Democrats claim they serve the poor, but their latest plan will hurt low-income Americans’—especially racial minorities, immigrants and young people—ability to tap loans that pay for bills like water and electricity.
However well-intentioned, Senate Democrats’ patronizing plan to establish a national interest rate cap is counterproductive for people in need and could very well push them to underground financial products in an unregulated, shadow economy.
U.S. Senate Banking Committee Chairman Sherrod Brown (D-Ohio) is reportedly planning to revive his proposal for a national interest rate cap of 36%, believing he can overcome the 60-vote filibuster threshold. But the committee’s leading GOP member, Sen. Pat Toomey (R-Pa.) reportedly plans to block it—as he should.
Reuters reports “an industry group representing payday lenders said such a cap would effectively eliminate small dollar loans by making them unprofitable,” and data from the the Consumer Federation of America shows “While the median interest rate on small-dollar loans is between 25% and 38%, rates on some short-term loans of hundreds of dollars can be as high as 251%.”
But Tom Lehman, associate professor of economics at Indiana Wesleyan University, points out the real-world intellectual sleight-of-hand when Democrats use these inflated annualized, triple or quadruple digit interest rates. At the Mises Institute, he gives the example of a typical payday loan fee, of $15 per $100 borrowed for a typical loan term of just 14 days, making the annualized compound interest rate “easily in the triple-digit range.”
Lehman also writes about an academic analysis estimating that the median payday loan fee in North Carolina is $36, with a median, two-week loan of $244, which is an effective annual percentage rate of 419 percent.
“The critics of payday lending view these relatively high interest rates with much alarm, arguing that the fees charged are exploitative of poor borrowers lacking in personal financial management skills,” Lehman writes. “Yet, the effective annual interest rate on the payday loan may not even enter the mind of the borrower. In all likelihood, the borrower cares not what the ‘effective APR’ is on the loan. The real price signal to which the borrower responds is the flat fee that is charged to hold the postdated check. If the value attached by the borrower to the immediate cash advance exceeds the value of the principle plus the fee one or two weeks hence, then the borrower will undertake the transaction, pure and simple.”
If Democrats successfully kill off short-term lending in its current form, these borrowers will still need access to credit—this would force them to use even more pricey avenues, including overdraft protection, bouncing personal checks or underground market alternatives. For lower-income Americans, these alternatives to payday lending could push them over a financial edge.
Thomas Miller Jr., professor of finance at Mississippi State University, wrote that “A 2013 Pew Charitable Trusts survey found that more than 60 percent of payday loan users would have to delay paying other bills without access to these loans. The alternative to short-term loan debt is being indebted to existing creditors—where failure to pay might mean losing access to utilities, like water and electricity.”
If Senate Democrats are successful at enticing enough anti-free market Republicans to sign onto this bill, they could literally be leaving America’s most vulnerable people out in the cold.