Let the Borrower Beware: Towards a Framework for Debiasing Rollover Behavior in the Payday Loan Industry

Abstract

Each year, millions of Americans take out payday loans, marketed as short-term bridge loans until their next payday. Characterized by triple-digit annual percentage rates (APRs) and mandatory balloon payments, many consumers default of their loans, forcing them to repeatedly extend, or rollover their initial loan. This process is repeated until the borrower is able to repay the principal and accumulated fees. This article offers a behavioural analysis of the propensity of consumers to rollover payday loans. Cognitive biases taken from the behavioural economics literature are employed to explain why consumers are likely to rollover high-interest payday loans and how lenders capitalize off of a consumer’s biased decision-making. Namely, biases dealing with optimism, imperfect self-control, status quo, and hyperbolic discounting are discussed in the context of payday loan borrowing. Fischoff’s (1981) debiasing framework is employed to inform policy interventions geared towards payday lenders which could result in optimal decision-making for borrowers.