KU Connection

KU researcher checks out payday lending

With lures like “Cash Loans,” “No Credit Necessary” and “Big Cash Advance,” storefront signs across the nation now advertise the promise of easy money. This is the face of the payday lending industry, which has sprawled to encompass about 25,000 loan shops and $28 billion in annual loans in the United States, according to the Center for Responsible Lending.

“The typical payday borrower is middle class or lower middle class, has a job, has a bank account and is short on cash,” said Robert DeYoung, the Capitol Federal professor in financial markets and institutions at the KU School of Business. “This is probably because he or she has gone through their credit card borrowing limit and has no money in their bank account. A payday lender is probably the last, best source of cash for them.”

DeYoung has co-authored a new study into payday lending, representing some of the first academic inquiry into the burgeoning but controversial industry. Along with Ronnie J. Phillips of Colorado State University, DeYoung studied 24,972 payday loans made in Colorado after the state passed laws to allow payday lending and regulate lending fees.

Offering loans for no collateral but a backdated personal check, payday lenders are a convenient but costly means to obtain credit. Critics charge that payday lending exploits financially unsophisticated borrowers and liken the practice to loan sharking. For this reason, payday lending is illegal in a handful of states, and Congress has capped interest rates such lenders can charge members of the military.

“If you calculate the price charged for payday loans as an interest rate, it sounds like an astronomical price,” said DeYoung. “The typical payday loan in Colorado has been about $300, and the fee for that loan is $50. That’s one-sixth of the loan. If you calculate the annual percentage interest rate, that comes to about 450 percent.”

Why would anyone agree to such terms? According to DeYoung, the instant credit of a payday loan in some cases can amount to a good deal for borrowers.

“Put yourself in the position of a household who has a car that needs to be repaired, and if you don’t repair the car you’re going lose your job,” said DeYoung. “If you borrow $300 against your next paycheck—and it costs you $50—that may work out to a 450 percent annual interest rate. But that’s not a bad price to pay for not losing your job. The trouble is that households get in a position where they cannot pay the loan off and they have to roll it over. And if you roll over a $300 loan at a 50 percent fee six times, you’ve just paid $300 to get a $300 loan.” Read more.