Consumer Law

Article on Some Relationships Between Payday Borrowing and Credit Card Borrowing

By Jeff Sovern

Sumit Agarwal of the Federal Reserve Bank, Paige Marta Skiba of Vanderbilt and Jeremy Tobacman of Penn have written Payday Loans and Credit Cards: New Liquidity and Credit Scoring Puzzles?  Here's the abstract:

Using a unique dataset matched at the individual level from two administrative sources, we examine household choices between liabilities and assess the informational content of prime and subprime credit scores in the consumer credit market. First, more specifically, we assess consumers' effectiveness at prioritizing use of their lowest-cost credit option. We find that most borrowers from one payday lender who also have a credit card from a major credit card issuer have substantial credit card liquidity on the days they take out their payday loans. This is costly because payday loans have annualized interest rates of at least several hundred percent, though perhaps partly explained by the fact that borrowers have experienced substantial declines in credit card liquidity in the year leading up to the payday loan. Second, we show that FICO scores and Teletrack scores have independent information and are specialized for the types of lending where they are used. Teletrack scores have eight times the predictive power for payday loan default as FICO scores. We also show that prime lenders should value information about their borrowers' subprime activity. Taking out a payday loan predicts nearly a doubling in the probability of serious credit card delinquency over the next year.

Full post as published by CL&P Blog on September 21, 2009 (boomark / email).