In this four-part series, Andrew Morrison, a NILA member from Sun Loan Company, deliberates on wrong-footed policymaking, unintended consequences and the importance of safe, affordable small-dollar credit…..
PART 1: RATES AND RATE CAPS ARE POINTLESS AND DAMAGING
The 36% Annual Percentage Rate (APR) cap may be the single most idiotic initiative in all the screwed-up world of public policy. Not only is it based on fundamental errors, but its effects are the exact opposite of what is intended and disproportionately harm those it is designed to help. Former US Representative Barney Frank, the author of the Dodd-Frank Act, which established the CFPB, understood this – which was why he made sure the CFPB could not make any rules using APR.
Break-even rates – the rate at which a lender can make a loan without incurring a loss – are mostly a function of the size and length of the loan. This is because of the combination of fixed and variable costs.
As has been pointed out by the Consultative Group to Assist the Poor (a United Nations organization focused on financial inclusion), it costs more and takes longer to make a hundred $500 loans than to make one $50,000 loan. A loan made at 36% APR breaks even at about $3,000 or $4,000: it would be an outrageously high rate for a mortgage, and is utterly unrealistic for a $500 loan.
In that way, a 36% cap effectively cuts off access to all loans below about $4,000, including those most needed by lower income Americans, and for which they are most likely to qualify.
In addition, there is an inverse relationship between cost and rate. The lower the rate on the loan, the higher its cost is will be, and vice versa, because to get the rate down, the loan will have to be larger and have a longer maturity: you pay more actual interest, if you have a lower rate.
Thus, rate caps also cut off access to the lowest cost loans, those that lower income Americans can most easily afford. Wealthy Americans, who might want to borrow sums in excess of $10,000, are completely unaffected, while poorer citizens lose access to credit they desperately need. Rate caps are fundamentally discriminatory,and serve to keep the most needy people in need.
Remember: it’s cost that matters, not rate. You can’t buy anything with a rate.
