A recent piece in The Economist, made a number of points about payday loans, including the fact that they are rarely paid off in a single payment as intended; most are rolled over into new loans “leaving cash strapped borrowers caught in a cycle-of-debt.”
Traditional installment loans are structured to avoid the cycle-of-debt, through regularly scheduled, equal payments of principal and interest. They have long been seen as a more manageable, safe and affordable form of credit to payday loans, so this point need not concern us. The main thrust of the article, however, should. It deals with the effects of an APR cap on the availability of credit.
The article cites a new paper by Amir Fekrazad, an economist at Texas A&M University-San Antonio, which looked at the imposition of a APR price cap in Rhode Island. The study found that the law caused some borrowers to roll over their loans more often, increasing the likelihood of default, and that,
“The law also had several other unintended consequences: on average, the total number of borrowers rose by 32%, the number of loans per borrower jumped by 3.5%, and the principal of a typical loan climbed by 3%. All this amounted to approximately a 36% increase in total payday-loan volume. Poorer people began borrowing, too.”
This speaks to the point that we have made repeatedly: that capping the APR of loans, conceived as a means to break the “cycle-of-debt”, is poor public policy, not only for its failure to improve the condition of those that lawmakers are seeking to protect, but also for its lack of finesse. APR caps affect all sources of non-bank credit, not just the ones that are problematic. Given that an alternative to payday and title loans exists in the form of traditional installment loans, and, critically, that demand for credit remains constant, no matter what regulations are in place, we would hope policymakers at all levels of government would embrace more artful solutions that balance safety, affordability and access, avoiding the calamitous effects seen in Rhode Island.
The Economist piece is available here (free subscription to access). Mr Fekrazad’s paper is available at the link below:
Impacts of interest rate caps on the payday loan market: Evidence from Rhode Island (Texas A&M)
SOURCE: The Economist/Texas A&M University