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Are State Interest-Rate Caps an Automatic Benefit 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 is changed when states implement a rate cap and what options are left for consumers.

Updated on 12 July 2021.

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Small-dollar, short-term lenders, not burdened by the federal maximum interest rate they can charge borrowers interest rates of 400% or higher for loans.

More states are trying to bring this number down through setting rates caps to limit the high-interest lending. At present, there are laws that limit the short-term loan rate to 36% or less as per the Center for Responsible Lending. Other states are considering similar legislation.

“This legislative session, we’ve witnessed an increase in interest and renewed interest in the issue of limiting interest rates, and limiting the harmful effects of payday loans,” says Lisa Stifler, director of state policy for the CRL.

The opponents of rate-caps argue that when states cap interest, lenders can no longer operate profitably, and consumers who have a limited choice are left with no recourse. Consumer advocates argue that cap rates protect consumers from the shady lending practices.

Here’s what happens when a state limits 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 distinctly unattractive .

APR is an interest rate in addition to any fees charged by a lender. A $300 loan repaid in two weeks with the payment of $45 would be 391% APR. A similar loan that has an interest rate reduced to 36% would result in around $4.25 fee — and a lot less profit to the loaner.

APR isn’t an appropriate way to view the cost of a modest loan, says Andrew Duke, executive director of the Online Lenders Alliance, which is a group of online lenders with short-term terms.

“The number appears a lot larger and more significant than what the customer perceives to be the cost for this loan,” he says.

Duke advises that customers should use the actual fee to evaluate the affordability of a loan.

What the fee does not show is the costly, long-term debt cycle that a lot of borrowers end up in, Stifler says.

Over 80percent in payday loans are taken out within two weeks of the time it takes to repay the previous payday loan, according to the Consumer Financial Protection Bureau.

“The business model of payday loans and the industry is built on repeat credit,” Stifler says. “It is an item that creates the debt trap which eliminates people from the financial system.”

States that do not allow interest rates above 36% or prohibit payday lending, there’s no storefront payday lenders according to the Pew Charitable Trusts.

Consumers also have other choices

Some high-interest loans, like Pawn loans could remain even until a rate cap has been put in place, Duke says, but the restriction on consumers’ choices could force them to miss bill payments or incur penalties for late payments.

Illinois State Sen. Jacqueline Collins, D-Chicago who was a key co-sponsor of the consumer loan rates cap for Illinois that was signed to law on March believes that this law can remove the distraction of payday as well as other high interest loans and will give Illinois’ residents a better understanding of .

Credit unions, for example are able to offer small loans. Although credit scores are considered when filling out a loan application but a credit union typically has a previous relationship with the borrower and is able to assess their ability to repay the loan with other information. This makes it easier to qualify for a .

For consumers having trouble paying their bills Stifler suggests contacting service providers and creditors to request a payment extension. She suggests that consumers contact credit counseling services that can provide free or minimal financial aid or religious institutions that offer food, clothing and assistance in getting to an interview.

Exodus Lending is a Minnesota non-profit that works to promote fair lending regulations and refinances residents’ high-interest loans by reinvesting them in interest-free loans.

A lot of people who visit Exodus for assistance say they have opted for the high-interest loan because they felt too shy to ask a trusted family member or friend for assistance, says Exodus’ Executive Director, Sara Nelson-Pallmeyer. If Minnesota limits interest rates on small, short-term loans — which the bill currently that is currently in the legislature would accomplish She says she’s not worried about the impact on consumers.

“They’re going to do the same things people do in states where they’re not allowed,” she says. “Borrow from people you love, request the for more time, work an additional job, make a sale of your plasma — all the kinds of things people do who don’t go to payday lenders, and that’s the majority of people.”

This article was written by NerdWallet and was originally printed in The Associated Press.

About the author Annie Millerbernd is a personal loans writer. Her work has been published in The Associated Press and USA Today.

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