By: Eric Reed
February 4, 2014
Who takes out payday loans?
For more and more Americans, access to traditional lines of credit is getting increasingly difficult. Banks have tightened their lending, and companies demand ever more perfect scores before they'll issue a credit card. The result has left millions of consumers turning to small dollar loans, services such as payday lenders, pawn shops, deposit advances, auto title loans and non-bank installment loans.
These loans tend to be bad deals for consumers, as they're often designed to take advantage of people who need cash and have no other way to get it. A recent study by the Center for Financial Services Innovation explored who the customers of these small dollar services are, and why they choose such high-interest, low-reward options.
According to the CFSI, small dollar borrowers tend to fit one of four profiles:
1. Unexpected Expenses
These infrequent borrowers are responding to a sudden, unexpected expense, generally a large one. Often they need money for an emergency, or to help out a family member or friend. According to the CFSI, this profile borrows infrequently, with 47% using small dollar lenders at most once or twice a year.
Like all four profiles the unexpected expense has limited access to traditional credit, otherwise they would use a bank or credit card. This borrower tends to use his or her payday loan to pay for necessities, such as medical bills or car repairs, and generally has a reasonable income and some savings.
These borrowers are using credit exactly as intended; they just can't get a bank to give them the time of day.
2. Misaligned Cash Flow
These borrowers access small amounts of money frequently to pay for day to day expenses such as bills, utilities and rent. They do so because their cash flow is misaligned with their expenses, leaving them short on money when they need it. This could be an individual who had unexpectedly low income one month, gets paid out of sync with their billing cycles or whose income fluctuates.
These are heavy users of small dollar credit. They borrow frequently, with half of the misaligned cash flow profile taking out six or more loans per year. Almost a fifth of them take out these high interest loans on a monthly basis.
Still, for this profile, the cash flow issues are chronic but typically short. They generally pay their loans back quickly, although the frequency with which they borrow may indicate someone living beyond their means.
3. Exceeding Income
These borrowers are living beyond their means. Their expenses exceed their income, but since they don't have an American Express, they charge it all to the check cashing service.
These are the heaviest users of small dollar loans, taking out both large and small sums on a regular basis. Small loans are frequent for this profile since their lifestyle generally leaves them without money for day-to-day expenses such as food and clothing. In fact borrowers exceeding their income are the most likely to take out a small dollar, high interest loan for living expenses.
These borrowers use small dollar loans most frequently, and often roll loans over when they can't pay.
4. Planned Purchase
Like a borrower responding to unexpected expenses, someone making a planned purchase fits the profile of a traditional borrower without access to traditional credit. The CFSI describes these borrowers as "a unique niche in the SDC market," using loans to make single, large purchases for which they've planned well in advance. Although interest is much higher than it would be through a credit card or a bank, this borrower has typically thought through and planned for it.
These are the least frequent borrowers but for the largest amounts, more than half the members of this profile borrow over $1,000 per loan. They also tend to be the most stable of all small dollar credit users, with relatively high levels of income and some savings. They aren't users forced into a loan either by circumstances or poor planning and so have a greater degree of control over their financial products.