Association for Public Policy Analysis & Management

In the current regulatory environment of the US, there are large differences in each state’s payday lending laws. This results in some states which cap interest rates and fees, and effectively eliminate payday lending while other states have few limitations, and thus payday lenders charge high interest rates and fees. The Pew Trust foundation has classified these as “restrictive” and “permissive” states, respectively. Another type of classification exists, states that are considered to have “hybrid” regulations. These states have some restrictions on payday loans, but they are permissive enough that lenders still operate there. These restrictions can include maximum loan amounts, limits on loans per year, limits on “rollovers”, ability to switch to a payment plan, and other regulations. One of the main purported objectives of these laws is to reduce the likelihood that an individual falls into a “debt trap cycle” through using payday loans. In this paper, I use insights from behavioral science to examine these regulations and make the argument that many of these well-intentioned policies may be falling short of their goals, due to information asymmetries. I pay particular attention to the 2010 law in Washington state, mainly the feature which allows conversion to a payment plan at no cost if an individual is unable to pay their initial payday loan. Despite these new regulations, many Washington borrowers still default, and/or take out the maximum amount of loans (eight) permitted by state law in a one-year period. This provides anecdotal evidence that not all individuals are fully taking advantage of the change in Washington law. Informed by theory, the online application of a local payday lender, and a recent visit to a payday loan storefront, I compare two hypothetical individuals who have different knowledge about their ability to convert to a payment plan. I then show how these two individuals have vastly different outcomes in terms of total interest and fees paid. Throughout the text I also speak to the large variation of payday lending law at the state level, the recent push to use ballot initiatives to cap interest rates, and discuss potential policy changes meant to mitigate harm due to information asymmetry in the payday lending space.