Payday Loans versus Pawn Shops: The Effects of Loan Fee Limits on Household Use  

Robert B. AveryFederal Reserve Board

Katherine A. SamolykConsumer Financial Protection Bureau Sept 23, 2011 

The views expressed are those of the authors and do not necessarily represent those of the Board of Governors of the Federal Reserve System or the Consumer Financial Protection Bureau.

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This Paper

Uses data from the January 2009 Unbanked/Underbanked Supplement to the Current Population Survey

Examines how state-regulated fee ceilings on payday loans and pawn shops affect households’ use of these products

Explores conjectures about market dynamics (Flannery and Samolyk, 2007) Store operations involve largely fixed costs in supplying

the product Stores generally charge the fee ceiling rate If demand is relatively price inelastic (“good” a necessity,

few substitutes) Level of fee ceilings determines profitable scale of store

operations and number of stores needed to meet inelastic loan demand: Quantity of loans supplied need not change

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Findings Demand appears to be relatively price inelastic; funds

primarily used to meet basic living expenses and lost income

Payday loan use adjusted for demographic characteristics does not vary systemically with fee ceilings in the range where stores currently operate (except for the very lowest ceilings)

Pawn shop use is higher where fee ceilings are higher

Controlling for use associated with household demographics, stores per capita vary positively with fee ceilings

Within a range; lower ceilings may not markedly reduce payday loan availability

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Payday Loans

Fairly standardized: 2 week loans of several hundred dollars, typically 15-20$ fee per $100 borrowed

Minimal underwriting Borrower gives lender a post-dated check for amount

borrowed and fee ID, recent checking account statement, and a pay stub, check

of recent payment history (Teletrak) On maturity date, borrower pays loan or lender deposits check;

or borrower pays another fee and lender extends another loan to the borrower

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Pawn Shop Loans

Pawnshops loans are collateralized by the items being pawned; LTVs in the 40-60% range.

Borrower need not have a bank account, a regular source of income, or a credit check.

Trade groups estimate that the typical pawn loan is for about $80, with a contract maturity of 30 days and loan fee of 20 percent of the loan amount.

If borrower does not repay or renew; the lender takes physical possession of the item

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State Payday Regulations

States regulate payday lending Effective APRs generally exceed state usury ceilings

(>390% APRs) States generally have had to pass “enabling

legislation” permitting the payday product; regulations can include

Fee ceilings Loan amount limits Limits on rollovers or consecutive loans

Usury ceilings or very low payday loan fee limits effectively “prohibit” payday lending in 13 states and DC

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State Pawn Shop Regulations

Pawn shops also regulated by states; regulations can include: Fee limits The amount of time before a loan is considered in

default Return requirements (that sale proceeds in

excess of the loan amount and fees must be returned to the borrower)

Pawn shops operate in all states; even those with very low limits

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Evidence about Customer Use Evidence of frequent payday loan use: Caskey (2005): state government data show most customer use payday

loans more than 6 times a year; one quarter had 14 or more loans during the year.

Flannery and Samolyk (2007): store data from two large payday lenders: 40 percent of loans were roll-overs/renewals; roughly one half of loans were to accounts that had taken out more than six loans that year

Skiba and Tobacman (2008) data for a large payday lender indicate half of the borrowers default on a loan within a year of their first loan; but have paid fees for five payday loans before they defaulted (90% of original loan’s principal).

Evidence that payday borrowers are likely to be financially constrained (although working, moderate income and educational attainment) Ellihasuen and Laurence (2001) credit card balances near limits;

outstanding balances Logan and Weller (2009) lower wealth, more likely to have been

denied credit

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Evidence about Customer Use

Less known about pawn shop use: According to Pawnshopstoday.com, “Around 80 percent

of pawn loans tend to be repaid and that repeat customers account for much of the loan volume; often borrowing against the same item repeatedly.”

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Evidence About Supply Side Focal Point Pricing (DeYoung and Phillips):

Charge payday ceiling rate and compete away excess profits by entry

Flannery and Samolyk (2007)

Stores tended to charge ceiling rates

Scale economies imply that profits related to loan volume: more loans, bigger loans

Prager (2009) Higher fee limits associated with more payday stores

per capita

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Evidence About Supply Side

Higher fee limits associated with more payday stores per capita (Caskey(1991), Prager (2009), Shackmen and Tenney (2006))

Some evidence that pawn shops make larger loans when ceilings are lower (Shackmen and Tenney, 2006)

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How do fee ceilings effect availability of payday and pawn shop loans?

Within current range of ceilings where lenders can operate

Conjecture one Higher fee ceilings should reduce demand But if there is excess demand at the ceiling rate; supply

determines equilibrium quantity Higher fee ceilings increase the quantity sold

Conjecture two Higher fee ceilings reduce volume of loans needed to cover fix

costs and be profitable Increases the number of stores a market can support Relatively little affect on quantity sold

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Our Strategy

The 2009 Unbanked/Underbanked Survey: A supplement to the Jan 2009 CPS sponsored by the FDIC. Large nationally representative sample allows state-level estimates of usage.

Included questions about :

Use of payday loans and pawnshop loans

Reasons for using a product rather than going to a bank

Reasons why the credit was needed

Matched with the rich CPS demographic data

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Our Strategy

We use CPS data to estimate loan demand associated with household demographic characteristics using only within-market variation.

Use these estimates to construct geographic estimates of usage adjusted for the demographic component of demand.

Examine how adjusted-usage estimates are related to state fee ceilings

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Payday Loan and Pawnshop Demographic Demand

60 percent of borrower say they could not borrow elsewhere.

Major use of funds: basic living expenses; lost income and specific bill or expense also important reasons

Multivariate results: Demographics of Use Higher payday or pawnshop use: renter; has children Unemployed;

moderate age (25-45); divorced, separated or widowed; Lower use of both product: college degree; foreign born Higher payday use: disabled; moderate income; moderate education;

single female head of household; Black; Native American; (Lower use among retired)

Higher pawnshop use: unbanked; lower income; single; smaller renter effect; larger Native American effect; smaller Black effect; larger UE effect; less of an education effect; no FHOH effect;

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Table 5: Multivariate Analysis of Household Demographics and AFS Credit UseA: Use payday loan 1 B: Used Pawnshop 2

Independent Variable Coefficient Std. Error Coefficient Std. Error

Unbanked -0.0051 0.0049 0.0469 0.0034 <.0001***

Renter 0.0486 0.0030 <.0001*** 0.0091 0.0021 <.0001***

Race (NHW)

Black 0.0586 0.0040 <.0001*** 0.0084 0.0028 ***

Native American 0.0253 0.0104 * 0.0262 0.0073 ***

Parentage (no chlidren)

Children 18+ 0.0204 0.0052 <.0001*** 0.0173 0.0036 <.0001***

Children <18 0.0320 0.0055 <.0001*** 0.0174 0.0039 <.0001***

Labor Force Status (employed)

Unemployed 0.0192 0.0050 *** 0.0434 0.0035 <.0001***

Retired -0.0105 0.0045 * -0.0041 0.0031

Disabled 0.0140 0.0055 * -0.0013 0.0039

Household Income (LT$15K)

HH income$15-30K 0.0102 0.0044 * -0.0122 0.0031 <.0001***

HH income 30-50 0.0138 0.0045 ** -0.0175 0.0031 <.0001***

HH income $50-75K 0.0027 0.0049 -0.0263 0.0034 <.0001***

HH income>$75K -0.0075 0.0050 -0.0289 0.0035 <.0001***

Householder Age (LT 25)

Age 25-34 0.0260 0.0056 <.0001*** 0.0107 0.0040 **

Age 35-44 0.0227 0.0058 <.0001*** 0.0113 0.0041 **

Marital Status (married)

Widowed 0.0132 0.0063 * 0.0097 0.0044 *

Divorced/separated 0.0199 0.0053 *** 0.0165 0.0037 <.0001***

Single 0.0039 0.0054 0.0085 0.0038 *

Education (no HS diploma)

High school diploma 0.0070 0.0040 -0.0014 0.0028

Some college/AA 0.0151 0.0042 *** -0.0022 0.0029

College degree -0.0117 0.0049 * -0.0109 0.0035 **

Post graduate -0.0116 0.0049 * -0.0051 0.0034

Female head of household 0.0213 0.0057 *** -0.0044 0.0040

Foreign-born -0.0273 0.0043 <.0001*** -0.0161 0.0030 <.0001***

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How Fee Limits Affect Use

State Fee Limits per $100

State Group Payday Fee

Range Pawn Fee RangeNot Permitted NA

Low $10-$12 $1-$9

Medium $15-$16 $10-$19

High $17-$20 $20-$25

No Ceiling/Very High > $20 or None None

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Second Stage: Fee Ceilings and Loan Use Net of Demographics

Dependent variables: Usage adjusted for demographics (actual usage less usage predicted by demographics) in a given geographic area (Equivalent to “fixed effects” from 1st stage)

Sample includes 365 geographic areas identified in the CPS data in states where payday stores can operate

Explanatory variables include: Fee ceiling categoriesCategorical variables for broad region; rural

dummy; median income of market where the area is located

Relative fee ceilings on “substitute” product

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Nonlinear effect of payday fee ceilings on usage adjusted for local demographics; lower in the lowest payday fee-ceiling group—but also lower in the high fee-ceiling group ($17-20 per $100)

Pawn shop use is highest in the high fee-ceiling group ($20-25 per $80)

Table 6: Multivariate Analysis of Fee Ceilings and Adjusted AFS Credit Usage

A: Incidence of Payday borrowing adjusted 1 B: Incidence of Pawnshop borrowing adjusted 1

Coefficient Std. Error Coefficient Std. Error Coefficient Std. Error CoefficientStd. ErrorIntercept 0.0050 0.0067 0.0042 0.0069 -0.0171 0.0128 -0.0061 0.0042

Payday fee ceiling group 3

Group 1 (lowest ceilings) -0.0271 0.0060 *** -0.0286 0.0066 ***

Group 3 -0.0103 0.0046 * -0.0094 0.0047 *

Group 4 0.0054 0.0084 0.0051 0.0084 Group 5 (no ceilings) -0.0063 0.0071 -0.0065 0.0071

Pawn shop see ceiling group 4

Group 2 (next to lowest ceilings) -0.0092 0.0050 -0.0034 0.0039

Group 3 0.0238 0.0127 0.0129 0.0032 ***

Group 4 (no ceilings) 0.0137 0.0138 0.0048 0.0042Relative pawn shop fee ceiling Lower -0.0041 0.0043 0.0222 0.0121 0.0074 0.0043 Higher -0.0073 0.0083 0.0018 0.0067 -0.0006 0.0032

Region: North -0.0013 0.0055 0.0002 0.0058 -0.0129 0.0041 ** -0.0099 0.0035 **

Region: West 0.0112 0.0047 * 0.0135 0.0052 0.0069 0.0028 * 0.0068 0.0025 **

Rural -0.0010 0.0055 -0.0001 0.0057 -0.0047 0.0035 -0.0063 0.0030 *

Market income group 2 0.0003 0.0061 0.0016 0.0063 -0.0005 0.0038 -0.0008 0.0033Market income group 3 -0.0003 0.0068 0.0015 0.0070 -0.0027 0.0044 -0.0031 0.0037Market income group 4 (highest) -0.0125 0.0076 -0.0106 0.0078 -0.0030 0.0050 -0.0047 0.0040

Dependent Variable Mean 0 0 0 0Number of geographic areas 2 365 365 365 516r squared 0.0765 0.0799 0.1416 0.1310

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Effects of Fee Ceiling on Specific Demographic Groups

Table 9: Pawnshop Residuals by State Fee Ceilings<$10 $10-$19 $20-$25 No Ceiling

Variables Group Group Group Group

Total Households -0.012 -0.001 0.004 -0.003Race

Black -0.025 0.003 0.002 -0.014

Hispanic -0.008 -0.005 0.010 -0.010

Asian -0.003 0.003 0.000 -0.002

Native American -0.048 -0.001 0.020 -0.017

Other race -0.011 0.005 -0.008 -0.024

NonHispanic White -0.010 -0.002 0.003 -0.001

Household Income

HH income<$15K -0.033 0.003 0.009 -0.015

HH income$15-30K -0.015 -0.002 0.003 0.005

HH income 30-50 -0.014 -0.005 0.008 -0.003

HH income $50-75K -0.005 -0.001 0.005 -0.005

HH income>$75K -0.004 0.000 0.001 -0.003

HH income missing -0.009 -0.005 -0.002 0.000

Education

No high school diploma -0.021 0.002 0.005 -0.005

High school diploma -0.016 -0.002 0.004 -0.003

Some college/AA -0.012 -0.004 0.005 -0.003

College degree -0.005 -0.002 0.005 -0.001

Post graduate -0.004 0.002 -0.003 -0.005

Female head of household -0.029 0.004 0.001 -0.016

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Fee Ceilings and Stores per Capita

Only have store count data at the state level

Use estimates from demographic regressions to summarize mean use (demand) at the state level

Find state fee ceilings (and demographics) are strong predictors of the number of payday stores and pawn shops per capita.

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State fee ceilings (and demographics) are strong predictors of the number of payday and pawn stores.

Table 7: Multivariate Analysis of AFS Credit Fee Ceilings and Stores per Capita

Panel A: Number of payday stores per-capita

Coefficient Std. Error

Intercept -2.4352 0.6319 ***

Payday fee ceiling group 2

Group 1 (lowest ceilings) -0.4631 0.2071 *

Group 3 0.3321 0.1527 *

Group 4 0.9400 0.3251 **

Group 5 (no ceilings) 0.5290 0.2779

Estimated demand from Demographics 74.0100 14.1603 ***

Dependent Variable Mean 1.0331n 37.0000r squared 0.6599

Panel B: Number of pawnshop stores per-capita Payday States All States

Coefficient Std. Error Coefficient Std. Error

Intercept -0.7320 0.2794 * -0.7754 0.1957 ***

Pawn shop see ceiling group 3

Group 2 (next to lowest ceilings) 0.2674 0.1202 * 0.2438 0.0822 **

Group 3 0.4473 0.1069 *** 0.4238 0.0769 ***

Group 4 (no ceilings) 0.3429 0.1458 * 0.3425 0.0957 ***

Estimated demand from Demographics 40.2732 11.6707 ** 43.1111 9.0218 ***

Dependent Variable Mean 0.4373 0.3993

n (states) 1 37 51

r squared 0.5516 0.6450

*, *, *** : Significant at the 5%, 1%, and .1% levels

1 First column regressions only use geographic areas in states where payday lending is permitted.

The second uses all areas.

2 Base group is states with $15-$16 fee caps3 Base group is states with the lowest fee caps

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Payday Loans and Pawn shop “Substitutability”

Table 10: Interactions between Payday and Pawn Shop Fee CeilingsAverage Incidence of product usage by group adjusted for demographicsPayday loansPayday loan Fee Ceiling

Pawn Shop Loan Fee Ceiling

Lower Same HigherNo Payday 1.20 1.14$10-$12 1.62 3.37 2.40$15-$16 5.22 4.59$17-$20 4.31 4.66 4.39High or No ceiling 4.15 5.90Pawnshop UsePayday loan Fee Ceiling

Pawn Shop Loan Fee Ceiling

Lower Same HigherNo Payday 1.11 1.92$10-$12 0.85 3.65 2.18$15-$16 1.65 1.89$17-$20 1.97 2.48 2.39High or No ceiling 1.86 1.77

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Findings

Demographics do explain a lot of the cross-market variation in usage.

Adjusted Payday Use appears to be relatively uncorrelated with state fee ceilings Lower in the lowest fee ceiling group but also in the

medium fee ceiling group ($17-20 per $100 borrowed); even though lower ceilings appear to reduce the number of stores

Adjusted pawnshop is somewhat more sensitive to fee ceilings; highest use in higher fee group ($20-25 per $100 borrowed) and stores per capita are the highest for states in this fee group

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Issues

Use of small high cost loans: repeated use to make ends meet

Other AFS products: Auto-title lending; refund Anticipation loans; RTO

Direct deposit advance

What is the best we can do? Product limitations Disclosure, framing the costs Enforcement Subsidize more affordable product