American Financial Services Association

Fed Report Echoes AFSA: Rate Caps Restrict Credit

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Fed Report Echoes AFSA: Rate Caps Restrict Credit

The Federal Reserve Board of Governors on August 12 released an extensive study entitled The Cost Structure of Consumer Finance Companies and Its Implications for Interest Rates: Evidence from the Federal Reserve Board’s 2015 Survey of Finance Companies.

The study, authored by Lisa Chen and Gregory Elliehausen, confirms and expands on what AFSA has been saying for decades: using the annual percentage rate (APR) as the sole indicator for the suitability of a loan is a poor way to judge the quality of the underlying credit.

The report updates a 1962 analysis in the report of the National Commission on Consumer Finance of so called “break-even APRs” for different loan amounts between $100 and $3,000. In short, the Fed study shows the cost of loan by the lender.

The Fed survey is extensive but has a few key takeaways, particularly as it relates to APRs that are required for consumer finance companies to break even.

  • A loan amount of $2,530 is necessary to break even at 36 percent.
  • For large loan amounts the curve for break-even APRs is nearly flat. The rate is 17.48 percent for a $13,057 loan amount and 16.25 percent for a loan amount of $17,805.
  • While larger loan amounts have much lower interest rates than smaller loan amounts, larger loans entail greater interest payments (finance charges) and a longer period of indebtedness. In addition, risky consumers may not qualify for larger loan amounts.
  • With substantial fixed costs, high interest rates are necessary to provide sufficient revenue to cover the costs of providing such loans.
  • If small loan revenue is constrained by rate ceilings, only large loans will be provided.
  • Consumers who need a small loan or only qualify for a small loan would not be served.

AFSA is reviewing the Federal Reserve report carefully and will be using its findings to continue to illustrate how restrictive rate caps ultimately limit credit options for consumers.

August 13th, 2020 by