Federal lawmakers seek to lower payday loan rates from 400% to 36%

Tens of millions of Americans are turning to high-cost loans that regularly bear interest rates of over 400% for day-to-day expenses, such as paying bills and covering emergency expenses. For many, these rates end up being just too high and leading to a seemingly endless cycle of debt.

But that could soon change. This week, five members of Congress plan to introduce federal legislation that would ban these exorbitant rates on a variety of consumer loans, including payday loans. Instead, the Fair Credit for Veterans and Consumers Act in the House would cap interest rates at 36% for all consumers.

Rep. Glenn Grothman, R-Wis., and Jesus “Chuy” Garcia, D-Ill., are co-sponsoring the legislation in the House, while Sens. Sherrod Brown, D-Ohio, Jack Reed, DR.I., and Jeff Merkley, D-Ore., are simultaneously introducing a side bill in the Senate. Bipartite legislation is constructed from the framework of the Military Loans Act 2006which capped loans at 36% for active duty military.

Specifically, this week’s legislation would extend those protections to all consumers, capping interest rates on payday loans, car titles and installment loans at 36%. This is well below the current average of 391% APR on payday loans. calculated by economists at the St. Louis Fed. Payday loan interest rates are more than 20 times higher than Average APR per credit card.

“We already had a military personnel and military base bill that was a resounding success,” Grothman told CNBC Make It. “If you leave it there, it gives you the impression that we have to protect the army, but we will leave [payday lenders] go wild and take advantage of everyone.”

The personal loan landscape

Lenders argue that high rates exist because payday loans are risky. Typically, you can get these small loans in most states by visiting a store with valid ID, proof of income, and a bank account. Unlike a mortgage or car loan, no physical collateral is usually required. For most payday loans, the loan balance, along with the “finance charge” (service charge and interest), is due two weeks later, on the day of your next payday.

Still, consumer advocates have long denounced payday loans as “debt traps” because borrowers often can’t repay the loan immediately and get stuck in a borrowing cycle. The research carried out by the The Consumer Financial Protection Bureau found that nearly one in four payday loans are re-borrowed nine or more times. Additionally, it takes borrowers about five months to repay the loans and costs them an average of $520 in finance charges, Pew Charitable Trusts reports. This is in addition to the original loan amount.

“It’s okay to get caught up in a payday loan because that’s the only way the business model works,” Nick Bourke, director of consumer credit at The Pew Charitable Trusts, told CNBC Make It News. last year. “A lender is not profitable until the customer has renewed or re-borrowed the loan between four and eight times.”

These loans are ubiquitous. More than 23 million people took out at least one payday loan last year, according to financial research firm Moebs Services. In the United States, there are approximately 23,000 payday lenders, nearly double the number of McDonald’s restaurants.

Payday loans “are borrowers with interest rates that regularly exceed 600% and often lock them into a downward spiral of debt,” Brown said in a statement about the new legislation. “We need to make it clear in the law — you can’t rip off veterans or any other Ohioans with predatory loans that trap people in debt,” he added, referring to his home state.

Still, payday loans are an accessible option for those with poor or no credit that might not be approved by a traditional bank. Payday loans can also be cheaper than other credit options, such as overdrafts. If your the bank assesses an average fee of $35 on a short purchase of $100, you pay an APR greater than 12,700%. Keep in mind that the median overdraft amount is much lower, around $40, reports Moebs. Additionally, many banks will charge overdraft fees for each purchase made while your checking account is overdrawn.

The payday loan controversy

Payday loans and consumer loans are not a new phenomenon, and there are already federal and state laws in place to help consumers. In reality, California passed new rules in September that prevent lenders from charging more than 36% on consumer loans between $2,500 and $10,000. This week’s bills would not replace the state’s existing infrastructure, Grothman says.

Payday loans, in particular, have been a hotly debated issue ever since the CFPB, the government agency charged with regulating financial firms, first delayed implementing era payday loan rules. Obama earlier this year that required lenders to ensure borrowers could repay their loans before issuing. cash advances.

Since then, Democrats have tried to rally support to craft federal rules banning high-cost lending. Rep. Alexandria Ocasio-Cortez, DN.Y., and Sen. Bernie Sanders, I-Vt., introduced new legislation targeting loans in May. They jointly published the Moneylenders Prevention Act, that would cap interest rates on credit cards and other consumer loans, including payday loans, at 15% nationwide.

But this week’s bill is the first with bipartisan support.People shouldn’t take these loans, but the number of financially illiterate people is just too high in our society,” Grothman says, adding that it makes people “vulnerable to buying the wrong product.” federal rules in place to change that, he says, as more and more The payday loan industry is moving more online.

Still, proponents of law-abiding payday lenders say capping rates would make it difficult for storefronts to continue providing these types of unsecured loans. Without these lenders, consumers may not have many options if they need a cash advance. “The Federal Deposit Insurance Corporation experimented with a 36% loan cap, but reviews of this pilot program clearly showed that the loans were simply not profitable enough for banks to continue offering the product,” said said D. Lynn DeVault, Community President. Financial Services Association of America, which represents payday lenders.

“Small dollar loans are often the cheapest option for consumers, especially when compared to bank charges – including overdraft protection and bad checks – or unregulated offshore Internet loans and penalties for late bill payments,” DeVault said in a statement to CNBC Make It.

But consumer advocates say capping payday loan rates won’t have a significant impact on consumers’ ability to get money. Many states already impose restrictions on interest rates, and consumers have found other ways to address financial shortfalls, says Diane Standaert, former director of state policy at the responsible credit center.

Ohio, which previously had the highest payday interest rates in the country, implemented legislation in April that capped annual interest on such loans at 28% and banned auto title loans. Although the number of lenders has decreased since the new rules came into force, there are still currently 19 companies holding licenses to sell short-term loans, with 238 locations, according to a Cincinnati-based NPR News affiliate.

Even if the bill doesn’t make it out of the Senate, Grothman hopes the additional discussion and education will help people understand what they’re getting into when taking out a high-interest loan.

“It’s a shame when people work so hard for their money and then lose it, and really get nothing in return but a high interest rate,” he says.

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Sally J. Minick