Our 21st-century consumer economy operates almost entirely through credit and debt. In the past, consumers used cash for daily basic expenses, saved for rainy days and reserved credit for big purchases like cars and homes.
But now even the smallest consumer transactions are often structured through some form of credit. People borrow more with credit than ever before. As of the second quarter, consumers amassed an extra $73 billion in debt, with overall debt levels rising by 4.5% from a year earlier, to reach $16.84 trillion, per Experian data. In doing so, American consumers have made themselves extremely vulnerable to a myriad of predatory lenders in this digital age. These lenders not only market to and prey upon those most at risk, but trap them in a destructive cycle of debt, surpassing a 600% annual percentage rate in some states.
A proposed national interest rate cap of 36% will protect consumers from predatory lending practices that exploit their vulnerability and desperation. This 36% cap would also level the playing field for responsible lenders who offer fair and transparent products that help consumers build credit and wealth.
Critics argue that the question of capping interest rates is nuanced and would limit access to credit for those who need it. This argument regarding access to credit is disingenuous and dangerous. High-cost small-dollar loans, for example, are marketed as short-term loans for emergency expenses, but the loans are widely known as "debt traps'' with some payday business models clearly dependent on borrowers defaulting and taking out back-to-back loans to cover the initial loan, subsequent fees and repeated defaults.
Too many nonbank lenders operate without sufficient regulation. They can avoid usury caps by setting up their businesses in states that do not have maximum interest rate laws. Nonbanks can also partner with banks that are not bound by these state laws through something called a rent-abank scheme: The bank issues the loans but the nonbanks service them and collect higher rates.
My home state, New Jersey, has its own 30% cap on all consumer loans. But if safe harbors exist in other states, predatory high-cost lenders can set up shop in those states without APR limits and offer higher cost loans to borrowers anywhere.
We should note that the proposed national limits would not preempt New Jersey's, or any other states' existing regulations. In fact, they would strengthen their efforts to combat predatory lending by creating a nationwide standard.
Another critique of the proposed cap is that small-dollar lenders cannot make enough profit to stay in business. Consumers shouldn't be subjected to usurious debt trap loans and possible financial ruin simply to maximize industry profits. The payday, auto title and installment loan companies alone make up multibillion-dollar industries that often prey on our most vulnerable communities.
Redlining and other forms of historic discrimination have denied people of color, especially African Americans, access to credit for generations and made them prime targets of predatory lending. Exorbitant interest rates, which lead to higher rates of default, end up damaging credit scores and locking them out of the mainstream and less expensive finance markets. High-cost lending only perpetuates and widens the racial wealth gap and generational wealth disparities. The cap would require lenders to make loans that borrowers can afford to repay without falling deeper into debt.
Capping interest rates isn't a new concept. Currently, 45 states, along with the District of Columbia, have set rate caps on small-dollar installment loans.
Additionally, in 2007, the Military Lending Act recognized the dangers of unchecked lending rates and implemented a 36% cap, protecting active-duty service members. The Department of Defense based its recommendations for the MLA on its analysis that 36% APR is a reasonable and sustainable rate with which businesses can operate successfully.
There is also strong bipartisan support for interest rate caps. In past ballots, voters in states like Nebraska, Colorado, South Dakota, Montana, Ohio and Arizona have all approved or reaffirmed rates at or below 36% by margins exceeding two-to-one. A survey from January 2020 revealed that 70% of voters, almost evenly split between Republicans and Democrats, are in favor of a 36% cap.
In recent years, Congress proposed legislation that provides a 36% cap. As the financial climate of the U.S. rapidly changes, I urge Congress to introduce and pass a cap that reflects reasonable standards with no loopholes. Like the MLA, the legislation must require the 36% APR cap to include all fees and add-ons. The legislation must uphold states' abilities to adopt even stronger protections. The federal law would act as a baseline, with states free to improve upon it.
