Financial Literacy Seminar Series May 16, 2013 - - PowerPoint PPT Presentation

Safe Small-Dollar Loans Research Financial Literacy Seminar Series

May 16, 2013 www.pewtrusts.org/small-loans

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Pew’s Consumer Financial Security Work

Safe Small-Dollar Loans

• pewtrusts.org/small-loans

www.pewtrusts.org/money

• Checking, debit and overdraft
• Prepaid cards
• Credit cards

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Existing Research – Payday Lending

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Motivations | Expectations vs. Reality

• California Department of Corporations (2008): Borrowers use loans

mostly for bills and regular expenses, and are aware of fees.

• CFSI (2012): Borrowers use loans for regular bills. 40% said loan cost

more than expected.

• Morse & Bertrand (2010): Borrowers dramatically underestimate APR,

cost of loan; expect to pay loan back in about a month.

• Lusardi & Scheresberg (working paper): Most high-cost borrowers show

low levels of financial literacy; this is a driver of usage.

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Impact on Well-Being

• Zinman (2008): After Oregon law change, households report worse

financial outlook, increased unemployment.

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

border of a payday state report delaying health care, moving due to financial problems, and more trouble paying bills.

• Bhutta et al (working paper): Compares those narrowly approved to

those narrowly denied a payday loan. Finds that credit scores of both are persistently low, and remain similar for both groups irrespective of whether they are granted a payday loan.

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

payday loans fare better in a budget simulation game than those without, but those who use the loans heavily fare worst. “I'm no better off than I was when I first applied, I'm actually worse off, because I'm deeper in debt than I was when I first started.”

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Pricing & Profitability

• DeYoung & Phillips (FRBKC)(2009): Payday lenders in Colorado

charged the ceiling permitted by law over time.

• Stegman & Faris (2003), DeYoung & Phillips (2009): Payday lenders’

profitability is dependent upon borrowers chronically using loans.

• Stephens, Inc. (2011): Storefront customers only become profitable
• nce they have borrowed four or five times.
• Ernst & Young (2009): Payday lenders earn $1.37 for each $100 lent,

and do not earn excessive returns.

• Avery & Samolyk (draft): Access to credit is not affected by fee caps

(at least as low as $10 per $100), with volume per store lower in higher-cap states and higher in lower-cap states.

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Bounced Checks/Overdraft

• Bretton Woods data analyzed by CRL (2009): States with and w/o

payday loans had similar levels of HH income spent on NSF fees.

• Campbell et al (2008): Counties with access to payday loans had

higher rates of involuntary bank account closures (which are mostly due to excessive overdrafts) than counties without access to payday loans.

• Morgan & Strain (2008): After payday left states, bounced checks

went up in Georgia, but not in North Carolina, compared to other states that still had payday loans.

• Zinman (2008): After Oregon law change resulting in fewer payday

lenders, no significant change in bounced checks relative to Washington. A majority of payday borrowers overdrafted in past year (CFPB, Pew)

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Cycle of Debt Issues

• Parrish & King (2009): 76% of loans are re-borrows within two weeks
• f paying back a previous loan, suggesting most payday demand is

generated by shortfalls caused by previous loans.

• Caskey (2002): Similar findings, but points out plausibility of both

sides’ arguments.

• CFPB (2013): Confirms that long-term borrowing is norm in both

conventional and bank payday. Two-thirds of payday borrowers had 7+ loans in a year (mostly w/in 14 days of previous loan). Bank deposit advance users took out a median of 14 advances over eight pay periods.

• Mayer (2012): Historical evidence that single-repayment loans have

been understood to inherently lead to long periods of indebtedness. Loans with repayment periods that are too short and payments that are too high encourage repeat borrowing, creating an “annuity” for the lender.

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The Fundamentals

(Pew’s July 2012 Report)

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How Payday Loans Work

• Packaged as “short-term” loan for “temporary needs”

– Obtained from storefronts, online, some banks

• Borrower has an income source and checking account

– Writes a check, post-dated for next payday, or gives electronic authorization to debit account

• Short repayment period, tied to borrower pay cycle

– Conventional payday loan is 2 weeks w/ lump-sum repayment. – If borrower cannot pay that, pays fee to renew or borrows again

• Average loan size $375
• Avg. fee per two weeks: $55 store, $95 online, ~$35 bank

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Repeat Borrowing is the Norm

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Administrative data overwhelmingly shows that people use payday loans heavily:

• Avg. borrower in debt five months during year
• 80% borrowers use 3+ loans per year (97% of all loans)
• Loan volume heavily skewed toward frequent borrowers

– 63% of all loans go to people using 12+ per year – More borrowers use 17+ loans per year than just one

• Each year (CRL analysis of Veritec Oklahoma data):

– 13% of loans are borrower’s first that year – 76% are renewals or re-borrows w/in one pay period – 11% are new loans more than one pay period later

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Payday Loan Business Model

• Nearly all loans go to repeat borrowers

– 97% of loans go to those using 3+ per year – 63% of all loans go to people using 12+ per year

• Consecutive usage is the norm

– More than three quarters of loans originated before next pay period

• The business model requires extended or repeat usage
• Similar problems may arise in installment lending variations

– Refinancing (“loan flipping”), add-on fees

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Report: See p.11

Bank Deposit Advance Loans (CFPB Data)

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CFPB Data

• 18% of users or occasional users (median 2 pay periods/yr)

– Account for only 3% of all transactions

• More than half are heavy users (median 10+ pay periods/yr)

– Account for 81% of all transactions – Very heavy users (median 19+ pay periods/yr) – 34% of transactions

The Fundamentals

(Pew’s July 2012 Report)

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Methodology – Pew Survey Research

• First-of-its-kind survey of American payday loan borrowers

– Random Digit Dialing, including cell phones, Spanish, minimum of six attempts per phone number

Two-part survey:

• Omnibus (49,684 total screens)

– Demographic and usage findings based on first 33,576 screens – Margin of error +/-0.2 percentage points

• Follow-up, in-depth survey with 451 to 703 borrowers

– Margin of error +/- 4.2 to 4.6 percentage points

• 10 two-hour borrower focus groups in five cities

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• 1. Who Uses Payday Loans?

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• 1. Who Uses Payday Loans?

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For more information, see Pew July 2012 report at Appendix A

Odds of Borrowing

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The odds of using a payday loan are:

• 57 percent higher for renters than for homeowners
• 62 percent higher for those earning less than $40,000

annually than for those earning more

• 82 percent higher for those with some college education
• r less than for those with a four-year degree or more
• 103 percent higher for those who are separated or

divorced than for those of all other marital statuses (single, living with a partner, married, or widowed)

• 105 percent higher for African Americans than for other

races/ethnicities

• 1. Who Uses Payday Loans?

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• 2. Why Do Borrowers Use Payday Loans?

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• 3. What Would Borrowers Do Without Payday Loans?

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Payday Lending Regulation Is Not Leading to Increased Online Borrowing

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Payday Lending Regulation Is Not Leading to Increased Online Borrowing

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How Borrowers Choose and Repay

(Pew’s February 2013 Report)

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“If you can’t pay that money back when you…agreed to, they let you just pay the interest, and then it gets easier and easier for you to renew that loan, because you’re saying, well, I need to do this with this money, and I can pay this $17.50 or $35 and go ahead on.” —Storefront borrower, Birmingham, AL

Payday loans are unaffordable

Most Use Payday Loans for Recurring Expenses

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Report: See p.10

Renewing is Affordable, But Paying Off is Not

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Only 14% of borrowers can afford

enough out of their monthly budgets to pay off an average storefront payday loan

($375 principal + $55 fee = $430 due in two weeks).

< $430

Report: See p.14

Renewing is Affordable, But Paying Off is Not

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Report: See p.15

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The choice to borrow is driven by perception, and desperation

“You don’t know that it’s going to take you six months when you’re going into it, to pay.” —Online borrower, New York

Most Use Payday Loans for Recurring Expenses

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See Pew’s July 2012 Report

What Are the Options?

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Payday Loan, Cash Advance Home Equity Credit Card Bank / CU / Installment Loan

What Are the Options? Seeking Credit vs. Seeking Ways to Manage Finances

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Payday Loan, Cash Advance Home Equity Credit Card Bank / CU / Installment Loan Budget / Cut Back Delay Paying Bills Family / Friends Sell / Pawn

41%

Payday borrowers

• wn a home

60%

Payday applicants have a credit card

CREDIT OPTIONS OTHER OPTIONS 81% 62% 57% 57%

Payday borrowers who would use these

• ptions if payday

loans did not exist

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So, why do people use unaffordable loans?

Why People Use Unaffordable Loans

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Report: See p.20

Why People Use Unaffordable Loans

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“If you’re that desperate then you almost do any terms.” —Storefront borrower, NH

Report: See p.20-21

– Credit scores ~510 – 4x delinquencies and 3x new inquiries past 12 months

Why People Use Unaffordable Loans

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“I don’t want to prolong it too much, and then it becomes another bill, because that’s essentially what will happen. If I’m paying over six months, it’s just another bill, like I have another extra cable bill or something.” —Online borrower, NY

Report: See p.22

Why People Use Unaffordable Loans

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Report: See p.23-25

Why People Use Unaffordable Loans

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Report: See p.23-25

“Should I pay this whole loan back, or pay the little fee they told me to pay a month? I’m gong to pay them a little money.” —Storefront borrower, IL

Why People Use Unaffordable Loans

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“I think [it’s safe] because they are through the bank and the bank has FDIC insurance.” “Well, they’ve got usury laws, don’t they? I think probably the payday loans aren’t subject to usury laws, but the banks because they’re chartered by the federals, they’ve got a lot of pressure on them to stay within the usury laws.” “For the banks, on the door it says FDIC so you know it’s governed.” “…I was at the ATM actually, and it was there, offering me a direct deposit

• advance. So, I thought I would try it. They did it for me. They put it right on the

ATM where I was at, so I went for it.” —Bank deposit advance borrowers from a San Francisco, CA, focus group

Report: See p.28

Why People Use Unaffordable Loans

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“It could be a little too easy.” —Storefront borrower, IL “It’s contradictory, but it’s like I wouldn’t fall into the trap if I didn’t have the option.” —Online borrower, NY “When I paid them off… they’d send me stuff in the mail, we’ll give you this, we’ll give you this, we’ll give you this, you know, and they’d call me on the phone…. I knew what they were up to, you know, because it was so easy to fall right back into that.” —Storefront borrower, NH

Report: See p.29

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To pay off the loans, many borrowers ultimately turn to the same options they could have used instead of payday loans in the first place

“I finally paid those off, but I would probably still be doing it if it wasn’t for my parents helping out with things.” —Online borrower, Manchester, NH

Paying Off the Loans

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Report: See p.37

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Payday loans do not eliminate overdraft risk

“And even if you tell them the money is not there, guess what? They’re going to put that check through and it’s going to bounce two times before they come back and say, ‘well, can you send us another check?’ So now you have two extra fees on your bank account.” —Storefront borrower, Chicago, IL

Payday Loans Do Not Eliminate Overdraft Risk

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Report: See p.32-35

Payday Loans Do Not Eliminate Overdraft Risk

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Report: See p.32-35

Deposit Advance Loans Do Not Eliminate Overdraft Risk (CFPB Report)

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CFPB Data

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Borrowers feel relief, but they also feel that payday loans take advantage of them

“It can be lifesaving, but, yes, it is a trap that’s hard to get out of.” —Storefront borrower, Birmingham, AL

Loans Take Advantage… But Also Help

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Report: See p.39-44

Borrowers Have Torn Feelings

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Report: See p.42

“Customer Satisfaction”

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“So you feel like when [you] go into a place like that, it’s like Norm from Cheers…. You’re back. I mean, they’re happy to see you, because you’re a regular.” —Storefront borrower, Birmingham, AL

Report: See p.45-46

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Borrowers want changes, and more regulation

By a 2-to-1 Margin: Borrowers Want Changes to the Loans

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Report: See p.47

By Nearly a 3-to-1 Margin: Borrowers Favor More Regulation

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Report: See p.48

Some Are Relieved When Payday Stores Are Gone

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“I’m glad they’re gone. I hope they never come back.” “[Now that payday lenders are gone] you can’t get stuck in it.” “Just keep them out, we don’t need them.” “Because there’s too many little things to worry about, you know. They’re out, leave them

• ut, and you know what I mean? Then you don’t have to worry about it.”

—Former storefront borrowers from a Manchester, NH, focus group (due to a recent law change, payday loan stores are no longer available in NH)

Report: See p.50-51

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Summary and Review

Key Takeaways – Fundamentals

• 12 million borrowers annually

– Average 5 months debt, pays $520 interest on $375 loan

• Using loans to cover regular living expenses

– 7 in 10 loans are for regular expenses like rent or credit card bills – Just 1 in 6 is for an unexpected expense like a car repair

• Borrowers have other options

– Cut expenses, borrow from family/friends, sell/pawn items, delay bills

• Restrictive state laws not driving people online

– Online usage rates same everywhere, even where there are no stores

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Key Takeaways - Choosing and Repaying

• 1. Payday loans are unaffordable
• 2. Choice to use payday loans is driven by unrealistic

expectations, and desperation

• 3. To eventually pay off, 41% of borrowers needed a cash infusion

– Help from friends/family, sell/pawn, other loans, tax refunds….

• 4. Payday loans do not eliminate overdraft risk
• 5. Borrowers feel torn about the experience
• 6. A strong majority of borrowers favor more regulation

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Project Director: Nick Bourke 202.552.2123 nbourke@pewtrusts.org Research Methodology: Alex Horowitz 202.540.6315 ahorowitz@pewtrusts.org

Some Data About Overdraft

Pew’s nationally representative survey of those who experienced overdraft at the POS or ATM

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Almost 1 in 5 Americans Overdrafted At ATM or POS in Past Year

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Source: Pew Safe Checking in the Electronic Age Project, Nationally Representative Survey, 2012

Overdraft

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Overdraft – Usually Charged as Penalty Fees

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Overdraft

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Overdraft

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Overdraft

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