On July 29, the US Senate banking committee held a hearing entitled “Protecting Americans from Debt Traps by Extending the Military’s 36% Interest Rate Cap to Everyone”. NILA has a public interest responsibility to point out the disastrous nature of such a policy. Our comments are laid out in a letter to the committee, reproduced below.
July 23, 2021
The Honorable Sherrod Brown, Chairman
The Honorable Pat Toomey, Ranking Member
U.S. Senate Committee on Banking, Housing, and Urban Affairs
Dear Chairman Brown and Ranking Member Toomey,
On behalf of the National Installment Lenders Association (“NILA”) I write to share our perspective regarding the efficacy of interest rate caps in advance of the Committee’s July 29th hearing entitled: “Protecting Americans from Debt Traps by Extending the Military’s 36% Interest Rate Cap to Everyone”. NILA is the voice of lenders that offer traditional installment loans (or “TILs”) in 18 states and provide millions of Americans with safe and affordable credit.
We appreciate the Committee’s commitment to protecting consumers from debt-traps and predatory loan products. We share those concerns and encourage the Committee to develop targeted policies that ensure strong consumer safeguards. At the same time, we urge the Committee to appreciate the unintended consequences of sweeping policies that would end access to our product. While interest rates and annual percentage rates (“APRs”) are appropriately used to help consumers compare loans of similar size and duration, they do not provide insight into the full picture of the quality of a loan. As you weigh policy options, it is critical to understand the limitations of using APR as the only measure of affordability for small dollar loans.
A SUCCESS STORY:
Installment loans give the consumer a clear, structured and manageable roadmap for debt repayment. The TIL model is in marked contrast to the payday loan model that generates profitability at the borrower’s expense and can trap them in a cycle of unsustainable debt. We began to add “traditional” as a descriptor to our product in recent years because payday and other actors have tried to confuse people into believing the products are similar. They are not.
Unlike payday, or credit cards for that matter, TILs have a series of structural characteristics that make them safer, more affordable and provide the most predictable path for borrowers to pay off their loan. Specifically:
- NILA members underwrite loans to test the borrower’s ability to repay,
- Loans are payable in equal installments of principal and interest,
- There are no balloon payments or other “tricks or traps”,
- A bank ACH arrangement is not required for loan approval, and
- We report to the credit bureaus, enabling borrowers to build or repair their credit.
NILA worked with the Consumer Financial Protection Bureau (CFPB) under the leadership of then Director Richard Cordray to develop the 2017 Small Dollar Rule. The rule sought to prohibit predatory lending by including provisions like mandatory underwriting provisions, testing for the ability to repay and providing a transparent breakdown of principal and interest. During the September 2015 Semi Annual CFPB Report to the House Financial Services Committee, Cordray said, “…we are trying to make sure that there is room for responsible lending, room for community banks and credit unions in particular, but others, installment lenders who are traditional and have responsible products. It’s a tough balance, that’s why it’s a difficult rulemaking…” Director Cordray understood the importance of striking a regulatory balance in maintaining access to safe credit while ensuring that products help consumers.
Interestingly, our industry exists as a result of a consumer-focused movement that began about 100 years ago among progressive state legislatures. Their goal was to make safe, affordable and legal credit available to their constituents. Legislative reformers recognized that the public needed a regulated and safe alternative to loan sharks and organized criminals. A century later, the satisfaction of our customers is very high, well above that of the banks or credit card companies. Furthermore, we remain grateful that regulatory leaders, like CFPB Director Cordray, understand the nature and benefits of the TIL structure for consumers in need of responsible small-dollar loans. Our industry and consumers have truly been a success story.
AVOIDING A CATASTROPHE:
We believe it is important to structure loans that are safe and affordable, therefore we are deeply concerned about any effort to extend the Military Lending Act’s (“MLA”) 36% APR cap to all borrowers. There are a number of reasons we believe this blanket rate cap would be very detrimental to those people with the fewest credit options. Please consider:
There is no evidence that the MLA has been a success. This is especially true given the expansion of the 36% ceiling being extended beyond payday loans to TILs in 2017. There has been no study done by the Department of Defense (“DOD”) or the Consumer Financial Protection Bureau (“CFPB”) as to those impacts. The existing evidence suggests that the expansion is more than likely to have harmed borrowers. Earlier this year, the state of Illinois enacted a similar cap to extend the MLA to all borrowers, and it has resulted in severe and unintended consequences of sweeping up responsible, traditional installment lenders as well. As a consequence, our members are in the process of closing hundreds of branches, laying off hundreds of employees and having to tell tens of thousands of customers we can no longer serve them. Unfortunately, our former customers will either not be able to borrow or will be forced into less regulated online loans, high interest revolving credit cards or even illegal alternatives
Service members differ very significantly from civilian borrowers. Even if one believes members of the armed forces have not been as negatively affected as one would expect, it is important to acknowledge the critical differences in the two populations. Military personnel and their families are rightly afforded many unique benefits, such as, housing assurance, medical coverage, education tuition assistance and even access to free tools to perform maintenance on their personal vehicles. These benefits mitigate their need for small dollar credit.
Most importantly, a special benefit each branch of the military has its own relief society. While each one has a different mission they all exist to provide financial assistance to both current and retired service members. There is no civilian equivalent to these programs. Therefore, the damaging effects of a 36% cap are more muted. This would not be the case (as we are currently witnessing in Illinois) for civilian borrowers.
History proves a 36% rate cap cannot work on small loans. The origins of this discussion date to the early part of the 20thCentury when borrowers were preyed upon by loan sharks making illegal loans. In New York, for example, loan rates were capped at 6% which was a boon to organized crime. Reformers acknowledged that as the size and duration of a loan is reduced the rate of interest would necessarily need to rise. This is a function of the fact that, in part, the fixed costs associated of large loans and small loans are similar.
Around 1920, Arthur Hamm with the Russell Sage Foundation (and other reform minded activists) coalesced around a rate cap of 3%-per-month or 36% annually. Later some concluded the rate needed to be higher, at 3.5%-per-month or 42% annually. Either way, lenders were unwilling to risk capital and make loans much below $300 or the equivalent of $4,075 today (see endnote)—a loan size well above the $700 to $1,200 loans that our customers demand.
IF NOT RATE CAPS, THEN WHAT?
The key determinant of the quality of a loan is in how it is structured, not solely the interest rate or APR. With that in mind, we respectfully suggest policymakers focus on two key points:
APRs are a misleading measure of cost for “small dollar” credit. Proposals to cap APRs stem from a misunderstanding of the measure’s usefulness. APRs are a function of the size and duration of a loan not its actual overall cost. The larger the loan size and longer time frame over which it is paid back, the lower the APR will be and vice versa. This highlights why average mortgage rates are comparatively low, between 2-5%. It is because they are large loans that are stretched over 15 to 30 years.
I would like to provide a few examples that illustrate this point. Suppose you loan a friend $100, and only ask for $1 of interest for a total of $101 in repayment. If you are repaid in a week the APR would be 52%. If you are paid the next day it would be 365%. If in an hour, the APR would be 8,760%. These sound like outrageous and predatory APRs, but in fact this would be a very inexpensive (and unprofitable) loan given the total cost is only $1 or 1% of the loan amount. Conversely, a borrower of a $300,000 thirty year, 3.5% fixed rate mortgage has to pay back $485,000 with finance costs totaling 62% of the loan amount, or $185,000. This demonstrates why federal Truth in Lending Act regulations do not focus solely on APRs as a measure of cost but mandate the disclosure also in terms of the cost in total dollars, as well as the total cost as a percentage of the loan amount. By these measures, TILs are considered a source of very low cost credit.
Protect consumers by focusing on the structural elements of loan products. All consumer credit is not the same. Loans that test the ability to repay, have equal payments of principal and interest and have other beneficial elements give consumers the best opportunity for success. Conversely, policies instituting APR caps are indiscriminate and effectively ban not only payday loans but beneficial installment credit, leaving borrowers with only expensive revolving, less regulated, or even illegal credit alternatives.
Our industry has a 100-year history of providing safe, structured, and affordable credit, and our customers are overwhelmingly appreciative of the financial services we provide. We understand that safeguards are needed to protect the small dollar loan market. However, interest rate ceilings result in unintended consequences that eliminate access to affordable credit that low- to middle-income borrowers rely on. We believe that TILs represent the loan construct that provides the optimal balance of attributes for small dollar borrowers. This model offers the least risk and best opportunity for financial security for millions of Americans. We look forward to working with you to protect consumers from predatory lending, while ensuring the most vulnerable borrowers have access to beneficial financial services.
Thank you for your attention to this important matter.
National Installment Lenders Association
Endnote: For an excellent documentation of the history around the origins and efficacy of the 36% APR cap we would suggest “City of Debtors” by Anne Fleming.