Senate Majority Whip Dick Durbin (D-IL) and three co-sponsors recently introduced yet another ill-advised bill to impose a nationwide All-in 36 percent interest rate cap. The measure would mean that lenders would be prohibited from offering loans, regardless of their length or the risk posed by the borrower, with a rate above 36 percent, including fees, which the law interprets as adding to the financing cost.
Lawmakers have proposed similar bills that simply run afoul of the research. With this bill, however, Sen. Durbin appears to be out of touch with what happened in his own home state when the legislature there imposed a similar rate cap in 2021.
Illinois lawmakers presumably thought they were helping borrowers by limiting the all-in rates lenders could charge. But did they? Did this rate cap improve consumer welfare and protect the underprivileged from so-called predatory lenders? And, importantly, did this rate cap make small-dollar loans more affordable?
Two colleagues and I addressed these questions and other findings in a recent study. We documented the measurable effects on Illinois borrowers after the 36 percent all-in rate cap went into effect.
We examined the number and size of unsecured installment loans over a twelve-month period—six months before the imposition of the all-in cap and six months after. We sorted credit bureau data into credit score buckets by county or county groups for Illinois and Missouri, which we chose as a comparison state because it had no legislated rate cap. In Missouri, the competitive market set borrowing rates.
Basic economic theory predicts that interest rate caps have effects that differ across groups of borrowers. A rate cap will affect borrowers with poor credit differently than those with a strong credit history. In our study, we found that the all-in 36 percent rate cap impacted subprime borrowers, those with credit scores below 600, most significantly.
Using a statistical technique called “difference in differences in differences,” we estimated how the number of loans made after the cap was imposed and compared it to an estimated number of loans that would have been made without the cap. According to our model, in the period following the imposition of the 36 percent cap, the number of loans to subprime borrowers fell by 38 percent. Meanwhile, the average loan size increased by 35 percent from where it would have been without the cap.
Additionally, we estimated that the total dollars loaned to subprime borrowers fell about 14 percent, or about $26 million. The deepest subprime borrowers, those with the fewest credit alternatives, were the most affected: the dollars lent to them fell by about 26 percent. This amount may sound trivial in Washington, where lawmakers pass legislation routinely in the billions of dollars and appropriate budgets in the trillions.
This amount of money, however, is significant to the Illinois families denied access to credit. We estimated that roughly 34,000 Illinois families with few credit options now have even fewer options because they lost access to unsecured installment loans.
We also examined the results of a survey of actual installment loan borrowers in Illinois who lost access to credit after the 36 percent rate cap imposition. Ninety-three percent of the respondents said their pre-cap loans helped them manage their financial situation. Unlike prime borrowers, who have many credit options, two-thirds of these borrowers said that they were often unable to pay bills without the aid of short-term installment loans. Finally, seventy-nine percent of borrowers surveyed responded that they would like the option to return to their previous lender operating under pre-cap conditions.
Senator Durbin, his co-sponsors, and the list of organizations who endorse an all-in 36 percent rate cap may all think they are doing a great thing for working families, but their good intentions stand in stark contrast to the cold facts observed when rate caps like the one they propose, have been imposed. Legislators claim they care about consumers who are struggling financially, but if their struggles lead them to miss payments and pay bills late, the result is a lower credit score, further limiting their access to credit. Such was the case when Illinois instituted its version of Senator Durbin’s proposed rate cap, which harmed Illinois borrowers with low credit scores while providing additional credit access to borrowers with higher credit scores.
It’s time for members of Congress to pump the brakes on “All-in Rate Caps.” Instead, they should fully consider the real impacts of imposing these rate caps and examine the efficacy of using alternate means of measuring the cost of short-term loans before taking action. Ignoring the evidence while plowing ahead with misguided government interventions will only lead to more bad policy.
Thomas W. Miller, Jr., is a professor of finance and holder of the Jack R. Lee Chair in Financial Institutions and Consumer Finance at Mississippi State University and a Senior Research Fellow at Consumers’ Research.
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