horrible, the research on its effect at a more macro level is limited and highly ambiguous. One study shows that payday lending makes local communities more resilient; another says it increases personal bankruptcies; and so on.
All a consumer needs to get a payday loan is an open bank account in relatively good standing, a steady source of income, and identification. Lenders do not conduct a full credit check or ask questions to determine if a borrower can afford to repay the loan. Since loans are made based on the lender’s ability to collect, not the borrower’s ability to repay while meeting other financial obligations, payday loans create a debt trap.
Payday lending works like this: In exchange for a small loan—the average amount borrowed is about $350—a customer agrees to pay a single flat fee, typically in the vicinity of $15 per $100 borrowed. For a two-week loan, that can equate to an annualized rate of almost 400 percent. The entire amount—the fee plus the sum that was borrowed—is generally due all at once, at the end of the term. (Borrowers give the lender access to their bank account when they take out the loan.) But because many borrowers can’t pay it all back at once, they roll the loan into a new one, and end up in what the industry’s many critics call a debt trap, with gargantuan fees piling up. As Mehrsa Baradaran, an associate professor at the University of Georgia’s law school, puts it in her new book, How the Other Half Banks, “One of the great ironies in modern America is that the less money you have, the more you pay to use it.”
Maybe that’s about as good as it gets on the fringe. Outrage is easy, and outrage is warranted—but maybe payday lenders shouldn’t be its main target. The problem isn’t just that people who desperately need a $350 loan can’t get it at an affordable rate, but that a growing number of people need that loan in the first place.
You don’t have to worry about any embarrassing phone calls to your employer; LendUp does not call them. Take the five minutes to put in an application online or using a mobile device and you could have money in as few as within one business day. LendUp can’t guarantee receipt of your funds within a certain timeframe, though, because although we initiate a transfer of money to you, your bank controls when you’ll have access to it.
DEYOUNG: Oh, I do think that our history of usury laws is a direct result of our Judeo-Christian background. And even Islamic banking, which follows in the same tradition. But clearly interest on money lent or borrowed has a, has been looked at non-objectively, let’s put it that way. So the shocking APR numbers if we apply them to renting a hotel room or renting an automobile or lending your father’s gold watch or your mother’s silverware to the pawnbroker for a month, the APRs come out similar. So the shock from these numbers is, we recognize the shock here because we are used to calculating interest rates on loans but not interest rates on anything else. And it’s human nature to want to hear bad news and it’s, you know, the media understands this and so they report bad news more often than good news. We don’t hear this. It’s like the houses that don’t burn down and the stores that don’t get robbed.
Just kidding; we still have no idea why men or women do anything in particular. But the study, released today in the Proceedings of the National Academy of Sciences, is interesting because it is one of the first to discover differences in the brain’s structural connectivity in a large sample size of people from a variety of age groups.
In a profitability analysis by Fordham Journal of Corporate & Financial Law, it was determined that the average profit margin from seven publicly traded payday lending companies (including pawn shops) in the U.S. was 7.63%, and for pure payday lenders it was 3.57%. These averages are less than those of other traditional lending institutions such as credit unions and banks.
DeYOUNG: OK, in a short sentence that’s highly scientific I would begin by saying, “Let’s not throw the baby out with the bathwater.” The question comes down to how do we identify the bath water and how do we identify the baby here. One way is to collect a lot of information, as the CFPB suggests, about the creditworthiness of the borrower. But that raises the production cost of payday loans and will probably put the industry out of business. But I think we can all agree that once someone pays fees in an aggregate amount equal to the amount that was originally borrowed, that’s pretty clear that there’s a problem there.
Our latest Freakonomics Radio episode is called “Are Payday Loans Really as Evil as People Say?” (You can subscribe to the podcast at iTunes or elsewhere, get the RSS feed, or listen via the media player above.)
Elizabeth Warren has endorsed the idea of the Postal Service partnering with banks to offer short-term loans. But even some fellow opponents of payday lending think that’s unfeasible. In a New York Times op-ed last fall, Frederick Wherry, a sociology professor at Yale, pointed out that doing this would require the Postal Service to have a whole new infrastructure, and its employees a whole new skill set. Another alternative would seem to be online companies, because they don’t have the storefront overhead. But they may have difficulty managing consumer fraud, and are themselves difficult to police, so they may at times evade state caps on interest rates. So far, the rates charged by many Internet lenders seem to be higher, not lower, than those charged by traditional lenders. (Elevate Credit, which says it has a sophisticated, technology-based way of underwriting loans, brags that its loans for the “new middle class” are half the cost of typical payday loans—but it is selective in its lending, and still charges about 200 percent annually.) Promising out-of-the-box ideas, in other words, are in short supply.
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“Alongside our other new rules for payday firms – affordability tests and limits on rollovers and continuous payment authorities – the cap will help drive up standards in a sector that badly needs to improve how it treats its customers.”
ZINMAN: And what we found matching that data on job performance and job readiness supports the Pentagon’s hypothesis. We found that as payday loan access increases, servicemen job performance evaluations decline. And we see that sanctions for severely poor readiness increase as payday-loan access increases, as the spigot gets turned on. So that’s a study that very much supports the anti-payday lending camp.
Consumer Notice: Payday loans are intended for short-term financial needs only, and should not be used excessively. If you have mounting debt or credit troubles, Easy Online Payday Loan suggests you seek the advice of a credit professional.
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Along with reforming payday lending, Cordray is trying to jawbone banks and credit unions into offering small-dollar, payday-like loans. Theoretically, they could use their preexisting branches, mitigating the overhead costs that affect payday stores and hence enabling profitable lending at a much lower rate. This is the holy grail for consumer advocates. “What everyone really wants to see is for it to come into the mainstream of financial services if it’s going to exist at all,” Cox says.
WINCY COLLINS: I advise everyone, “Do not even mess with those people. They are rip-offs.” I wouldn’t dare go back again. I don’t even like walking across the street past it. That’s just how pissed I was, and so hurt.
A report from the Federal Reserve Bank of New York concluded that, “We … test whether payday lending fits our definition of predatory. We find that in states with higher payday loan limits, less educated households and households with uncertain income are less likely to be denied credit, but are not more likely to miss a debt payment. Absent higher delinquency, the extra credit from payday lenders does not fit our definition of predatory.” The caveat to this is that with a term of under 30 days there are no payments, and the lender is more than willing to roll the loan over at the end of the period upon payment of another fee. The report goes on to note that payday loans are extremely expensive, and borrowers who take a payday loan are at a disadvantage in comparison to the lender, a reversal of the normal consumer lending information asymmetry, where the lender must underwrite the loan to assess creditworthiness.