36% payday loan rate caps may not fully protect consumers

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Several states, including Illinois and Nebraska, recently implemented restrictions capping interest rates at 36% on consumer loans, including payday loans.

Proponents claim these restrictions prevent consumers from gaining the upper hand with these traditionally expensive loans, but opponents argue that these types of laws will reduce access to credit by forcing lenders to close their doors with unsustainable rates, leaving people who to turn to when they are strapped for cash.

New research published on Monday seems to indicate that while these 36% rate caps may be well-intentioned, a different approach could actually have a bigger impact on reducing the number of Americans caught in a so-called “Debt trap” where they have trouble repaying the loan.

Consumers may be better served by rules that require lenders to deny borrowers any new loan for a period of 30 days after taking out three consecutive payday loans, the report finds. About 90% of borrowers surveyed said they wanted extra motivation to avoid payday debt in the future, and this system would allow that without immediately limiting access to credit.

“In our opinion, banning payday lending hurts consumers on the net, but regulations that allow payday lending, but limit repeat borrowing, can help consumers,” says Hunt Allcott, one of the study’s principal investigators and visiting professor of law at Harvard University.

Payday loans can be easy to obtain, but difficult to repay. In states that allow payday loans, borrowers can usually take out one of these loans by going to a lender and simply providing valid ID, proof of income, and a bank account. Unlike a mortgage or car loan, no physical collateral is usually required and the borrowed amount is usually due two weeks later.

Still, high interest rates, which reach over 600% APR in some states, and short lead times can make these loans expensive and difficult to repay. The research carried out by the The Consumer Financial Protection Bureau found that nearly one in four payday loans are borrowed nine or more times. In addition, borrowers take about five months to repay loans and cost them an average of $ 520 in finance charges, Pew Charitable Trusts reports.

Putting in place a 30-day “cooling off period” for payday loans allows consumers to access credit when they need it, but it also forces them to repay the loan sooner (rather than paying off the loan sooner). continue to borrow the loan), which is in line with what borrowers are doing. say they want for themselves in the long run, says Allcott.

The cooling off period should be at least a month because it is long enough to force borrowers to go through a payroll cycle without getting a payday loan, Allcott says.

“Most people, within days of paying, have a lot of money in their bank account. make ends meet, ”Allcott says.

It should be noted that Monday’s research makes several key assumptions, including that rate caps on consumer loans, including the 36% model, will effectively act as a total ban on payday loans.

In addition, the research does not take into account the effect of moderate interest rate caps or rules that encourage people to gradually repay loans, which have been implemented in the past. Ohio and the now canceled Consumer Financial Protection Bureau Rule 2017.

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