Payday lending is a controversial segment of the consumer finance industry. A payday loan is a small, single payment loan that is repayable on the borrower’s next payday. Typically, payday loans are between $100 and $500 and have a term to maturity of about 14 days. Because of the small loan amount and short term to maturity, annual percentage rates for payday loans are commonly between 390 and 700 percent. Not surprisingly, the high annual percentage rates have led to allegations that payday loans are predatory. Industry critics often argue that the high interest charges and single payment feature of the product make repayment of the debt difficult, trapping many borrowers in a series of renewals that ultimately lead to insolvency. Payday lenders contend that the product satisfies credit constrained consumers’ liquidity needs for short term credit to manage unexpected expenses and shortfalls in cash. Although payday loans have a high price, the costs arising from delinquencies and late payments that such unexpected events could trigger may be even higher. These contentions need not be mutually exclusive. As with other credit products, some borrowers may have problems repaying while others are able to pay on time and receive benefits from the item being financed.

Historically, consumer finance companies provided small loans to relatively high risk, credit constrained consumers. Finance companies have largely abandoned the small loan market (Brito and Hartley 1995). Finance companies along with banks and credit unions prefer to provide access to such credit to more creditworthy consumers through revolving accounts. A notable characteristic that distinguishes payday loan customers from customers of other high price lenders such as pawnbrokers and rent to own companies is that all payday loan customers have a banking relationship. Payday loan customers must have a checking account to qualify for a payday loan, and most have an automobile loan or other type of consumer debt with a bank or finance company.