Watch out for high interest rates when you get a larger loan

Everything that is wrong with a high-cost loan is only worse when the loan is larger and the terms are longer.

New 36 percent interest rate caps in states that previously had no limits are an important step in the right direction, according to a new report from the National Consumer Law Center, an organization that works on behalf of low-income consumers. However, a 36 percent interest rate that’s reasonable for a small loan can lead to high and unaffordable interest on a larger loan. 

The report looks at five-year, $10,000 loans and finds that, while a majority of states cap the interest rate and fees, many permit interest rates that are too high for larger loans with longer terms.

Three states that failed to cap interest rates in 2018 have enacted 36 percent rate caps, a rate that is still very high for loans of this size.

Seven states have increased rate caps and weakened consumer protections over the same period, and a handful of others still fail to provide any protections at all. 

“While 36 percent has become the widely accepted metric for an affordable small dollar loan, states must recognize that it’s too high for larger loans,” said Andrew Pizor, senior attorney at the National Consumer Law Center and co-author of the report. 

“A borrower who repays a $10,000 loan over five years at 36 percent APR will face $11,680 in interest charges, repaying more than double the amount borrowed,” Pizor said. “For example, by increasing its rate from 25 percent to 36 percent, Oklahoma added over $4,000 to the cost of a $10,000, 5-year loan. And some states permit rates that are even higher.”

The center’s report surveyed the interest rates and loan fees allowed by all 50 states and the District of Columbia for an unsecured five-year, $10,000 installment loan. The survey found:

• Forty-two states and the District of Columbia cap the interest rate and fees for a $10,000 loan, with a median cap of 27 percent APR.
• Six states, Alabama, California, Idaho, South Carolina, Utah, and Wisconsin, don’t place any cap on interest rates and fees for a loan of this size. These states only require that the interest and fees not be unconscionable – so high that they “shock the conscience.”
• Two states, Delaware and Missouri, have no interest rate limit or even a bar on unconscionability. 

Pizor said the longer terms on larger loans increase the impact of interest rates on a consumer’s ability to repay a loan and increase the risk that the consumer will fall into a debt trap. For example, if a $10,000, five-year loan carries 36 percent interest, after a full year of payments the consumer will have only reduced the principal by $870.

The report recommends capping APRs well below 36 percent for large loans, with rates decreasing as loan amounts increase and including all fees and payments in the APR limit.

So, as always, it’s buyer beware. Don’t get trapped by one of these high-interest loans. Look for alternatives, for example, a lower interest rate that may be available at a local credit union.