Some policymakers have expressed concern that short-term subprime credit offerings such as payday loans don’t provide sufficient time for borrowers to save for repayment, which could lead to repeat borrowing and chronic debt issues. A recent study co-authored by Professor Paige Skiba at Vanderbilt Law School finds that borrowers given more time to pay back their loans handle repayment in a similar fashion to those with less time.
Using a dataset of payday loan borrowers from Texas whose grace periods varied, Skiba and her co-authors found that borrowers with more time to save up for repayment did not in fact pay down a larger portion of their loans.
“We find that (borrowers with longer grace periods) do not accelerate their loan repayments and make initial loan repayments that are nearly identical on average to what we see for the short-duration borrowers,” they write in Time to Repay or Time to Delay? The Effect of Having More Time before a Payday Loan Is Due, published in the American Economic Journal: Applied Economics.
The paper explores several potential reasons for this behavior. Factoring risk and income-related “shocks” (e.g., unsteady income, unforeseen medical bills, tax refunds) failed to explain it. The authors also considered the impact of heuristics (mental shortcuts used to simplify problems) in decision-making. If a borrower planned to pay down the same amount on each due date regardless of the balance, or just the minimum required, that would certainly diminish the benefit of a longer grace period. The study’s models show that while heuristics may play a part in borrower decision-making, more research would be required to confirm.
“The evidence we have gathered here shows at a minimum that people are not optimizing their repayment behavior on a regular basis,” Skiba says.
“Economists assume people can make perfect, complex calculations, never procrastinate, etc.,” she adds. “We know from research – and intuition – that these assumptions are unrealistic, especially in credit market settings.”
The authors note that their findings have implications for policymakers seeking to improve subprime credit markets. “Our results suggest that having more time to repay a loan will not, by itself, meaningfully improve repayment behavior or result in smoother consumption profiles,” they write.
Time to Repay or Time to Delay? The Effect of Having More Time before a Payday Loan Is Due is co-authored by Susan Payne Carter of the US Military Academy, Kuan Liu of the Sam Walton College of Business at University of Arkansas, and Justin Sydnor of the University of Wisconsin – Madison.
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