Federal lawmakers seek to lower payday loan rates from 400% to 36%

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Tens of millions of Americans are turning to high cost loans that regularly carry interest rates of over 400% for everyday expenses, such as paying bills and covering emergency expenses. For many, these rates end up being too high and lead to a seemingly endless cycle of debt.

But that may soon change. This week, five members of Congress plan to introduce federal legislation that would ban these sky-high rates on a variety of consumer loans, including payday loans. Instead, the Fair Credit Act for Veterans and Consumers in the House would cap interest rates at 36% for all consumers.

Rep. Glenn Grothman, R-Wis., And Jesus “Chuy” Garcia, D-Ill., Co-sponsor the legislation in the House, while Sens. Sherrod Brown, D-Ohio, Jack Reed, DR.I., and Jeff Merkley, D-Ore., Simultaneously introduce a parallel bill in the Senate. Bipartite legislation is built on the framework of the Military Loans Act, 2006, which caps loans at 36% for active-duty members.

Specifically, this week’s legislation would extend those protections to all consumers, capping interest rates on payday loans, car titles and installment loans at 36%. That’s well below the current average APR of 391% on payday loans calculated by economists at the St. Louis Fed. Interest rates on payday loans are over 20 times Average APR by credit card.

“We once had a bill regarding military personnel and military bases that turned out to be a huge success,” said Grothman. CNBC do it. “If you leave it there, it leaves you with the impression that we have to protect the military, but we will leave [payday lenders] go wild and enjoy everyone. “

The Payday Loan Landscape

Lenders argue that high rates exist because payday loans are risky. Typically, you can get these small loans in most states by going to a store with valid ID, proof of income, and a bank account. Unlike a mortgage or car loan, no physical collateral is usually required. For most payday loans, the loan balance, along with any “finance charges” (service charges and interest), are due two weeks later, on your next payday.

Yet consumer advocates have long criticized payday loans as “debt traps” because borrowers often cannot repay the loan immediately and get stuck in a borrowing cycle. The research carried out by the The Consumer Financial Protection Bureau found that nearly one in four payday loans are borrowed nine or more times. In addition, borrowers take about five months to repay loans and cost them an average of $ 520 in finance charges, Pew Charitable Trusts reports. This is in addition to the original loan amount.

“It’s okay to get caught up in a payday loan because that’s the only way the business model works,” said Nick Bourke, director of consumer finance at The Pew Charitable Trusts. CNBC do it Last year. “A lender is not profitable until the customer renews or borrows the loan between four and eight times.”

These loans are ubiquitous. More than 23 million people used at least one payday loan last year, according to financial research firm Moebs Services. In the United States, there are approximately 23,000 payday lenders, almost twice the number of McDonald’s restaurants.

Payday loans “engage borrowers with interest rates that regularly exceed 600% and often trap borrowers in a downward spiral of debt,” Brown said in a statement on the new legislation. “We need to be clear in the law – you can’t rip off veterans or any other Ohioian with bad loans that trap people in debt,” he added, referring to his home state.

Still, payday loans are an accessible option for those who may have poor or no credit that might not be approved by a traditional bank. Payday loans can also be cheaper than other credit options, such as overdrafts. If your the bank estimates an average fee of $ 35 on a short purchase of $ 100, you pay an APR well over 12,700%. Keep in mind that the median overdraft is much lower, around $ 40, Moebs reports. Additionally, many banks will charge an overdraft fee for every purchase you make while your checking account is overdrawn.

The payday loan controversy

Payday loans and consumer loans are not a new phenomenon, and there are already federal and state laws to help consumers. In fact, California adopted new rules in September, which prevent lenders from charging more than 36% on consumer loans of $ 2,500 to $ 10,000. This week’s bills would not replace existing public infrastructure, Grothman says.

Payday loans, in particular, have been a hotly contested issue since the CFPB, the government agency responsible for regulating financial companies, first delayed the implementation of Obama-era payday loan rules earlier this year, lenders were required to ensure borrowers could repay their loans before issuing cash advances.

Since then, Democrats have sought support for crafting federal rules that would ban high-cost loans. Representative Alexandria Ocasio-Cortez, DN.Y., and Senator Bernie Sanders, I-Vt., Introduced new lending legislation in May. They jointly published the Law on the Prevention of Usurers, which would cap interest rates on credit cards and other consumer loans, including payday loans, at 15% nationwide.

But this week’s bill is the first with bipartisan support.People shouldn’t take these loans, but the number of financially illiterate people is just too high in our society, ”Grothman says, adding that it makes people“ vulnerable to buying a bad product ”. federal rules in place to change that, he says, as more and more Payday Loan Industry Moves More Online.

Still, supporters of law-abiding payday lenders claim that the rate cap would make it difficult for storefronts to continue providing these types of unsecured loans. Without these lenders, consumers may not have many options if they need a cash advance. “The Federal Deposit Insurance Corporation experimented with a 36% loan cap, but reviews of this pilot program clearly showed that the loans were simply not profitable enough for banks to continue to offer the product,” said D. Lynn DeVault, President of the Community. Financial Services Association of America, which represents payday lenders.

“Small loans are often the cheapest option for consumers, especially when compared to bank charges – including protection against overdrafts and bad checks – or unregulated offshore internet loans and penalties for late payment of bills, ”DeVault said in a statement to CNBC Make It.

But consumer advocates say capping payday loan rates won’t have a significant impact on consumers’ ability to get money. Many states already impose restrictions on interest rates, and consumers have found other ways to address financial deficits, says Diane Standaert, former director of state policy at the Center for Responsible Lending.

Ohio, which previously had the highest payday interest rates in the country, implemented a law in April capping annual interest on such loans at 28% and banning auto title loans. While the number of lenders has declined since the new rules took effect, there are currently still 19 companies licensed to sell short-term loans, with 238 locations, According to a Cincinnati-based NPR News affiliate.

Even if the bill doesn’t make it out of the Senate, Grothman hopes the additional discussion and education will help people understand what they’re getting into when they take out a high-interest loan.

“It’s a shame when people work so hard for their money and then lose it, and get nothing but a high interest rate in return,” he says.

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