No conscensus has been reached on whether access to these high-cost, short-term balloon loans makes consumers better off or worse. Advocates point to cases where payday loans appear to be a customer’s best option. For instance, if unexpected medical expenses leave a family short on money to pay utilities, a payday loan may be preferable to an electricity shutoff and eventual reconnect fee. Alternative sources of funds may be unavailable in the case of emergency (for instance, credit cards may be maxed out) or more expensive than payday loans (as are overdraft fees at many banks).
However, opponents of payday lending point out that customers rarely report borrowing in response to such emergency situations. Pew Charitable Trusts (2012) finds that only 16% of payday customers took out their initial loan in response to an unexpected expense, while 69% reported borrowing to cover a recurring expense such as rent or groceries. In addition, though they are marketed as short-term loans designed to deal with transitory shocks, a significant fraction of customers use payday loans repeatedly. 1 Such repeat borrowing fuels the claim that payday loans can trap borrowers in cycles of debt. Research such as Parrish and King (2009), Melzer (2011, and Carrell and Zinman (2013) suggests that the damage caused by such debt cycles outweighs the benefits of access.
For this reason it may be productive to ask not whether payday lending is good or bad on net, but instead which type of payday lending would be best
Given the continued debate over its merits and the long history of high-cost, short-term loans aimed at credit-compromised customers (Caskey, 1996) it seems likely that payday lending, or something similar to it, will remain a feature of the credit landscape for the forseeable future.
Both sides of the debate tend to treat “payday lending” as a monolithic entity, but in practice it is a pastiche of practices shaped by a diverse set of state laws. States have approached payday lending with a variety of regulatory strategies including price caps, size caps, prohibitions on repeat borrowing, prohibitions on simultaneous borrowing, “cooling-off” periods, mandates to provide amortizing alternatives, and many combinations thereof. Some of these forms of regulation may create payday loans that lead to better outcomes than others. Though a few papers, notably Avery and Samolyk (2011), have attempted to compare regulations of differing strengths (in the case of Avery and Samolyk (2011), higher price caps versus lower ones), efforts to distinguish among regulatory strategies have so far been limited.
Research such as Morgan and Strain (2008), Elliehausen (2009), Fusaro and Cirillo (2011), and Morse (2011) has supported the notion that access to payday lending is welfare-enhancing
This paper breaks down the monolith of payday lending in order to judge the relative merits of lending under different regulatory regimes. It uses a novel institutional dataset covering all loans originated by a single large payday lender between , in 26 of the 36 states in which payday lending is allowed–a total of over 56 million loans. Unlike previous payday datasets, the depth and breadth of these data span a variety of regulatory environments, making it possible to estimate of the effects of a variety of regulatory approaches.
However, the data are also limited in some ways. Most importantly, customer activity outside of payday borrowing is unobserved, making it impossible to estimate effects on overall financial health. Second, because the data come from a single lender one cannot credibly estimate the effect of state laws on total lending volume. For these reasons this paper focuses on loan terms and usage-based outcomes. In particular, it focuses on customers’ propensity to borrow repeatedly. Whatever their other views, payday lending’s supporters and detractors often tend to agree that very persistent indebtedness is undersirable and indicative of counterproductive use, making repeat borrowing a useful object of study.