1. Payday Loans versus Pawn Shops: The Effects of Loan Fee Limits on Household Use Robert B. Avery Federal Reserve Board Katherine A. Samolyk Consumer 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. 1

2. 2 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

3. 3 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

4. 4 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

5. 5 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

6. 6 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

7. 7 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

8. 8 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 loans 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

9. 9 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.

10. 10 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

11. 11 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)

12. 12 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

13. 13 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

14. 14 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

15. 15 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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17. 17 How Fee Limits Affect Use State Fee Limits per $100 State Group Payday Fee RangePawn Fee Range Not PermittedNA Low$10-$12$1-$9 Medium$15-$16$10-$19 High$17-$20$20-$25 No Ceiling/Very High> $20 or NoneNone

18. 18 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 1 st stage) Sample includes 365 geographic areas identified in the CPS data in states where payday stores can operate Explanatory variables include: Fee ceiling categories Categorical variables for broad region; rural dummy; median income of market where the area is located Relative fee ceilings on substitute product

19. 19 Nonlinear effect of payday fee ceilings on usage adjusted for local demographics; lower in the lowest payday fee-ceiling groupbut 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)

20. 20 Effects of Fee Ceiling on Specific Demographic Groups

21. 21 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.

22. 22 State fee ceilings (and demographics) are strong predictors of the number of payday and pawn stores.

23. 23 Payday Loans and Pawn shopSubstitutability

24. 24 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

25. 25 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