Payday Loan Flipping–Are Interest Rate Caps the Answer?

A 2007 Payday Loan study issued by the Center for Responsible Lending uncovered the darker side of short-term lending–repeat borrowers. Like chain smokers, repeat borrowers go from one payday loan to another. It’s not uncommon for a borrower in financial difficulty to use one short term loan to pay off an older one. Sometimes referred to as payday loan flipping, these repeat borrowers find themselves in dire circumstances that often lead to bankruptcy.

As part of the study (called Springing the Debt Trap), the Center noted the following data:

  • 90 percent of payday lending business is still generated by trapped borrowers with five or more loans, even in states that have attempted reform;
  • 60 percent of payday loans go to borrowers with 12 or more transactions per year;
  • 24 percent of loans go to borrowers with 21 or more transactions per year;
  • One of seven Colorado borrowers have been in payday debt every day of the past six months;
  • Nearly 90 percent of repeat payday loans are made shortly after a previous loan was paid off.

What causes payday loan flipping

According to the study, only 2% of payday loan borrowers pay off the loan when initially due without obtaining another loan sometime the same year. In other words, 98% of borrowers access payday loans more than once each year. The reason, according to the study, is simply that the borrowers cannot afford to pay off the loan in two weeks (the average term for a cash advance) and still pay for the basic necessities of life.

Specifically, the study found that:

The inability to repay their payday loans and meet basic needs drives consumers to continue to take out loans over the course of multiple pay periods. In fact, regulator data collected in several states shows that the average payday borrower has more than eight transactions per year.

The study further found that the majority of a payday lenders business comes from repeat borrowers. “If these borrowers only took out an occasional payday loan, lenders would be faced with sharp reductions in revenue that would threaten the viability of their business model.” Alternatively, lenders might be forced to charge more for the loans to offset the decline in demand.

Do current state law limitations address payday loan flipping?

According to the study, current state laws do not successfully address payday loan flipping. The study noted the following legislative attempts to limit payday lending:

  • Renewal bans/cooling-off periods
  • Limits on number of loans outstanding
  • Payment plans
  • Loan amount caps based on a borrower’s income
  • Databases which enforce ineffective provisions
  • Regulations that narrowly target payday loans

The study concludes that none of these measures effectively addresses the repeat borrower issuer. In fact, the study argues that such provision can make matters worse, as they tend to legitimize the payday loan industry.

Spring the Debt Trap–Is its conclusion meaningful?

The conclusion from its study is best expressed in the following, taking verbatim from the study:

Those states which enforce a comprehensive interest rate cap at or around 36 percent for small loans have solved their debt trap problem; realizing a savings of $1.5 billion for their citizens while preserving a more responsible small loan market.

This conclusion raises a very significant question, however. Where do borrowers turn if they do not have access to payday loans? One option may simply be to incur bounced check fees, late payment penalties, and other fees that often exceed the cost of a payday loan. The study concluded, however, that such consequences were limited:

While payday lenders predict doomsday scenarios for their borrowers if they are no longer allowed to charge triple-digit interest rates, former payday borrowers who no longer have access to payday loans tell a much different story. A recent study from the North Carolina Commissioner of Banks found
that “three-quarters of low- and middle-income people were unaffected by the ban on payday lending…of those that were affected by the end of storefront payday lending, more than twice as many reported that the absence of payday lenders had a positive impact on their lives.” The report
also shows that North Carolina families have a myriad of credit and other options for dealing with financial crises.

This is consistent with the industry’s own survey findings that less than 10 percent of payday borrowers took out a payday loan because they had no other credit alternatives. In addition, payday borrowers and the general public also overwhelmingly support an interest rate cap, even if it results
in less credit.


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