Phantom Demand: Short-term Due Date Generates Need for Repeat Payday Loans

Abstract

State legislatures authorized short-term payday loans at triple-digit rates in the 1990s and early 2000s. Since the start of this authorization, the payday lending industry has grown tremendously, from around 500 locations in 1990 to over 22,000 locations across 35 states today. While this seems to signal a strong need for short-term loans, we hypothesize that a large share of loan volume is merely generated by “churning” borrowers who cannot afford to fully retire their payday loan debt into a new loan each pay period. Therefore, our analysis seeks to determine what share of total payday loan volume is a result of borrowers being unable to repay one loan without taking a new loan during a two-week period, a proxy for the same pay period. Finally, we determine the financial impact of this loan churning to borrowers by estimating the fees paid to service these loans.Using detailed regulator data form Florida and Oklahoma that tracks the number of days between successive loans made to the same borrower, we find that a large majority of payday loans are originated shortly after a previous loan is paid back, with half of new loans opened at the borrower’s first opportunity and 87 percent of new loans opened within a two week or less pause in borrowing. Using this information to estimate the share of total loan volume, we find that this “churning” of borrowers from one paycheck to the next accounts for three-quarters of total loan volume annually and resulting in the generation of $3.5 billion in fees.We largely attribute this pattern of churning borrowers from one loan to the next with the requirement that a payday loan be paid off, in its entirety, with a single paycheck. A low- to moderate-income household is unlikely to have enough money left over after repaying the payday loan to meet their basic obligations without another infusion of payday loan credit.