Payday loans are making headlines again. A new study by the Pew Charitable Trusts mentions the plight of payday borrowers whose repayments lead to checking account overdrafts and a compounding of fees and charges.
A New York Times article has noted that major banks have played a role in the growth of internet payday lending by enabling lenders to make automatic withdrawals from borrowers’ accounts. Bank of America, Wells Fargo, and JP Morgan Chase are among those involved, reaping overdraft charges even in states where payday lending is banned and even after borrowers—wanting to repay their loans to avoid an automatic rollover—have requested that withdrawals be stopped.
While payday loans are a particularly egregious form of predatory lending, with APRs exceeding 500 percent, they’re not the most widely used form of nonbank credit. That distinction falls to pawnshop loans. According to FDIC’s June 2011 survey, 3.5 million U.S. households used pawnshop loans within the past 12 months. In comparison, an estimated 2.1 million households took out payday loans. The number of American households that have ever used a pawnshop loan is 9.0 million, compared with 5.6 million for payday loans. Both of these numbers are increasing by about 15–20 percent annually.
Payday lenders have increasingly shifted their marketing to web-based products, as states have imposed outright bans and other restrictions. Although this has boosted the growth in payday lending, the take-up of these loans is limited by the requirement that borrowers be employed and have a bank account.
In contrast, even the unbanked (those without bank accounts) can use pawnshop loans for small-dollar credit. These are short-term loans for which property items such as jewelry or home electronics equipment serve as collateral. The loan term is usually one month and the amount normally less than $100. The customer who repays the loan (including interest and fees) reclaims their pawned item. Those unable to repay must forfeit their item, which the pawnbroker can then sell. The customer also has the option of renewing the loan.
Storefront pawnbrokers have been popularized by television series such as “Pawn Stars” and “Hardcore Pawn.” As with payday lending, pawnshop loans are increasingly transacted through the internet, including through eBay.
What we’re learning from recent surveys of nonbank credit users is that these consumers engage in the serial, myopic use of multiple credit sources—all too often, in a stressed-out search to meet recurring basic spending needs, not isolated emergency expenses. This is the picture that emerges from No Slack: The Financial Lives of Low-Income Americans (by Michael Barr, based on the 938 interviews conducted under the 2005–2006 Detroit Area Household Financial Services study) and A Complex Portrait: An Examination of Small-Dollar Credit Consumers (by Rob Levy and Joshua Sledge, based on 1,112 interviews conducted nationally in 2012).
In thinking about the policy and regulatory issues of the alternative financial services sector, we should focus not on any particular type of loan product, but on the array of credit sources tapped by consumers as they try to avert hardship while unable to borrow in the financial mainstream. Their credit sources include not only pawnshop loans, payday loans, and account overcharges, but also auto title loans, tax refund anticipation loans, and rent-to-own contracts. These sources tend to be used interchangeably in a de facto, high-risk portfolio choice, motivated by perceptions of financial cost that are often ill-informed. These poor decisions have lasting consequences through damaged credit scores. Among the many reasons for the slowness of our recovery from the Great Recession may be the increasing reliance on high-cost, high-risk, nonbank borrowing, with its adverse effects on the near-term creditworthiness of low- and middle-income working families.
Photo by Flickr user Eddie~S, used under a Creative Commons License (cc-by-sa 2.0)