For the millions of Americans who struggle to afford an unforeseen expense, high interest payday and online loans may seem like acceptable options despite the inherent risk.
But guidelines issued by federal regulators in the spring could bring a competitor to low dollar lending: banks. The guidelines omit a previous suggestion from the Federal Deposit Insurance Corp. that bank loans should have annual percentage rates of 36% or less.
While some consumer advocates say a rate cap is necessary consumer protection, researchers say banks can check a borrower’s credit and offer affordable loans, something payday lenders whose APRs exceed. often 300% usually do not.
If your only option is a high interest loan from whatever source, take control by understanding the rate and monthly payments and choosing a lender who verifies your repayment capacity.
UNDERSTAND YOUR RATE
There is no federal interest rate cap on small loans of a few thousand dollars or less, and banking regulators cannot impose one. But 45 states cap APRs on $ 500 loans, while 42 states have caps on $ 2,000 loans. See the National Consumer Law Center’s fact sheet to see the APR cap in your state.
The NCLC advocates a federal rate cap of 36%. Associate Director Lauren Saunders says without one, high rates could permeate other credit products. Many lenders who offer APRs of 36% or less tie your rate to the risk of lending you, based on your credit history. If you’ve had trouble making loan or credit card payments in the past, the lender may consider you a high-risk borrower and give you a rate close to 36%.
APRs are useful for comparing loan products, but seeing dollar amounts can help consumers assess whether they can make the required payments on an installment loan, says Alex Horowitz, senior research manager at The Pew Charitable Trusts.
If the only loan you can qualify for is over 36%, calculating your monthly payments can help you figure out what you can afford.
A bank would have to charge $ 50 to $ 60 on a $ 400 loan paid off over three months to make it profitable, Horowitz says. That’s an APR of around 75 to 90%. A 2017 study by Pew found that many consumers believe it’s a fair rate.
Small loans are currently dominated by online lenders, says Leonard Chanin, deputy president of the FDIC.
But the “simple loan” of the American bank offers a rare example. The loan typically has an APR of around 71%. Borrowers with automatic payments pay a fee of $ 12 for every $ 100 borrowed and repay the loan over three months.
OppLoans, a Chicago-based online lender, provides loans to borrowers with bad credit and has APRs of up to 160% in some states. CEO Jared Kaplan says it’s more expensive for his business to acquire and subscribe to customers, resulting in higher rates.
“Whether (your APR is) at 79, 99, or 160, you’re dealing with a risky customer base and the price should justify that risk,” he says.
CHOOSE A LENDER WHO VERIFIES YOUR FINANCIAL DATA
Lenders who do not determine your repayment capacity using information such as your income, existing debts, and credit information tend to offer high interest loans with short repayment periods, which makes them difficult to repay and traps you in a cycle of debt.
Banks and other lenders who can access your bank account information and payment history can determine if you can afford the loan.
Simple loan applicants must have a checking account for six months and have direct deposits sent to the account for three months before they can apply, said Mike Shepard, senior vice president of consumer loans at the US Bank.
This ability to underwrite an existing customer, rather than someone they don’t already know, helps make a bank loan affordable for consumers, says Horowitz.
OTHER WAYS TO EVALUATE A SMALL LOAN
Besides low APRs and a review of your repayment capacity, here are a few things to look for if you need a high interest loan.
– Full cushioning. Monthly payments must repay both principal and interest on a loan. Interest-only payments do not reduce the principal of the loan, so interest continues to accumulate at the same rate. Check the loan amortization schedule before you agree to borrow.
– Credit reports. The lender should report your monthly payments to at least one – and ideally all three – of the major credit bureaus. If you make your payments on time, this report can improve your credit.
– No origination or prepayment fees. Set-up fees, sometimes referred to as administrative fees, and prepayment penalties help the lender make money, but they have little benefit to you.
This article was provided to The Associated Press by the NerdWallet personal finance website. Annie Millerbernd is a writer at NerdWallet. Email: [email protected] Twitter: @annieanyway.
NerdWallet: What is an installment loan? https://bit.ly/nerdwallet-installment-loan
National Center for Consumer Law: State rate caps for $ 500 and $ 2,000 loans https://www.nclc.org/images/pdf/high_cost_small_loans/payday_loans/FactSheet-StateRateCap.pdf
Annie Millerbernd of Nerdwallet, The Associated Press