Climate change driving demand for predatory loans, research shows

Two competing payday loan stores stand on the corners of an intersection in south Los Angeles. An area of persistent poverty, south LA is also a banking desert where payday lenders fill the gap. Long lines form inside the stores on the first of the month, when rent is due.

Guillermina Molina, a 60-year-old retired housekeeper, visits the same Speedy Cash each month. During the summer months – which are becoming increasingly hot – she runs her air conditioner but frets about her utility bills. “It’s kind of hard because the [power bill] is coming up too high because you gotta have the air conditioner on,” Molina said.

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During heatwaves, Molina’s daughter, Vanessa Vargas, checks in on her every day. “I don’t want to pull up to her house and find her [passed out] because of the heat,” she said.

Molina doesn’t have savings, so to cover her bills she takes out a $225 payday loan every month, paying $45 in interest on each loan. When she’s unable to pay back her loan on time, she’s charged extra. “There’s nothing left over,” Vargas said.

Molina’s financial struggles are common. According to the Pew Charitable Trusts, 12 million Americans take out payday loans each year, paying $9bn in fees. New research suggests climate change is driving up demand for these loans.

A study released earlier this year found that extreme temperature shocks – like heatwaves and cold snaps – are leading to surges in demand for payday loans in the US.

The paper, published in January by the Bank of Canada, suggests extreme heat and cold may increase demand for payday loans in several ways: increased energy costs as people turn on heating or cooling devices, lost income for people who are unable to work in extreme heat, and health problems leading to medical costs for underinsured or uninsured people.

“We are quite surprised with the fact that there is actually a strong effect stimulating increasing demand during extreme heat and cold days,” said lead author Shihan Xie, an assistant professor of economics at the University of Illinois.

Xie’s study looked at satellite temperature data, a dataset of payday loan applications and zip codes to see how temperature affected loans. (The paper has not yet been peer reviewed, but Xie said it will be.)

Researchers found that counties with higher populations of Hispanic people, who are overrepresented in outdoor jobs, see larger increases in demand for payday loans with extreme heat days. They also found that loan delinquency and default rates increased with more extreme heat days.

Xie said the findings highlight the vulnerability of lower-income households to climate shocks and underscore the need for targeted policies, such as utility assistance programs that could help a consumer like Molina. “We hope we can provide more evidence on how the program could be better designed to help low-income households,” Xie said.

Payday loans are short-term, high-interest loans that are typically $500 or less. The lender typically gives the borrower cash in return for a postdated check timed to coincide with their next paycheck two to four weeks later. Fees are about $15 to $20 per $100 loan, which works out to a 400% to 600% annual percentage rate (APR), according to Xie’s analysis. The interest rates at Speedy Cash, where Molina borrows money, can reach 460%. (Speedy Cash did not reply to requests for comment.)

“If you’re looking at how much they charge over a week or two weeks, it’s not that much. But if you think about it in the annual sense, then the interest rates are extremely high,” Xie said.

The loans are widely seen as predatory, with the average customer earning about $30,000 a year and remaining in debt for an average of five months a year, according to a 2012 Pew Charitable Trusts study. One 2021 study found that lenders disproportionately target Black and Latino communities.

Payday loans are restricted or outlawed in 18 states and Washington DC, but many lenders find ways around the laws by offering high-interest loans online or operating on sovereign tribal land.

Utility bills are among the most common reasons that people take out payday loans. The 2012 study by the Pew Charitable Trusts found that seven in 10 borrowers use payday loans for recurring expenses like rent and utilities. Another study in 2012 by the Center for Financial Services Innovation found the most common use for short-term loans like payday loans was to cover utility bills.

Extreme heat does not affect all communities equally. People who live in urban “heat islands” with fewer trees and parks are at greater risk from heat, according to the Environmental Protection Agency. Due to systemic discrimination, like historic redlining, people of color and lower-income residents are more likely to live in heat islands.

Molina lives in a heat island. South LA has little tree cover, and bus stops carry ads warning of heatstroke. The largely lower-income area experiences higher rates of heat-related emergency room visits compared to wealthier areas of the city, according to a University of California, Los Angeles, data analysis.

Erika Toriz, founder and CEO of Haven Neighborhood Services, a community group in south Los Angeles, said her clients struggle with an impossible choice: endure heat stress and illness, which can be deadly, or take out payday loans to pay for cooling, which can lead to a cycle of debt.

Many of her clients put foil on their windows to reflect sunlight or use wet towels to stay cool. Those with air conditioning avoid running it for too long. “Families are worried that their electric bill is going to go up, because they can’t afford that. Even going up $25 is a huge difference,” she explained. “For our clients, it’s like putting a meal for one or two days on their table.”

For some workers, heat can affect their ability to earn a living. A 2021 study found that outdoor workers – who earn a median annual income of $31,000 a year – risk losing as much as $1,700 in annual income by mid-century as a result of extreme heat. Kristina Dahl, co-author of the study and principal climate scientist at the Union of Concerned Scientists, said: “One implication of that lost income from extreme heat could be seeking out payday loans, which have huge interest rates and can really catalyse a cycle of debt.”

Black and Hispanic workers are disproportionately affected by extreme heat, facing productivity losses 18% greater than non-Hispanic white workers, according to a 2021 report by the Atlantic Council. “Climate change is just pushing them even further toward this financial brink,” Dahl said.

Xie noted that hurricanes and wildfires trigger government aid and insurance that can help households handle financial stress, but heatwaves and cold snaps do not. “Those smaller events still have strong effects on household wellbeing,” she said.

Utility assistance programs like the federal Low Income Home Energy Assistance Program (Liheap) can provide some relief, she said, but many households are either unaware that they exist or do not know how to file claims for assistance. “Making [this] program more widely available and accessible to low-income households could also be one of the strategies” to help people cope with extreme temperatures, Xie said.

Vargas said she wasn’t sure whether her mother qualified for California’s Liheap program because she already receives other forms of government assistance. “A lot of these programs, there’s a lot of red tape,” Vargas said.

Karen Lusson, senior attorney at the National Consumer Law Centre, said many states don’t spend enough on low-income energy programs. “The allocations just don’t cover the need,” she said.

Lusson said Xie’s study highlighted the “heat-or-eat conundrum” in which families face difficult choices between paying utility bills or buying groceries and medicine. “When you throw in climate change, and the fact that 2023 was the hottest year in the recorded history of the planet, the unaffordability problem can be expected to grow more dire,” she said.

Molina is not thinking about the long term – she’s more focused on her mounting expenses. “It’s too high: the lights, the gas, even the food,” she said. “What can I do? I just thank God I’m living every day.”