Misguided and Misinformed on APR

Americans of all stripes rely on consumer credit to pay for the things they need. From cars to homes, vacations to home renovations, consumer credit is an integral part of financing Americans’ ways of life. Now, though, some members of Congress and consumer “advocates” are pushing the woefully and inaccurately titled “Veterans and Consumers Fair Credit Act,”  which would impose arbitrary and damaging limits on all Americans’ access to credit.

This legislation would make it much harder for working Americans to get loans, by placing a 36% “all-in” rate cap on all consumer loans.  The rate is arbitrary, because there is no data or research that indicates that an interest rate capped at 36% is any different than, say, a 99.9% rate cap or a 32% rate cap.  In fact, while the Military Lending Act, on which this legislation is based, has been in place for more than a decade, there is no clear data that indicates whether the cap has helped or hurt servicemembers and their families in addressing their financial goals and needs. 

But there is data that shows a rate cap on consumer credit products is damaging to the very people Congressional sponsors claim to be helping.  According to a recent study, in order to break-even under the proposed all-in Annual Percentage Rate (APR) cap, traditional installment loans would have to be at least $2,600 to $4,000. Many Americans don’t need loans that are that large, and moreover, they may not qualify for them. Taking away the option for small loans, however, doesn’t remove the need for access to these products.

Many consumer advocates point to high APRs as a hallmark of bad loans. Those “outrageous” interest rates they tout often sound too crazy to be true …  because they usually are. A simple example shows why using APR on small-dollar loans is so deeply misleading. Suppose you borrow $100 and you only must repay $101. If you repay that loan in one year, 365 days from when you took it out, the APR will be just one percent. If you repay it in one month, the APR is 12%. One week? 52%. If you pay the loan back the day after you take it out? The rate is what appears to be a massive 365%. If you repay that $100 loan with $1 of interest an hour after you take it out, you’ll be paying an 8,760% interest rate.

Consumer advocates rarely take the time to explain that length of a loan is a crucial factor in APR and instead, scare consumers with large, out-of-context numbers. A more honest focus on straightforward questions like, “What is the total amount I have to repay?”, “What is the monthly payment?”, and “How many payments do I have to make?” would leave consumers with a much clearer idea about the affordability of these loans.

Most importantly, this legislation is a solution in search of a problem. Installment loans don’t have balloon payments, or early payment penalties, or hidden fees. There is no “fine print,” as they are already regulated by federal and state truth-in-lending laws. They are “plain vanilla” loans with transparent, easy-to-understand terms, due dates, and payment amounts. The average loan is about $1,500. The average monthly payment is about $120 and the average term is 15 months. Traditional installment loans often meet an urgent need for many consumers, such as repairing a car for work or dealing with a medical emergency, or an every-day need, such a paying for a family vacation.

Misguided and misinformed regulatory efforts too often end up making things worse, not better, for the for the very people the policies aim to help.  Let’s not make that mistake by hindering consumers’ access to credit.