Payday Lender, Austin, Texas, October 2013
Bonuses for large loans are a current trend in payday loan lending circles. As discussed in this blog, larger payday loans have a lower default rate. Offering a bonus for larger loans is equivalent to offering a lower interest rate.
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Economists, Will Dobbie and Paige Mart Skiba, in their paper, use data from Payday lenders in a number states to estimate an econometric model of the payday loan model. Their paper uses borrower income, demographic information, and loan eligibility details to test for moral hazard and adverse selection in the payday loan market.
They find no evidence of moral hazard. A larger loan actually decreases the probability of a default. They find that a $50 larger payday loan leads to a 17 to 33 percent drop in the probability of default. In addition, their results show the relationship between factors such as credit score (-), home owner ship (-), income (-) and age(-) on the probability of default.
Definition: In economic theory, a moral hazard is a situation where a party will have a tendency to take risks because the costs that could incur will not be felt by the party taking the risk