Consumer Litigation Funding: Just Another Form of Payday Lending?

This article provides a side-by-side comparison of payday lending and consumer litigation funding in order to aid policymakers. Funding has similarities with payday lending because they are both alternative financial services, involve high interest rates, and cater to customers who need money for living expenses. However, they differ in ways that regulators should recognize. Many justify bans on payday lending by pointing to the fact that millions of borrowers every year are getting stuck in an inescapable cycle of interest payments. While legal finance has real costs, funding’s nonrecourse nature prevents consumers from getting stuck in a cyclical repayment of debt. Moreover, prohibitions may not be appropriate at this time because there is little empirical evidence on how funding affects consumer welfare and there is room for interest rates to fall as the industry continues to expand and competition increases among funders. States should take the initiative to partner with financiers to study the effect of this new form of credit on borrowers. Some states have implemented disclosure regulations that mandate that funders itemize the fees, present a repayment schedule, and relay the APR. However, customers do not have the legal expertise or financial sophistication to estimate case duration and to put this information together with funding contract terms to get an accurate sense of where they may end up on a repayment schedule. Thus, financiers should disclose a reasonable approximate repayment amount and date to improve borrowers’ understanding of the costs of nonrecourse advances

Americans with payday loans spent or saved their tax rebates,rather than using it to pay off debt

In 2001, the U.S. government gave a major tax rebate to Americans of $300 per person. In new research Paige Marta Skiba examines the impact of this rebate to those with outstanding payday loans, which can have annualized interest rates of up to 600 percent. In a study of nearly 47,000 payday loan borrowers, she finds that rather than using the rebate to pay back debt, most spent or saved their rebate, and did not decrease their loans by a large amount. She argues that while payday loans may appear to make financial sense for those who are unable to get credit from other sources, the onerous interest payments may help to drag them into a cycle of revolving deb

Regulation of Payday Loans: Misguided?

Since payday lenders came on the scene in 1990s, regulation of their predatory practices has been swift and often severe. Fourteen states now ban payday loans outright. From an economist\u27s perspective, high-interest, short-term, small loans need not be a bad thing. Payday credit can help borrowers smooth consumption, unequivocally improving welfare as consumers borrow from future good times to help cover current shortfalls. These benefits of credit can accrue even at typical payday loan interest rates of 300%-600% APR. The question of whether payday credit actually assists borrowers in this way is an empirical one. In this Article, I review the existing evidence on how borrowers use payday loans. I document the prevalence of rollovers and default, the effect of varying principal amounts and loan durations, the existence of self-control problems and myopia among borrowers, and the demand for payday loans over other types of cheaper credit. I then document the disconnect between this collection of evidence and the existing regulatory frameworks which purport to help consumers avoid misuse of payday loans. These regulations on payday lending include outright bans, price caps, minimum and maximum loan lengths, minimum and maximum loan sizes, and rollover restrictions. I argue that: (1) outright bans are misguided, (2) larger loans can actually help borrowers, (3) loan-length restrictions are ineffective, and (4) rollover restrictions do make sense

Regulation of Payday Loans: Misguided?

Since payday lenders came on the scene in 1990s, regulation of their “predatory” practices has been swift and often severe. Fourteen states now ban payday loans outright. From an economist’s perspective, high-interest, short-term, small loans need not be a bad thing. Payday credit can help borrowers “smooth” consumption, unequivocally improving welfare as consumers borrow from future good times to help cover current shortfalls. These benefits of credit can accrue even at typical payday loan interest rates of 300%–600% APR. The question of whether payday credit actually assists borrowers in this way is an empirical one. In this Article, I review the existing evidence on how borrowers use payday loans. I document the prevalence of rollovers and default, the effect of varying principal amounts and loan durations, the existence of self-control problems and myopia among borrowers, and the demand for payday loans over other types of cheaper credit. I then document the disconnect between this collection of evidence and the existing regulatory frameworks which purport to help consumers avoid misuse of payday loans. These regulations on payday lending include outright bans, price caps, minimum and maximum loan lengths, minimum and maximum loan sizes, and rollover restrictions. I argue that: (1) outright bans are misguided, (2) larger loans can actually help borrowers, (3) loan-length restrictions are ineffective, and (4) rollover restrictions do make sense

Do Payday Loans Cause Bankruptcy?

An estimated ten million American households borrow on payday loans each year. Despite the prevalence of these loans, little is known about the effects of access to this form of short-term, high-cost credit. We match individual-level administrative records on payday borrowing to public records on personal bankruptcy, and we exploit a regression discontinuity to estimate the causal impact of access to payday loans on bankruptcy filings. Though the size of the typical payday loan is only $300, we find that loan approval for first-time applicants increases the two-year Chapter 13 bankruptcy filing rate by 2.48 percentage points. There appear to be two components driving this large effect. First, consumers are already financially stressed when they begin borrowing on payday loans. Second, approved applicants borrow repeatedly on payday loans and pawn loans, which carry very high interest rates. For the subsample that identifies our estimates, the cumulative interest burden from payday and pawn loans amounts to roughly 11% of the total liquid debt interest burden at the time of bankruptcy filing

The Ticket to Easy Street? The Financial Consequences of Winning the Lottery

A fundamental question faced by policymakers is how best to help individuals who are in financial trouble. This paper examines the consequences of the most basic approach: giving people large cash transfers. To determine whether this prevents or merely postpones bankruptcy, we exploit a unique dataset of Florida Lottery winners linked to bankruptcy records. Results show that although recipients of $50,000 to$150,000 are 50 percent less likely to file for bankruptcy in the two years after winning relative to small winners, they are equally more likely to file three to five years afterward. Furthermore, bankruptcy records indicate that even though the median winner of a large cash prize could have paid off all of his unsecured debt or increased equity in new or existing assets, he chose not to do either. Consequently, although we cannot be sure other recipients of financial assistance would react in the same way lottery players did, our results do suggest that some skepticism regarding the long-term effect of cash transfers may be warranted.

Information Asymmetries in Consumer Credit Markets: Evidence from Payday Lending

Information asymmetries are prominent in theory but difficult to estimate. This paper exploits discontinuities in loan eligibility to test for moral hazard and adverse selection in the payday loan market. Regression discontinuity and regression kink approaches suggest that payday borrowers are less likely to default on larger loans. A $50 larger payday loan leads to a 17 to 33 percent drop in the probability of default. Conversely, there is economically and statistically significant adverse selection into larger payday loans when loan eligibility is held constant. Payday borrowers who choose a$50 larger loan are 16 to 47 percent more likely to default. (JEL D14, D82, G2

Pawnshops, Behavioral Economics, and Self Regulation

Pawnbroking is the oldest source of credit. There is growing public interest in day-to-day pawnbroking operations, as evidenced by the popularity of reality shows such as “Pawn Stars” and “Hardcore Pawn.” Television viewers’ curiosity about an old credit institution may be due to the fact that 7% of all U.S. households have used pawn credit. Although pawnshops predate biblical times, researchers know surprisingly little about this ancient form of banking and its customers. We fill this gap by documenting detailed information on pawnshop loan repayment and default, and by discussing how pawnshop borrowers’ behavior is consistent with various behavioral economics phenomena

Dude, Where\u27s My Car Title?: The Law, Behavior, and Economics of Title Lending Markets

Millions of credit-constrained borrowers turn to title loans to meet their liquidity needs. Legislatures and regulators have debated how to best regulate these transactions, but surprisingly, we still know very little about the customers who use title loans. This Article reports findings from the first large-scale academic study of title lending customers. We surveyed over 400 title lending customers across three states and obtained information about customers’ demographic and behavioral characteristics. Based on the results of our survey and guided by insights from behavioral economics, this Article seeks to reframe the title lending debate. Instead of focusing on the risks and consequences of borrowers’ cars being repossessed, as the vast bulk of the literature does, we argue that the primary problem that most borrowers face is underestimating the true cost of taking out a title loan. Borrowers’ survey responses demonstrate that many borrowers are overly optimistic and experience self-control problems that affect their ability to make timely loan payments. We argue that these deviations from the assumptions of classical economics do not warrant an outright ban of title lending, but they do provide room for policy interventions. Policymakers can improve efficiency in title lending markets by requiring lenders to disclose to consumers the likely experiences they will have with their title loans rather than merely requiring lenders to communicate pricing information

Payday Loans and Credit Cards: New Liquidity and Credit Scoring Puzzles?

Using a unique dataset matched at the individual level from two administrative sources, we examine household choices between liabilities and assess the informational content of prime and subprime credit scores in the consumer credit market. First, more specifically, we assess consumers' effectiveness at prioritizing use of their lowest-cost credit option. We find that most borrowers from one payday lender who also have a credit card from a major credit card issuer have substantial credit card liquidity on the days they take out their payday loans. This is costly because payday loans have annualized interest rates of at least several hundred percent, though perhaps partly explained by the fact that borrowers have experienced substantial declines in credit card liquidity in the year leading up to the payday loan. Second, we show that FICO scores and Teletrack scores have independent information and are specialized for the types of lending where they are used. Teletrack scores have eight times the predictive power for payday loan default as FICO scores. We also show that prime lenders should value information about their borrowers' subprime activity. Taking out a payday loan predicts nearly a doubling in the probability of serious credit card delinquency over the next year.