A Tutorial on the Economics of Payday Lending: Loan Sharking or Risky Lending

20 Pages Posted: 6 Apr 2017 Last revised: 12 Apr 2017

See all articles by John D. Martin

John D. Martin

Baylor University - Department of Finance, Insurance & Real Estate

Arthur J. Keown

Virginia Tech - Pamplin College of Business

Date Written: April 4, 2017

Abstract

The typical payday loan is for less than $500, has a maturity of two weeks, is secured by the borrower’s post-dated check or debit authorization, and carries a compound annual rate of interest that can easily exceed 10,000 percent. If you imagined the terms of illegal loan sharking you may not envision rates this high, and these loans are legal in 35 states!

The objective of this brief tutorial is to describe the little understood world of payday lending. Specifically, we explain the nature of payday lending, reveal the true cost of payday loans from the borrowers perspective and contrast this with the expected return the lender anticipates given the very high default rates on this type of loan, provide context regarding the significance of payday loans as a source of financing for individuals, and describe the public policy issues surrounding their use.

Keywords: Payday Loans, Non-Bank Consumer Finance

JEL Classification: D14, G23

Suggested Citation

Martin, John D. and Keown, Arthur J., A Tutorial on the Economics of Payday Lending: Loan Sharking or Risky Lending (April 4, 2017). Available at SSRN: https://ssrn.com/abstract=2946399 or http://dx.doi.org/10.2139/ssrn.2946399

John D. Martin (Contact Author)

Baylor University - Department of Finance, Insurance & Real Estate ( email )

P.O. Box 98004
Waco, TX 76798-8004
United States
254-710-4473 (Phone)
254-710-1092 (Fax)

HOME PAGE: http://hsb.baylor.edu/html/martinj

Arthur J. Keown

Virginia Tech - Pamplin College of Business ( email )

1016 Pamplin Hall
Blacksburg, VA 24061
United States
540-231-8647 (Phone)
540-231-3155 (Fax)

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