Loans with a typical APR exceeding 500% – surely that’s impossible? Or even if they do exist, no one in their right mind would sign up for these terms, right? Well, ask the people walking into one of these:
Because of the risk involved in making pay day loans, the cost to the borrower of obtaining such ‘alternative finance’ is higher than regular credit. The problem is that pay day borrowers usually don’t have access to regular credit. As the Economist eloquently puts it: “For someone who is truly hard-up, the only thing worse than borrowing $200 at 600% APR may be not borrowing $200 at all.”
So pay day loans are expensive. But are they harmful, and should they be regulated? The arguments for and against pay day lending are familiar and well-rehearsed economic justice arguments:
- AGAINST: “Offering pay day loans is taking advantage of vulnerable people.”
- FOR: “But no one is forcing the borrowers – it’s their own choice.”
- AGAINST: “But poor people make poor choices when tempted by shrewd lenders – somebody do something!”
- FOR: “Who? The government? Who says they know what’s best for people?”
Obviously, this discussion is going nowhere – it’s unavoidably political. But don’t despair, there is a third way: the behavioural intervention. A behavioural intervention is Nudge speak for giving people better structured information so that they can make better choices. This is what a pair of economists from the University of Chicago investigated in a well designed field experiment. The researchers manipulated the print on the cash envelopes used in 77 branches of a US pay day lending firm over a two-week period. They tried three print versions as experimental treatments:
- A comparison of pay day loan APR to other forms of credit
- A list of the accumulated cost of pay day loans in dollars, compared to credit card borrowing fees
- Information on how quickly people repay pay day loans
Compared to a control group who receive non-manipulated, company branded envelopes, the second envelope manipulation reduced the likelihood of the recipient re-applying for a pay day loan in the next pay cycle by 11%. Furthermore, individuals in all three envelope treatments reduce their average borrowing over the next pay cycle by more than the control group.
So, assuming that at least some pay day borrowers would rather not use pay day loans to make ends meet, the behavioural intervention is a success. Whilst I’m not sure that the conclusion “information disclosure that is inspired by, and responds to, cognitive biases or limitations that surround the payday borrowing decision has a significant effect” is warranted (the treatment is actually less effective for those who spend the loan money on eating out and holidays), the reduction in loans across the whole sample is encouraging. Perhaps this is one for the Behavioural Insights Team?