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Defining and detecting predatory lending

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Donald P. Morgan

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Abstract

We define predatory lending as a welfare-reducing provision of credit. Using a textbook model, we show that lenders profit if they can tempt households into "debt traps," that is, overborrowing and delinquency. We then test whether payday lending fits our definition of predatory. We find that in states with higher payday loan limits, less educated households and households with uncertain income are less likely to be denied credit, but are not more likely to miss a debt payment. Absent higher delinquency, the extra credit from payday lenders does not fit our definition of predatory. Nevertheless, it is expensive. On that point, we find somewhat lower payday prices in cities with more payday stores per capita, consistent with the hypothesis that competition limits payday loan prices.

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Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 273.

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Date of creation: 2007
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Handle: RePEc:fip:fednsr:273

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Related research
Keywords: Predatory lending ; Loans; Personal;

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This paper has been announced in the following NEP Reports: References listed on IDEAS
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  1. Markus K. Brunnermeier & Jonathan A. Parker, 2004. "Optimal Expectations," NBER Working Papers 10707, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Stefano Della Vigna & Ulrike Malmendier, 2004. "Contract Design and Self-control: Theory and Evidence," The Quarterly Journal of Economics, MIT Press, vol. 119(2), pages 353-402, May. [Downloadable!] (restricted)
  3. Mark Flannery & Katherine Samolyk, 2005. "Payday lending: do the costs justify the price?," Proceedings, Federal Reserve Bank of Chicago, issue Apr. [Downloadable!]
  4. Gropp, Reint & Scholz, John Karl & White, Michelle J, 1997. "Personal Bankruptcy and Credit Supply and Demand," The Quarterly Journal of Economics, MIT Press, vol. 112(1), pages 217-51, February.
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  5. Ausubel, Lawrence M, 1991. "The Failure of Competition in the Credit Card Market," American Economic Review, American Economic Association, vol. 81(1), pages 50-81, March.
  6. Sumit Agarwal & Souphala Chomsisengphet & Chunlin Liu & Nicholas S. Souleles, 2005. "Do Consumers Choose the Right Credit Contracts?," CFS Working Paper Series 2005/32, Center for Financial Studies. [Downloadable!]
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  7. Karen M. Pence, 2003. "Foreclosing on opportunity: state laws and mortgage credit," Finance and Economics Discussion Series 2003-16, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  8. Andreas Lehnert & Dean M. Maki, 2002. "Consumption, debt and portfolio choice: testing the effect of bankruptcy law," Finance and Economics Discussion Series 2002-14, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  9. Laibson, David, 1997. "Golden Eggs and Hyperbolic Discounting," The Quarterly Journal of Economics, MIT Press, vol. 112(2), pages 443-77, May.
  10. Stefano DellaVigna & M. Daniele Paserman, 2004. "Job Search and Impatience," NBER Working Papers 10837, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  11. repec:bep:eapadv:v:5:y:2005:i:1:p:1412-1412 is not listed on IDEAS
  12. Lalith Munasinghe & Nachum Sicherman, 2000. "Why Do Dancers Smoke? Time Preference, Occupational Choice, and Wage Growth," NBER Working Papers 7542, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  1. Scott Carrell & Jonathan Zinman, 2008. "In harm’s way? Payday loan access and military personnel performance," Working Papers 08-18, Federal Reserve Bank of Philadelphia. [Downloadable!]
  2. Adam B. Ashcraft & Til Schuermann, 2008. "Understanding the securitization of subprime mortgage credit," Staff Reports 318, Federal Reserve Bank of New York. [Downloadable!]
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