Illinois’s 36% Solution is No Solution At All
Earlier today, the American Financial Services Association, the Illinois Financial Services Association, the Independent Finance Association of Illinois, and the Illinois Automobile Dealers Association wrote to Illinois Gov. J.B. Pritzker to express concerns with Senate Bill 1792, and urge a veto on the bill, which would create the Predatory Loan Prevention Act and institute a 36 percent rate cap based on the federal military annual percentage rate for all loans not exceeding forty thousand dollars, including vehicle loans.
While SB 1792 contains many admirable provisions aimed at creating a more equitable Illinois, the proposed rate cap would leave Illinois consumers worse off and immediately cut off access to credit for millions of Illinois citizens.
The letter, which can be read in full here provides background on the Military Lending Act (MLA) and the military APR (MAPR) and why is should not be applicable to the broader U.S. consumer population. But there are three key reasons why Governor Pritzker should veto SB 1792:
First, a third of Illinois adults will be ineligible for safe and affordable installment credit if this bill becomes law. Our traditional installment members test ability to repay, verify application elements, have robust compliance processes, and check and report to credit bureaus. The fixed costs associated with extending a traditional installment loan before a loan is made—EXCLUDING the cost of personnel and commercial space—includes receipt of application / portal fees, credit bureau pull, ID & background data, job verification costs, cost of funds, red flag check portal fee, and income verification costs. These costs—for one small-dollar lender for example—add up to $85 for each loan before the loan is even made.
As the chart in the letter makes clear, 3.5 million Illinois consumers – about 36% of Illinois adults – would be excluded from accessing credit. Under SB 1792 traditional installment lenders would be required to stop lending to Illinois borrowers with credit scores under 650 in order to stay in business.
Second, the claim by consumer advocates and policymakers that “banks will step in” is a myth. The idea that banks and credit unions can pick up the slack from established licensed non-bank lenders is not sustainable. Banks and credit unions cannot successfully balance their business models with the provision of safe and affordable credit for non-prime borrowers, and loans for small-dollar amounts cannot be made profitably at 36%.
Banks are closing branches all over the country at an increasing pace. They are not going to open new ones in historically underserved communities in order to make unprofitable, risky, subprime consumer loans. Where they have dabbled in small loans, they make payday, or “deposit advance” loans, relying on their control over the customer’s bank account in lieu of underwriting, or they make “overdraft” loans, where the cost, along with the cost of bank NSF fees, can often be significantly higher in APR terms than mainstream traditional installment lending credit.
Third, despite the misinformation and fear tactics spread by supporters of this legislation, traditional installment loans are safe and affordable credit. For small-dollar loans, the quality, affordability, and soundness of the loan is best judged by its structure, and not its interest rate. This is because interest rates on small amounts can be misleading as to cost. For example, say you lend me $100 today and charge me $1 in interest:
➢ If I pay you back in one year, the APR is 1%
➢ If I pay you back in one month, the APR is 12%
➢ If I pay you back tomorrow, the APR is 365%
➢ If I pay you back in an hour, the APR is 8760%
Same dollar in interest, vastly different APRs.
For over 100 years, traditional installment lenders have consistently provided consumers with reliable, community-based small-dollar credit that is accessible and affordable, giving borrowers a tried-and- tested mechanism to safely manage their household credit. Furthermore, unlike payday loans, these loans require an underwriting process that includes a calculation of the borrower’s ability to repay a loan out of their monthly budget and also report loan performance directly to credit bureaus, which is vital for Illinois borrowers looking to build a credit history and increase their financial mobility.
In fact, traditional installment loans have repeatedly been recognized as safe payday alternatives by government officials at both the federal and state levels. For instance, the National Black Caucus of State Legislators (NBCSL) passed a resolution in 2016 that stated:
NBCSL supports the expansion of Traditional Installment Loans as an affordable means for borrowers to establish and secure small dollar closed end credit while preventing cycle of debt issues inherent with non-amortizing balloon payment loans.3
This was also demonstrated recently by decision of the federal Consumer Financial Protection Bureau (CFPB) to exclude traditional installment loans from the provisions of its Payday Lending Rule.
While elite borrowers, such as members of the Illinois state legislature and government employees, may be able to find other sources of credit or afford larger loan sizes, many of their fellow citizens will be left in credit deserts and forced to turn to more dangerous, or illegal, options such as loan sharks.
Because our members report to credit bureaus, they help hundreds of thousands of Illinois adults graduate out of subprime credit scores each year – so we deeply understand the effects of this bill. This will have a ripple effect in those communities where unregulated lenders will operate and proliferate, credit mobility will decline, debt costs will increase as will overall debt loads, and long-term wealth will decline when people lose access to both affordable credit and means to improve their credit scores. Elite borrowers will remain unaffected. Only those in the lowest third of tiered credit scores will find themselves unable to access credit or build their credit history using traditional installment loans.
MAPR is not a solution for Illinois and accordingly SB 1792 should be vetoed.
January 22nd, 2021
