Every so often, talk of curbing excessive lending practices by instituting usury laws at a federal level resurfaces, and speeches are made, hearings are held and editorials are written, but nothing ever comes of it. This begs a couple of questions: For starters, what are usury laws exactly, and—perhaps more importantly—do we need them?
Usury laws are those that prevent high interest rates, and as a result typically garner popular support, especially in times such as these when the economy is fledgling and anger toward financial institutions is running high. However, you cannot truly evaluate the merit of these laws, which at their basis are a means of forcing lenders to serve the greater public good, without understanding their practical effect.
Would they solve anything?
Obviously, the goal of any proposed usury legislation would be to force lenders into lowering the interest rates that they offer to high-risk customers. After all, people already getting low rates don’t need any assistance. The problem with this kind of thinking is fairly clear. Congress wants to step in and force lenders to abolish high interest rates under the assumption that lenders will simply lower their highest rates while continuing to approve loans at the same rate. They won’t.
Congress is unlikely to force lenders to approve loans, so usury laws would simply result in lenders shutting out a sizeable consumer segment. Usury laws therefore don’t nudge lenders toward social service but instead force them to avoid doing business with anyone whose credit warrants an interest rate higher than what politicians have deemed excessive.
But who is Congress to tell you what interest rate you can or cannot accept when borrowing money? Do they understand your circumstances when you decide to get a loan? Usury laws assume that people who take a 40% interest rate simply don’t know any better, but the truth is that most people who take loans with high interest rates do so because they need the money. And with usury laws in place, that money might not be available when they need it most.
Bad credit, out of luck
Imagine that your car breaks down and you need to borrow money to fix it ASAP because you cannot perform your job without it (e.g. you are an independent contractor). Problem is, your credit history indicates that you’re likely to get approved for a loan with a 20% interest rate. If a usury-law-borne interest rate cap of, say, 16% happened to be in place at the time, the bank would consider you too much of a risk to legally receive a loan. They would turn you down. You wouldn’t get the money. Your car wouldn’t get fixed. As a result, your income would go down, making it difficult to pay your other bills and putting your already-insufficient credit in jeopardy of becoming even worse. If, on the other hand, you’d gotten that loan, the car would have gotten fixed and you would have been free to move on with your life.
Ultimately, we are a free people living in a free country. The government should not be telling us which loans we can or cannot take. Their job is to make sure that business practices are fair. The details of loans must therefore be clearly disclosed so that consumers can make informed decisions, but the decisions are still the consumers’ to make. Congress is composed primarily of wealthy people who probably have good credit; the restrictions they are putting into law will probably never affect them. And while these laws make Congress look like they are in touch with the average person, in the end, they’re not actually lowering interest rates for anyone. Instead, they’re merely preventing people with bad credit from getting loans which they may desperately need.
This is a line of thinking that we, as a free market economy, cannot afford to take. The restrictions imposed by usury laws are bad on all sectors of the economy, and Congress as well as those who jump on the federal usury law bandwagon whenever it pops up must understand that. What’s more, its time for states with usury laws to also abolish them.