Dartmouth Payday Loan Study: Oregon Rate Cap Harms Consumers

Discouraged Consumers

In 2007, the State of Oregon imposed a low payday loan rate cap of $10 per $100 borrowed (150 percent APR), and extended the previously common two-week payment period to a minimum of 31 days. Numerous sources have spoken out against this regulation, claiming it to be unfair and harmful to the economic well-being of Oregon consumers. There are academic studies that suggest that this is so,  including a December 2008 paper by Dartmouth College Economics professor Jonathan Zinman. In his study “Restricting Consumer Credit Access: Household Survey Evidence on Effects Around the Oregon Rate Cap,” Zinman examines what happens when access to payday loans is restricted, using survey data from payday loan customers. The scarcity of access was directly related to the new low rate making the payday loan business model unsupportable – some businesses closed their doors.

The rate cap mindset, Zinman believes, comes out of the school of thought that restricting credit rates prevents over-borrowing. Using neighboring Washington State as a control group sample to set off against the results of the Oregon survey – the states were “on similar economic trajectories at the time of the surveys: both states had experienced four consecutive years of employment growth, and both states forecasted a flattening of employment rates for the latter half of 2007″ (Oregon Office of Economic Analysis 2007; Washington Economic and Revenue Forecast Council 2007) – Zinman finds that borrowing decreased in Oregon relative to Washington (which did not have the same rate cap).

Moreover, payday loan customers turned to less desirable sources (most commonly, relying upon checking account overdraft or paying bills late) during times of short-term financial need. When a substitute is not sufficient, loss of checking account, criminal charges and utility shutoff are possible outcomes, to name a few of the most common.

Payday loan access: for good or for harm?

There is some question as to whether access to payday loans does borrowers more good than harm. Supporters point out that as the use of payday loans has grown, consumer financial welfare has improved; they typically borrow if there is a benefit. Others believe that unrestricted access leads to over-borrowing, justifying regulation of access. As of the time of Zinman’s study, at least 13 states had heavy restrictions on payday loan terms. New Hampshire and Ohio are the most recent states to restrict access, and others states like Virginia are attempting to follow suit. President-Elect Barack Obama seeks to cap no fax payday loan rates at 36 percent, nationwide.

Looking at the current base of  literature on the effects of access to payday loans, Zinman notes several studies that suggest that access to this short-term credit helps borrowers “smooth negative shocks” (Morse 2007; Wilson et al. 2008), contributes to consumers retaining their jobs (Karlan and Zinman forthcoming) and helps them better manage financial distress (Morgan and Strain 2008). Zinman’s findings concur with these cited authors’ work.

Understanding the payday loan market

Before the 2007 Oregon legislation, payday loans were commonly two-week loans. Customers typically took out $100 to $300 in return for a post-dated check, dated to coincide with the borrower’s next scheduled payday. The fee was commonly$15 per $100 loaned over the two-week period (effectively a 390 percent APR).

Who is doing the borrowing? The documentation Zinman references indicates people with steady employment and a checking account. Their credit histories may not be perfect, and household income generally falls below $50,000 but above $20,000. The mean age is 47 and over 60 percent of borrowers are female.

What are payday loans used for in Oregon?

“Bills, emergencies, food/groceries, and other debt service” were the most common answers in Zinman’s study. A mere six percent chose “shopping or entertainment.” If a payday loan had not been available, 70 percent claimed they “didn’t know” what alternative they would have used during their emergency. Interestingly, only eight percent stated “bank” or “credit union” and 15 percent said they would go to a pawn shop or use a credit card or car title loan.

Cap the payday loan, cap financial well-being

Those who support the use of payday loans argue that they help borrowers avoid missed work days (lost wages). Reducing payday loan access in Oregon, Zinman found, hindered productive spending that was directly related to successful job retention or job search.

Logically, he finds this to be consistent with consumer financial well-being. Broken down, that translates to survey data reporting

“low levels of recent or expected deterioration in financial condition… fewer than 20 percent say that their situation has been getting worse, and fewer than 10 percent expect their situation to get worse in the future.”

Oregon has hurt its citizens; other states should take notice

Zinman found that as the cap restricted credit opportunities, financial condition of borrowers suffered. Oregon’s policy change decreased short-term borrowing relative to the Washington control group, and the disenfranchised borrowers typically resorted to less desirable, more expensive alternatives like checking overdraft. Critics such as those in the video below who continue to use the behavioral model as a reason to cap or ban the payday loan should take a moment to consider the hard data. Dartmouth College Professor Zinman has shown that the regulation has been harmful to the people, which in turn does not bode well for the state economy, particularly during the serious recession America currently faces. Turning away from the evidence is harmful and irresponsible to the people.