By David Morrison May 19, 2014
DETROIT – Payday loans paid off in installments rather in one lump sum are significantly less expensive for consumers, carry less rollover for borrowers, and result in a smaller payday loan industry, according to a researcher with the Pew Charitable Trusts.
Alex Horowitz, research manager for small dollar loans at the organization, shared some of the research he had conducted into payday lending, lenders and their customers with attendees of the National Inclusiv of Community Development Credit Union's 40th annual conference on May 16 in Detroit.
Horowitz said payday loan customers often have accounts at banks or credit unions and have incomes of, on average, $30,000 per year. But he also noted that, contrary to the assertions of the payday lenders, more than half of people taking out payday loans were taking them out to cover monthly expenses.
“Fully 58% of the customers of payday lenders that we surveyed reported they had trouble making monthly bills and that they used payday loans to help cover those gaps,” Horowitz said. “Only 42% of borrowers said they took out the loans because of one time, surprise expense and that they are able to meet their monthly expenses regularly.”
He also noted that, on average, the lump sum payday payment took 36% of the borrower's next paycheck, a percentage which was far too high and which led to re-borrowing most of the time.
By contrast, Horowitz said, Pew research has shown that most borrowers cannot afford to repay more than 5% of their paycheck at a time for their short-term loans, on average about $55 per payment.
“The standard the payday loan industry is using is one of ability to collect,” Horowitz said, “not ability to repay. There is a significant difference.”
An ability-to-collect standard only verifies that there is an existing bank account and an existing source of funds and does not consider the impact of repayment on a borrower's other financial obligations. An ability-to-repay standard requires underwriting a loan to verify a borrower should be able to meet their loan payments in light of other financial obligations.
This results in an industry which exists on repeat borrowing, he said, adding that 97% of payday loans go to borrowers who take out at least three per year and 63% go to borrowers who take out at least 12 loans per year.
Horowitz also cited payday loan industry data which acknowledged that a borrower has to take four to five loans before he or she is profitable for a payday lender and that most borrowers are in debt to a payday lender five months of the year, paying $520 to borrow $375.
Rollover borrowers carry their importance to payday lenders because the greatest payday lending expense is not loan losses but overhead, Horowitz said.
This fact played a role in what happened in Colorado after 2010 when that state passed a law which mandated installment payments on payday loans and not lump sum payments, Horowitz explained.
First, the average payment on a payday loan, on a per payment basis, dropped from $429 to $47, a plunge of 89%, he reported. This meant the average borrower went from spending $476 on an annual basis for a payday loan, to $277. It also meant that the share of a subsequent loan payment on a borrower's paycheck dropped from 38% to 4% and that the percentage of borrowers who had to re-borrow the same day they made a payment dropped by 51%. Previous to the change, 61% of payday loan borrowers in Colorado had to re-borrow the same day they paid off a previous loan, afterward only 30% did.
The result, Horowitz said, was a payday loan industry without about half the number of stores than it had before (238 vs 505), but with remaining stores serving about double the number of borrowers per year.
“This change did not wipe the industry out nor did it remove access to the loans for borrowers who needed them,” Horowitz said. “What it did was make the loans affordable enough that they could become more like the loan the industry claimed they were: short-term, small loans to help borrowers with an urgent need for cash.”