The Senate Committee on Banking, Housing, and Urban Affairs proposed this interest rate cap at a hearing and expressed the intent behind the idea. This proposed legislation aims to help American consumers avoid paying excessive and unreasonable amounts on small-dollar loans.
What would this interest rate cap look like? Would this legislation reduce debt in poor communities or take away a lifeline by putting lenders out of business?
This article explains how the federal 36% interest rate cap on consumer loans will affect short-term loans.
Small-dollar, short-term loans
The lenders that will be affected the most by this proposed legislation will be small-dollar, short-term lenders such as payday and title lenders.
- Payday lenders let borrowers borrow against their paycheck. The loan must be paid off after two weeks or you can roll it over. All you need to get approved is a valid ID, a bank account, and a steady paycheck.
- Title lenders let you borrow against your vehicle. If you can’t pay back your loan, they have the right to repossess your car. All you need to get approved is a valid ID and a running vehicle in your name.
Both of these types of loans are high-cost ─ usually triple-digit APR rates ─ because almost everyone gets approved.
These types of lenders don’t run your credit, making them the only option to get money in an emergency or if you can’t get approved by the bank.
Consumer loan interest rates and fees
Not every state allows payday or title lending. But of the ones that do, only 18 states have the 36% interest rate cap in place for payday and title loans.
Without a federal cap on interest rates, lenders in some states charge as much as 600% APR. Because it is so easy to take out a loan ─ all you need is a valid ID, a bank account, and proof of income ─ just about anyone can fall victim to unfair and unreasonable loans.
Consumer loans that exceed 36% interest are expensive and can be an extreme challenge to pay off. About 25% of payday loans end up being reborrowed at least nine times, so for some people, the interest and fees end up costing more than the amount borrowed.
Reintroducing the bill
This idea of a federal interest rate cap was introduced in 2019. The bill will be reintroduced soon. The goal of this bill is to help American consumers avoid paying excessive and unreasonable amounts on small-dollar loans.
Failure to comply with the 36% interest rate cap could result in the loan being rendered null and void once this legislation is passed. This means the lender will not be able to collect or retain any principal, fees, interest, or other charges on the loan.
If this legislation passes, all charges on a credit transaction, including all fees, must be included in the APR. Otherwise, lenders could charge excessive fees as a loophole.
Fortunately, major banks have taken steps to provide reasonable and responsible loans to American consumers.
The bank’s role
Major banks have recently introduced small-dollar lending programs, which have put a strain on payday and title lenders.
If small-dollar lenders go out of business ─ which some lenders claim is possible if a federal interest rate cap goes into effect ─ banks will be at an advantage.
As of May 2020, the Federal Reserve allows banks to offer small-dollar loans, as long as they follow the lending principles. This ensures the loans are fair and responsible.
Advocates of the 36% interest rate cap believe 36% is a fair and reasonable amount to charge on a small-dollar loan. This number is not arbitrary. It has been affirmed as an appropriate amount to charge so that the majority of borrowers can pay it back.
Put simply, 36% interest is the upper limit of sustainable lending. This number ensures that lenders don’t take advantage of borrowers while still being able to stay in business.
What would the federal interest rate cap mean for payday lenders?
If this legislation passes, lenders will have to work swiftly to accommodate this new regulation. They will first have to decide if they could stay in business while charging a max of 36% interest. If not, they will have to make serious changes to their budgets.
Payday lenders will no longer be able to keep consumers in a loan ─ they do this by offering to roll over the loan or take out another loan ─ because it will be much easier for the consumer to pay off the loan in the first place.
More and more states impose the 36% cap
Over the past few months, many states have put a limit on payday and other short-term loan interest rates to protect consumers from debt traps. Interest rates on short-term loans are dropping from 400% to 36% across the country.
Other states have proposed the bill but are waiting on a signature from the governor. States such as Ohio have introduced other limits and regulations which have helped reduce sky-high interest rates on payday loans.
Even though many states are moving towards more fair payday and title loans, over half of US states do not have anyrestrictions on short-term loans. Anyone with a valid ID and proof of income can take out a loan.
According to one title lender, Texas is the state with the highest title loan interest rates. The average APR for a subprime loan in Texas is 664%, which is unbelievably high. This interest rate is 40 times higher than the average interest rate for credit cards.
Pros of the federal capped interest rate
The major advantage of the federal capped interest rate is that it will protect consumers from drowning in high-cost loans. Supporters of this bill believe that any interest rate above 36% is predatory.
This federal interest cap will put an end to high-cost payday loans that have robbed American consumers of billions of dollars. These lenders make most of their profit by hooking borrowers into a debt trap, a never-ending cycle of paying off debt.
High-cost payday loans take advantage of American consumers who can’t get approved for loans at traditional banks. These predatory payday loans are known to set up in poor communities and prey on naïve and desperate consumers.
Payday and title loans should be seen as a way to help people in financial emergencies, not as a way to take advantage of desperate people and trap them in debt.
Some people believe that payday loans and title loans going out of business may be a good thing. People will then rely on banks for small-dollar loans, which could protect them from predatory loans and reduce systemic racism.
The cons of the federal capped interest rate
Opponents to the idea of a federal capped interest rate claim that this policy will actually reduce access to credit because it will cause lenders to go out of business. If lenders go out of business, consumers will have nowhere to go for emergency cash.
Opponents to this bill also believe that it takes money away from the economy when lenders go out of business. Payday lenders help people pay to fix their car so they can go to work, pay medical bills, and pay for other emergencies.
Also, the high interest rates short-term lenders charge seems high, but in reality, the short length of the loan and the small amount of the loan means most borrowers don’t pay much more than $50. However, this only applies to small-dollar, short-term loans.
A different approach
Another approach that could help consumers avoid excessive amounts of debt is to introduce a policy that requires lenders to deny borrowers who apply for loans within 30 days after they have taken out three consecutive payday loans.
This approach would regulate payday lending by limiting repeat borrowing, which could help consumers avoid debt traps. It would force consumers to pay back the loan rather than keep reborrowing.