Payday lending is among the highest risk subsets of subprime lending. Payday lending is characterized by small-dollar, short-term, unsecured lending to borrowers who are typically experiencing cash flow difficulties.
Many financial institutions have failed to properly assess and control the risks associated with their payday lending programs. The consequences of deficiencies in risk management practices for payday lending programs can be severe.
The risks of payday lending are challenging for bankers and merit the continuing attention of financial institution examiners.
What Are Payday Loans?
Payday loans are small-dollar, short-term, unsecured loans that borrowers promise to repay out of their next paycheck or regular income payment. Payday loans are usually priced at a fixed-dollar fee, which represents the finance charge to the borrower. Because these loans have such short terms to maturity, the cost of borrowing, expressed as an annual percentage rate, can range from 300 percent to 1,000 percent, or more. An example of a typical loan process for payday lending is described in the adjacent box.
Who Are the Borrowers?
Typically, payday customers have cash flow difficulties and few, if any, lower-cost borrowing alternatives. Payday customers tend to be frequent users of payday advances, often choosing either to “roll over” their credits or to obtain additional subsequent extensions of credit. This data indicates that the cash flow difficulties experienced by many payday customers are a long-term credit characteristic as opposed to a short-term temporary hardship.