Misguided Efforts to Limit Loan Rates

On January 13, 2021, the Illinois legislature passed SB 1792, that, among other things, overhauls the state’s consumer finance laws through the provisions of the “Predatory Loan Prevention Ac.t” SB 1792 would extend the 36% “all-in” Military Annual Percentage Rate (MAPR) finance charge cap of the federal Military Lending Act (MLA) to “any person or entity that offers or makes a loan to a consumer in Illinois” unless made by a statutorily exempt entity (i.e., a bank, savings bank, savings and loan association, credit union or insurance company). (SB 1792 separately amends the Illinois Consumer Installment Loan Act and the Payday Loan Reform Act to apply this same 36% MAPR cap.) The cap is effective immediately upon the Governor’s signature.

Under SB 1792, any loan made in excess of a 36% MAPR would be considered null and void, and no entity would have the “right to collect, attempt to collect, receive, or retain any principal, fee, interest, or charges related to the loan.” The legislation provides for a fine of up to $10,000 for each violation.

The efforts of the Illinois legislature are well intended, but will not work.

An August 12, 2020 Federal Reserve article entitled, “The Cost Structure of Consumer Finance Companies and Its Implications for Interest Rates: Evidence from the Federal Reserve Board’s 2015 Survey of Finance Companies,” provides strong support for the position that interest rate caps can be harmful to consumers by limiting the availability of small dollar loans.

Using data from the Fed’s 2015 Survey of Finance Companies, the article found that break-even APRs were quite high for small loan amounts but declined rapidly as the loan amount increased.  A $594 loan required a 103.54 APR, a $1,187 loan required a 60.62 APR, and a loan amount of $2,530 was necessary to break even at a 36 APR.

The response to state laws, such as Illinois’s, is not cheap credit, it is no credit. Lending in amounts below the breakeven APR level will cease. Borrowers needing loans in amounts less than $2,500 will have limited options, such as open-end lines of credit.

There is an expectations that more laws limiting the rates on consumer loans, both federal and state, will be enacted . The Federal Reserve’s 2020 article should be required reading for state and federal legislators before voting on such laws.