Can Banks Help Consumers Trapped In Vicious Cycle Of Payday Loans?

12 million Americans get a payday loan every year, racking up $7.4 billion annually in expensive debt. According to a study from Pew Charitable Trusts, the average payday loan is $375, although most borrowers end up indebted for five months and have to cough up $520. Can banks and credit unions help consumers escape the payday lending trap?
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Who Uses Payday Loans?

Pew’s study found that most payday loan borrowers are white, most are female, and most are 25 to 44 years old. However, after controlling for other characteristics, there are five groups that have higher odds of having used a payday loan: home renters, those earning below $40,000 annually, those without a four-year college degree, those who are separated or divorced, and African Americans.

Among employed payday loan borrowers, 20% have multiple jobs, and several borrowers explained that a second job was critical to allow them to meet basic expenses. Others with one job were dependent on the income of another household member and said the loss of a second household income would leave them unable to pay regular bills. Previous research has found that 25% of small-dollar loan borrowers reported a loss of income, such as a job loss or reduction in hours, as a reason for a shortage of funds.

Ironically, payday borrowers are very familiar with traditional sources of credit, and are not eager to take on more debt.

Reality Check: Proponents of payday lending love to talk about overdrafts as the primary alternative to a payday loan. Borrowers instead mostly describe their alternatives as taking on long-term debt, cutting back on expenses, or borrowing from family or friends. But even within this narrow range of options, it is nearly impossible to comparison shop, because a payday loan’s ultimate cost and duration are vastly different from the stated loan terms.

No Way Out

“You don’t know that it’s going to take you six months when you’re going into it, to pay.”
— Payday Borrower, New York

Most payday borrowers are dealing with persistent cash shortfalls. 58% of payday loan borrowers have trouble meeting monthly expenses at least half the time, one-third say they have trouble meeting their bills most of the time.

69% of payday borrowers report using their initial payday loan to meet a recurring expense, while only 16% said it was for an unexpected emergency.

Four in five borrowers use three or more loans per year and account for 97% of all loans. More than 60% of all loans go to people using 12 or more loans per year. 76% of loans are renewals or quick re-borrows.

Only 14% of borrowers say they can afford to repay an average payday loan out of their monthly budgets. The average borrower can afford to pay $50 per two weeks to a payday lender, but that amount only covers the cost to renew the loan for another two weeks. This is why most borrowers renew or re-borrow rather than repay their loans in full — 76% of loans are renewals or quick re-borrows.

As one payday borrower in Pew’s study puts it: “When Friday comes around, you have to give them your paycheck — what you owed them — which cleared off the first loan, but now you have nothing, so you have to re-borrow to survive the week or two weeks.”

In other words: Renewing a payday loan is affordable, but paying it off is not.

“It’s really basic,” explains another payday borrower in Pew’s study. “If you’re taking out $300 and they’re charging you $90, you pay $390. If you do not pay it back in two weeks, you’re paying $90 out of your check every two weeks until you pay the full amount.”

Some borrowers ultimately turn to the same options they could have used instead of payday loans to finally pay off the loans. 41% need an infusion of cash from the outside to eliminate payday loan debt, including getting help from friends or family, selling or pawning personal possessions, taking out another type of loan, or using a tax refund.

Why Do People Borrow When They Can’t Afford to Repay?

The choice to use payday loans is largely driven by unrealistic expectations and by desperation. Borrowers perceive the loans to be a reasonable short-term choice but express surprise and frustration at how long it takes to pay them back. 78% of borrowers rely on information provided by the lenders themselves, who are selling these loans as a “safe, two-week product.”

Key Fact: 37% of borrowers say they would have taken a payday loan on any terms offered.

Consumers aren’t totally clueless. They know how the game is played. 86% say the terms and conditions on payday loans are clear.

What Are Bank Deposit Advance Loans, And Are They Any Better?

A deposit advance loan is a payday loan for up to $500 that some banks offer to customers who have direct deposit. The structure mimics a conventional payday loan, with the entire loan plus interest due on the borrower’s next payday. The cost — $7.50 to $10 per $100 per pay period, resulting in APRs of 196% to 261% for a 14-day loan — is lower than that of a typical storefront loan ($10 to $20 per $100 per pay period, or 261% to 521% APR). The loans are secured by the customer’s next direct deposit, and the bank repays itself immediately when that deposit is received. Depending on the bank, the loans may be advertised in branches, by direct mail, through email, at ATMs, or on a bank’s website.

Previous research indicates that although bank deposit advances are advertised as two-week products, average customers end up indebted for nearly half the year, similar to the experience of payday loan customers borrowing from storefronts. In Pew’s focus groups, bank deposit advance borrowers explained that, once the bank has withdrawn the full amount plus interest, they frequently cannot meet their expenses and, like store- front and online payday borrowers, must re-borrow the loan amount.

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Other Alternatives to Payday Loans

Although a large portion of payday loan applicants have credit cards, many have exhausted their limits. Pew’s survey found that 2 in 5 payday borrowers used a credit card in the past year, and most had “maxed out” their credit at some point during the same period.

Among payday borrowers who do not have a credit card, nearly half do not want one, and almost as many have been turned down or expect they would be turned down if they tried to get one.

Some consumers mistakenly believe payday loans are a better, more affordable option than credit cards. For example, one payday borrower told Pew that a credit card’s APR of 23.99% would cost more per month than a payday loan (which in his state costs $17.50 per $100 borrowed, or 17.5% every two weeks).

Most payday borrowers are also getting stung by overdrafts on their checking accounts. More than half of payday loan borrowers report having overdrafted their accounts in the past year, and 27% report that a payday lender making a withdrawal from their bank account caused an overdraft. 46% of consumers using online payday lenders say they have incurred overdrafts that the lender triggered.

38% of payday loan borrowers report having used a prepaid debit card in the past year, triple the rate at which the general population uses these products.ii Prepaid cards are often advertised as a way to avoid checking account overdraft fees and credit card debt, perhaps explaining their appeal to payday loan users, who are eager to avoid both of these.

Consumer Hold Unhealthy Views on Payday Lending

Borrowers hold unrealistic expectations about payday loans. In focus groups, people described struggling to accommodate two competing desires: to get fast cash and to avoid taking on more debt. They cited the “short-term” aspect of payday loans as a reason for their appeal and described how a payday
loan appeared to be something that could provide needed cash, for a manageable fixed fee, without creating another ongoing obligation. They were already in debt and struggling with regular expenses, and a payday loan seemed like a way to get a cash infusion without creating an additional bill. Despite this appeal, the reality is that the average borrower ends up indebted to the payday lender for five months of the year.

Lenders benefit from this misperception, because they rely on borrowers to use the loans for an extended period of time. Prior research shows that the payday loan business model requires repeat usage in order to be profitable.

A majority of borrowers say the loans simultaneously take advantage of them and provide relief. Despite feeling conflicted about their experiences, borrowers want to change how payday loans work. By almost a three-to-one margin, borrowers say they favor more regulation of payday loans.

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