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

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Are the State Interest Rate Caps an automatic Benefit for Borrowers?
This is how the market for small-dollar loans alters when states implement a rate cap and what options remain for consumers.


Last updated on July 12, 2021

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Small-dollar, short-term lenders unburdened by a federal maximum interest rate, can charge borrowers rates of 400% or more for their loans.
More states are trying to bring the number down by establishing rates caps to limit the high-interest lending. Currently, , have laws that limit to short-term loan interest rates at 36% or less as per the Center for Responsible Lending. Other states are considering similar laws.
"This legislative session, we've witnessed an increase and renewed interest in limiting interest rates and reducing the negative effects of payday loans," says Lisa Stifler, director of state policy for the CRL.
Rate-cap opponents say that when a state caps interest lenders cannot be profitable, and customers with already limited options lose their last resort. Advocates for consumers say that cap rates protect consumers from the shady lending practices.
Here's what happens when a state caps interest rates and what options consumers have for smaller-dollar loans.
Legislation targets APR
In order to deter high-interest lending and protect consumers against predatory loans Legislation is aimed at the somewhat complicated and certainly un-sexy .
APR is an interest rate, plus any fees charged by a lender. A $300 loan repaid in two weeks and with the payment of $45 would be a 391% APR. The same loan which has its APR reduced to 36% could incur a roughly $4.25 fee -- and a lot less profit from the lending institution.
APR isn't the best way to view the cost of a small loan according to Andrew Duke, executive director of the Online Lenders Alliance, which is a group of online lenders with short-term terms.
"The number appears much higher and more striking than what the borrower perceives to be the cost of that loan," he says.
Duke says consumers should instead utilize the actual fee to evaluate the affordability of a loan.
However, what the fee does not reveal is the expensive, long-term debt cycle that many borrowers end up in, Stifler says.
More than 80percent of payday loans are taken out within two weeks of the time it takes to repay an earlier payday loan, according to the Consumer Financial Protection Bureau.
"The business model for payday loans and the industry is based on repeated taking out loans," Stifler says. "It is an industry that can lead to the debt trap which pushes people out of banking."
States that do not allow interest rates above 36% or ban payday lending, there are payday lenders that are not located in stores, according to the Pew Charitable Trusts.
Consumers can choose from a variety of alternatives
Certain high-interest loans such as the pawn loans are likely to remain even when a rate cap is implemented, Duke says, but restricting consumers' choices could force them to miss payment on bills or pay charges for late payment.
Illinois State Sen. Jacqueline Collins, D-Chicago who was a key co-sponsor of the new consumer loan rates cap for Illinois that was signed into law in March, believes that this law can remove the stigma of payday or other lucrative loans and provide the state's residents a better understanding of .
Credit unions, for example they can provide small loans. While credit scores are considered when filling out an loan application however, a credit union usually has a previous relationship with the borrower and is able to determine their capacity to repay the loan using other information. This can make it easier to qualify for the loan .
For consumers struggling to pay bills, Stifler suggests contacting creditors and service providers for extensions to payments. She suggests that consumers contact credit counseling services which may offer no-cost or inexpensive financial assistance, or religious organizations, which can help provide food, clothing and assistance in getting to an interview.
Exodus Lending is a Minnesota nonprofit that advocates for fair lending laws and refinances high-interest loans with interest-free ones.
Many people who come to Exodus for help say they took out a high-interest loan because they felt too embarrassed to ask a family member or friend for help, says Executive Director Sara Nelson-Pallmeyer. If Minnesota caps interest rates on short-term, low-cost loans -- something a bill put on hold by the legislature would do -- she says she's not worried about how the public will be affected.
"They're going to do the same things individuals do in states where they're not allowed," she says. "Borrow from people you love, request to work more, take on an additional job, make a sale of your plasma -- just the kinds of things people who don't have access into payday lending, which is the majority of people."
This piece was written by NerdWallet and first published in The Associated Press.


About the author Annie Millerbernd is an individual loans writer. Her work has been published on The Associated Press and USA Today.







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