What Are the Laws About Short Term Loans?

Each state has its own laws about short-term loans. While most have caps on the interest rates that can be charged on these loans, the limits are not very restrictive. Because many consider short-term loans predatory in nature, there have been attempts to tighten the restrictions, especially the maximum annualized interest rate that can be charged. A federal limit on payday loan interest rates has been proposed in both bodies of Congress.

Features

Short-term loans are generally provided for a period of two weeks to a few months. They are sometimes called payday loans because they're intended to be paid out of the borrower's upcoming paycheck. The Consumer Federation of America (CFA) published a study in early 2009 concluding that short-term loans are predatory in nature and leave those who use them worse than they started. The report made recommendations for interest rate limits below those of most individual state laws.

Identification

Ten states and the District of Columbia have laws on short-term lending that make the practice virtually unprofitable. This is done by capping the annualized loan rate a maximum of 25 to 30 percent, which is far below the triple-digit rates that are frequently allowed in other states, or fixing the amount of interest to a particular dollar amount. Georgia bans payday lending outright. Others limit the number of outstanding short-term loans an individual can have, or the ability to roll over one short-term loan for another.

Size

The vast majority of states, however, encourage payday lending or at least have laws that favor short-term lenders. Delaware, Idaho, Nevada, South Dakota, Utah and Wisconsin have no limits on the amount of interest that can be charged on a short-term loan. Where there are limits, they are frequently several times the amount of the initial loan. In Louisiana, the annual percentage rate (APR) on a $250 loan is 521 percent, more than five times the amount borrowed.

Effects

A borrower should expect to pay interest on a loan, but having to pay several times the amount of the loan can be difficult, if not impossible. Short-term lenders have two major disadvantages against them. First, because the amount of the principal is usually small (usually only a few hundred dollars), any fixed fee charge, such as an origination fee, is a large percent of the principal. Second, because the period of the loan is so short, the interest due compounds quickly, producing the three- and even four-digit annualized rates. Not surprisingly, consumers who get trapped in these loans have a difficult time every paying off their debt.

Potential

The CFA study concluded that limiting annualized interest rates on short-term loans to 36 percent would help these debtors leave the cycle of indebtedness behind. Taking the burden of high interest payments off them, it is believed, will also help stimulate more spending on traditional consumer goods. The CFA recommendations have been incorporated into the Protecting Consumers from Unreasonable Credit Rates Act, introduced in both the House and Senate. If passed into law, this act would restrict short-term loan interest rates across the country.

References

• Legal Status of Payday Lending by State
• CFA Study: High Risk of High-Cost Short-Term Loans

Resources

• Payday Loan Consumer Information
• Payday Loan Laws
• Summary of State Payday Loan Acts