Capping interest rates is supposed to help consumers — in theory, at least. In reality, however, imposing caps on how much interest lenders can charge often harms the people these limits are intended to help. That fact is borne out by recent research regarding Arkansas’s interest rate cap.
The state constitution imposes a 17% interest rate limit on consumer loans. That means that Arkansans do not have access to some loan products, such as payday loans, that must charge higher interest rates in order to be profitable. Some people contend this is a good thing, since high-interest loans prey on low-income people, trapping them in a cycle of debt.
That argument has some flaws, however. Short-term, high-interest loans are a way for consumers without savings or access to other credit products to meet their financial needs. Banning these loans does not remove the financial problems that cause consumers to seek these loans. People choose these loans not because the loans are perfect but because these loans are their best option among a variety of other options. Some of these other options may not be so pleasant.
Consider if you have car problems that would cost you $400 to fix. If you don’t have a savings account with that much money in it, then what do you do? You could go to family, but maybe you don’t have a relative that has that much money. You could save up the money, but that will be difficult to do if you need a working vehicle to go to your job. A high-interest short-term loan would provide you the money you need to make the repairs and keep your vehicle running so you can go to work.
The fact that Arkansans view it in their self-interest to take these loans was demonstrated in a recent study by the Mercatus Center at George Washington University. The study’s authors found that Arkansans in border counties travel out of state to obtain these loans. The state’s rate caps, in essence, actually lead to higher costs for the state’s residents, since traveling to Mississippi or Oklahoma for a loan is more costly than just going down to the local strip mall.
The study’s authors conclude that:
On average, Arkansas residents pay an APR of 80 percent for loans, with an average loan size of $1,051. After adjusting for travel costs to obtain the loan from a neighboring state, Arkansas residents pay an average rate of about 93 percent.
People are obviously willing to pay for this product or they would not travel long distances to obtain it. Unfortunately, Arkansans who do not live in border counties have much farther to travel, so they are effectively shut out of this market. They are denied the opportunity to access these loans that they may need to deal with financial emergencies that arise.
Obviously, high-interest loans can be abused. Consumers can take them out for frivolous reasons (I personally know people who have done so). Some people can have a hard time paying them back. But individuals have a variety of reasons for taking out these loans. They are the best judges of whether or not they need them. Merely because we do not like the idea of a financial institution charging a high interest rate is no reason to deny people a credit option that, as their usage shows, so many people desire.