Are State Interest-Rate Caps an Automatic Benefit for Borrowers?

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Are State Interest-Rate Caps an Automatic Win for Borrowers?
Here's how the environment for small-dollar loans changes when a state implements rates caps and what options are left for consumers.


Last updated on July 12, 2021.

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Small-dollar, short-term lenders not burdened by federal maximum interest rates are able to charge borrowers rates of 400% or greater for loans.
More states are trying to bring the number down by establishing rate caps in order to stop the high-interest lending. Currently, , have laws that limit short-term loan rates to 36% or lower as per the Center for Responsible Lending. Other states are considering similar laws.
"This legislative session we've seen an increase in interest as well as renewed enthusiasm for the issue of limiting interest rates and reducing the negative effects associated with payday loans," says Lisa Stifler, director of state policy for the CRL.
Rate-cap opponents say that when states cap interest, lenders can no longer be profitable, and customers with limited options have no choice but to turn to the last option. Consumer advocates argue that caps free consumers from the shady lending practices.
Here's what happens when states cap interest rates and what options consumers have for small-dollar loans.
Legislation is aimed at APR
To deter high-interest lenders and to protect consumers from lenders who offer predatory loans The law addresses the somewhat complicated and distinctly unattractive .
APR is an interest rate in addition to any fees charged by a lender. A $300 loan paid back in two weeks and with a $45 fee would have 391% APR. A similar loan that has an interest rate lowered to 36% could incur an approximate $4.25 fee -- and much less revenue from the lending institution.
APR isn't an appropriate way to evaluate the cost of a smaller loan according to Andrew Duke, executive director of the Online Lenders Alliance, which represents lenders who offer short-term loans online.
"The amount appears much higher and more significant than what the customer believes to be the price that is this loan," he says.
Duke suggests that consumers use the actual fee to determine the loan's financial viability.
What the fee does not reveal is the expensive, long-term debt cycle that many people who borrow get into, Stifler says.
More than 90% in payday loans are taken out within two weeks of the time it takes to repay a previous payday loan, according to the Consumer Financial Protection Bureau.
"The business model of payday loans and the industry is based on repeat taking out loans," Stifler says. "It is an industry that can lead to an unsustainable debt cycle that removes people from banking."
In states that prohibit interest rates above 36% or otherwise ban payday loans, there are no storefront payday lenders as per the Pew Charitable Trusts.
Consumers have other options
Some high-interest loans, like pawn loans, may remain until a rate cap has been put in place, Duke says, but restricting consumers' choices may force them to skip the payment of bills or incur charges for late payment.
Illinois State Sen. Jacqueline Collins, D-Chicago, who was a chief co-sponsor for the new consumer loan rate cap in Illinois which was enacted into law in March says she hopes this law can remove the naiveté of payday loans as well as other high interest loans and will give Illinois' residents a better understanding of .
Credit unions, like, can offer small loans. While credit scores are considered on an loan application however, a credit union usually has a history with a borrower , and can evaluate their ability to repay the loan using other information. This could make it easier to qualify for a .
If you're struggling to pay bills, Stifler suggests reaching out to service providers and creditors to request extensions to payments. She recommends consumers turn to credit counseling services, which can offer free or minimal financial aid or religious institutions, which can help provide clothing, food and even help in getting to an interview.
Exodus Lending is a Minnesota non-profit organization that promotes fair lending laws and refinances residents' high-interest loans with loans that are interest-free.
A lot of people who visit Exodus to seek help claim they took out an interest-only loan because they were too ashamed to ask a relative or friend for assistance, says the executive director, Sara Nelson-Pallmeyer. If Minnesota caps interest rates on small, short-term loans -- something a bill put on hold by the legislature is aiming to achieve -- she says she's not worried about how consumers will fare.
"They're going to do the same things is common in states where they aren't permitted," she says. "Borrow from people who you value, ask to work more, get another job, or sell your plasma -- these are the kinds of things people do when they don't need to go to payday lenders, which is the majority of people."
The piece was written by NerdWallet and was first released in The Associated Press.


About the author Annie Millerbernd is an individual loans writer. Her writing has been featured in The Associated Press and USA Today.







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