CFPB’s new management should avoid rate caps on small loans
With new leadership at the Consumer Financial Protection Bureau (CFPB), there are growing concerns that new attempts to cap the effective interest rates on small loans will recur. This would be a mistake for several reasons.
First, the CFPB does not have the power to impose a usury cap. The Dodd-Frank Act that created the Office States:
Nothing in this title should be interpreted as conferring on the Bureau the power to establish a usury limit applicable to an extension of credit offered or granted by an insured person to a consumer, unless expressly authorized by law. (12 USC §5517 (o))
Any interest rate cap on small loans is actually a usury cap. The Cordray-era CFPB proposed a rule that instituted a de facto the prohibition of loans to people who do not meet the conditions of “repayment capacity” when these loans have a total cost of credit greater than an annual percentage rate of 36% (APR). were circumstances in which loans could be made.
However, the requirements for extending a loan beyond that limit were so onerous that many potential borrowers simply wouldn’t qualify, and most lenders wouldn’t try to see if they could. Without the 36 percent requirement, some of these loans would likely have been made. This made the 36% figure an effective limit. It is likely that the new CFPB will try to make similar arguments in any new regulations.
Also, the idea of a rate cap using annual percentage rates is misplaced when it comes to small loan amounts. As John Berlau argued in his CEI study, “The 400% loan, the $ 36,000 hotel room and the unicorn“Applying annualized analyzes like the APR to much shorter-term loans is an apple-or-orange comparison.” The Obama-era office argued that many low-loan consumers were “trapped” in much longer debt cycles, but as Hilary Miller argued. in another CEI study, he failed to prove his thesis. As he put it, “There is no evidence that payday loans trap consumers in a cycle of debt, that they are damaging, or that the particular numerical loan limits offered by the CFPB will improve consumer welfare. . “
Finally, the commonly touted figure of a cap of 36% APR has little rational basis and does not work as advertised. The number is simply the cap used in the Military Loans Act, where it was supposed to prevent enlisted servicemen from taking on too much debt. However, like the recent office Intervention force notes that “the use of alternative financial products is estimated to be six to eight times higher among military families than among the general public”, suggesting that price caps do nothing to reduce the demand for alternative financing in these families.
As a working group concluded:
[H]years of study and experience have shown that usury laws interfere with the availability of credit and the inclusion of marginalized borrowers. Wear caps promote convoluted circumvention practices such as re-pricing terms that make prices and product features less transparent and reduce competition. Usury caps often deprive consumers of preferred financial products and force them to turn to alternative suppliers and more expensive and less desirable products.
For these reasons, the new CFPB management should avoid setting a de jure or de facto cap interest rates on small loans.