Each year some 10 million American households borrow money through payday loans. Payday lenders now have more storefronts than McDonald’s and Starbucks combined. But a recent study shows that payday-loan applicants who received the quick cash after their first application were significantly more likely to file for Chapter 13 bankruptcy than those whose initial application was denied.
Paige Marta Skiba, assistant professor at Vanderbilt University Law School, and Jeremy Tobacman, assistant professor in the department of business and public policy at The Wharton School, found that first-time applicants who received a payday loan were almost twice as likely to file for bankruptcy within two years as those denied the first time. The interest from payday and pawn loans amounted to an average of about 11 percent of the total liquid debt interest burden at the time of the bankruptcy filing.
“Our research finds that payday loans and their interest payments may be sufficient to tip the balance into bankruptcy for a population that is already severely financially stressed,” says Skiba.
Skiba and Tobacman looked at four years of data for the state of Texas from a prominent payday loan company. From 2000 to 2004, the company received more than a million applications. The average loan request was around $300. The median annual income on the applications was $20,000 with a median checking account balance of $66.
“Payday loans seem to be the straw that breaks the borrower’s back,” says Skiba, “because the loans are normally due every week or every other week, so other debts like credit cards or mortgages tend to be ignored.”
First-time borrowers tended to continue borrowing. The researchers found that first-time applicants who were approved applied for about five more loans within a year than did rejected first-time applicants. “Access to payday-loan credit predicts roughly $2,300 of additional payday borrowing within two years,” says Skiba.
And those who were denied their initial payday loan request? Researchers say their probability of taking out a pawn loan doubled.
The full study, titled “Do Payday Loans Cause Bankruptcy?” can be downloaded online.
© 2015 Vanderbilt University
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