Small-Dollar Loans Products and Policies for Alternative Credit - - PowerPoint PPT Presentation

Small-Dollar Loans

Products and Policies for Alternative Credit

Nick Bourke November 7, 2012

The Pew Charitable Trusts

www.pewtrusts.org/small-loans

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Safe Small‐Dollar Loans

• pewtrusts.org/small‐loans

Other Consumer Financial Security Projects at Pew:

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

Agenda

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• Brief overview of existing payday loan research
• Payday loan market: Who borrows, where, and why
• Borrower choices and the decision to borrow
• Online payday lending & the impacts of regulation
• Policy Considerations
• Q & A

How Payday and Deposit Advance Loans Work

• Borrower has an income source and checking account

– Post‐dated check or electronic authorization to debit account

• Lump‐sum repayment (usually, entire loan due in 2 weeks)

– If cannot repay entire loan, pays fee to renew or borrows again – Some variations exist, e.g. VA requires min term of 2 pay cycles

• Fees range by state law and product channel

– $10 per $100 (261% APR) to $20 per $100 (521% APR) in storefronts – $25 per $100 online (652% APR) – Some variation for bank Deposit Advance Products (DAPs)

www.pewtrusts.org/small-loans

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Existing Research – Payday Lending

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Bounced Checks/Overdraft

• Bretton Woods data analyzed by Center for Responsible Lending

(2009): States with and without payday loans had similar levels of household 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 said they overdrafted in past year

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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 (forthcoming): 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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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 (b/c bills due before

paycheck or consistently more than income, or unexpected expense

• r drop in income). 40% said loan cost more than expected.
• Elliehausen & Lawrence (2001); also Cypress (2004): Borrowers aware
• f fees, but not APR.
• Morse & Bertrand (2010): Borrowers dramatically underestimate APR,

cost of over three months, expect to pay loan back in about a month.

• Mann (forthcoming): Comparing survey responses to lender data, may

find closer correlation between borrower expectations and actual length of repayment???

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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 (forthcoming): 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.

• Avg. payday loan is $375. Avg. fee is $55 (storefront) or $95 (online)

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Debt Trap 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.

• Fusaro & Cirillo (2011): Randomly assign borrowers to either

regularly‐priced or free payday loans. Both groups need 8 loans (7 renewals/re‐borrows) to retire debt. Authors interpret this as high interest rates not causing cycle of debt.

• 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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Repeat Borrowing

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Administrative data overwhelmingly shows that people use payday loans heavily :

• Average borrower in debt five months during year.
• 80% of borrowers use 3+ loans per year (97% of all loans).
• 63% of all loans go to people using 12+ per year.
• More borrowers use 17+ loans per year than just one.
• Each year (CRL):

– 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 Lending: Who Borrows, Where They Borrow and Why + Effects of Regulation

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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 survey with 451 storefront payday borrowers

– Margin of error +/‐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 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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• 1. Who Uses Payday Loans?

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• 2. Why Do Borrowers Use Payday Loans?

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“Thinking back now to (that FIRST / the) time you took out a payday loan, which of the following best describes what specifically you needed the money for?

Packaging vs. Experience

Average Borrower: 8 loans per year $375 loan, $520 in fees ($895 total paid) Indebted five months during the year

• Short‐term loan
• To cover small, often unexpected expenses
• Designed to solve temporary cash‐flow problems
• Not intended for long‐term use

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• 2. Why Do Borrowers Use Payday Loans?

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How did you find out about bank deposit advances? “I found out about it because when you do the online banking there is this thing, I hadn’t heard about it, and it just says that I can do a direct deposit advance. And I clicked on it, like ‘Oh! Really?’ And then, well, it’s very quick and easy….”

Borrowers of Bank Payday Loans

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How do you know if deposit advances from banks are safe?

“I think so because they are through the bank and the bank is FDIC Insurance. I don’t know. I am just assuming that. I would assume so.” “Well they 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 federals, they got a lot of pressure on them to stay within the usury laws.” “Yes, government pressure about usury laws or something like that whereas payday loans are probably not regulated strongly.” “For the banks, on the door it says FDIC so you know it’s governed.”

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• 3. What Would Borrowers Do Without Payday Loans?

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… and maybe savings?

Alternative Forms of Credit

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And now what do you do for credit?

“My direct deposit now goes to the credit union because it’s just a better deal…. [T]hey ask me if I want to pay $100.00 in increments or pay $50.00 increments, do I want to pay in three months…. I can stretch it out for five

• months. I can pay $50.00 a month, for five months. Or $100.00 a month for

two months. I get to choose how I wanted to pay it back. How

much I wanted to pay, so it was a whole lot better.”

The Importance of Having Options

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Credit Options

Mortgage / HELOC

Credit Card Payday, Auto Title Loan

Alt. Installment etc.

X X ?

Options… for Credit

Non‐Credit Options

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Credit Options

Mortgage / HELOC

Credit Card Payday, Auto Title Loan

Alt. Installment etc.

57% Percentage of payday borrowers who would use these options if payday loans did not exist 57% 62% 81%

A small market – not well understood

60%

Payday applicants have a credit card – nearly all maxed out

41%

Payday borrowers

• wn a home

12 Million

Americans use payday loans each year, paying $7.4 billion in finance charges

Family / Friends Delay Paying Bills Budget / Cut Back Sell / Pawn

Options… for Managing Finances

Use Savings?

What is the Payday Loan Experience Like?

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Not Short‐Term

What is the Payday Loan Experience Like?

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Customer service drives good feeling

“They always…speak to you by first name and say, hello, how you doing when you first come in the store, and they’re good with remembering your name and your face.”

Fast relief, but…

“I do like payday loans… (but) they do take advantage because, you know, they do know that you need the money, and they know that they got you.”

Convenient / Accessible

– Top two factors: How quickly, whether I can qualify – About 80% of first‐time applicants approved

How Do Borrowers Repay?

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“That’s what happens: You wind up short the next, the following week, so you have to do it again…. I just was short for a while. Then I finally caught up on my own without doing that. I went to the pawn shop with one thing. Sometimes I’d find things at the flea market that I could take to pawn shops and I could sell them. I would see an antique at a flea market, and I could take it to an antique shop. I do things like that if I can.”

How Do Borrowers Repay?

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• Timely payment – but frequent renewal / quick re‐borrow

– Can afford the $50+ renewal fee – Generally cannot afford the $400+ lump sum repayment – Helps explain why payday loss rates are low (3 percent), and re‐borrow rates are high (76% of loans renewals or quick re‐borrows)

• To eliminate payday loan debt, many borrowers turn to the same
• ptions they originally chose not to use:

– Help from family / friends, sell or pawn possessions, delay paying some bills, and change budgets / cut expenses. Savings?

• Use windfall such as a tax refund

Outcomes – Help or Harm?

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Data shows that for perhaps 1 in 5 borrowers, there is some time shifting / consumption smoothing occurring. …But they represent only 3% of loan volume. What about the 4 in 5 who use 3+ loans annually / 97% of volume? Or the subgroup who use 12+ loans annually / 63% of volume?

• Credit scores remain tarnished, overdrafts continue
• Average 5 months in debt, $520 in finance charges per year
• Often turn to other options anyway

So Why Do People Choose to Use Payday Loans?

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Why – The Underlying Need

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• Persistently weak credit profiles,

permanent cash‐flow shortfalls

• Not simply responding to short‐term

shocks

Why – The Choice to Borrow

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Non‐Credit Options Credit Options

Mortgage / HELOC

Credit Card Payday, Auto Title Loan

Alt. Installment etc.

Family / Friends Delay Paying Bills Budget / Cut Back Sell / Pawn

Why – The Choice to Borrow: Possible Frameworks

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• Desperation

– Credit scores ~510, 4x delinquencies and 3x new inquiries past 12 months – About 1/3 of borrowers would accept a loan on any terms

• Reliance on the lender

– Packaging suggests the loan will be short‐term and affordable – Comfortable customer service relationships

• Perception

– Payday / DAP / SDC is “not another bill” – Focus on the fee, rather than the whole repayment – Confusion (e.g. 15% payday loan fee vs. 15% APR)

What About Overdraft?

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• Median bank overdraft fee is $35

– APRs of 5,000 percent or more!

• But:

– Overdraft is not an alternative option, – Nor a replacement for other options

Overdraft Activity – 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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Overdraft Is Not “Alternative Credit”

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Median bank fee is $35

• APRs of 5,000 percent or more!

But:

• Overdrafting generally is done by mistake

– Intentional use of overdraft as credit is rare

And Besides:

• Most payday borrowers also overdraft anyway

Overdraft is a function of tight budgets, limited information and lender policies. It is not an “alternative choice”

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Where Do Borrowers Get Payday Loans?

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Payday Lending Regulation Is Not Leading to Increased Online Borrowing

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• Permissive states are the least

regulated and allow initial fees

• f 15 percent of the borrowed

principal or higher

• Hybrid states have relatively

more exacting requirements than permissive states

• Restrictive states either do not

permit payday lending or have price caps low enough to eliminate payday lending in the state

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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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Many Reject Online as an Alternative

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Key Concerns with Online Payday Lending

• Dissemination of personal information

– “. . . I want to know how they got all my information. I mean, these loan companies are supposed to have some type of security . . . .”

• Harassment or fraud

– “They had all my information . . . my routing, my numbers, my banking account, my e‐mail address, my job. It . . . was like the biggest mistake . . . [Y]esterday I had 15 missed calls from Officer John Marshall. He called me from five different numbers, a 911 emergency number. I was frantic. I thought something happened to my wife and kids, and it was Officer John Marshall. He called me from a 718 number, a 616

• number. He's telling me why are you ignoring my phone calls? You can't run away

from this.”

• Withdrawals and obstacles to repayment

– “[T]hey tell you the only way that you can pay an additional principal is to go online but they can't send me the website, they don't know how I can log in, they don't have any information.”

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Payday Lending Regulation Is Not Leading to Increased Online Borrowing

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Key Takeaways & Policy Considerations

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Key Takeaways

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• Payday loan usage is across the demographic spectrum
• Payday loans are for ordinary living expenses – not

unexpected emergencies

• Packaging diverges widely from actual consumer experience
• “Options” include non‐credit as well as credit choices

– Payday loans often fail as a substitute for non‐credit / overdraft – Choice to borrow: A function of desperation, reliance, perception?

• State laws that restrict payday lending have an impact

– Borrowers not being driven online (it’s not seen as a substitute) – Hybrid policies not decreasing usage, but are decreasing cost

A Few Policy Considerations

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Task is to eliminate harms and pave the way for a functional small‐dollar loan marketplace

• Consumer Financial Protection Bureau

– Authorized to regulate Unfair, Deceptive or Abusive Acts or Practices in the payday lending market. But not “rate caps.”

• OCC, FDIC, FTC remain important – especially for bank

Deposit Advance Products (DAP)

• State law continues to matter

– States have the power to influence cost, usage – Online is a particular challenge, but some strategies exist

Additional Online Resources

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Quiz Report & Exec Sum State Data Interactive Collected Resources Summary Infographic

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www.pewtrusts.org/small-loans

Media: Samantha Lasky 202.540.6390 slasky@pewtrusts.org Project Director: Nick Bourke 202.552.2123 nbourke@pewtrusts.org Research Methodology: Alex Horowitz 202.540.6315 ahorowitz@pewtrusts.org

Online Borrowers Are Different

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And are less likely:

• To be retired
• To be disabled
• To be 60 years of age or older

Online borrowers are more likely:

• To earn $50,000 or more
• To have a college degree
• To be 18‐39