The business of payday loans, pawn shops and other high-cost methods of financing has experienced tremendous growth over the past two decades, and in recent years, nearly one in four Americans have used them, according to a new paper from the National Bureau of Economic Research.
The rise of this kind of borrowing, often marketed as a means of making it to the next paycheck, reflects the needs of a population struggling to make ends meet.
Given the price of such borrowing, it may also be a measure of desperation: The financing fees on the loans are often very high, with annualized percentage rates on common payday loans reaching more than 300 percent, according to the Consumer Financial Protection Bureau. In the agency’s research, the median amount borrowed was $350.
“This method of borrowing cannot be considered a ‘fringe’ behavior limited to a small segment of the population,” said Annamaria Lusardi, director of the Global Center for Financial Literacy at George Washington University, who wrote the paper with colleague Carlo de Bassa Scheresberg. “It is firmly rooted in the American financial system. The solidly middle class are using these methods of borrowing.”
The research paper comes as U.S. regulators are preparing to issue new rules for banks offering the short-term, high-interest loans tied to direct deposits of salary or government benefits. The proposed regulation reportedly would restrict borrowers from taking more than one such loan a month.
Those rules would not affect the loans offered by storefront vendors, pawn shops and other services, however.
The research by Lusardi and de Bassa Scheresberg is based on the 2009 U.S. National Financial Capability Study, a large survey for the FINRA Foundation that asked whether over the last five years respondents had used any of five “alternative financing” methods. It was the survey’s inaugural year.
Almost 12 percent had used a pawnshop, 9 percent had taken out a payday loan, 6 percent had taken an auto-title loan, 6 percent had used a rent-to-own store and nearly 6 percent had gotten a tax-refund anticipation loan. The survey said that overall, 24 percent of people had used one of those methods of financing.
The researchers connected the use of these high-cost borrowing methods to consumers with low levels of education and financial literacy — not only the financial shocks inflicted by the financial crisis. Indeed, Lusardi said, there are signs that these methods of borrowing remain widespread after the recession.
Lusardi suggested that high schools could add courses in financial literacy.
“It might be the best way for people to borrow, but do the people really know what it means to borrow at such a high interest rate? Are people really understanding and fully aware of the terms?” Lusardi said. “If we want to prevent big mistakes, we have to invest in financial literacy.”