The Wrong Choice?

Even though many payday borrowers have enough unused credit on their credit cards to cover the amount of the payday loan, they still end of choosing the more costly option.

 

 

This report from the Federal Reserve Bank of Chicago is not brand new (it was released on January 13, 2009), but it is obviously still relevant and I just found it.  Payday Loans and Credit Cards: New Liquidity and Credit Scoring Puzzles? examines the choices that consumers make in bridging the gap between paychecks.  The core focus of the paper is on how households make their choices from where they get extra short-term liquidity (payday loans versus credit cards) and if these are the lowest-cost choices.

The paper concludes:

Regarding liquidity, we find that most account holders with a major credit card issuer have substantial unused liquidity on their credit cards at the time they borrow on payday loans. Their annual pecuniary losses from payday borrowing, compared to using their credit cards, are large compared to previously identified liquid debt puzzles. Regarding credit scores, payday lenders could obtain useful information about default probabilities by examining the FICO scores of applicants in addition to Teletrack scores, and credit card issuers would benefit from having frequently-updated information about whether their account holders are payday borrowers.

The paper also proposes two very interesting questions regarding this conclusion that warrant further research:

Why do payday lenders generally use only Teletrack scores and not also FICO scores when making lending decisions, and why do credit card issuers not aggressively seek information about payday borrowing by their customers?

If your credit union offers payday loans and/or credit cards, you may want to use the Fed’s report as a starting point for (re)examining the short-term liquidity needs of your members.

 
 

March 12, 2010


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