With Senator Sharrod Brown (D-OH) now serving as chair of the Senate Banking, Housing, and Urban Affairs Committee, legislation could probably be put forward to cap interest payments on loans. While the entire proposal is yet to be released, any move to cap interest rates can be seen as part of Senator Brown’s effort to end what he regards as “abusive lending practices.” While high-interest rate loans, notably payday loans, are routinely subject to criticism, an outright ban on them could deny many low-income Americans access to essential lines of credit, leaving them financially vulnerable to unexpected bills.
Although there is currently no set definition of a payday loan, generally, they are short-term, high-interest loans for individuals in need of short-term cash. These loans are usually due on a consumer’s next payday. The Consumer Financial Protection Bureau (CFPB) estimates most loans are less than $500 and are given to consumers with little or bad credit history. Because of the high-risk lenders take when providing these loans and the need to make a profit to stay in business, interest rates can reach almost 400%.
While offering higher interest rates than traditional forms of income, payday loans have become an essential part of the country’s credit system. Forbes estimated “as many as 12 million Americans take a payday loan each year,” and borrowers “typically earn about $30,000.” It’s also estimated there are currently “23,000 payday lenders in the U.S., almost twice the number of McDonald’s restaurants.” The significant number of payday loans issued each year, combined with the high number of providers, shows an actual consumer demand for this type of service.
Unlike traditional loans, payday loans are significantly easier to acquire, only requiring “a source of income and a valid identification.” The lack of restrictions means almost anyone who needs access to short-term financial support can obtain a payday loan.
Despite the significant high interest these loans can have, consumers regularly find them helpful in providing short-term access to finances. A 2016 study by the Global Strategy Group, the Terrance Group, and the Community Financial Services Association of America found despite the bad press payday loans generally receive, “96% say their payday loans…have been useful to them personally” in meeting unexpected financial commitments. The same study found that 75% of those who have taken payday loans are likely to recommend them “to friends and family.”
The significant popularity of payday loans among those who have used them means any cap on interest rates would deny consumers access to a source of financing they overwhelmingly approve.
One of the most significant benefits of a payday loan is that it provides access to financial resources to consumers who would otherwise be denied access to traditional forms of lending. A recent study found 24% of Americans, almost 1 in 4, do not qualify for a credit card. In low-income communities, only about 45% of Americans have access to a credit card.
This limited access to credit cards means payday loans are often the only source of credit accessible to millions of Americans. Capping interest rates, thereby exposing lenders to unacceptable levels of risk, will only serve to deny these consumers access to their only financial lifeline. In fact, borrowers stated the number one reason they turned to payday loans (57%) was “to pay for an unexpected expense, such as car repair or medical emergency.”
Without this lifeline, consumers are faced with the choice of missing rent, mortgage, and utility payments or obtaining funds through illegal activities. Adam B. Summers from Reason found both options left consumers paying more and facing greater economic insecurity.
One of the principal critiques of payday loans is they exploit and deceive those in vulnerable financial positions. The evidence overwhelmingly challenges this argument. Studies show 86% of borrowers felt lenders clearly explained the loan terms and understood the charges associated with the high-interest rates.
With such a high proportion of Americans understanding the commitment of a payday loan and its consequences, it is difficult to put forward a strong case that payday loans exploit and deceive financially insecure Americans.
Capping interest rates on payday loans might seem like a good policy, but the reality is that imposing regulations on lenders could inflict significant damage onto consumers by denying them access to short-term credit. The denial of credit would be particularly harmful to low-income Americans who struggle to qualify for credit cards or other forms of lending. The result would mean more Americans inevitably pushed to the financial brink by politicians in Washington. Sometimes the best thing Washington can do is nothing at all.