As you likely know, payday lenders have a bad reputation for being a scam or even described as predatory lending, when really, it’s another outlet for individuals to utilize if they find themselves in financial distress.
On May 9th, 2019, The Hill released an article that highlights a bill that was presented by Representative Alexandria Ocasio-Cortez of New York and Senator Bernie Sanders of Vermont, aiming to put a cap on interest rates for consumer loans at 15%.
People claim that this will put an end to the payday lending industry. Alexandria is quoted as writing in an email to her supporters,
“Predatory lending and our credit rating system targets lower income Americans and people who are living paycheck to paycheck with manipulative practices and hidden fees – trapping millions in a cycle of systemic poverty as their hard-earned money is funneled into exorbitant bonuses for Wall Street executives.”
The proposed legislation is called the Loan Shark Prevention Act.
One of the data points that are flashed include the high interest rates, typically rising high into the triple digit levels. While this bill seems to paint payday lenders as the villain and consumers as the victim, the bill may not be as terrible as it’s laid out. Yes, it will certainly have an impact on not only the payday lending market, but consumer markets around the country.
Currently, interest rates are high on payday loans for a reason. When you take out a 30-year mortgage your interest rate is lower because you in theory are paying on the note for 30-years. The means the lender can spread their return on investment over those 30-years.
Payday loans are only meant to last roughly 15 to 30 days. The reason for a high interest rate is since the life of the loan is in days and the lending is to riskier clients, the lender must be compensated appropriately. If an interest rate on a payday loan was 2%, that would mean at the very best $2 for every $100 lent would be earned.
The proposed rate cap of 15% can be seen beneficial in the long run because it can increase the people willing to take out a payday loan. Certainly it would take time for the market to adjust but if an individual can get the same interest rate at a payday lender of credit card, consumers may be more inclined to visit a payday lender.
Again, while the initial shock of a rate drop would take time to adjust to, after the business plan of a payday lender shifted it could look at increased volume if consumer knew their interest rates were capped at 15%.
Simple business is if the margins are lower, you’ll need increased traffic to become or remain profitable. Again, if someone can get a credit card with the same rate but only needs the cash for a short-term fix, payday loans may become more appealing.
Are 15% Interest Rates Realistic?
The last point of this bill is the realistic nature of what it’s doing. Can you imagine all the large financial institutions agreeing to have their credit card products capped at 15%? Not only that, if the bill covers all consumer lending products, that means personal loans and similar products would also be capped, affecting banks and credit unions.
Keep in mind that the payday lending market has always been a target for politicians due to the demographic this market is associated with. In an attempt to gain votes, it can be easy to target a market that seems less appealing on the surface, but really provides that same financial products as the next financial institutions.
This bill has become one of Bernie Sanders talking points as he begins his 2020 Presidential campaign. While this is only a purposed bill at this point, it’s something to watch as the campaign continues and should it materialize, look for the payday lending industry to adjust and capitalize on the new rate rules.