Although every state has laws that limit the rate of interest that can be charged on loans, there exist broad exemptions, exceptions, and loopholes based on the type of lender or borrower, the loan amount, the nature of the loan contract, or the subject of the loan contract.
Some lenders have found a way to get around those laws.
According to Lauren Saunders, an attorney with the National Consumer Law Center (NCLC) who was recently interviewed by NPR’s Chris Arnold for “All Things Considered,” a lot of on-line lenders are using what she calls “rent-a-bank schemes” to enable them to skirt state laws, since most banks are not subject to state interest rate caps. The simple version of how this works is that the on-line lender does the work of finding the customers, approving the loans, and collecting on the loans, but “at the moment that the money actually goes to the consumer” it comes from “a bank that’s not covered by the interest rate limitations.” The on-line lender “then immediately buys the loan back from the bank” or the bank keeps the loan, but sells a derivative interest in the loan to an entity associated with the on-line lender.
The solution that some are proposing is a new federal law to limit interest rates.
There is already a federal law to protect members of the military from “predatory lenders.”
The Military Lending Act, passed in 2006 and amended in 2017, caps the interest rate for loans given to active-duty service members, activated members of the Guard and Reserve, and their covered dependents at an annual percentage rate (APR) of 36 percent.
The Protecting Consumers from Unreasonable Credit Rates Act of 2019 (S.1230) was introduced on April 29 in the U.S. Senate by Dick Durbin (D-Ill.). It would extend the military 36 percent cap on interest rates to all consumers because “high-cost lending persists in all 50 States due to loopholes in State laws, safe harbor laws for specific forms of credit, and the exportation of unregulated interest rates permitted by preemption.” And because there is no federal interest rate cap, “consumers annually pay approximately $14,000,000,000 on high-cost overdraft loans, as much as approximately $7,000,000,000 on store-front and online payday loans, $3,800,000,000 on car title loans, and additional amounts in unreported revenues on high-cost online installment loans.” The bill finds that consumers “pay on average approximately 400-percent annual interest for pay-day loans, 300-percent annual interest for car title loans, up to 17,000 percent or higher for bank over-draft loans, and triple-digit rates for online installment loans.” The bill was referred to the Committee on Banking, Housing, and Urban Affairs and never heard from again.
But on November 12, a similar bill, the Veterans and Consumers Fair Credit Act was introduced in the House (H.R.5050) by Jesús “Chuy” García (D-Ill.) and Glenn Grothman (D-Wis.), and in the Senate (S.2833) by four senators. According to a Garcia press release,
Predatory loans are trapping families in a cycle of debt. We know that the Military Lending Act has preserved access to credit while protecting consumers from predatory payday lenders. Some states have extended these proven protections to all their residents, but my constituents in Illinois remain vulnerable to payday loans, debt collection, vehicle repossessions, and more. Veterans and consumers deserve the same protections from vicious debt traps that active-duty service members receive, and the Veterans and Consumers Fair Credit Act will do just that.
We already protect military service members under the Military Lending Act, which means that we have recognized the predatory nature of high-interest loans to our men and women in uniform. This raises the question — if it is wrong to allow predatory lenders to target our service members, why is it right to let them target the rest of the community?
According to a “fact sheet” about the bill, the Veterans and Consumers Fair Credit Act would eliminate high-cost, predatory payday loans, auto-title loans, and similar forms of credit in all 50 states by:
- Reestablishing a simple, common sense limit on predatory lending
- Preventing hidden fees and loopholes
- Preserving access to credit
- Maintaining low industry compliance costs from compromise rules already in effect
- Upholding stronger state protections
The bill has been applauded by the aforementioned Saunders of the NCLC:
Most Americans would be shocked to learn that today predatory lenders can legally charge 100%, 200%, or even higher interest rates in many states. While a 36% rate cap sounds high to most people, and it will not hurt legitimate businesses, it will stop the most egregious forms of loan sharking. The 36% interest rate cap goes back more than a century and is widely supported by the American public on a bipartisan basis. Reasonable interest rate caps are the simplest most effective protection against predatory lending.
So, should there be a federal cap on interest rates?
Of course not, and for a variety of reasons.
First of all, the cure might be worse than the disease. Although the Veterans and Consumers Fair Credit Act would supposedly protect financially vulnerable Americans, it might have the opposite effect of cutting their access to loans altogether. It would shut out riskier borrowers seeking smaller lines of credit because it would give lenders an incentive to make only larger, long-term loans to cover their fixed costs.
Second, it is not the proper role of government to protect people from “predatory lenders.” Interest rates are simply the price we pay for credit. They are contingent on a variety of factors, including consumer demand for credit and the risk to the lender. A national cap on interest rates is essentially a federal price control. And even worse, it is an arbitrary price control based on Soviet-style central planning by government bureaucrats and regulators. Once a national cap on interest rates is accepted, no logical or reasonable argument can be made against the federal government’s setting a maximum price on haircuts, hotel rooms, manicures, oil changes, car rentals, or facelifts.
Third, there is no authorization in the Constitution for the federal government to cap interest rates. Just as there is no authorization in the Constitution for the federal government to have Medicare, Medicaid, Social Security, welfare, or unemployment compensation. If there are to be rate caps and tighter rules to protect consumers against “predatory lending,” then they will have to be instituted on the state level.
And fourth, to institute a federal cap on interest rates does violence to free exchange, free trade, free contract, free markets, and a free society. The government should not interfere in any way with any transaction between a willing lender and a willing borrower. Just as the government should not interfere in any way with any transaction between a willing seller and a willing buyer.