There has been a strong debate about the risks and benefits of payday loans for many years now. Some argue that payday loans are predatory and increase the stress on already strained borrowers. Others argue that payday loans serve as a crucial source of liquidity for individuals who would otherwise have no other alternatives. Academic research on this question has been generally inconclusive.
Neil Bhutta, an economist at the Federal Reserve Board in Washington, D.C. provides some new insights to this issue in his recent paper. Payday Loans and Consumer Financial Health. Overall, his research, which uses a novel data set and methodology, finds no evidence that payday loans increase delinquencies or financial stress on borrowers
Abstract (from paper):
In this paper, I draw on nationally representative panel data comprised of individual credit records, as well as Census data on the location of payday loan shops at the ZIP code level, to test whether payday loans affects consumers’ financial health, using credit scores and score
changes, as well as other credit record variables, as measures of financial health. In order to identify the effect of payday loans, I take advantage of geographic and temporal variation in
access arising from differences in state lending laws. In addition to standard identification strategies based on state law variation, I also follow Melzer’s (2011) novel strategy of exploiting within-state variation in access to payday loans due to differences in the proximity of ZIP codes in states that prohibit payday lending to states that allow payday lending.
Overall, I find little to no effect of access to payday loans on credit scores and other credit record outcomes. The results contrast with previous research…