Cap those crazy rates

EMAIL  |   PRINT  |   SHARE  |   RSS
google my aol my msn my yahoo! netvibes
Paste this link into your favorite RSS desktop reader
See all RSS FEEDS (close)
By Marlys Harris, Money Magazine editor-at-large

Many states still have laws that limit the interest a lender can charge. But in 1978 the Supreme Court ruled that national banks could charge a consumer the rate of the state where the bank was based.

So a deluge of banks and card companies fled to South Dakota and Delaware, where there were no maximum rates. In response, other states rolled back interest rate limits too. After that, the sky - or perhaps outer space - became the limit for consumer-loan rates.

It's now perfectly legal - and not at all uncommon - to lend money at triple-digit APRs. Sure, you might blame the folks who pay these rates for their troubles - it's true they generally have credit problems - but we're learning now that over-indebted consumers can hurt the whole economy.

This experiment in unrestrained rates should end. Even mainstream companies now feel free to charge rates that might embarrass loan sharks. What makes it more confusing is that those rates are often quoted as fees.

Consider the "courtesy overdraft" protection some banks and credit unions give their customers. Some courtesy: Often without warning, the bank adds, say, $500 to the customer's available balance.

The account holder might see it at an ATM and cheerily use a debit card or checks to pay for groceries, dry cleaning and gas without realizing that his real balance is maybe only $49. The average charge per incident is $20 to $35, plus $2 to $5 a day on the amount outstanding, until the loan is repaid. A $100 overdraft with a $20 fee that lasts for two weeks has an effective APR of 520%.

Even worse are predatory loans that target the poor and near-poor. The most prevalent are offered by so-called payday lenders, who now have more than 22,000 outlets across the country.

The loans work like this: A strapped consumer who needs to pay a bill writes a personal check, usually for $350 to $1,000, for an advance on funds. He gets the cash minus the fee, generally about $15 to $30.

The payday lender holds the check, usually for two weeks, until the borrower's next paycheck comes in. Then the check is deposited. If the borrower doesn't have enough funds to make good on the check, he renews the loan. That's another fee.

The Center for Responsible Lending found that a customer who rolls the loan over the average 10 times a year winds up paying $793 for a $325 loan. "It's a debt trap," says Jean Ann Fox of the CFA. "Once you get in, you can't get out."

How to fix it: When payday lenders opened around military bases and charged soldiers huge rates, Congress took umbrage and passed the Military Lending Act of 2007. It caps rates including fees on payday and other high-priced loans at 36%, but it applies only to military families. Well done. But why not protect everyone?

Lenders complain that limiting the rates they can charge would hurt some consumers because many people wouldn't be able to get credit at all when prevailing interest rates were high. But if the maximum is pegged to rise and fall with some index, this shouldn't be as big a problem.

Of course, traditional financial institutions could be doing more to reach lower-income borrowers. We're glad to see some credit unions stepping into the breach. In North Carolina, where lawmakers cracked down on payday lenders, credit unions and banks ramped up loans of less than $600 by 37% in four years. APRs there were capped at 36%.

Send feedback to Money Magazine

They're hiring!These Fortune 100 employers have at least 350 openings each. What are they looking for in a new hire? More
If the Fortune 500 were a country...It would be the world's second-biggest economy. See how big companies' sales stack up against GDP over the past decade. More
Sponsored By:
More Galleries
17 cool gadgets that tease the future Smart telescopes, surveillance for dogs, an electric roadster and more from CES 2018. More
These 12 airplane beds let you really sleep on a flight For the price of a premium class ticket, you may just get a space that's comfortable, private, and quiet enough to ensure a good rest. More
CES 2018 kicks off with oddball gadgets The biggest tech show of the year opened with a collection of quirky gadgets. More