If the Economy Struggles, Will People Turn to Payday Lenders? The Answer Is Surprising

Since the early 1990s, modern payday lending has been a source of short-term financing for individuals who need funds fast. However, it’s also a controversial practice that’s undergone many state and federal reforms to protect consumers against predatory lenders. With a potential recession looming, will an economic downturn—and the resulting financial strain on consumers—lead to an increased reliance on payday lending? While it’s certainly possible, there isn’t sufficient historical data to definitively answer this question.

Key Takeaways

• Payday loans are small, high-interest loans that typically must be repaid by the borrower’s next payday.
• Historical data shows some evidence of a rise in payday lending during the Great Recession, but a drop during the pandemic due to government financial assistance.
• Increased payday lending can lead to significant financial consequences for borrowers.

Understanding Payday Lending

According to the Consumer Financial Protection Bureau (CFPB), a payday loan is a small, short-term, unsecured loan with a high annual percentage rate (APR). It gets its name from the fact that borrowers essentially trade a portion of their next paycheck for early access to the same amount of money (minus the cost of any fees).

While loan terms can vary between lenders, a typical payday loan has:

• A maximum loan amount of $500
• A repayment term of two to four weeks (i.e., a standard pay period)
• A lump-sum repayment structure
• Authorization for automatic repayment, usually through either a postdated check or an electronic bank account withdrawal
• A high APR relative to the size of the loan, potentially in the triple digits
• No credit check requirement

Important

Payday loans are only available in 32 states; they are effectively outlawed in others. Of those states that permit payday loans, some impose strict safeguards limiting their costs and usage, but most states have few safeguards in place.

The Relationship Between Economic Downturns and Payday Lending

In theory, if an economic downturn puts a financial strain on consumers, they’re more likely to resort to payday lending in order to get by. However, the available data paints a more nuanced picture.

Does Payday Lending Increase During Economic Downturns?

According to a 2016 study published by the Federal Reserve Bank of Chicago, payday lending did increase during the Great Recession. However, because the researchers lacked payday lending data from years prior to 2007, it’s uncertain whether the increase was a continuation of an ongoing trend or directly related to the recession. That said, the researchers also found that more middle-income borrowers have been taking out payday loans since 2007. 

Meanwhile, a 2020 report from the California Department of Financial Protection and Innovation found that Californians’ reliance on payday loans actually dropped during the 2020 recession, likely as a result of pandemic-related government assistance. In other words, other forms of financial relief can help stave off and even lower the use of payday loans during recessions.

Consequences for Borrowers

If borrowers do have to rely on payday lending during a recession, they should proceed with caution. Payday loans are notoriously expensive and often predatory. If you’re not careful, you could end up stuck in a cycle of debt.

For instance, unpaid payday loans can be rolled over into a new payday loan to defer full repayment, at the cost of an additional fee. In 2022, the CFPB estimated that approximately 80% of payday loans were rolled over; as a result, borrowers ended up paying more in fees than the original principal. In the worst-case scenarios, you could ruin your credit and be forced to declare bankruptcy.

The Bottom Line

Payday lending regulations have come a long way since the industry’s inception. In 2020, federal regulators steered conventional banks away from bankrolling payday lenders and toward offering more sustainable “small-dollar loans.” Unlike their payday lending counterparts, these loans can be repaid over longer terms through installments and have much lower initial fees. 

Currently, there isn’t conclusive evidence to say for certain whether payday lending increases during a recession. However, for a middle- or low-income individual, taking out one of these loans would most likely exacerbate the financial strain they’d already be feeling amid an economic downturn. Regardless of the state of the economy, small-dollar loans and other alternative sources of funding can help minimize consumers’ reliance on risky payday loans.

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