Payday Lending: Do the Costs Justify the Price?

Abstract

The payday advance industry makes small, very short-term consumer loans through an extensive network of storefront shops. Customer demand for this product appears to be very strong, and the industry has grown dramatically over the past decade. Yet many observers view the industry with suspicion. The fees charged on payday advances convert to very high annualized rates of interest (APRs). And the media (and others) circulate anecdotes about payday borrowers who renew their loans frequently and become burdened by the high associated fees. Some analysts claim that the industry could not survive without these chronic troubled borrowers. Yet it is difficult to understand the determinants of the industry's profitability because researchers have had very limited access to micro level data about payday advance firms. Using proprietary store-level data provided by two large payday lenders, we study store costs and profitability. We examine how profitability is related to the borrowing patterns of payday advance customers, default losses, and store characteristics. We also ask how profitability varies with local economic and demographic conditions. We find that fixed operating costs and loan loss rates do justify a large part of the high APRs charged on payday advance loans, and that a store's loan volume is a key determinant of its profitability. However, we do not find that loan renewals or loans from frequent borrowers are more profitable than other loans per se, although they certainly contribute to a store's loan volume. Finally, controlling for loan volume, we also do not find that economic and demographic conditions in the neighborhoods where stores are located have much of an effect on profitability, although they do slightly influence default losses.