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The Payday Lending Trap

The Center for Responsible Lending released a report yesterday verifying for the first time what many have suspected about the payday lending industry. It often “traps” borrowers in a cycle of borrowing in order to be able to pay off their first (or second, or third) loan and still be able to cover their expenses before their next paycheck.

Payday loans are marketed as a convenient, lower-cost alternative to bouncing a check, paying service charges for a returned check, or piling up fees due to late bill payments. The estimated 19 million people who take out a payday loan in the United States each year typically only need to prove that they have a reliable source of income and a checking account in order to be approved for their loan.

As CRL points out, however, lenders generate volume and profit by requiring loans to be paid in full by the next payday and charging nearly $60 in fees for the average $350 loan. These terms essentially guarantee that “low-income customers will experience a shortfall before their next paycheck and need to come right back in the store to take a new loan.”

In fact, the Center for Responsible Lending finds that 76 percent of payday loans are made because of “churning,” or when a borrower needs to take out a new payday loan every pay period to cover their expenses and the amount they owe on their previous loan.

Earlier this year, the Center for American Progress published a report that also offered first-of-its-kind analysis of payday loan borrowers using new data from the 2007 Survey of Consumer Finances. Our report found that families who had taken out a payday loan within the past year:

  • Tend to have less income, lower wealth, fewer assets, and less debt than families without payday loans.
  • Were more likely to have heads of households who were minorities and single women than their counterparts.
  • Were more likely to have heads of households who were younger and had less education.
  • Were less likely to own their own home or identify themselves as savers than families who did not withdraw a payday loan.

Because payday loans are accompanied by such high fees—often amounting to a 400-percent annual percentage rate—the use of such loans may impede the wealth creation for borrowers who have less wealth to begin with. Given the large growth in payday lending transactions and high frequency of “churning,” payday lending practices and regulations deserve the close scrutiny of policymakers.

Some states have already implemented tight regulations or even outlawed payday lending and two bills have been introduced in Congress that would cap the annual interest rate that can be applied to payday loans. Importantly, restrictions on payday loans should be “balanced with more savings opportunities and other, lower-cost credit opportunities for families who currently rely on payday loans.” Learning more about the particulars of payday loan borrowers, lenders, and the costs of such loans is an important step in curbing their use and developing better alternatives for these borrowers to turn to.

Amanda Logan is a Research Associate with the economy team at the Center for American Progress and co-author along with CAP Senior Fellow Christian E. Weller of the Center’s report “Who Borrowers from Payday Lenders?" To learn more about the Center’s consumer credit policy recommendations please go to the Credit and Debt page of our website.