Millions of people use payday loans each year to borrow small amounts of money to make ends meet. Alex Horowitz, who has led Pew’s small-dollar loans research for over 10 years, looks back at major developments in payday loans over the past 30 years.
This interview has been edited for clarity and length.
Q: You’ve read virtually all the available studies, conducted extensive research, and created recommendations for regulations and product designs in this field. After all that, what can you tell us about why people use payday loans?
A: The overwhelming reason is to cover regular expenses such as rent, mortgage, utilities, and so on. Ideally, people wouldn’t use credit to pay for these ordinary expenses. But hourly wage earners have inconsistent work schedules and therefore wide fluctuations in income, which can create financial shortfalls. So, when their credit cards are maxed out or savings accounts are empty, millions of people each year borrow a few hundred or even a thousand dollars—what we call small-dollar loans—to help fill the gap.
Q: What do we know about the demographics and preferences of payday loan borrowers?
A: One reason The Pew Charitable Trusts created its consumer finance project in 2010 was to help fill an important gap in the research. Back then, surprisingly little was known about who uses payday loans or why, and about the experiences and opinions of payday loan borrowers. Pew’s Payday Lending in America series of reports, based in part on a survey of nearly 50,000 adults and a great deal of market research, filled in those gaps. The series includes four in-depth reports about payday loans, plus a related report about auto title loans. A companion report examined installment loans from consumer finance companies.
Our research identified groups that were disproportionately likely to use payday loans: renters, African Americans, people ages 25-44, parents of minor children, and those earning less than $40,000. Through surveys and focus groups, it became clear that borrowers valued the liquidity that payday loans offer but also wanted the loans to have fair prices and affordable payments. We found that the large majority would prefer to borrow small installment loans or lines of credit with fair terms from their banks or credit unions—which we know they already use, because payday loans require borrowers to have an income and a checking account—rather than take out payday loans. But at the time, no large banks offered such loans, so we pursued making that a reality.
Q: But what’s wrong with payday loans in the first place?
A: Single-payment payday loans are unaffordable and harmful for most borrowers. The repayment periods are too short, the required payments are too large, and the annual percentage rates (APRs) are 10 times higher than traditional interest rate limits set by states. There is also evidence of numerous other problems, such as a deceptive business model; structural incentives for lenders to encourage borrowers to refinance; borrower defaults; abuse of borrower checking accounts; and weak price competition.
Q: Are regulators aware of these harms?
A: In 2016, Pew submitted a comment letter to the Consumer Financial Protection Bureau (CFPB) that in Section 3 summarized our key research findings, including information about borrower profiles and the financially fragile state of borrowers, the unusually strong leverage that lenders have over borrowers, what borrowers want, and what the public supports. The comment letter also provided more information on the core problems in the payday loan market.
Q: And how did the CFPB respond?
A: The next year, in 2017, the CFPB issued some payday loan underwriting regulations, but in 2020 it rescinded these rather modest regulations—leaving the issue squarely in the hands of state lawmakers.
Q: Let’s take a step back in time. How has the payday loan market changed since its emergence?
A: Modern payday loans first came on the scene in the early 1990s. Payday loans are the way they are because dozens of states created exemptions from their traditional usury caps for single-payment loans. Then the industry grew quickly into the 21st century. Payday lenders started expanding into online lending, which created new consumer risks: These loans let online lenders operate without the high overhead costs of stores, but they charged as much or more than storefront lenders because of high customer acquisition costs, credit losses, and other challenges. Neither storefront nor online lending saw much price competition. As the market evolved, all the largest payday lenders began issuing installment loans or lines of credit in many states, which created several new problems, even as single-payment loans remain widespread.
Q: What about more recently?
A: There have been two very important positive developments in the last decade or so. One is that some states reformed their payday loan laws so that single-payment loans were replaced by a new type of safer, affordable small installment loan that is widely available not only from payday lenders but also from other lenders, including consumer finance lenders and financial technology companies. The other development is that banks have been entering the small-loan market in a big way since 2018, giving millions of people who might otherwise turn to payday or similar loans access to affordable credit. This trend is poised to save consumers, in the aggregate, billions of dollars each year. These developments show empirically that it’s possible for a regulated market to provide superior loans that lead to better outcomes for people with poor or no credit history—and what policymakers can do to achieve that.
Q: Were these developments a surprise, given what previous research was telling us?
A: Literature reviews published in 2015 and 2019 summarize a lot of the earlier work in this area. Most of the papers used a wide range of indirect metrics to assess consumer welfare and essentially tried to determine whether consumers are better off with high-cost, single-payment loans with APRs usually above 300%, or with no loans at all.
But the developments of the past decade have largely made that question moot.
Now we know definitively that it’s possible for consumers to have access to small-dollar loans with smaller payments than what payday loan providers were offering, and at much lower prices—both from nonbank lenders and from banks. The two scenarios posited in much of the early research—that you could either have single-payment loans with APRs above 300% or you could have minimal access to credit—have turned out not to be the only possible options.
Q: And why did it turn out that those aren’t the only two scenarios?
A: It’s a false dichotomy, because when states require lenders to charge lower rates and let borrowers repay loans in small installments, credit remains available.
The better question, and one that’s still relevant, is: How can the landscape for payday and similar high-cost loans improve markedly for consumers while still maintaining access to small credit? Two academic papers foresaw the feasibility of credit staying available to consumers at a lower cost—because the researchers recognized that while nonbank lenders had high fixed costs per store, their customers were largely price insensitive. That implied that the market was not price competitive, and that with moderate price caps, lenders might simply consolidate stores and become more efficient without reducing consumers’ access to credit.
Q: So the good news is …?
A: States such as Colorado (2010), Hawaii (2021), Ohio (2018), and Virginia (2020) have shown empirically that payday loan borrowers can maintain access to credit and achieve better outcomes when single-payment loans are replaced by loans that offer consumers affordable installment payments, reasonable time to repay, much lower prices, and other safeguards.
