“Your APR is not your interest rate.” The CFPB felt it was necessary to include this notice as a disclosure in mortgages because most consumers, and many commentators, assume it is.
The Annual Percentage Rate (APR) on a loan is an artificial construct, made up of the annual interest rate and the loan fees, which are generally earned just once, when the loan is made. These fees, which typically represent the fixed costs of making the loan, are then reduced to an annualized rate and added to the interest.
If the cost of making the loans and the fees are the same for any size and length of the loan, it follows that their impact will always be more significant on smaller and shorter loans than on bigger and longer ones.
Therefore, APRs are principally a function of the size and length of a loan.
In a free market, the quoted APR will be a function of the lender’s break-even APR, a function of the lender’s actual costs.
For a transaction to be fair, it must, by definition, be fair to both parties. If you don’t know about a lender’s actual costs, you are obviously in no position to guess whether a quoted APR is fair.
These costs are a combination of fixed and variable costs. Fixed costs are the same for all loan sizes. Their impact will always be less on a big loan than on a small loan in percentage terms.
Therefore, it makes no sense to impose the same rate on small loans as on larger ones. It makes even less sense to impose a lower rate on smaller loans. There can be no rate that is fair or sustainable for all loan sizes.
36% was never an adequate rate for small loans. Even when the rate was introduced, a hundred years ago, it was only used for more substantial loans, the equivalent today of $2,500 or more. Before costs like a living wage, health insurance, payroll taxes, computers, air conditioning, and compliance costs were considered.
APRs were introduced as part of the Truth in Lending Act in 1968. There were no APRs and, therefore, no APR caps before that.
APRs were designed to help consumers compare two loans of equal size and maturity, where one might have a higher interest rate and lower fees, and the other lower interest and higher fees. They were never intended, and should never be used, to compare or set a standard for loans of different sizes and maturities.
There is an inverse relationship between cost and APR. Bigger loans have lower APRs than smaller loans but cost more in dollars and in total charges as a percentage of the loan proceeds.
The term “high-interest loan” is dangerously confusing and, frankly, ignorant. When somebody talks about high-cost lending, they generally mean low cost (but higher rate) lending. Usually, consumers, especially lower-income borrowers, care about keeping actual costs down both in dollars and as a percentage of the loan, not having a lower “APR.” Since you can’t have both, the smart borrower tends to pick the loan that costs less in actual $$. After all, you can’t buy anything with an APR.
Any rate cap cuts off access to smaller, lower-cost loans. Many institutions, like banks, that are forced to stay within a 36% cap, decide not to make loans of less than $5,000. If a borrower lives in a state with such a cap, they are generally unable to get a smaller loan. If they only need $500, they are forced to borrow more than they need, pay far more in interest over the life of the loan, and stay in debt much longer - if they qualify at all.
Because rate caps cut off access to the cheapest loans, often the only loans lower-income borrowers can afford, while leaving big, expensive loans unaffected, rate caps are inherently discriminatory. They hurt disproportionately the very people they are designed to help.
The UN defines poverty as the lack of certain essential goods and services, including access to credit. By cutting off access to credit for lower-income Americans, rate caps directly increase poverty.