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Illinois Provides a Perfect Case Study on How Rate Caps Hurt Americans

The data is back on Illinois 2021 legislation that mandated a lending rate cap, and the troubling results should act as a cautionary tale in what not to do. Lending rate caps cut off access to credit for those who need it most, and overall has increased costs for borrowers. Illinois’ experiment with rate caps has failed, and should come to an end.

The Federal Reserve Board recently released a study on the impact of the 2021 legislation that mandated a lending rate cap of 36 percent per annum (APR) for loans under $40,000 from non-bank and non-credit-union lenders. The limit, which was implemented in a misguided effort to protect consumers from predatory lending practices, ended up eliminating the availability of loans for consumers who are most likely to seek out these loans in the first place.

APR is often the main metric people consider when determining if a loan is a good deal or not, but APR alone is probably the worst metric to use. APR measures the cost of credit over an entire year, including the interest rate and any additional fees. However, APR can be misleading, as it is calculated based on the assumption that the loan is held for a full year, which doesn't reflect reality for short term loans.

The study found that the lending rate cap had a significant impact on the availability of credit in the state. As a result, consumers, particularly those with lower credit scores, have fewer options for obtaining credit. The Federal Reserve’s research found that after the imposition of the rate cap,  the number of loans available to subprime borrowers were reduced by 44 percent, and deep subprime borrowers were reduced by 57 percent. 

This is particularly troubling for two reasons. First, the effects of the rate cap have been swift and far reaching. Most policy changes take years to have the level of impact this change has had in six months. Second, and more importantly as taxpayers continue to feel the effects of hyperinflation, reducing access to emergency short term loans will be damaging to the people who need it most. 

The Federal Reserve also found that the lending rate cap had a negative impact on the financial security of borrowers. Nearly 40 percent of respondents indicated that their financial wellbeing has declined since the imposition of the interest-rate cap, while only 11 percent of the respondents indicated that their financial situation improved over the same period. Respondents also indicated that they have faced difficult circumstances since losing access to loans, including missing billing dates thus generating late fees, cutting back on necessities, being sent to debt collections and having services turned off. The data also shows that 40 percent of respondents reported not being able to access loans when they needed them. 

Similar legislation with caps on lending rates have been proposed on the federal level, such as the Veterans and Consumer Fair Credit Act (S. 2508). This bill was introduced in the 117th Congress by Senators Sherrod Brown (D-OH) and Jack Reed (D-RI), and sought to implement a 36 percent rate cap for all Americans. The Federal Reserve's study of the Illinois law should be viewed as a case study for exactly why these divisive policies should not be implemented in the first place. 

While the intention of Illinois's lending rate cap was to protect consumers from predatory lending practices, the rate cap has had unintended consequences for taxpayers. The policy has cut access to credit for thousands of borrowers in Illinois while also increasing the overall cost of credit for consumers. At the same time, the policy has also decreased transparency in lending decisions. It's important to balance the need for protecting consumers from predatory lending with the need for maintaining a functional credit market. Regulators should carefully consider these trade-offs when evaluating lending rate cap proposals in the future.