Loan Rate Cap Would Be Disastrous for Minnesota Consumers Seeking Access to Credit


George Merkt, Contributor

Recently, legislation was introduced in the Minnesota Legislature (House File 290) which would place a 36 percent cap on the rate that lenders could charge consumers for short-term and small-dollar loans.

This is terrible news for Minnesota consumers, especially those who have difficulty accessing credit and thus rely on alternative financial services to make ends meet. It would be bad news also for the many consumers who currently use alternative financial services because they’re faster, easier, and more efficient than what are considered “traditional” loans.

Short-term and small-dollar loans such as “payday” loans offer easy political soundbites about interest rates and vulnerable consumers. Yet hardly any consumers are complaining about them—in the past three years, the Consumer Financial Protection Bureau has received a total of only 12 complaints about them from Minnesotans.

What rate cap activists don’t want consumers to know—and what they depend on consumers not understanding—is that the core element of their persuasion messaging just doesn’t work when you apply basic math.

Insisting that using an Annual Percentage Rate (APR) as the only meaningful way to evaluate financial products is a disingenuous way to generate opposition to short-term and small-dollar lending—annualizing the interest rate on a loan repaid in less than a year artificially inflates the interest rate to eye-popping numbers. Yet judging the fairness of interest rates and loans in actual dollars and cents is a much more useful metric.

For example, on the cost basis alone, very few people would insist that a $100 loan with $10 in interest repaid in 30 days is unreasonable. Indeed, many people would love to take that deal! However, when the interest rate on that very loan is annualized, it amounts to more than 121 percent—well above the artificial threshold that rate cap activists decry as usury.

Rate cap legislation would make short-term and small-dollar lending unprofitable in the state and thus would eliminate what is often the only source of credit for many Minnesota consumers.

Compounding the problem, an artificial rate cap would be highly discriminatory, targeting mainly a select set of consumers. Women are more likely than men to be “underbanked” and therefore use alternative financial products like short-term and small-dollar loans. Similarly, roughly a quarter of Black, Hispanic, and American Indian households are underbanked, compared with only about nine percent of White households.

In 2021, Illinois implemented a rate cap bill similar to what activists are pushing here in the Gopher State. It has been an abject failure and is illustrative of what would happen if Minnesota were to replicate its mistake. Borrowers have suffered.

J. Brandon Bolen of Mississippi College, Gregory Elliehausen of the Board of Governors of the Federal Reserve System, and Thomas Miller of Mississippi State University, published a study and found that in Illinois the interest-rate cap decreased the number of loans to subprime borrowers by 44 percent, increased their average loan size by 40 percent, and diminished the financial well-being of borrowers.

In the study’s survey data, the researchers found that 56 percent of respondents were unable to borrow money at least once in the nine months after the imposition of the rate cap. These people who were unable to obtain a loan reported that they paid bills late, incurring fees, and that they had to borrow from family or friends, fell into debt collection, and were forced to pawn personal possessions. Thirty-nine percent reported that their financial well-being was worse after the imposition of the rate cap. A whopping 79 percent said they would like to return to their pre-rate-cap lenders.

Clearly, Minnesota lawmakers would be wise to reject House File 290.