Too many Americans are living without savings. Forty percent of Americans can’t cover a $400 emergency through cash, savings or even by using a credit card. Worse yet, 60 million Americans struggle to qualify for loans to pay such an expense because they lack the required credit.
The truth is, applying for a loan is a tale of two realities. Good credit brings options. Without it, many are shut out of the system. Absent other options, millions are trapped in an endless cycle of debt, grappling with bank overdraft fees and predatory lenders who charge 400 percent or more in interest, making bad situations worse.
Looking to help, lawmakers recently proposed the Veterans and Consumers Fair Credit Act to eliminate payday loans — and much more — by banning consumer loans exceeding a 36 percent annual percentage rate (APR). Unfortunately, with America’s savings crisis unsolved, such a broad ban would hurt those who need loans by making them rely on loan sharks and others who operate outside of the law.
This conversation must shift to how best to protect consumers without acceptable credit from being taken advantage of, while maintaining their access to funds to pay for a car repair, medical expense or even holiday expenses. To that end, there are many common sense regulations that can serve as guardrails to protect consumers in the small dollar loan market without stifling financial choice.
First, consumers should be allowed to take out loans in excess of 36 percent APR if no other option is available. My company actually turns away business if a customer can get better terms elsewhere. We check whether they qualify for a loan from a consortium of 17 other lenders with APRs less than 36 percent. Only 7 percent qualify through these traditional lenders, leaving 93 percent without alternatives if we didn’t exist. This shows that credit access is already scant and in need of more options, not less.
Small dollar loans can also be more tightly regulated.
Lenders should be obligated to report loan payments to all three major credit bureaus. This would help non-prime consumers elevate their credit to near prime, and so forth. Rates should also be completely transparent through interest-only costs with prepayment penalties abolished.
Additionally, all small dollar loans should be structured to ensure consumers can repay them by adhering to strict payment-to-income ratios and income verification. This helps address a primary pain point with many types of unaffordable short-term loans that leads to 80 percent not being paid back in two weeks — driving a cycle of dependency and often inescapable debt.
Finally, small dollar loans should amortize, just like a mortgage. Every payment should decrease the outstanding principal rather than only paying the interest. We see that many short-term loan products aren’t just high-interest — they also don’t chip away at principal, and that’s critical to eliminating rollovers. This guideline would greatly reduce the chances of consumers getting trapped in recurring loans.
There certainly needs to be more action to protect credit-challenged consumers, but we need to be careful about unintended consequences that could push millions of Americans even further onto the sidelines of the economy.
Jared Kaplan is the Chief Executive Officer of OppLoans, a leading financial technology platform that provides accessible products and a top-rated experience to middle income, credit-challenged consumers.
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