Research & Commentary: Regulating Payday Loans

Published September 30, 2013

Over the past several years, states have begun considering new laws that would place severe limits (interest rate caps) or even bans on certain types of short-term loans, often called “payday loans.” The practice of payday lending, often including a high interest rate or substantial collateral, can be quite risky for the lender. 

Some advocacy groups claim payday lending is inherently predatory. They cite studies showing most consumers who use such loans are poor or undereducated. But several of these studies have been proven flawed, with incorrect conclusions being drawn from the data and distributed widely by consumer groups. 

Payday loans serve an important purpose by meeting people’s need for short-term emergency loans when other sources of financing are unavailable. They’re clearly more desirable than the alternatives—bounced checks and late fees—which only further damage blemished credit histories. According to a study by the Federal Reserve Bank of New York, when Georgia and North Carolina banned payday lending, people in those states “bounced more checks, complained more to the Federal Trade Commission about lenders and debt collectors, and filed for Chapter 7 bankruptcy protection at a higher rate.” 

Advocacy groups suggest payday lending is a cause of poverty, when in reality payday lenders serve a group of consumers essentially blacklisted from more mainstream loans. If these misguided regulations or bans continue, consumers likely will have to endure a rise in bankruptcies, overdraft fees, and foreclosures.

Payday loan companies take on enormous financial risk when they lend money to people with severely blemished or nonexistent credit histories. The inherent risk of these loans necessitates the fees charged. If the fees are unreasonable, consumers will not use the service. Consumers, not government officials, should determine whether a payday loan will meet their needs. 

Protecting consumers from fraud is a just and necessary function of government, but it’s important that consumers’ and lenders’ rights not be infringed. The market for these loans developed and thrived because the lenders provide a service people need. Banning payday loans in order to address a problem affecting a small group of irresponsible lenders and uninformed borrowers harms the people who need these loans. 

The following documents provide additional information about payday loans.

Payday Lending Limits May Be Harming Borrowers
Writing in the Heartlander digital magazine, Matthew Glans reports on payday loans and the efforts by critics to place new regulations on their sale and use. 

Payday Holiday: How Households Fare after Payday Credit Bans
The New York Fed describes the effect of payday loan bans on individual households. The author examines whether payday loans are preferable to alternatives, including credit card late fees and overdraft charges.

Ohio Payday Loan Law Takes Toll on Needy
Steve Watkins discusses the aftermath of an Ohio law limiting interest rates that can be charged by payday lenders: “Opponents say that’s far too expensive and traps borrowers in a cycle of debt. But payday lenders say it’s unfair to view it as an annual rate, because borrowers are paying the loan back in two weeks. They also say they need to charge that much to cover costs.”

Payday Lending: Do the Costs Justify the Price?
Mark J. Flannery and Katherine Samolyk examine how profitability is related to the borrowing patterns of payday advance customers, default losses, and store characteristics. The authors find fixed operating costs and loan loss rates do justify a large part of the high APRs charged on payday advance loans, and a payday loan store’s loan volume is a key determinant of its profitability. They did not find loan renewals or loans from frequent borrowers are more profitable than other loans per se, although they contribute to a store’s loan volume. The results showed economic and demographic conditions in the neighborhoods where stores are located did not have much of an effect on profitability, although they do slightly influence default losses. 

An Experimental Analysis of the Demand for Payday Loans
Bart J. Wilson, David W. Findlay, James W. Meehan Jr., Charissa P. Wellford, and Karl Schurter examine what effect, if any, the existence of payday loans has on individuals’ ability to manage and survive financial setbacks. The authors find payday loans help the subjects absorb expenditure shocks and, therefore, survive their cash flow crises.  

Payday Lenders: Heroes or Villains?
Adair Morse examines whether access to high-interest credit (payday loans) exacerbates or mitigates individual financial distress. Morse found California foreclosures increase after disasters, but the existence of payday lenders mitigates half of the distress impact (1.2 foreclosures per 1,000 homes). Lenders also mitigate 2.67 larcenies per 1,000 households, with no effect on burglaries or vehicle thefts. Morse’s methodology demonstrates his results apply to ordinary personal emergencies, with the caveat that not all payday loan customers may be borrowing for emergencies. 

Do Payday Loans Trap Consumers in a Cycle of Debt?
Marc Anthony Fusaro and Patricia J Cirillo studied whether the high interest rates on payday loans trap consumers in a “cycle of debt.” Fusaro and Cirillo tracked these loans and found no difference in loan repayment rates between the treatment group and a control group of borrowers who paid conventional interest rates. This result forms strong evidence that high interest rates on payday loans do not cause of a “cycle of debt.” 

Legal Loan Sharking or Essential Service? The Great “Payday Loan” Controversy   
Michael Lynch of Reason magazine examines the payday lending debate and addresses how payday loans compare in cost to bank overdraft and late fees.

Cap on Payday Loans Would Hurt Those Most in Need,0,4377218.story
An economist from the Employment Policies Institute describes the negative effect a payday loan ban could have on poorer working families.

Nothing in this Research & Commentary is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this and other topics, visit The Heartlander’s Finance and Insurance News Web site at, The Heartland Institute’s Web site at, and PolicyBot, Heartland’s free online research database, at 

If you have any questions about this issue or The Heartland Institute, contact Heartland Institute Senior Policy Analyst Matthew Glans at 312/377-4000 or [email protected].