The Senate Banking, Housing and Urban Affairs Committee proposed this interest rate cap in a hearing and expressed the intent behind the idea. This bill aims to help American consumers avoid paying excessive and unreasonable amounts on small loans.
What would this interest rate cap look like? Would this law reduce the debt of poor communities or remove a lifeline by bankrupting lenders?
This article explains how the federal interest rate cap of 36% on consumer loans will affect short-term loans.
Low value short term loans
The lenders that will be most affected by this bill will be the short-term lenders, such as payday lenders and title lenders.
- Payday lenders let borrowers borrow against their wages. The loan must be repaid after two weeks or you can roll it over. All you need to be approved is a valid ID, a bank account, and a regular paycheck.
- Securities lenders allows you to borrow against your vehicle. If you can’t repay your loan, they have the right to repossess your car. All you need to get approved is valid ID and a moving vehicle in your name.
Both types of loans are expensive – usually triple-digit APR rates because almost everybody is approved.
These types of lenders not manage your credit, making it the only option for getting cash in an emergency or if you can’t get approval from the bank.
Interest rates and charges for consumer loans
Not all states allow payday lending or securities lending. But of those who do, only 18 states have a 36% interest rate cap in place for payday loans and securities lending.
Without federal interest rate caps, some state lenders charge as much as 600% APR. Because taking a loan is so easy – all you need is a valid ID, 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 repay. About 25% of payday loans end up being borrowed at least nine times, so for some people the interest and fees end up getting expensive. Following than the amount borrowed.
Reintroduce the invoice
This idea of a federal interest rate cap was introduced in 2019. The bill will soon be reintroduced. The purpose of this bill is to help American consumers avoid paying excessive and unreasonable amounts on small loans.
Failure to comply with the 36% interest rate ceiling could result in the nullity of the loan once this law is adopted. This means that the lender will not be able to collect or keep the principal, fees, interest or other charges on the loan.
If this legislation passes, all charges on a credit transaction, including all charges, must be included in the APR. Otherwise, lenders could charge excessive fees as a loophole.
Fortunately, the big banks have taken steps to provide reasonable and responsible lending to American consumers.
The role of the bank
The big banks have recently introduced low-cost lending programs, which have put a strain on payday lenders and securities lenders.
If small lenders go out of business – which some lenders claim is possible if a federal interest rate cap kicks in – the banks will have an advantage.
As of May 2020, the Federal Reserve has allowed banks to offer low-value loans, provided they adhere to lending principles. This ensures that the loans are fair and responsible.
Proponents of the 36% interest rate cap believe 36% is a fair and reasonable amount to charge on a small loan. This number is not arbitrary. It has been asserted as an appropriate amount to charge so that the majority of borrowers can repay it.
Simply put, an interest rate of 36% is the upper limit for durable loans. This number ensures that lenders do not 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 is passed, lenders will have to work quickly to adapt to this new regulation. They will first need to decide if they can stay in business while charging a maximum interest of 36%. Otherwise, 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 renew the loan or take out another loan – because it will be much easier for the consumer to repay the loan in the first place.
More and more states are imposing the 36% cap
In recent months, many states have placed limits on interest rates on payday and other short-term loans to protect consumers from debt traps. Interest rates on short-term loans drop from 400% to 36% across the country.
Other states have proposed the bill but are awaiting the governor’s signature. States like Ohio have introduced other limits and regulations that have helped reduce exorbitant interest rates on payday loans.
Even though many states are moving towards more equitable payday loans and land titles, more than half of U.S. states do not have allrestrictions on short-term loans. Anyone with a valid identity document and proof of income can take out a loan.
According to a securities lender, Texas is the state with the highest interest rates on securities lending. The average APR for a subprime loan in Texas is 664%, which is insanely high. This interest rate is 40 times higher than the average credit card interest rate.
Benefits of the Federal Capped Interest Rate
The main benefit 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 end the high cost payday loans that have stolen billions of dollars from American consumers. These lenders derive most of their profits by luring borrowers into a debt trap, a never-ending cycle of debt repayment.
High cost payday loans benefit American consumers who cannot get loan approval from traditional banks. These predatory payday loans are known to take hold in poor communities and prey on naive and desperate consumers.
Payday loans and title loans should be seen as a way to help people in financial emergency, not a way to take advantage of desperate people and trap them in debt.
Some people think that payday loans and title loans are going bankrupt. People will then rely on banks for small loans, which could protect them from predatory lending and reduce systemic racism.
The disadvantages of the federal capped interest rate
Opponents of the idea of a capped federal interest rate claim that this policy will actually reduce access to credit because it will bankrupt lenders. If lenders go bankrupt, consumers will have nowhere to go for emergency cash.
Opponents of this bill also believe it takes money from the economy when lenders go bankrupt. Payday lenders help people pay for car repairs so they can go to work, pay medical bills, and pay for other emergencies.
Plus, the high interest rates charged by short-term lenders seem high, but in reality the short loan term and small loan amount mean that most borrowers don’t pay more than $ 50. However, this only applies to small, short term loans.
A different approach
Another approach that could help consumers avoid excessive debt is to introduce a policy that requires lenders to turn down borrowers who apply for loans within 30 days of taking out three consecutive payday loans.
This approach would regulate payday loans by limit repeated borrowing, which could help consumers avoid debt traps. This would force consumers to repay the loan rather than continue to borrow.