Do Payday Loans Trap Consumers in a Cycle of Debt?

Abstract

It is estimated that payday lenders made $40 billion of loans in 2010. But these loans are controversial, with one of the politically charged claims being that the high interest rates on payday loans trap consumers in a “cycle of debt.” We test this claim by conducting a field experiment whereby a random sample of borrowers are given interest-free payday loans. We then track these loans and find no difference in loan repayment rates between this treatment group and a control group of borrowers who paid conventional payday-loan interest rates. This result forms strong evidence that high interest rates on payday loans are not the cause of a “cycle of debt.”

Keywords: payday loan, cycle of debt, household finance, controlled field experiment

JEL Classification: D14, D18, G28