By Annie Millerbernd | Nerdwallet
Low-cost, short-term lenders, unencumbered by a maximum federal interest rate, can charge borrowers rates of 400% or more on their loans.
But more and more states are reducing that number by setting ceiling rates to curb high-interest lending. Currently, 18 states and Washington, DC, have laws that limit short-term loan rates to 36% or less, according to the Center for Responsible Lending. Other states are evaluating similar legislation.
“This legislative session, we have seen increased and renewed interest in limiting interest rates and limiting the damage caused by payday loans,” said Lisa Stifler, director of state policy for CRL .
Opponents of rate caps say that when a state caps interest, lenders can no longer operate profitably and consumers with already limited options lose their last resort. Consumer advocates say caps free borrowers from predatory lending models.
Here’s what happens when a state caps interest rates and what alternatives consumers have for small loans.
The legislation targets the APR
To deter high-interest lenders and protect consumers from predatory lending, the legislation targets the somewhat complex and decidedly unattractive annual percentage rate.
The APR is an interest rate plus any fees charged by the lender. A $ 300 loan paid off in two weeks with fees of $ 45 would have an APR of 391%. The same loan with an APR reduced to 36% would cost around $ 4.25 – and much less income for the lender.
APR is not an appropriate way to visualize the cost of a small loan, says Andrew Duke, executive director of the Online Lenders Alliance, which represents short-term online lenders.
“The number ends up sounding much higher and more dramatic than what the consumer perceives to be the cost of the loan,” he says.
Duke says consumers should instead use the actual fees to assess the affordability of a loan.
But what the fees don’t show is the expensive, long-term debt cycle many borrowers find themselves in, Stifler says.
More than 80% of payday loans are taken out within two weeks of paying off a previous payday loan, according to the Bureau of Consumer Financial Protection.
“The payday loan industry business model is based on repeat borrowing,” says Stifler. “It’s a product that sets off a debt trap that actually pushes people out of the financial system.”
In states that don’t allow interest rates above 36% or otherwise prohibit payday loans, there are no in-store payday lenders, according to the Pew Charitable Trusts.
Consumers have other options
Some high-interest loans, like pawn shops, can stick around after a rate cap is implemented, says Duke, but limiting consumers’ options could force them to miss paying bills or incur credit fees. delay.
Illinois State Senator Jacqueline Collins, D-Chicago, who was a major sponsor of the consumer loan rate cap in Illinois that was enacted in March, says she hopes the new law will remove the payday distraction and other high-interest loans and give residents of the state a clearer view of affordable alternatives.
Credit unions, for example, can offer small loans. Although credit scores are factored into a loan application, a credit union often has a history with a borrower and can assess their ability to repay the loan using other information. This can make it easier to qualify for a credit union loan.
For consumers who are struggling to pay their bills, Stifler suggests contacting creditors and service providers for a payment extension. She recommends that consumers turn to credit counseling agencies, which can offer free or inexpensive financial assistance, or religious organizations, which can help provide food, clothing, and travel assistance. job interview.
Exodus Lending is a Minnesota nonprofit organization that advocates for fair lending laws and refinances resident high interest loans with interest free loans.
Many people who seek help from Exodus say they chose a high interest loan because they were too ashamed to ask a friend or family member for help, explains Executive Director Sara Nelson-Pallmeyer. If Minnesota caps interest rates on small, short-term loans – something a bill pending in the legislature aims to do – she says she doesn’t care how consumers are ‘will draw.
“They’re going to do what people do in states where they’re not allowed,” she said. “Borrow from loved ones, ask for more hours, take a second job, sell your plasma – just the things people do that don’t go to payday lenders, and that’s most people.” . “
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Annie Millerbernd writes for NerdWallet. E-mail: [email protected].