resources

Instituting an annual percentage rate (APR) cap on the fees for short-term, small-dollar loans is an effective ban of the service and fails to address consumers’ need for credit, instead leaving them with one less credit option. In fact, the Center for Responsible Lending, which has led the campaign to prohibit small-dollar lending in various states, said that one state’s policymakers “fully understood that [an APR cap] would ban the product,” when the legislature passed an APR cap in 2008.

What a Short-Term, Small-Dollar Loan Really Costs

There’s a lot of confusion about what a short-term, small-dollar loan costs, but customers would tell you that the answer is simple and straightforward: typically, $15 to borrow $100 until your next payday. Period.

There are no hidden fees, no compounding interest – just $15. Whether a customer repays their loan in three days or 30, they will pay the same one-time fee.

A number of states have implemented, or have sought to implement, arbitrary interest rate caps on consumer loan products, including short-term, small-dollar loans. These misguided restrictions have proven ineffective and counter-productive, reducing access to regulated credit for hardworking Americans, and subsequently pushing them towards costlier, less regulated alternatives. Many policymakers, think tank experts, independent researchers and academics have confirmed the negative consequences of arbitrary rate caps on consumers in need of credit and greater financial inclusion, as well as the value of providing consumers with access to small-dollar credit options.

Some state and federal regulators have called for an annual percentage rate (APR) cap on the fees for small-dollar loans.

Attempts to over-regulate small-dollar lending harm consumers by eliminating a critical choice for thousands of people who need credit. Consumers’ need for credit does not disappear once these regulations are in place. Instead, they either cannot meet their financial obligations, or they are forced to choose costlier or less regulated options, such as overdraft programs, unregulated loans or bankruptcy. For these reasons, more than two-thirds (69 percent) of short-term, small-dollar loan users oppose government restrictions on the loans, according to a national poll.

Short-term loans have become the perennial bogeyman of America’s financial system. Routinely decrying these loans as predatory toward low-income Americans, state legislatures, federal agencies, and the U.S. Congress have proposed gratuitous regulatory reforms and legislation that would cap interest rates at 36%, effectively outlawing the practice. While these new proposals enjoy some support, few have considered the unintended consequences of such efforts.

This linked paper below examines the role that short- term loans have in today’s financial system and the extent to which these loans offer American consumers access to capital not available through other sources. In particular, it highlights that interest rate caps could deny low-income and unbanked Americans access to credit while also forcing them into equally pernicious debt traps. This paper should serves as a clear warning about the dangers of imposing arbitrary caps on short- term loans, particularly for low-income and unbanked Americans who depend on access to short-term loans to make ends meet.

Another option. That’s what cash-strapped Michiganders would get from imperfect-but-practical legislation to modernize Michigan’s 15-year-old payday lending law. And the need for such has arguably never been greater, as President Donald Trump and Congress remain at odds over a second relief package to ease the economic fallout of the deadly coronavirus that continues to wreck government and household budgets alike.

We see a stark example of this in Illinois, where the legislature passed, and the governor signed

into law, a bill capping the maximum allowable annual interest rate at 36 percent. After the rate

cap went into effect in March 2021, a survey of borrowers who previously met their credit needs

through short-term, small-dollar loans found that these consumers’ financial situation actually

declined in many instances after the rate cap took effect. Consumers reported that, with the

financial products they relied on no longer available in their state, they struggled to pay their

bills, were unable to access credit, or were forced into worse alternatives like late bill payments,

skipping urgent appointments or vital expenses, or pawning valuables. When asked if they

would like the option to return to their previous lender if they had a funding need, 79% of survey

respondents answered in the affirmative and an additional 12% were not sure.

While it may be tempting to criticize those who specialize in serving this population and view their fees and practices as exploitative, it is crucial to consider the critical need these services fulfill. Providers must take into account the short-term nature of the loans and the higher risks and costs associated with providing these services. In fact, some of the most heavily criticized financial practices, such as installment loans or “payday lending,” and check protection services, actually enable vulnerable communities to participate more fully in today’s technology-driven economy. Without these services, individuals may be compelled to turn to the black market, exacerbating their lack of access to banking and loan products.