Let’s not hinder consumers’ access to credit

Perhaps coincidentally an organization not wholly unfamiliar with less than reputable financial institutions, the Center for Responsible Lending, released a poll that indicated a bipartisan majority of American consumers supported a 36 percent rate cap on pay day and installment loans.

Let me be clear, there are plenty of predatory payday lenders out there taking advantage of unsuspecting consumers. It’s a worthy goal to protect consumers from predatory or unscrupulous lending practices by payday or vehicle title lenders.

But CRL rigged its poll outcome by asking an incomplete question: “As you may know, the average annual interest rate on payday loans is 391 percent. Would you support or oppose a proposal to put a cap on the interest rates that payday lenders may charge at 36 percent annual interest?”

When asked that way, who wouldn’t agree?

But the rest of the question should have been “… even if it means that consumers would not be able to borrow funds of less than $2,500.” That’s because a rate cap on all consumer loans would make it much harder for working Americans to borrow the funds they need for everything from car repairs, refrigerators or furniture. For example, a study on the costs to offer consumer credit by the National Commission on Consumer Finance found that the break-even APR for a 12-month $1,000 loan is 77 percent.

Another academic study found that to break-even under the proposed 36 percent cap, traditional installment loans would have to be at least $2,600 to $4,000. Many Americans don’t need loans 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.

Consumer advocates point to high APRs as a hallmark of unfair or predatory loans. Those “outrageous” interest rates they tout often sound too crazy to be true … because they usually are if one is dealing with a responsible lender.

Consumer advocates rarely take the time to explain that the length of a loan is a crucial factor in APR.

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 percent. One week? 52 percent. If you pay the loan back the day after you take it out? The rate is what appears to be a massive 365 percent. If you repay that $100 loan with $1 of interest an hour after you take it out, you’ll be paying an 8,760 percent APR.

Consumer advocates rarely take the time to explain this fact of APR. Instead they scare consumers with large, out-of-context numbers, like 391 percent. 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 — and policymakers — with a much clearer idea about the affordability of these loans.

Finally, something CRL doesn’t disclose: Installment loans don’t have “balloon payments,” early payment penalties, or hidden fees. They are already regulated by federal and state truth-in-lending laws. They are 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.

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

Bill Himpler is president and CEO of the American Financial Services Association, which represents the consumer credit industry.