A 2019 study by Northwestern Mutual revealed some sobering statistics on consumer debt in America. It found that the average American adult has nearly $30,000 in debt, and that figure doesn’t even include mortgage debt. More shockingly, the study found that Americans spend over one-third of their income on debt repayment, on average.
News stories about studies like this often blame American consumers for failing to live within their means. However, two federal legislators, Senator Bernie Sanders and Representative Alexandria Ocasio-Cortez, point the finger at a different culprit: big banks and other financial institutions. In a white paper published on Medium, they argue that lenders are keeping Americans trapped in debt by gouging them with “sky-high fees and usurious interest rates.”
To tackle this problem, Sanders and Ocasio-Cortez introduced the Loan Shark Prevention Act in 2019. It would limit the amount of interest lenders can charge on any type of loan, anywhere in the nation, to 15%.
The lawmakers claim this legislation will protect American consumers by forcing lenders to charge reasonable rates. But their critics say it will have the opposite effect. By making it unprofitable for lenders to give loans to low-income Americans, critics argue, it will open up a new market for real loan sharks — illegal lenders who charge sky-high rates and use violence, or the threat of violence, to make sure they collect.
What the Loan Shark Prevention Act Does
Most U.S. states have usury laws that limit the amount of interest lenders can charge on credit cards and other consumer loans. However, the 1978 Supreme Court ruling Marquette National Bank v. First of Omaha Corp. effectively made these laws irrelevant. The case centered on a bank headquartered in Nebraska, where the interest rate cap was 18%, that was marketing credit cards in Minnesota, where the cap was 12%. A Minnesota bank sued the Nebraska bank for violating the state’s usury law, but the Supreme Court ruled the law did not apply because the plaintiff bank wasn’t located in Minnesota.
This ruling made it possible for national banks to get around state usury laws by moving their headquarters to one of the few U.S. states that don’t have any. In the years that followed, banks stampeded toward these states. If you’ve ever wondered why every credit card bill you receive seems to have a mailing address in Delaware, Nevada, or South Dakota, that’s the reason.
The Loan Shark Prevention Act would impose a new ceiling on loan interest, this time on a national scale. Banks wouldn’t be able to get around this limit by using the Marquette ruling because the limit would apply everywhere in the country.
Provisions of the Act
The Loan Shark Prevention Act is an amendment to the Truth in Lending Act (TILA), a 1968 law that requires lenders to disclose the terms of a loan to borrowers. It would add a new section to the TILA with these provisions:
- Nationwide Cap on Interest. The law would limit interest on all types of consumer loans to 15%. However, this limit would not apply to loans made by credit unions.
- Restored State Limits. In any state that currently has an interest limit lower than 15%, banks would have to adhere to that limit. It would effectively undo the Marquette ruling by requiring banks to set their interest rates based on where the borrower lives, not where the bank has its headquarters.
- Limits on Bank Fees. If all the law did was limit interest, many banks would probably try to get around it by adding extra banking fees to loans. In order to prevent this, the law says the 15% limit must include all “finance charges.” It prevents banks from imposing any other fees that are higher than the finance charges.
- Option to Raise the Limit. A 15% limit could become unsustainable for banks if overall interest rates rise into the double digits, as they did in the late 1970s and early 1980s. In order to avoid this problem, the act gives the Federal Reserve the power to raise the nationwide interest cap if it determines that the 15% rate poses a threat to lenders. However, it can’t increase the rate above this level for more than 18 months at a time.
- Penalties for Overcharging. Any bank that charged borrowers more than 15% on a loan would forfeit the interest on the loan. It would lose not only the amount over the 15% limit but also all the interest charged on the loan.
- Refunds for Customers. Under the law, if you discovered you paid more than 15% interest on any loan, you could sue the bank to collect a refund of the interest you paid. You would be allowed to sue the bank for all the interest and fees it had charged you, not just the overcharge. You would have up to two years after your last payment to bring a suit.
Effects on the Lending Sphere
This bill would have a major impact on the consumer lending sphere. It would eliminate some types of loans altogether and put stricter limits on others. However, it would not affect some types of loans, either because their current rates are too low or the law specifically exempts them.
Loans That Would Be Eliminated
The Loan Shark Prevention Act would effectively outlaw payday loans. These are small, very short-term loans that do not require a credit check. To make this type of loan profitable, payday lenders charge extremely high interest rates — about $15 for every $100 borrowed over a two-week period, according to the Federal Reserve. That works out to an annual percentage rate (APR) of more than 390%. With a federal interest rate cap of 15%, payday lenders simply wouldn’t be able to stay in business.
The act would have the same effect on auto title loans. These work much like payday loans but with a twist: Instead of giving the lender access to their paychecks, borrowers offer up their cars as collateral. If they can’t repay the loan on time, the lender seizes the car and sells it. Auto title loans come with the same high interest as payday loans, plus an array of additional fees.
Loans That Would Be Limited
The Loan Shark Prevention Act wouldn’t eliminate credit cards, but it would drastically reduce the interest lenders can charge on them. According to CreditCards.com, the average APR for credit cards as of January 2021 was 16.05%, higher than the limit set by the act. And that’s just the average; for people with poor credit, the typical interest rate is over 25%. Only “low-interest” cards have an average rate significantly below the limit, at 12.77%
With the act in place, lenders would have to lower their rates on all credit cards. The maximum rate would be 15%, and even the low-interest rate would have to drop somewhat to make those cards attractive. Lenders would probably stop offering any cards for people with poor credit since they would no longer be able to charge a high enough interest rate to make up for the added risk these borrowers present. That would make it much harder for anyone with damaged credit to rebuild their credit score.
Pro tip: An alternative way to rebuild credit is through a Credit Builder Account from Self. Unlike a secured credit card, you aren’t required to put down a deposit. Instead, you’ll be able to save money and rebuild your credit at the same time.
The act could also significantly curtail personal loans, especially unsecured loans, which often charge higher rates. According to ValuePenguin, the average interest rate for personal loans in January 2021 ranged from 10% for people with good credit to 28% for those with poor credit. If the Loan Shark Prevention Act passed, lenders would likely stop offering personal loans, or at least unsecured loans, to borrowers with low credit ratings.
Loans That Would Not Change Much
Many types of loans would change little, if at all, as a result of the Loan Shark Prevention Act. It would not have much effect on:
- Mortgage Loans. According to ValuePenguin, the average interest rate for a 30-year fixed-rate mortgage in 2017 was only 4%. Even for borrowers with poor credit, the typical interest rate is nowhere close to the 15% limit set by the act. Even if overall interest rates rise significantly in the future, the top rate for mortgage loans is unlikely to reach this limit.
- Student Loans. Interest rates for most student loans are also below the 15% limit. For federal student loans, the typical rate ranges from about 5% to 7.6%. Even for private student loans, which are much more costly, the top rate is only 14.44%. However, if interest rates rise by much in the future, the 15% limit could make banks less willing to offer private student loans.
- Auto Loans. The Loan Shark Prevention Act could affect interest rates for car loans, but not by much. Auto loan interest rates range from around 3% for buyers with good credit to 10% for those with poor credit. So, for the immediate future, auto loan rates would remain largely unchanged. However, if interest rates rise sharply, buyers with poor credit would likely find it harder to get a loan.
- Business Loans. Interest rates for many types of small-business loans can be higher than the 15% limit — sometimes quite a bit higher. Borrowers can pay up to 80% for a line of credit, 99.7% for an online term loan, and 200% for a merchant cash advance. However, the Loan Shark Prevention Act wouldn’t affect any of these loans because it applies only to consumer loans. The law it amends, the TILA, does not cover any loan made “primarily for a business, commercial, or agricultural purpose.”
- Loans From Credit Unions. Some loans made by credit unions have interest rates higher than 15%. However, the Loan Shark Prevention Act specifically exempts credit unions from the 15% cap. Credit unions would be able to continue offering payday alternative loans (PALs), which are small, short-term loans with a maximum interest rate of 28%. PALs provide a more affordable alternative to high-interest payday loans, but only for people who have access to a credit union.
Support for the Act
According to Sanders, the Loan Shark Prevention Act has received praise and support from many consumer advocacy groups, including Consumer Action, Demand Progress, and the American Federation of State, County and Municipal Employees (AFSCME). Editorials in support of it have appeared in Forbes and Nation of Change.
The bill’s supporters argue that the law is necessary to rein in excessively high interest rates. They point out that the median interest rate for credit cards climbed to more than 20% in 2019, even as the average interest paid on savings accounts dropped to less than 0.1%.
Worse still, banks typically charge the highest rates to low-income consumers, the very people who can least afford it. Thus, these consumers often end up mired in debt, repeatedly renewing the loans they can’t manage to repay. Supporters of the bill see this practice as a form of financial exploitation that makes it harder for families to break out of poverty. Considering how little banks pay out to account holders, they say, limiting the interest rate to 15% would end this exploitation while still allowing banks to make a reasonable profit.
Of course, for the riskiest borrowers, banks probably wouldn’t offer loans at lower rates; they would simply stop making them. That’s why many supporters of the bill think it needs to be coupled with a new public banking option to give underbanked consumers more access to financial services.
Sanders and Ocasio-Cortez recommend offering basic banking services through post offices. The U.S. has done this before, operating a Postal Savings System from 1911 through 1966, and many other countries -including China, France, and Japan – still do it today. This proposal would provide banking services in many low-income communities that currently have no commercial banks, giving residents an alternative to expensive check-cashing services and payday lenders. Other alternatives include digital banking services such Chime and citizen accounts administered directly by the Federal Reserve.
However, if the Loan Shark Prevention Act makes it somewhat harder to borrow money in America, that may be a benefit, not a drawback, Robert Hockett of Forbes argues. Hockett points out that consumer debt in America in 2019 exceeded $4 trillion, a level not seen since just before the financial crisis of 2008. That crisis came about largely as a result of irresponsible lending — banks pushing subprime mortgages on borrowers who couldn’t really afford them. If stricter lending limits prevent banks from making such risky loans in the future, it will help keep the economy stable.
Criticisms of the Act
Not everyone agrees with Hockett’s argument that restricting credit for low-income borrowers is a good thing. An editorial in The Washington Post argues that, although the boom in credit card lending has made it easier for buyers to get in over their heads with debt, it’s also given millions of households access to the benefits of credit cards, including “convenience, rewards programs and increased liquidity.” Many of these borrowers are using credit cards responsibly, and cutting off their access to credit would only hurt them.
But there’s an even bigger danger for vulnerable, low-income borrowers: If they can no longer get loans from banks, other lenders will almost certainly step in to provide this service at terms even less favorable than banks offer today. Desperate consumers will use costly store installment plans or rent-to-own deals to buy the items they’re now financing with credit, or they’ll borrow from pawnshops at annual rates significantly higher than 25%. Or, worse still, they could turn to genuine loan sharks, who really do break kneecaps.
That may sound far-fetched, but it’s happened before. In the late 19th and early 20th centuries when state usury laws put strict limits on lending, legitimate banks couldn’t make much of a profit with small loans to working people, so they didn’t offer them. But there was still a huge demand for this service, so illegal lenders stepped in to fill it. They provided small loans at high interest rates and threatened borrowers with beating and mutilation if they didn’t pay up.
Sanders and Ocasio-Cortez argue that reinstating usury laws doesn’t have to cut off much-needed credit for working families or spur illegal lending. With postal banking, they claim, low-income borrowers could continue to get loans when they need them at more reasonable rates. However, the Loan Shark Prevention Act in its current form does nothing to establish a postal banking system. Unless the legislators can pass a second bill to do this, the Loan Shark Prevention Act will end current credit sources for those who need them most, leaving nothing but unethical lenders in their place.
The goal of the Loan Shark Prevention Act — to eliminate predatory lending and break the cycle of debt for working- and middle-class families — is a noble one. However, it’s not clear that the bill, as it exists now, would do much to achieve this goal.
It would lower interest rates on some types of loans, and it would eliminate exorbitant payday and auto title loans. But it would do nothing to curb predatory practices in many other types of lending, including mortgages, auto loans, and student loans. And it might make the problem worse by driving low-income borrowers into the arms of alternative lenders, legal or illegal, whose terms and practices are even more abusive.
For the Loan Shark Prevention Act to help working families, it must go hand in hand with a public option for banking, such as postal banking, which would offer credit at more reasonable rates. In fact, such a public option would go a long way toward helping low-income borrowers even if the Loan Shark Prevention Act doesn’t pass. With new, lower-interest loans available, working-class consumers wouldn’t need to rely on abusive payday loans or high-interest credit cards, and these types of lending would gradually wither away.
If Sanders and Ocasio-Cortez really want to help these borrowers, it might make more sense for them to focus on their postal banking proposal first and worry about restoring usury laws later.