Publication Date

May 2015

Author(s)

Allison Freeman, Lucy Gorham

Client/Funder

Center for Responsible Lending

It is clear that those who use payday loans need access to short-term, small-dollar credit. With growing wage and income inequality and in the absence of living-wage jobs, people are bound to continue to need short-term, small-dollar loans to smooth consumption as unexpected expenses and unanticipated drops in income arise. The question going forward is not whether short-term consumer credit should be allowed, but rather how it might best be structured to minimize harm and maximize benefit to consumers and still generate a reasonable return for the institutions that offer it.

In advance of the Consumer Financial Protection Bureau’s beginning rulemaking on short-term, small-dollar consumer loans, the Center for Responsible Lending contacted the UNC Center for Community Capital to request a review of the academic literature on the costs and benefits of payday lending. The literature review has two main elements: 1) an examination of the articles claiming that payday loans harm or benefit consumers; and 2) an examination of the literature overall, including its limitations and shortcomings.

The literature on payday lending implies that use of short-term, high-interest-rate consumer credit might have any number of negative effects on borrowers’ lives. Suggested negative outcomes include: poor job performance, foreclosure, forced moving, foregoing or curtailing necessary expenditures (for food, health care, etc.), aggravating indebtedness, difficulty in servicing overall debt, bankruptcy, and an indirect negative effect on credit score.

Researchers also suggest a number of positive outcomes from payday borrowing, including avoidance of more expensive substitutes (bounced checks, for example), avoidance of job loss, avoidance of bank account closure, avoidance of complaints against lenders and debt collectors, avoidance of property crimes, avoidance of landlord-tenant disputes, and improvement in credit scores. It is interesting to note that only the last item in this list is a true “benefit” (though, as the Center for Responsible Lending’s analysis of Mann (2014) and Priestley (2014) makes clear, the jury is still well out on the relationship between payday borrowing and credit score improvements). All of the other “perks” of payday lending are really the avoidance of other bad things, and most of those things stem from people not having sufficient money in their lives.

It is clear that those who use payday loans need access to short-term, small-dollar credit. With growing wage and income inequality and in the absence of living-wage jobs, people are bound to continue to need short-term, small-dollar loans to smooth consumption as unexpected expenses and unanticipated drops in income arise. The question going forward is not whether short-term consumer credit should be allowed, but rather how it might best be structured to minimize harm and maximize benefit to consumers and still generate a reasonable return for the institutions that offer it.