Specialized emergency lenders play a crucial role in providing access to credit for individuals who may not qualify for traditional loans from banks or credit unions. These lenders offer small, short-term loans to help borrowers meet their financial needs in the short-term, and can be a lifeline for those facing unexpected expenses or a temporary financial setback.
On March 23, 2021, Illinois implemented an interest rate cap of 36% per year for loans under $40,000 from non-bank and non-credit-union lenders. Using data from Illinois and Missouri (a state without an interest rate cap), researchers found that the cap significantly decreased the availability of small-dollar credit, especially for subprime borrowers, and worsened the financial well-being of many consumers.
An online survey of short-term, small-dollar credit borrowers in Illinois showed that most respondents were unable to borrow money when needed following the implementation of the interest rate cap, and only 11% reported that their financial well-being improved as a result of the cap, while 79% preferred to return to their previous lenders.
The implementation of interest rate caps can severely limit the ability of short-term lenders to provide this vital service to consumers. As the research cited above indicates, the implementation of this cap significantly decreased the availability of small-dollar credit, especially for subprime borrowers, and worsened the financial well-being of many consumers in Illinois.
In the American Southwest, Afterpay, a “buy now, pay later” service, will no longer be available to customers in New Mexico effective January 1, 2023, due to regulatory changes in the state. The changes, made through the passing of House Bill 132, limit “predatory” lending by altering the cap on small loan interest rates from 175% to 36% and limiting fees on late payments within 10 days to 5 cents on the dollar for the total installment price.
The goal of the law was to set a reasonable rate for interest, not eliminate it altogether, according to Rep. Daymon Ely, one of the sponsors of the bill. Yet one unintended consequence of this change has seen the withdrawal of Afterpay and other similar service providers from the state, potentially impacting the financial well-being of consumers who relied on these services.
“It’s not intended to run anybody out,” Ely said.
My response? The road to hell is paved with good intentions.
These findings highlight the importance of short-term lenders in providing access to credit for individuals who may not have other options. New Mexico will surely see financial health plummet just as has already been witnessed in Illinois.
Why have politicians again decided to pick and choose “winners” in the marketplace? Surely, Mr. Ely could have focused his attention on the big banks using “predatory” practices of charging overdraft fees.
One key difference between overdraft fees charged by big banks and short-term loans is the cost of borrowing. Overdraft fees charged by big banks can be quite high, with some banks charging fees of around $35 for each overdraft transaction. These fees can add up quickly, leading to significant costs for individuals who frequently overdraft their accounts.
In contrast, short-term loans typically have lower fees, with annual percentage rates (APRs) ranging from around 100% to 1000%. While these APRs may look high, they are generally lower than overdraft fees charged by big banks.
Another difference between the two options is the duration of the borrowing. Overdraft fees are typically charged on a per-transaction basis, with the fees continuing to accrue until the individual has sufficient funds in their account to cover their overdraft.
In contrast, short-term loans are typically paid off within a few weeks to a few months. This means that individuals who take out short-term loans will typically have a fixed period of time in which to repay the loan, rather than having fees continue to accrue indefinitely.
Politicians like Mr. Ely should stop burdening their constituents with costly “feel-good” legislation. As is being witnessed with the interest-rate cap in New Mexico, this well-intended legislation is creating costly consequences. Will Mr. Ely offer to pick up the tab?