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Study: Payday Loans Cause More Bankruptcies

This article was written by in Debt Reduction. 11 comments.

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.

Do Payday Loans Cause Bankruptcy? [Paige Marta Skiba, Vanderbilt University Law School and Jeremy Tobacman, University of Oxford]
via Research Recap via

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Updated March 7, 2012 and originally published March 20, 2008.

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About the author

Luke Landes is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about Luke Landes and follow him on Twitter. View all articles by .

avatar 1 Anonymous

In my own words as an instructor of graduate level Quantitative Analysis, “Correlation does not mean Causation.” Just because 2 variables are related does not mean one causes the other. While it is possible that is the case, it is not a given. Both events could be caused by another common factor.

After browsing through the linked paper I didn’t see in the conclusion that they are saying there is a correlation. They, do state that there is a statistically significant difference in bankruptcy filing, and then jump to conclude that Pay Day loans cause them. That is BAD statistics, no doubt about it.

I agree Pay Day Loans are bad, but it is just as likely that people more likely to file bankruptcy are more likely to use Pay Day Loans. Or, again, that some 3rd factor is linking both of them.

Then again, this is from a law school. Guess they should have brushed up on more than plugging values into statistical equations and charts!

avatar 2 Anonymous

This is just further proof that pay day loans and cash advances are the biggest scam going. Loan sharks don’t even charge the rates they do. They should be outlawed.

avatar 3 Anonymous

My best guess at a plausible explanation is that people who can get payday loans out are more likely to have recently had sufficient credit to take out other loans. Chronic debt coupled with one emergency is often enough to push people into bankruptcy.

If you don’t have the debt (or the ability to acquire any), you may still be in serious trouble if an emergency occurs, but bankruptcy is unlikely to provide any relief.

avatar 4 Luke Landes

Curtis: While I normally agree that “correlation does not imply causation,” the data presented here seem to be as controlled as possible. The two groups being compared are “accepted for a payday loan” and “rejected for a payday loan,” (not “payday loan customers” vs “non-customers”) so the only external variable I can imagine is the slight difference in credit scores (the variable that differentiates the two groups). In fact, those *accepted* for a payday loan — the same who have filed significantly more bankruptcies within 2 years — have *higher* credit scores. This goes *against* the normal convention that those filing for bankruptcy have *worse* credit.

No, this doesn’t eliminate the possibility of other variables affecting the outcome, but it doesn’t seem likely.

plonkee: That’s a good comment. Keep in mind, however, that those rejected for payday loans went on to find other credit like pawn loans where collateral takes the place of a credit history.

avatar 5 Anonymous

I just discovered your blog and have spent a few minutes looking around. I personally place a high value on intellectual honesty and I admire your efforts to be personally transparent and also to provide an educational forum for readers. I hope you’ll keep up the fine work.

Having said that, I’m struck by a certain irony here…I’m posting this response to a post about the link between payday loans and bankruptcies. The 7 advertising links on the pages that surround the headline are ALL focused on quick financing options and 2 of the specifically mention pay day loans.

I recognize the fact that you are very open about the advertising policies on the site and you do not have any paid blog posts. I want to reiterate that I’m very impressed with the transparency and quality information on the site. But accepting ads from firms that push payday loans on a site like this seems to run counter to what I perceive your purpose to be.

avatar 6 Luke Landes

Mark: I’d like to reserve comments for actual discussions about articles and not about this website itself, but I have certainly given a lot of thought to the type of advertising I accept here. The bottom line is that readers here are intelligent enough to a: make their own good choices and b: realize that advertising does not imply endorsement. The purpose of this site is to track my personal finance progress and missteps and to provide commentary on a variety of topics. Payday loan companies will continue to exist whether they advertise here or not, and I am not facilitating much of anything by accepting their advertising. Even “legitimate” banking institutions offer unscrupulous, payday loan-like products. If I limit advertising to companies that are squeaky clean and never take advantage of customers… well… I guess the site would look a lot less cluttered. :-)

That being said, I’m always re-evaluating my decisions based on what readers like to see. I’d be happy to discuss further via email (not via comments… let’s stick to the topic).

avatar 7 Anonymous

As a representative of the payday lending industry, I would like to point out that in Georgia and North Carolina, where payday lending was also effectively banned, a Federal Reserve Bank of New York Staff Report found that bounced checks, personal bankruptcies and complaints about debt collectors jumped significantly when consumers no longer had a payday loan option.

avatar 8 Anonymous

We need to stop blaming the payday lenders for everyone else’s irresponsibility! If I borrow 100 bucks from a friend, and am not able to pay it back, I don’t blame my friend for lending me the money! That is just stupid. So why are we blaming our payday lender friends for providing a great service? In a recent article by ex senator and presidential candidate George McGovern, he says, “[p]ayday lending bans simply push low-income borrowers into less pleasant options, including increased rates of bankruptcy,” Mr. McGovern rightly poses the question: “Why do we think we are helping adult consumers by taking away their options?”

Later in the article, he says, “[t]he nature of freedom of choice is that some people will misuse their responsibility and hurt themselves in the process. We should do our best to educate them, but without diminishing choice for everyone else.”

This is how we need to look at this topic. Leave the payday loan stores alone and look for other options. Instead of taking away payday lenders, beat them at their own game by giving consumers even more alternatives!

avatar 9 Anonymous

When comparing the two groups, those who were approved for payday loans and those who were not, is any consideration being given to the other forms of debt that these consumers have? Perhaps the people who are not approved for a payday loan also do not have other forms of debt. It’s hard for me to believe that a $500 debt (a typical payday loan amount) would push someone into bankruptcy. If the payday loan debt were forgiven or restructured, would the consumer then be able to repay their other debts as scheduled? Additionally, compare consumers with payday loans to consumers who pay bounced check fees. I’d like to see a study comparing the bankruptcy rates between those who pay bounced check fees and overdraft protection fees on their checking accounts, and those who do not qualify for overdraft protection or who do not qualify for checking accounts. Can the same “conclusion” be made that bounced check fees or overdraft protection fees cause bankruptcy?

avatar 10 Anonymous


avatar 11 Anonymous