Amanda Logan on Payday Lending

What are payday loans and why do people use them?

A payday loan is a small loan, usually between 300 and 500 dollars, that a borrower takes out for a short term, usually around two weeks, or until their next payday. While the fees associated with this loan may sound small, varying by state, but on average about 16 dollars for a 100 dollar loan, they can turn into an annual percentage rate of 400 percent for a loan, meaning that in the long run a borrower can end paying a lot more than they originally anticipated if they wind up having to take out another loan, or renew their loan, or roll over the loan, as is the case for many borrowers who find that they donŐt have enough money to cover their expenses and pay off the loan when the loan is due. People borrow payday loans because they are a convenient option. You usually only have to provide proof of an income and ID and a checking account in order to qualify, and they use these loans to cover expenses associated with emergencies or even basic consumption needs such as food and gas. Interestingly, only a small percentage of payday loan borrowers say that they borrow from these lenders because itŐs the only option available to them.

Who borrows from payday lenders?

Using data from the 2007 survey of consumer finances, which for the first time asked respondents whether they had borrowed from a payday lender, we found that families that had taken out a payday loan tended to have lower levels of income, lower wealth levels, lower assets, and lower debt levels. We also found that the heads of households who borrowed from a payday lender tended to be younger, have lower levels of educational attainment, be more likely to be a minority, and were also more likely to be headed by single women. Additionally, we found that roughly four out of 10 families who borrowed from a payday lender owned their own home as compared to seven out of 10 families who did not borrow from a payday lender.

Why are policymakers focused on these loans in particular?

Policymakers and issue organizations are concerned about the use of payday loans because of the high costs that can be associated with them. Additionally, the FDIC has pointed out that when used on a long-term basis, which can be the case for some families who find themselves falling into a cycle of borrowing, these loans can ultimately cost the family a lot more than they originally anticipated and put them in a hard financial position. Some states have already taken the steps and enacted legislation that effectively outlaws such high, sometimes triple-digit, percentage rates on these types of loans. Additionally, there have been several proposals, including a bill put forth by Senator Durbin, to cap the national interest rate charged to consumer loans at 36 percent.