“FACT: Two-thirds of individuals who use both credit cards and payday loans have at least $1,000 of credit card liquidity left when taking out a payday loan.”

The term “Payday Loan” comes with more negative connotations than the term “carpetbagger” did after the Civil War. Our industry, “the business of lending to the masses” has evolved from old-school, analog face-to-face paper transactions, to digital customer transactions including acquisition, underwriting, funding, servicing, and collecting while reinventing the nomenclature from payday loans to installment loans, line-of-credit loans, early access to wages, buy-now-pay-later, pawn…

The bottom line? 50%+ of households are one paycheck away from being homeless.

This behavior – resorting to costly alternative loan products by consumers rather than maxing out their credit card – is puzzling because payday loans carry very high-interest rates [when erroneously computed as an Annual Percentage Rate. Much like choosing to take a cab/Uber from New York to Los Angeles], compared to 10 to 30 percent APR’s on credit cards.

This “mistake” is costly: these people could have saved $200+ annually by borrowing up to their credit card limits before taking out payday loans.

“This phenomenon has been termed the “Payday Loan Puzzle.”

Why do households take out expensive payday loans when they have far cheaper credit options available?

“Various behavioral explanations, such as self-control problems and financial illiteracy, have been put forward. In this paper, we propose a novel rational explanation for the payday loan puzzle, inspired by the following interview of an actual payday lender:

“Why are people taking out [payday] loans instead of using their credit cards?” Tim Ranney told me, “This guy was implying that these people weren’t smart enough to make the ‘right’ decision. I laughed in his face.‘They’re protecting the card! ’I told him. […]” Whereas failure to repay a payday loan won’t affect a consumer’s credit score, failure to repay a credit card will.— Lisa Servon (2017): The Unbanking of America.

“Our proposed “reputation protection” hypothesis is that people do not exhaust their credit card limits because they want to protect their credit scores. A credit score is a statistic computed by credit bureaus to access a person’s default risk.”

“Borrowing or defaulting on credit cards will affect one’s credit score, while payday loan lenders in the U.S. do not report defaults to the traditional credit bureaus!”

Reader, Click here to read this academic report in its entirety.

PAYDAY LOANS: THE BUSINESS OF LENDING TO THE MASSES

Several industry-sponsored studies have surfaced recently to determine who gets payday loans today. They are interesting but offer few surprises. The studies simply emphasize it’s the same demographic with a twist. Gig Workers are now in the mix. Again, rather obvious.

In a nutshell, THERE IS NO MAGIC to identifying the payday loan demographic. Payday loan borrowers are the 99%. Retail, health workers, service workers, office, administrative, gig…

Here are a few takeaways.

Payday loans are used by people who need CASH FAST and lack other financial options for repairing their car, keeping the lights on, paying for prescriptions, filling the pantry… in other words, unexpected expenses.

So, what’s good about payday loans? Virtually anyone who can breathe & has proof of a regular income and a bank account can gain access to cash when facing a sudden cash crunch.

What’s bad about payday loans? They are not amortized. The payday loan borrower must come up with the loan principal on their next payday.

The majority of payday loan borrowers do not abuse this feature. Say they live in California. They borrow $100. In reality, the payday loan lender advances the borrower $85. two weeks later, on payday, the payday loan borrower returns to the payday loan brick-n-mortar store or the internet portal and pays back the $85 loan principal + $15 fee. No biggie. That’s the legal rate in California for payday loans.

But, of course, there are always borrowers on the margin who abuse this simple transaction. Two weeks go by, the payday loan borrower is still in over their head and they pay the $15 BUT fail to add any $$ towards the original $85 loan principal. This goes on for weeks! Week after week, they pay the $15. Before long, they’ve paid $300/$400+ in $15 increments and still owe the payday loan lender the original $85 loan principal. NOT A HAPPY ENDING.

At some point, the majority of payday loan lenders implement a policy of insisting the payday loan borrower begin adding a minimum of $20/week to the $15 fee in an effort to force the payday loan borrower to pay down the loan principal. It’s simply the right thing to do!

Back to alternatives for solving the emergency financial challenges faced by potential payday loan borrowers; their ONLY alternatives are:

• Friends & family [Usually, they’ve already hit up friends & family. not an option + embarrassing]
• Their church [Rarely a viable alternative + embarrassing]
• Bounce a check and incur a $35 NSF fee [Result is a bank “loan” having a minimum 1800% APR & potential Check System database entry. That results in their NEVER having the ability to participate in the banking system again! BAD!!]
• Get a payday loan [Typically a 400% – 600% APR] online or at a Storefront location
• Go without lights, car repair… – lose their job [Not a good choice], forgo that prescription [Ugh!], etc.
• Go hungry/suck it up
• Borrower from their employer

NOTE: Quite frankly, PAYDAY LOAN products are dinosaurs! Virtually all forward-thinking payday loan lenders have evolved to various types of “installment loans, line-of-credit loans, even buy-now-pay-later” [BNPL] forms of payment. [These BNPL financial products are often worse than old school payday loans because consumers OFTEN fail to realize the payments eventually do come due and they simply forgot! The free interest evaporates and the late fees kick in.  It gets REAL UGLY fast. But, this issue is another Post.]

• Fact #1: The overwhelming majority of payday loan recipients (82%) have full-time jobs. When you add the number of recipients that work part-time or are already retired, that accounts for well over 90% of recipients.
• Fact #2: Payday loan borrowers work in sales, office, gig jobs, food service, and healthcare support.
• fACT 3: The most common employer of payday loan borrowers is Walmart, followed by Kaiser, Target, Home Depot, major restaurant employers, Uber, and Amazon
• Fact 4: The majority of payday loan recipients are employed full time
• Fact 5: Payday loan borrowers use payday loans to cover the timing mismatch of having an expense coming in before the paycheck arrives to cover it.