Home > News > Legislators Propose Interest Rate Cap, But Will It Work?

Comments 0 Comments
Advertiser Disclosure


Congress is taking aim at high-rate, short-term lenders in the U.S.

Representatives Matt Cartwright and Steve Cohn are joining forces with Senators Dick Durbin, Barbara Boxer, Richard Blumenthal, Jeff Merkley and Sheldon Whitehouse to establish a national usury limit for consumer credit transactions.

Their targets are banks and finance companies that market payday- and account-advance loans. Many view these loan products to be predatory because of the rates and fees the companies charge and because they’re designed to encourage consumers to re-borrow the funds over and over again.

Advance-type loans are, in effect, cash-flow accelerators: Money that would find its way into the consumer’s checking account in a week or two in the normal course is borrowed and repaid when the deposit actually comes to pass.

Therein lays the problem. By accelerating (moving forward) the cash-receipt date, the consumer creates a cash-flow hole later on. In other words, instead of waiting a week or two for the next payroll deposit, the consumer will have to wait an additional week or two beyond that point.

Then there’s the matter of how these loans are priced.

Short-term lenders often employ a split-pricing approach: one part interest to three, four or five parts fee. But because the loan amounts are typically modest in size—a few hundred dollars or so—the damage feels slight. That is, until you calculate its annual percentage rate.

Apart from the obvious reason (marketing) a company would choose to present its remuneration with split-pricing, the tactic may also be used by non-regulated lenders to skirt statutory usury limits and regulatory scrutiny.

Some states exclusively define usury in terms of interest rate, while others take an APR approach of combining rates and fees into a single metric. Depending on where the non-regulated lender sets up shop, the play between rates and fees can be all over the map, so to speak.

Reps. Cartwright and Cohen and their Senate colleagues hope to change all that.

Is This the Solution?

The prospective legislation proposes to leverage a 2006 law that limits interest rates for military members and their families into one that covers other types of consumer credit products as well. The 36% rate they have in mind is APR-based. It’s also roughly equal to the APR of a credit card cash advance that’s paid off within a year.

That’s why this idea may be a non-starter.

Advance-type loans are, by definition, very short-term in duration: one to three months at most. As I mentioned, they’re also typically for small loan values. The dilemma is this: lenders need to earn enough to cover the costs they incur to process and administer these loans, plus a profit to make it all worthwhile. The gross profit of a one-month loan for $500 that charges 36% APR is $15. There’s no way to make that pay, regardless of the size of the firm or the volume of its business—not when credit bureau reports alone can run as much as $10 a pop.

What’s more, it appears that the legislation also proposes to incorporate late fees and nonsufficient funds (bounced check) charges into the baseline APR calculation. If that’s the case, it’s time to call it quits. Although we can argue about limiting the values of these penalties, lenders incur real costs to collect past-due payments and they’re also charged NSF fees by their banks when the checks they deposit fail to clear. I am, however, curious why some of these fees are excluded from the APR calculation for loans that exceed three months’ duration. Fees that are forced to amortize over a month or two have a much greater impact on APRs than for those that can be apportioned over longer periods.

Speaking of APRs, I’m concerned that the prospective limit isn’t linked to a financial index. Interest rates are constantly in motion and even though they’ve been stuck on the low end of the scale for some time now, that won’t always be the case.

I’m also worried that the legislation doesn’t cap the size of the consumer loan that would be affected by it. For example, a five-year car loan that charges 36% will cost consumers more in interest over its life than the amount that was originally borrowed. Advance-type loans are one thing because of their relatively small dollar values, but larger loans are something else entirely.

Last, I’m disappointed that the prospective legislation targets only consumer loans. There has been a veritable explosion of alternative finance lenders offering comparably-priced advance-type loans to small businesses as well. Don’t those companies deserve the same level of protection? After all, small businesses are nothing more than consumers who are self-employed.

My hope is that Congress and the regulators will arrive at a more sensible, enduring and implementable solution. High-rate, advance-type loans have the potential to wreak financial havoc on those who can least afford it. The key is to strike a balance between the returns the lenders legitimately need to justify their efforts and what their customers can reasonably expect to pay back.

More Money-Saving Reads:

This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its affiliates.

Image: miki1991

Comments on articles and responses to those comments are not provided or commissioned by a bank advertiser. Responses have not been reviewed, approved or otherwise endorsed by a bank advertiser. It is not a bank advertiser's responsibility to ensure all posts and/or questions are answered.

Please note that our comments are moderated, so it may take a little time before you see them on the page. Thanks for your patience.

Credit.com receives compensation for the financial products and services advertised on this site if our users apply for and sign up for any of them.

Hello, Reader!

Thanks for checking out Credit.com. We hope you find the site and the journalism we produce useful. We wanted to take some time to tell you a bit about ourselves.

Our People

The Credit.com editorial team is staffed by a team of editors and reporters, each with many years of financial reporting experience. We’ve worked for places like the New York Times, American Banker, Frontline, TheStreet.com, Business Insider, ABC News, NBC News, CNBC and many others. We also employ a few freelancers and more than 50 contributors (these are typically subject matter experts from the worlds of finance, academia, politics, business and elsewhere).

Our Reporting

We take great pains to ensure that the articles, video and graphics you see on Credit.com are thoroughly reported and fact-checked. Each story is read by two separate editors, and we adhere to the highest editorial standards. We’re not perfect, however, and if you see something that you think is wrong, please email us at editorial team [at] credit [dot] com,

The Credit.com editorial team is committed to providing our readers and viewers with sound, well-reported and understandable information designed to inform and empower. We won’t tell you what to do. We will, however, do our best to explain the consequences of various actions, thereby arming you with the information you need to make decisions that are in your best interests. We also write about things relating to money and finance we think are interesting and want to share.

In addition to appearing on Credit.com, our articles are syndicated to dozens of other news sites. We have more than 100 partners, including MSN, ABC News, CBS News, Yahoo, Marketwatch, Scripps, Money Magazine and many others. This network operates similarly to the Associated Press or Reuters, except we focus almost exclusively on issues relating to personal finance. These are not advertorial or paid placements, rather we provide these articles to our partners in most cases for free. These relationships create more awareness of Credit.com in general and they result in more traffic to us as well.

Our Business Model

Credit.com’s journalism is largely supported by an e-commerce business model. Rather than rely on revenue from display ad impressions, Credit.com maintains a financial marketplace separate from its editorial pages. When someone navigates to those pages, and applies for a credit card, for example, Credit.com will get paid what is essentially a finder’s fee if that person ends up getting the card. That doesn’t mean, however, that our editorial decisions are informed by the products available in our marketplace. The editorial team chooses what to write about and how to write about it independently of the decisions and priorities of the business side of the company. In fact, we maintain a strict and important firewall between the editorial and business departments. Our mission as journalists is to serve the reader, not the advertiser. In that sense, we are no different from any other news organization that is supported by ad revenue.

Visitors to Credit.com are also able to register for a free Credit.com account, which gives them access to a tool called The Credit Report Card. This tool provides users with two free credit scores and a breakdown of the information in their Experian credit report, updated twice monthly. Again, this tool is entirely free, and we mention that frequently in our articles, because we think that it’s a good thing for users to have access to data like this. Separate from its educational value, there is also a business angle to the Credit Report Card. Registered users can be matched with products and services for which they are most likely to qualify. In other words, if you register and you find that your credit is less than stellar, Credit.com won’t recommend a high-end platinum credit card that requires an excellent credit score You’d likely get rejected, and that’s no good for you or Credit.com. You’d be no closer to getting a product you need, there’d be a wasted inquiry on your credit report, and Credit.com wouldn’t get paid. These are essentially what are commonly referred to as "targeted ads" in the world of the Internet. Despite all of this, however, even if you never apply for any product, the Credit Report Card will remain free, and none of this will impact how the editorial team reports on credit and credit scores.

Your Stories

Lastly, much of what we do is informed by our own experiences as well as the experiences of our readers. We want to tell your stories if you’re interested in sharing them. Please email us at story ideas [at] credit [dot] com with ideas or visit us on Facebook or Twitter.

Thanks for stopping by.

- The Credit.com Editorial Team