Last week, Sen. Jack Reed (D-RI) reintroduced S. 3549, the “Predatory Lending Elimination Act,” establishing an “all-in” national rate cap of 36 percent for consumer loans. The evidence is clear that many financial institutions would be unable to profitably offer many small-dollar loans, short-term consumer loans, and credit cards if this rate cap is adopted, ultimately harming consumers, especially low-income and subprime borrowers.
Rate Caps Reduce Lending
In March 2021, Illinois enacted similar legislation with an “all-in” rate cap of 36 percent. Three leading economists conducted an analysis of the law's effect and released a revised report entitled “Credit for me but not for thee: The effects of the Illinois rate cap” in July 2023. The report finds the interest rate cap in Illinois “decreased the number of loans to subprime borrowers by 38 percent.”
Respondents to a survey of Illinois consumers stated that: “The rate cap has failed to improve the financial well-being of Illinoisans, specifically those who relied on short-term, small-dollar loans.”
The study found when unable to obtain credit, consumers said “they were left with poor alternatives, including late bill payments, skipping urgent appointments or vital expenses, or pawning valuables.” 75 percent of respondents said they would like the option to go back to their previous lender if they were facing a need for funds, while 95 percent of respondents with incomes below $50,000 said the same.
When asked the question “Which of the following situations have occurred because you were unable to borrow money from a lender?” nearly 50 percent of respondents answered: “I paid bills late and generated fees.”
Most importantly, 93 percent of respondents answered “Yes” when asked “Did your loan help you manage your financial situation that you were facing at the time?”
Consumers’ Financial Well Being Has Not Improved Due to Rate Cap Laws
In New Mexico, where a 36 percent rate cap was implemented on January 1, 2023, a comparable study revealed that a majority of participants reported no improvement or status quo in their financial well-being. Specifically, 40 percent stated that their financial well-being did not improve, and 32 percent noted a decline. Additionally, 73 percent of respondents affirmed their preference to return to their previous lender if they had a funding requirement when asked, "If you had a funding need, would you like the option to go back to your previous lender?"
Calculation of the Rate Cap
The 36 percent Annual Percentage Rate (APR) cap in the Predatory Lending Elimination Act would be calculated under the Military Lending Act (MLA). While well-intentioned, the MLA calculates APR differently from other financial regulations and products, which do not include ancillary fees. For example, a $10 late fee on a consumer's credit card, even when paid once, would be calculated as 12 separate $10 payments, driving up the APR for that credit card. For many consumers, this method of calculating APR would result in the loss of a consumer's credit card by simply missing a payment when their credit card’s APR is below the 36 percent rate. Due to this calculation method, many card issuers may choose to cease issuing credit cards to subprime borrowers, limiting an important source of emergency credit for consumers.
Conclusion
Under the rate caps imposed by this legislation, the vast majority of financial institutions that provide consumer credit, small-dollar loans and credit cards to low-income and subprime consumers would be unable to turn a profit, resulting in a loss of credit availability for consumers who use these products. The vast majority of consumers who take out these short-term loans do so to cover utilities, emergency car repairs, rent, disruption of income, or debt consolidation. The imposition of rate caps in Illinois and New Mexico has only reduced credit options to consumers, giving them less flexibility and hefty fees for events that inevitably arise. Senators should carefully examine the results in Illinois and New Mexico before imposing these price controls nationally and reject this legislation and its effects on taxpayers.