36% caps on payday loan rates may not fully protect consumers
Several states, including Illinois and Nebraska, recently implemented restrictions that capped interest rates at 36% on consumer loans, including payday loans.
Advocates say these restrictions prevent consumers from getting over their heads with these traditionally expensive loans, but opponents argue these types of laws will reduce access to credit by forcing lenders to close their doors with rates. unsustainable, leaving people nowhere to turn when cash-strapped.
New research published Monday seems to indicate that while these 36% rate caps may be well-intentioned, a different approach may actually have a greater impact in reducing the number of Americans who get caught in a so-called “debt trap” where they have trouble repaying the loan.
Consumers may be better served by rules that require lenders to deny borrowers any new loan for a period of 30 days after taking out three consecutive payday loans, the report finds. About 90% of borrowers surveyed said they wanted extra motivation to avoid payday debt in the future, and this system would provide that without immediately limiting access to credit.
“In our view, banning payday lending hurts consumers on the net, but regulations that allow payday lending, but limit repeat borrowing, can help consumers,” says Hunt Allcott, one of the study’s principal investigators and visiting professor of law at Harvard University.
Payday loans can be easy to obtain, but difficult to repay. In states that allow payday loans, borrowers can usually take out one of these loans by going to a lender and simply providing valid ID, proof of income, and a bank account. Unlike a mortgage or car loan, there is usually no physical collateral required and the amount borrowed is usually due two weeks later.
Yet high interest rates, which exceed 600% APR in some states, and short lead times can make these loans expensive and difficult to repay. Research conducted by the The Consumer Financial Protection Bureau found that almost 1 in 4 payday loans are borrowed nine or more times. In addition, borrowers take about five months to repay loans and cost them an average of $ 520 in finance charges, Pew Charitable Trusts Reports.
Implementing a 30-day “cooling off period” for payday loans allows consumers to access credit when they need it, but it also forces them to repay the loan sooner (rather than continuing. to re-borrow the loan), which is what borrowers say they want for themselves in the long run, Allcott says.
The cooling off period should be at least a month because it was long enough to force borrowers into a payroll cycle without getting a payday loan, Allcott says.
“Most people, within days of their payment, have a lot of money in their bank account. It’s only within a few days of your next paycheck that you run out of money and you need a loan to make ends meet, ”Allcott says.
It should be noted that Monday’s research makes several key assumptions, including that rate caps on consumer loans, including the 36% model, will effectively act as a total ban on payday loans.
In addition, the research does not take into account the effect of moderate interest rate caps or rules that encourage people to gradually repay loans, which have been implemented in Ohio and now canceled Consumer Financial Protection Bureau Rule 2017.
Register now: Improve your money and your career with our weekly newsletter
Don’t miss: This is the net worth that Americans say you need to be financially comfortable with