Last month five legislators introduced the Veterans and Consumers Fair Credit Act, a bipartisan piece of legislation that proposes an ill-advised solution to a difficult problem. It seeks to put an interest rate cap on all loans nationally in the name of consumer protection. Unfortunately, it will likely have the opposite impact on the consumers it seeks to protect.
No one likes predatory loans where consumers can sink into a debt spiral that often ends up in financial ruin. While this bill seeks to focus on payday and car-title loans, two loan products that are universally disliked, it will also impact many installment lenders. These are the companies who sit between the low interest marketplace lenders and the payday loan industry, offering loans with APRs of 36% to 100%, many of whom provide critical financial support for struggling consumers.
The fact is that an interest rate caps is a very blunt instrument to use on a nuanced problem. There are some who believe that any interest rate above 20% or 25% is unacceptable and certainly 36% is out of the question to many. But what is the solution for people who simply don’t qualify for a loan at a lower percentage rate? According to the legislation proposed these people would just be out of luck. This will lead to more bankruptcies and more lives disrupted.
This is not just my opinion. This recent op-ed in The Hill by Consumers’ Research cited a study conducted in 2014 on the historical evidence of the impact of rate caps at the state level and they concluded that “state interest rate ceilings restricted credit availability…for higher-risk borrowers.” So, the legislation that is supposed to help higher risk borrowers in effect will price them out of the system and leave them with no good options.
Sometimes I think critics of high interest loans suffer from a kind of magical thinking. That if we simply legislate away a product the demand will go away. Clearly that is not going to happen, in fact demand will likely increase for a product that would now be banned.
Lenders have more sophisticated underwriting models today than ever before in history. They have long embraced deep analysis of traditional credit data but more lenders today are also using alternative data as it gets cautious approval from regulators. This will allow more people to be scored and more high-risk borrowers to be approved for loans. So, as we are on the cusp of being able to expand the universe of borrowers Congress wants to place new restrictions to curb this expansion.
Let’s Talk About Outcomes Not Interest Rates
Something that frustrates me about this entire debate is that no one talks about outcomes. While a 50% or even 100% APR term loan may sound like a huge price to pay for credit it is certainly less expensive than a bankruptcy or losing a job. And that is the key. Are people better off, on average, for taking out this loan?
Take Opploans for example. Opploans is a company that is often attacked for its so-called “predatory” loan practices. People look at the average APR, which is high I agree, and assume that this is a bad product. But as I have got to know the company better (listen to my podcast with CEO Jared Kaplan here), I am convinced they are providing a valuable service. They have a 4.8 star rating on both Credit Karma and LendingTree with thousands of reviews so they are clearly creating good outcomes most of the time.
Oportun is another great example. Their loans are targeted primarily at people with little to no credit history, often these people are immigrants and notoriously difficult to underwrite. They have provided more than 3.2 million small dollar loans and helped 760,000 people without a FICO score begin establishing a credit history. They are also a CDFI and recently became a public company. They are a mission driven company out to make their customers’ lives better and yes, they do lend money out above 36%.
There are many other examples of great companies I could list here who are completely committed to good outcomes for consumers but who lend money above 36%. Now, I recognize it is difficult to legislate on outcomes but let’s take this into consideration before taking on a drastic step like an interest rate cap.
Alternatives to High Interest Loans
The promise of fintech is to help improve the financial lives of everyone. There are many innovative products today that were not around even five years ago that are making a difference.
Chime has been one of the success stories of fintech over the past couple of years having built a huge customer base and raised a boatload of money. One of the reasons for this growth is that they pioneered their Early Direct Deposit feature where Chime members could get access to their pay two days early. Such a simple innovation has saved people huge amounts of money in overdraft fees and payday loans.
An even better product, in my opinion, along a similar vein is earned wage access. This is another fintech invention that allows workers early access to the wages they have already earned. Companies such as PayActiv, Earnin, Even, DailyPay and others offer solutions usually through employers. This is something that regulators should be actively supporting given the obvious benefits to people living paycheck to paycheck.
Another product is helping to set up employers with the ability to provide loans to employees beyond their current wages. Given the loans can be deducted directly from an employee’s paycheck many people who would face a triple digit APR if applying for a loan elsewhere can get a more reasonably priced loan. Companies like TrueConnect, HoneyBee and SalaryFinance are pioneering this new kind of offering that I expect will become commonplace in the near future.
These are the kinds of initiatives that regulators should be supporting, not the fool’s errand of an interest rate cap. We have the technology now to solve the problem that regulators are seeking to address. Of course, I am not saying they should ignore consumer protection. Far from it. They should be supporting new ideas, while at the same time ensuring consumers are protected. We can and should do far better than an interest rate cap. It feels like a 20th century solution to a problem that is being addressed very differently in the 21st century.