Payday Mayday: Visible and Invisible Payday Lending Defaults

Abstract

This paper uses two data sources to examine two indicators of distress in the payday lending context, both of which carry both immediate and cascading financial consequences for the borrower. The first is what we term a “visible default” — a default that is visible to both the borrower and the payday lender because the borrower fails to make a payment on the loan and the check or electronic payment that secures the loan bounces. The visible default rate should be considered a conservative measure of financial distress, however, as the borrower’s financial institution may allow a payment to go through even when there are insufficient funds in the account, charging an overdraft fee for doing so. As a result, this paper examines a second source of borrower distress, which occurs when the payment to the payday lender goes through because the bank covers it with an overdraft. We call this an “invisible default.”Key findings of our paper include: 1. Nearly half of all payday borrowers defaulted within two years of their first loan; 2. Of borrowers who defaulted, nearly half did so within the first two payday loans. 3.Default does not necessarily signal the end of payday borrowing, with many defaulters going on to repay their loan and even borrow (and possibly default) again at a later date. 4. Nearly one in five borrowers had a loan charged off by the lender. 5. One-third of payday borrowers experienced at least one invisible default in which their account was overdrawn on the same day that they made a payment to a payday lender. 6. For payday borrowers, overdrafts and bounced transactions frequently occurred close in time to the use of payday loans. Nearly half of payday borrowers incurred an overdraft or NSF fee in the two weeks after a payday loan transaction, and 64% paid overdraft or NSF fees at some point.