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«Monograph #35 April 2001 Gregory Elliehausen, Ph.D. Edward C. Lawrence, Ph.D. Credit Research Center McDonough School of Business Georgetown ...»

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PAYDAY ADVANCE CREDIT IN AMERICA:

AN ANALYSIS OF CUSTOMER DEMAND

Monograph #35

April 2001

Gregory Elliehausen, Ph.D.

Edward C. Lawrence, Ph.D.

Credit Research Center

McDonough School of Business

Georgetown University

Washington, D.C.

Credit Research Center

McDonough School of Business

Georgetown University

PAYDAY ADVANCE CREDIT IN AMERICA:

AN ANALYSIS OF CUSTOMER DEMAND

Gregory Elliehausen, Ph.D.

Senior Research Scholar Credit Research Center McDonough School of Business Georgetown University Washington, DC Edward C. Lawrence, Ph.D.

Professor of Finance College of Business University of Missouri-St. Louis St. Louis, Missouri April 2001 The Credit Research Center McDonough School of Business Georgetown University

About the Center:

The Credit Research Center was founded in 1974 by Robert W. Johnson, Professor of Finance at Purdue University’s Krannert Graduate School of Management. The center’s founding was an outgrowth of Dr. Johnson’s services as presidential appointee to the National Commission on Consumer Finance in 1969. During its 3-year existence the Commission coordinated a massive research program to study the operation of consumer credit markets in the United States.

Delivered to Congress in 1972, the Commission’s multi-volume report established the value of academic research for guiding public policy towards markets for financial services. With a combination of foundation and corporate grants, Dr. Johnson established the Credit Research Center at Purdue to provide an ongoing means of directing academic research expertise toward practical problems in consumer and mortgage credit markets.

Over the past quarter-century the Center has gained a national reputation for its work in evaluating public policy toward credit markets. The Center’s operations have been sustained by generous grants from both the public and private sectors. Over one hundred articles and monographs by distinguished scholars document its research product. The Center’s senior research staff have frequently testified before Congress and state legislatures on such topics as Truth-in-Lending disclosures, the impact of interest rate ceilings on credit availability, equal credit opportunity regulations, personal bankruptcy, credit insurance, credit scoring, credit card usage, and the impact of privacy regulations. The value of these contributions to rational discourse stems from CRC’s academic affiliation, rigorous external review of its research, and the years of research experience of its principal researchers and authors.

In July of 1997 the Center relocated its offices to Georgetown University in Washington, D.C.

The Center is a non-profit unit of the McDonough School of Business where it continues its tradition of non-partisan research and education on economic issues relating to consumer credit and markets for retail financial services. For more information about the Center and its publications visit its website at www.msb.edu/prog/crc.

CRC GOVERNING BOARD

2000-2001

–  –  –

EXECUTIVE SUMMARY

INTRODUCTION

CHAPTER 1 THE PAYDAY ADVANCE TRANSACTION

Loan Size and Finance Charges

The Underwriting Process

Costs

Regulatory Environment

State Laws

Federal Laws

Self-Regulation

Consumer Protection Issues

CHAPTER 2 ANALYZING THE BENEFITS AND COSTS OF A PAYDAY ADVANCE TRANSACTION

Analytical Model for Consumer Credit Use

Analysis of the Payday Advance Transaction

Evaluating Availability of Alternatives

CHAPTER 3 SURVEY OF PAYDAY ADVANCE CUSTOMERS

Survey Objectives

Target Population

Methodology

Sample Design and Selection

Interviewing

CHAPTER 4 FRAMEWORK FOR ANALYSIS

The Buyer-Behavior Model

Problem Recognition

Internal Search

External Search and Alternative Evaluation

Purchase and Outcome Evaluation

Information Processing in the Buyer-Behavior Model

i Determinants of the Extent of the Decision Process

Situational Factors

Product Characteristics

Consumer Characteristics

Environmental Factors

CHAPTER 5 SURVEY RESULTS

Characteristics of Payday Advance Customers

Family Income

Age, Marital Status, and Family Life-Cycle Stage

Income and Family Life-Cycle Stage

Education

Attitudes Toward Credit and Payday Advances

Attitudes toward Credit

Attitudes Toward Payday Advances

Perceptions of the Cost of Payday Advances

Consumer Experience With Payday Advance Credit

Frequency and Duration of Payday Advance Use

Use of Different Payday Advance Companies

Late Payments on Payday Advances

Availability of Alternatives to Payday Advance Credit

Availability and Use of Bank Card Credit

Debt-Payment Burdens of Payday Advance Customers





Credit Availability

Customers’ Most Recent Payday Advance Transaction

The Most Recent Payday Advance

The New Payday Advance Decision

CHAPTER 6 SUMMARY AND CONCLUSIONS

Survey of Payday Advance Customers

Survey Findings

Characteristics of Payday Advance Customers

Attitudes Toward Credit and Payday Advance Credit

Consumer Experience With Payday Advance Credit

Availability of Alternatives to Payday Advance Credit

The Most Recent Payday Advance

APPENDIX A Best Practices for the Payday Advance Industry

APPENDIX B Questionnaire

BIOGRAPHIES OF AUTHORS

–  –  –

Many people contributed to this study. Thomas A. Durkin, of the Board of Governors of the Federal Reserve System; James Lacko, of the Federal Trade Commission; and Michael E. Staten, of the Credit Research Center reviewed the questionnaire and provided detailed comments and suggestions. Members of the Credit Research Center’s Advisory Council also provided many helpful suggestions. Board members of the Community Financial Services Association of America (CFSA) provided a thorough review of the factual material regarding the payday advance industry.

At Market Facts, Cecile M. Johnson directed the survey of payday advance customers. She was assisted by Lefki Anastasiou. Both provided helpful guidance in the development of the questions. Alan Roshwalb designed and selected the sample. We also thank the CFSA-member companies and their customers who participated in the survey.

Thomas A. Durkin; Robert W. Johnson, of Consumer Credit Intelligence, LLC; and Michael E.

Staten reviewed the draft of this monograph. Their comments and suggestions greatly improved the content of the monograph. At the University of Missouri-St. Louis, Karen Wagster provided research assistance.

This project was supported, in part, by a grant from the Community Financial Services Association of America.

iii

EXECUTIVE SUMMARY

This monograph investigates consumers’ demand for payday advance credit. The data for the investigation are from a nationally representative sample of customers of payday advance companies belonging to the industry trade association, the Community Financial Services Association of America. Member companies operate about half of the approximately 10,000 offices offering payday advance credit. The survey was conducted from December 28, 2000 to January 9, 2001.

The payday advance industry emerged during the 1990s to cater to unfulfilled demand for very small, short-term consumer loans. Payday advance customers are primarily moderateincome consumers who are often in early stages of the family life cycle. They are more likely to use consumer credit and tend to have higher levels of consumer debt relative to income than the population as a whole. According to previous research, such consumers typically have high rates of return on investments in household goods. Because of the high return on household investment, they have strong demand for credit, which at the margin makes them insensitive to interest rates on loans. Thus, payday advance customers’ use of such credit, which has very high annual percentage rates, is consistent with the predictions of economic theory and previous empirical research.

Payday advance customers are generally aware of the cost of such credit. Nearly all payday advance customers were aware of the dollar amount of the finance charge on their most recent new advance. But few were able to report accurate annual percentage rates despite recalling receipt of that information in Truth in Lending disclosures. A likely explanation is that payday advance customers used finance charges rather than annual percentage rates in decisionmaking. Many costs that customers use payday advances to avoid (e.g., fees for returned checks or late payments) are typically expressed as dollar amounts, not annual percentage rates. Since customers did not use annual percentage rates to make their decision, they did not retain the information in memory.

In other circumstances, payday advance customers may use annual percentage rates.

Nearly all payday advance customers owe other types of consumer credit. They are concentrated in the middle levels of educational achievement. Other surveys have found these levels to be associated with relatively high awareness of annual percentage rates for consumer instalment credit. Moreover, payday advance customers who had bank cards were generally aware of the annual percentage rate on the bank card used most frequently.

Many customers recognize that payday advance credit is costly. Although many customers consider the cost of payday advances to be the same or less than fees for returned checks or late payments, a very large number thought payday advances were more expensive.

And the small percentage of customers who were dissatisfied with their most recent new payday advance cited the high cost as the reason for their dissatisfaction.

iv Payday advance customers perceived limitations in credit availability and had fewer alternatives than the population as a whole. Nearly three-fourths of payday advance customers have been turned down by a creditor or not given as much credit as applied for in the last five years. Two-thirds of customers considered applying for credit but changed their mind because they thought they would be turned down. Payday advance customers were less likely than the adult population to have a bank or retail credit card. Of the 56.5% of customers having bank cards, over half refrained from using such cards in the last year because they would have exceeded their credit limit.

Most payday advance customers use advances infrequently or moderately. About half of customers had advances outstanding less than a total of three months during the year, and nearly four in five had advances outstanding less than half of the year. Generally, payday advances were used at different times over the year. Over half of customers’ longest consecutive sequence of advances were less than a month. These findings suggest many payday advance customers use payday advances regularly for short periods of time. Attitudes expressed by customers disagreeing with the government limiting the number of times a consumer can obtain payday advances during the year are consistent with such use.

A small percentage of customers had payday advance credit outstanding for more than half of the year, however. These customers may have had few alternatives to payday advances.

Nevertheless, the favorable attitudes toward payday advances and the high level of satisfaction with the most recent advance suggest that for many of these customers continued use of payday advance credit was a choice, not a burden from which they could not escape. Of the customers expressing dissatisfaction with their most recent advance, only a very small percentage of customers were dissatisfied because of the difficulty of getting out of debt.

In sum, most payday advance customers use such credit as a short-term source of financing. Nearly all are aware of the finance charge for payday advance credit. Payday advance customers use other types of consumer credit and are likely aware of annual percentage rates for such credit. However, they may have difficulty obtaining additional credit from traditional creditors, especially on an unsecured basis. Thus, payday advances give these consumers a little control over their financial situation that they otherwise would not have. This may explain customers’ positive attitudes toward payday advance credit and high levels of satisfaction.

–  –  –



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