Researchers from George Mason University and Colby College Release New Study on Payday Lending

FAIRFAX, Va., Feb. 6 /PRNewswire-USNewswire/ -- A team of researchers from George Mason University and Colby College have found that allowing individuals access to payday loans improves the borrowers' ability to survive financially. Because payday loans can help the participants to manage their personal finances better, the availability of payday loans -- despite their high cost -- improves consumer welfare in the study by allowing borrowers to deal with unexpected expenses. However, borrowers whose demand for payday loans exceeds a certain threshold level are at a greater risk than those who do not have access to payday loans.

Payday loans are short-term loans of $100 to $500 that typically must be paid back within two weeks or by the borrower's next payday. The fees for these loans vary from $10 to $25 per $100 borrowed, which often represents an annual percentage rate of 391% or more.

The study was conducted by Prof. Bart J. Wilson of the Interdisciplinary Center for Economic Science at George Mason University, Profs. David W. Findlay and James W. Meehan, Jr. of the Department of Economics of Colby College, and Dr. Charissa P. Wellford, an independent economist. Karl Schurter, an under-graduate at the University of Virginia, is also a co-author of the study.

Using techniques of experimental economics, the investigators created a laboratory environment similar to that faced by financially strapped consumers. They then conducted a controlled experiment using 318 subjects to examine the effect, if any, that availability of payday loans has on individuals' abilities to manage and to survive financial setbacks. The principal objective of the study was to examine whether access to payday loans improves, worsens, or has no impact on the likelihood of becoming insolvent.

According to Prof. Wilson, access to payday loans in their environment, all else fixed, increases a borrower's probability of financial survival by 31%. Many participants effectively use payday loans as the means to absorb shocks when, for example, they do not sufficiently save for unexpected "rainy days."

The study, however, also found that the benefits from payday loans to borrowers decline if the loans are overused; taking out an excessive number of loans puts borrowers at greater risk than subjects to whom loans are unavailable.

The study sheds additional light on questions not easily answered with traditional empirical analysis, in part because disaggregated data do not exist, and in part because the behavior of payday loan customers is not readily observable at the time they make their borrowing decisions. The use of a laboratory environment allows the investigators to observe how payday loan customers' behavior responds to changes in the environment and the rules under which they make their short-term loan choices. An additional benefit of the laboratory study is that the economic decision environment is held constant so that all participants face the same financially challenging conditions.

Several states, including Virginia, are considering placing additional limits on loans, or banning them altogether, during their current legislative session.

The complete discussion draft from the study is available online at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1083796.