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36% payday loan rate caps may not fully protect consumers

Several states, including Illinois and Nebraska, recently implemented restrictions that cap interest rates at 36% on consumer loans, including payday loans.

Proponents say these restrictions prevent consumers from getting in over their heads with these traditionally expensive loans, but opponents argue these kinds of laws will reduce access to credit by forcing lenders out of business with rates unsustainable, leaving no one to turn to when they run out of money.

A new study published on Monday seems to indicate that while these 36% rate caps may be well intentioned, a different approach may actually have a greater impact on reducing the number of Americans who get caught in a so-called “debt trap” where they are struggling to repay the loan.

Consumers may be better served by rules that require lenders to deny borrowers any new loans for a period of 30 days after taking out three consecutive payday loans, the report finds. About 90% of borrowers surveyed said they wanted extra motivation to avoid payday loan debt in the future, and this system would provide that without immediately limiting access to credit.

“In our estimation, banning payday loans hurts consumers online, but regulations that allow payday loans but limit repeat borrowing can help consumers,” says Hunt Allcottone of the study’s principal investigators and a visiting professor of law at Harvard University.

Payday loans can be easy to get, but hard to repay. In states that allow payday loans, borrowers can usually take out one of these loans by going to a lender and simply providing valid ID, proof of income, and a bank account. Unlike a mortgage or car loan, no physical collateral is usually required and the amount borrowed is usually due two weeks later.

Yet high interest rates, which reach over 600% APR in some states, and short turnaround times can make these loans expensive and difficult to repay. The research carried out by the The Consumer Financial Protection Bureau found that nearly one in four payday loans are re-borrowed nine or more times. Additionally, it takes borrowers about five months to repay the loans and costs them an average of $520 in finance charges, Pew Charitable Trusts reports.

Implementing a 30-day “cooling off period” for payday loans allows consumers access to credit when they need it, but also forces them to pay off the loan sooner (rather than continuing to re-borrow the loan), which is consistent with what borrowers say they want for themselves in the long term, Allcott says.

The cooling-off period should be at least one month because it should be long enough to force borrowers into a payment cycle without getting a payday loan, Allcott says.

“Most people, within days of their paycheck, have a lot of money in their bank account. It’s not until a few days after your next paycheck that you run out of money and need help. a loan to make ends meet,” Allcott says.

It should be noted that Monday’s research is based on several key assumptions, including that rate caps on consumer loans, including the 36% model, will effectively act as a total ban on payday loans.

Additionally, the research does not take into account the effect of moderate interest rate ceilings or rules that encourage people to gradually repay loans, which have been put in place in Ohio and it now canceled Consumer Financial Protection Bureau 2017 Rule.

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