by Jeff Sovern
As I have noted before, payday lending and deposit advances present a conundrum for me: how to permit those who genuinely have a short-term borrowing need and who can't get the money elsewhere to borrow without creating a long-term debt trap. Recently I listened to hearing held by the Senate Special Committee on Aging titled Payday Loans: Short-term Solution or Long-term Problem? The hearings included poignant testimony from Annette Smith in which she described how a deposit advance loan became a debt trap for her. The short version: her sole income comes from her Social Security payments. More than five years ago, she took out a $500 loan to fix her car. The following month that amount, plus a $50 fee was automatically deducted from her bank account when she received her Social Security. But she couldn't live on the remaining funds, and so borrowed again. The cycle repeated the following month, and went on for five years. In all, she borrowed money 63 times, costing her nearly $3,000. In effect, she paid nearly $3,000 to borrow $500 for five years. And that's not unusual. According to the CFPB White Paper, Payday Loans and Deposit Advance Products, 14% of payday borowers/deposit advance customers borrow at least twenty times a year, and another 34% borrow between eleven and nineteen times a year.
But another group takes advantage of such loans only occasionally: the Bureau's white paper found 13% borrowed once or twice a year. Some believe that payday lending should be banned even as to them because of its great expense, but suppose you want to permit the occasisional borrowers to use payday lending but not create a debt trap. How could that be done?
One possible solution might be a disclosure remedy in the hope that the disclosure would dissuade those who might fall into a debt trap from taking out the loans but not prevent the occasionals from using the loans. I am not generally enthusiastic about disclosures, but one study, Marianne Bertrand & Adair Morse, Information Disclosure, Cognitive Biases and Payday Borrowing, 66 J. Fin. 1865, 1872-73 (2011), found a modest effect on payday borrower behavior when borrowers were shown a table comparing the cost of credit card borrowing and payday borrowing. On the other hand, during the Senate hearing, industry spokespeople stated that consumers already receive disclosures warning that the loan they are contemplating is expensive. We know that that has not eliminated the debt trap but perhaps something stronger would. The goal would be to construct a disclosure that is the equivalent of cigarette warnings, though as cigarette warnings have not completely succeeded in eliminating smoking, maybe something even more powerful is needed.
What should the warning look like? Ideally, that would be the function of consumer testing. My co-author, Chris Peterson, has argued that payday lenders should have signs reading "Warning: Predatory Lender." Perhaps that would do the trick, but I would like to see something more specific, like WARNING: This loan is so expensive that you should consider it only if you are DESPERATE to borrow the money, you cannot borrow the money elsewhere more cheaply, and you have a plan to pay it back next month so that you do not need to borrow it again and become trapped in debt, as many have." I would then like the warning to list alternate lenders that might be cheaper.
Another solution would be to require payday lenders to verify that their borrowers can repay the loans without becoming trapped, similar to the requirements imposed on mortgage lenders in some circumstances. But as that might drive the cost of such borrowing even higher, it would be better to avoid that route, if possible. I would start with consumer testing to see if a warning reduced the number of people caught in a debt trap.