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Should We Bring Back Usury Laws?

By JLP | October 14, 2009

In the last post, one of the questions I asked Charles Geisst was about usury laws. For those of you not familiar with the term, usury laws are essentially caps on the rate of interest that lenders are allowed to charge borrowers. In the past, usury laws were set at the state level but have pretty much disappeared over the last few decades.

Charles Geisst is calling for national usury laws. EDIT: He doesn’t mention a specific rate in his book, so I sent him an email and asked him what kind of rate he was talking about. His response: “Probably set it to float at about 400 basis points above conforming mortgage rate[s].”

My question to you is:

Do you think we need usury laws? Why or why not?

My opinion….

I hate regulation but in this case I think some sort of cap is a good idea. Here’s why I think this way:

Extremely high interest rates are usually charged to those who have no business borrowing money in the first place. The high interest rate, though compensating the lender for the increased risk of loaning money to people of limited means, only seems to insure that the borrower will default or at least not be able to meet the payments, requiring them to take out another loan. Peolpe who borrow money at extremely high interest rates are almost destined to fail.

Of course the issue with placing caps on interest charges, is that it will force payday lenders out of business. It will also most likely lead to loan sharks—a sort of black market for money. But, for all I know, those people may already exist.

Thoughts?

Topics: Credit, Question of the Day | 21 Comments »


21 Responses to “Should We Bring Back Usury Laws?”

  1. Eric Bouler Says:
    October 14th, 2009 at 12:31 am

    I agree that once you pass 18% it shows the greed or lack of faith that the loan will be paid back.

  2. John Says:
    October 14th, 2009 at 1:24 am

    Beware the law of unintended consequences. Capping the amount of interest poor credit risks pay just leads to increased charges to credit-worthy folks. The current move by BofA is a perfect example.

    In my view, poor credit risks pay more for credit, and that’s fair. Credit “reform” just leads to a risk-shift.

    In my humble opinion, folks who gripe about the high cost of credit and/or demand a return to usury laws applicable to financial institutions should simply pay with cash, check, or debit card.

    JLP, your first instincts were correct. Usury laws are bad.

  3. traineeinvestor Says:
    October 14th, 2009 at 1:31 am

    No. Even assuming that the cap would only apply to personal loans (i.e. not business or investment loans), the answer is still “no”. We need less regulation (not more) and more accountability by both borrowers and lenders (not less).

    A cap on interest rates needs to be high enough to allow lending to take place even during times when interest rates are high. Setting a cap which does not allow for this will mean that when interest rates get higher, lower quality borrowers will not be given finance (which may be a good thing) and credit facilities will get cancelled. Setting a cap which is high enough to allow for periods of high interest rates will be meaningless when interest rates are at more moderate levels.

    A resort to black market finance (with all the negative issues that raises) would also be a logical and expected consequence of another stupid law.

    To address the point about credit risk, if people are willing to lend money at very high rates to poor credit risks then should live with consequent default risk instead of being told that they can’t do what they want with their money.

  4. Tom Says:
    October 14th, 2009 at 7:43 am

    Ah, yes, let’s go back to the good old days where legislatures protect consumers from the marketplace. I was living in New York in the late ’70s and wanted to buy my first house. The New York legislature protected consumers by not allowing those nasty banks to charge mortgage rates above a certain level. I don’t remember the level, but I’m guessing 12%. Seems reasonable right?

    The problem of course was that inflation was over 12% and fixed rate mortgages were in the mid to upper teens (in states that didn’t have such usury laws). That meant one thing, it was literally impossible to obtain a mortgage since no bank would lend at 12% when their cost of funds was substantially higher than that. The only way to buy a house was to find a house for sale with an assumable mortgage and pay the owner’s equity as down payment. I was able to buy my first house with only 28% down while assuming a 9.5% mortgage. (We had already been saving for nearly 10 years toward the required down payment of 20%) Making it illegal for a bank to lend mortgage money at a rate that was higher than their cost of funds did not protect anyone except the homeowner who wanted to sell and who had an assumable mortgage. They could get a nice, inflated price for their house (which I was happy to pay since I had no other choice).

    These usury laws made it impossible for many people of good credit to buy a home. Interest is the price of money and price controls ALWAYS lead to shortages. Won’t we ever learn?

  5. Kathy Says:
    October 14th, 2009 at 8:58 am

    Not real sure what ALL of this means, but from what I understand…….the higher interest rates for those hi risk customers seems fair. The company will take a risk to see if you can make it happen, giving those who are trying to clean up their credit a chance. On the other hand, it is also those high interest rates that can keep someone from helping themselves to clean up their credit.

  6. BG Says:
    October 14th, 2009 at 9:06 am

    I don’t think a fixed cap is a good idea, like what Tom had in NY at 12%. What Geisst is saying is the cap “floats” to 4% over prevailing mortgage rates, which would’ve worked fine I suspect for Tom in NY — I could go for something like that.

  7. JLP Says:
    October 14th, 2009 at 9:15 am

    I know I’m the one who wrote the post, but I’m torn on this issue.

    On the one hand I hate to see people get taken advantage of and I know that extremely high interest rates—although justified for the increased risk of borrower default—are a lot of the time a self-fulfilling prophecy. The borrower would be better off if they were just turned down for the loan rather than to have it approved.

    On the other hand, PEOPLE NEED TO TAKE RESPONSIBILITY FOR THEMSELVES! That’s the bottom line. We shouldn’t even have to be talking about usury laws of any sort.

  8. Ben Says:
    October 14th, 2009 at 10:10 am

    I agree with john, lenders will find a way to make the money they want. With the new laws going into effect American express increased the miniman payment due. This will cause those strapped for cash to defualt and thus pay higher fees. Chase is also doing some additional fee charging. In other words legislation is worthless. There will always be a way around it. which is the same reason the irs tax rules are so immense and complicated.

  9. BG Says:
    October 14th, 2009 at 10:38 am

    If there are no caps, then you are “legalizing” loan sharks, are you not?

    Are you fine if “sharks” are charging grandma 911% interest rates?

    Cause, that is exactly what the PayDay loan places are charging according to this source:

    http://www.consumersunion.org/finance/paydayfact.htm

  10. Servius Says:
    October 14th, 2009 at 11:53 am

    No.

    An interest rate is the price of borrowing money. Controlling prices always causes all sorts of problems regardless of the commodity whose price is being controlled. In this case a price ceiling would cause a shortage of money for people who need short term high interest unsecured loans.

    If someone is untrustworthy for a lower interest loan, how will they earn the trust of creditors other than to borrow at a higher rate.

    I’ve used high interest credit cards to purchase things I need such as health care (above and beyond my insurance payments) or an appliance that was a great deal but I had to buy it 2 weeks before I had the cash available.

    In the end, having the high interest credit available saved me significant discomfort in one case and real money in the other.

  11. Ken Says:
    October 14th, 2009 at 12:16 pm

    Yes. We need usury laws to protect stupid people from entering a bad contract. We should have learned this from the subprime debacle.

  12. kevin Says:
    October 14th, 2009 at 12:33 pm

    Usury laws are an absurd economic concept… based on ignorance and superstition.

    Interest earned on loaned assets/money is fundamental to economic growth. Specific interest rates represent a “price” for temporary use of assets/money.

    Like any “price” in a voluntary market economy — a particular interest-rate {price} is based on Supply & Demand and individual preferences.

    Politicians can not possibly know what the future prices of any commodity or service “should” be — so how can they dictate what the correct {or maximum}
    interest rate should be ??

    If they had such super-knowledge, why limit their laws to just interest-rates (?)… let them dictate the price of everything soup to wages & salaries {??}

    High interest rates reflect high risk to lenders that they will not be paid back, and an overall market scarcity of funds available for loan; low interest rates indicate the opposite. Borrowers can take it, leave it, or shop around for better terms… just like anything else they want.

    Lenders are forced to adjust their interest rates to dynamic market conditions, just like any other seller. If they set their rates {prices} too high — they will have no buyers {borrowers}… and those lenders will earn nothing. That’s how free markets work so well.

    Yes, a few dumb people may take out loans at needlessly high interest rates… but they can also blow their paychecks on booze, over-priced jewelry, and a thousand other foolish purchases. It is not the government’s job nor right to control personal spending nor prices.

    Those favoring usury laws are fundamentally opposing economic freedom & personal liberty… though most don’t realize it.

  13. Courtney Says:
    October 14th, 2009 at 12:34 pm

    Maybe we should only bring back usury laws if we also bring back debtor’s prison?

  14. JLP Says:
    October 14th, 2009 at 12:39 pm

    As always, a great discussion.

    I like courtney’s suggestion of debtor’s prison…lol.

    Or, at the very least, make those who have had loans forgiven do community service projects like picking up trash, painting over graffiti…

  15. Evan Says:
    October 14th, 2009 at 12:41 pm

    JLP,

    I have been reading your blog for a really long time, and this is just a case where you are thinking with your heart instead of your head. Go back in your archives, how many times have you said the gov’t was getting too involved and then highlighting the unintended consequences?

    All that being said NY still has a usuary law (or at least they did when I was studying for the bar exam in 2006) – it was 29.99%! Not 18 or 12 LOL

  16. JLP Says:
    October 14th, 2009 at 12:46 pm

    Evan,

    Believe me, I hate government being too much in the lives of the people.

    I’m still undecided on this issue.

  17. JLP Says:
    October 14th, 2009 at 12:56 pm

    I think instead of usury laws, people who can’t afford credit, shouldn’t get it.

  18. JLP Says:
    October 14th, 2009 at 1:05 pm

    Interesting…

    Adam Smith liked the idea of some sort of usury law.

    Of course, we live in very different times than what Smith lived in.

  19. Stacey Says:
    October 14th, 2009 at 1:55 pm

    Let the markets work! No “need” for usury laws, tho’ there may be a “want” for them. If a person’s financial situation becomes too onerous, their remedy is bankruptcy. That’s the ultimate governmental “protection.” In the meantime, don’t be stupid w/your money/life. For example, avoid: Payday loans, repeatedly buying new cars (and possibly becoming upside down on the loan amount), divorce (costly for all!) excessive & costly gambling, shopping, drinking, fill-in-the-blank addictions, etc. In the proactive “to-do” column (for all) would be having adequate medical and disability insurance coverage. For many, auto, life and an umbrella policy would be necessary as well. A lot of life’s bumps can be mitigated w/responsible actions.

    And of course, there’s the ever-present PF mantra: “spend less than you make!”

    Now if beauty pageant contestants would just start saying that instead of “world peace” we wouldn’t have so many PF problems!

  20. BG Says:
    October 14th, 2009 at 2:48 pm

    Instead of trying to fix the real problem with usury, we need to be targeting the predatory lenders who use bait-n-switch, teaser rates, false promises, and all the other tricks that are used to swindle honest people’s hard earned money.

    “Vermont required lenders to tell consumers when their rates were substantially higher than competitors, with notices printed on a colored sheet of paper”

    This is _good_ regulation that we should be encouraging. I could never agree with completely unregulated capitalism.

  21. jim Says:
    October 15th, 2009 at 5:34 pm

    I think that some sort of limit on interest is reasonable. If for example they capped interest at 50% then I don’t see this as stifling business or the economy in anyway. It would be more of a protection against predatory lending practices which is a good thing.

    I do think better regulation of mortgages in general is a good idea. Theres no way that banks should have been giving mortgages without even checking peoples income as some were.

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