Interest Rate Cap Issue Update

Issue Update

Legislation expected to be introduced this Congress would impose a national 36% “all-in” interest rate cap on most consumer loans. It is expected to also include a provision that may require lenders to comply with any state rate cap based on the cardholder’s residence rather than the issuer’s location, a significant change that will make it difficult for many consumers to obtain credit.

Contrary to claims, the 36% price cap is not an “interest rate” cap. Its calculation includes not only interest, but other fees not included in the federal rate calculation used today (i.e., the annual percentage rate or APR). As a result, even low-rate small dollar loans banks are being encouraged to offer will exceed the threshold. For example, a $500 loan with a 60-day term, modest 15% simple interest rate, and (financed) $20 administrative fee would accrue about $13 in interest, but have a 40% rate under the bill—and thus be prohibited. Because credit card annual fees will be included in the calculation, popular and valued credit card features like rewards will be eliminated or reduced.

Moreover, the legislation’s cost calculation is seriously flawed, i.e., mathematically incorrect, as it assumes a fee imposed once a year is imposed 12 times a year. Some consumers who currently rely on credit cards or personal loans would be forced to turn elsewhere for short-term financing needs, including pawn shops, auto title loans—or worse, loan sharks and the black market.

Why It Matters

Proponents believe a rate cap would help consumers—especially subprime borrowers with less-than-perfect credit histories—by limiting what they pay on short-term credit, particularly on less-regulated payday loans. In reality, its impact would extend far beyond payday lenders to the broader consumer credit market to cover affordable small dollar loans (including “accommodation” loans), credit cards, personal loans, and overdraft lines of credit. A recent ABA analysis of data from Verisk Financial | Argus illustrates that tens of millions of current subprime cardholders would be at risk of losing access to credit cards if a rate cap were to become law.

Moreover, a rate cap’s negative effect on the consumer credit market could be even more severe in certain states if it requires banks to comply with state rate caps, which may be lower than 36%. In New York and Texas, for example, rate caps are set at 16% and 21%, respectively. As a result, federal legislation may cut off credit cards to tens of millions of borrowers in New York and Texas alone—including consumers with strong credit scores—and millions more throughout the country.

Recommended Action Items

Oppose Interest Rate Cap Legislation

Interest rate cap legislation would reduce access to credit for millions of consumers, particularly subprime borrowers who rely on affordable small dollar loans, credit cards, and other bank products for short-term financing needs and discourage development of innovative products designed for the under-served market.