A new study by researchers at Vanderbilt University Law School and University of Oxford reveals a strong correlation between approvals for payday loans and bankruptcy filings. Considering that people who are rejected for payday loans have other (limited) options for credit, it’s surprising that the rate of bankruptcy isn’t as high with this group. It’s quite possible that this can be interpreted as a cause-and-effect relationship. That is, being approved for payday loans increases the probability of filing bankruptcy.
Individuals who have been approved for payday loans have a probability of filing for bankruptcy within two years 2.48 percentage points higher than the probability for individuals who were rejected for payday loans.
It sounds obvious, but scientific findings that payday loans contribute to bankruptcy confirm any hunches. Payday loans a short-term loans with fees which, if viewed in terms of interest rates, are very high. Rates of 100% APR or higher are common. The loans are designed to be paid back in two weeks, however, so you only see a 100% interest rate if you roll over from one loan to the next for an entire year.
Most people who have the need to get cash quickly in the form of a payday loan don’t continue the cycle continuously for a year, but many do become repeat customers. The typical payday loan borrower will apply for about five more payday loans totalling over $1,500 within one year after the initial acceptance.
The study shows that interest from payday loans accounts for about 11% of the a bankrupty filer’s total interest burden, and this 11% could be what finally pushes an individual into declaring bankruptcy — the proverbial straw.
These results are consistent with the interpretation that payday loan applicants are financially
stressed; first-time loan approval precedes significant additional high interest rate borrowing; and
the consequent interest burden tips households into bankruptcy.
The authors of the research discount the idea that individuals preparing to declare bankruptcy quickly accumulate as much debt as possible to maximize bankruptcy’s “benefit.”
While it’s certainly possible to borrow money through a payday loan, pay the entire balance plus interest when it is due, and never become a payday loan customer again, this is not a typical scenario. Furthermore, those who have low credit scores may be rejected by payday loan companies and turn to pawn loans instead, with similarly high interest rates. Yet, the payday loan customers have the increased incidence of brankrupcty.
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Updated March 7, 2012 and originally published March 20, 2008.