Gregory Elliehausen

A COMPARATIVE ANALYSIS OF PAYDAY LOAN CUSTOMERS

One of the most rapidly growing and controversial forms of consumer lending to recently emerge in the marketplace has been payday advances. This form of credit allows the borrower to obtain a small amount of cash for a short period of time. Claims of predatory lending often arise due to the high annual percentage rates that result from the fees for borrowing small amounts of money for 2 wk or less. By analyzing the data collected in a national survey of payday customers, this research allows policymakers to better understand what type of consumer borrows from payday lenders, for what purpose, and what the true benefits and costs are. The results confirm a strong demand for payday loans that satisfy a real financial need within a certain segment of the population. (JEL D12, D18, G20) Copyright (c) 2007 Western Economic Association International.

Regulation of Subprime Mortgage Products: An Analysis of North Carolina's Predatory Lending Law

This paper estimates the effect of North Carolinas high-cost mortgage law on the subprime mortgage market in that state. The results indicate that creditors sharply restricted lending to higher risk consumers in North Carolina following passage of the law. Creditors did not restrict lending in neighboring states or to lower risk consumers in North Carolina. These results suggest that the restriction in North Carolina was due to rationing in response to higher costs imposed by the law. The findings of this study are of importance beyond North Carolina. Other states and municipalities have proposed or passed similar or more restrictive laws. These laws risk taking back some of the gains in credit availability that lower income and higher risk consumers gained in the 1990s.

Mortgage Contract Choice in Subprime Mortgage Markets

The boom in the subprime mortgage market yielded many loans with high LTV ratios. From a large proprietary database on subprime mortgages, we find that choice of mortgage rate type is not linear in loan sizes. A fixed rate mortgage contract is a popular choice when loan size, measured by LTV ratio, is small. As LTV ratio increases, borrowers become more likely to choose adjustable rate mortgage contracts. However, when LTV reaches a certain level, borrowers start to switch back to fixed rate contracts. For these high LTV loans, fixed rate mortgages dominate borrowers choices. We present a very simple model that explains this nonlinear pattern in mortgage instrument choice. The model shows that the choice of mortgage rate type depends on two opposing effects: a term structure effect and an interest rate volatility effect. When the loan size is small, the term structure effect dominates: rising LTV ratios making ARM loans less costly, and more attractive. However, when the loan size is large enough, the interest volatility effect dominates: rising LTV ratios making FRM loans less costly and preferable. We present strong empirical evidence in support of the model predictions.

Consumers' Use of High-Price Credit Products: Do They Know What They Are Doing?

A variety of consumer credit products have particular notoriety because of their high prices. The products include some small personal loans, pawnbroker loans, payday loans, automobile title loans, and refund anticipation loans. Critics of these credit products see little or no benefit to using high-price credit, assert that high-price credit products have great potential to harm consumers, and contend that consumers using such products often are uninformed or have been misled. This paper examines available evidence on consumers’ use of high-price credit within the context of their credit situation and decision process. The findings indicate that users of highcost credit generally fall into groups that economic theory predicts might benefit from use of such credit and suggest that decision processes for high-price credit products typically show signs of deliberation but usually do not include extensive problem solving. As such, decision processes for high-price credit products do not appear to be much different from decision processes for mainstream credit products.

Implications of Behavioral Research for the Use and Regulation of Consumer Credit Products

This paper reviews the behavioral literature on inter-temporal choice and decision making under uncertainty and assesses the evidence on behavioral influences affecting consumers credit decisions. The evidence reviewed suggests that consumers often do not consider all information available in the market nor deliberately evaluate each alternative. Consumers simplify, take shortcuts, and use heuristics, which may not always be optimal but nevertheless may be an economical means for achieving desired goals. While most economists and psychologists agree that cognitive errors and time inconsistent behavior occur, the extent to which these phenomena impair actual decisions in markets is not at all clear. At this time, neither existing behavioral evidence nor conventional economic evidence supports a general conclusion that consumers credit decisions are not rational or that markets do not work reasonably well. Empirical evidence suggests that behavioral research can help improve required information disclosures and contribute to more effective regulation, which enhances the performance of markets and improves individual outcomes.