Do Payday Loans Worsen the Cycle of Debt?

Written by  //  01/19/2012  //  College News  //  Comments Off

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Arkansas Tech professor’s findings dispute one widely-touted belief.

Payday loans, also known as cash advance loans, have aroused controversy in recent years as lawmakers have considered ways to rein in the industry. Such loans typically are taken out by low-income consumers who must pay their loan back with interest within 14 days. Those loans are offered by lenders to people who may find themselves coming up short as a rent payment, auto loan or other bill comes due. Handled correctly, the consumer takes out a loan, uses the money to cover an expense or an emergency and pays that loan back on time. However, late payments can be costly with borrowers incurring a fee and rolling over the loan, with interest, for another 14 days.

Debt Cycle

Some argue that the cycle of debt created by payday loans is significant with many borrowers caught in an endless cycle of borrowing money and rolling over their loan. It is that thinking that got Arkansas Tech University Prof. Marc Anthony Fusaro to conduct a comprehensive study to determine whether the high interest rates on these so-called payday loans cause borrowers to be trapped in a “cycle of debt.” Fusaro was the principle investigator for this new study.

Prof. Fusaro and his co-investigator, Patricia J. Cirillo, Ph.D., of Cypress Research, conducted a field experiment in which a random sample of borrowers were given interest-free payday loans. The investigators then tracked these borrowers and found no difference in loan repayment rates between the zero-interest borrowers and a control group of borrowers who paid conventional payday-loan interest rates. This result forms strong evidence that high interest rates on payday loans are not the cause of a “cycle of debt.”

Study’s Conclusions

Fusaro and Cirillo’s study is significant because the “cycle of debt” has long been asserted as a basis for limiting or banning payday loans, but apart from any academic quality research to affirm the claim.

“Our results indicate that high interest rates do not convert occasional users to chronic users,” Prof. Fusaro and Dr. Cirillo note in their conclusion. In this study the authors chose not to study the larger question of whether payday loans are welfare-enhancing for consumers. That issue has been considered in multiple settings by other investigators to mixed results.

Loan Dissatisfaction

The results are in line with earlier survey research demonstrating that only 2 percent of borrowers have indicated difficulty in getting out of debt as a reason with being dissatisfied with their loans.

The study is available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1960776. You may want to read up on what the Federal Trade Commission has to say about payday loans too.

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