CEI Report: APR Calculations Are Misleading When Applied to Short-Term Loans

Last week, a new Competitive Enterprise Institute (CEI) report criticized attempts to impose caps on short-term, small-dollar loans based on a hypothetical annual percentage rate (APR) that is unrelated to the product at hand.

John Berlau, co-author of the CEI report, stated that “using an annual percentage rate to calculate fees for short-term loans is misleading, because the loans are typically paid off in a matter of weeks, incurring a much smaller fee than a year-long calculation would imply.”

Payroll advances and short-term loans are typically not secured by collateral like jewelry or an automobile. The report noted that the higher fees reflect a risk of default that lenders take when offering such loans. Also, the report says consumers often prefer the higher fees over other potential outcomes such as incurring bank overdraft fees or defaulting on a loan.

“Government-imposed fee caps on small dollar loans will discourage lenders from offering diverse, innovative loans to low- and middle-income consumers, the very people who may not have savings accounts or credit cards available to cover urgent, short-term expenses like car repair or a large, overdue utility bill,” Berlau said.

The report explains that many fintech companies and small-dollar lenders offer a vital credit option to consumers who need it most. It suggests that lawmakers take a more distant approach when encouraging lenders to compete and innovate in offering services to consumers that foster financial inclusion.

Additionally, the report urges Congress to modernize the APR disclosure mandate in the 1968 federal Truth in Lending Act to better explain the true cost of credit for short-term loans and advances.

The full report is available here.