How To Justify An APR Greater Than 18%

Credit Unions: How To Justify An APR Greater Than 18%

Among credit union leadership, there’s a lot of internal debate about appropriate interest rates for small dollar loan products. By federal law, credit unions can charge a maximum interest rate of 28% APR for small dollar loans. Because credit union mission statements focus on the financial health and well-being of the community as a whole, some are loathe to charge the maximum interest rate, preferring to charge a more affordable 18%.

QCash Financial CEO Ben Morales explains, “There’s a handful of people [who] understand the need to charge 28%, and there’s a group of folks [who] have difficulty — at least in the credit union space — charging 28% for a loan.” In this recent video discussion, Morales explores the risks and benefits of charging slightly higher rates for small dollar loans.

The World of Small Dollar Lending

As discussed recently on the QCash Financial blog, 2019 research from the Pew Charitable Trusts shows that 12 million Americans take out payday loans every year, accumulating a total of nine billion dollars in loan fees. Small dollar loans from credit unions account for less than two percent of the $38.5 billion payday lending market in the United States. Until late 2019, the maximum amount credit unions could lend under payday alternative loan (PAL) regulations was $1,000. Recent additional regulations (PALs II) have increased that amount to $2,000, empowering credit unions to offer more help to those who need it; in 2020, more people than ever before needed that help.

While credit union leadership debates whether to charge 18 or 28% for small dollar loan products, payday lenders comfortably charge 500% or more for their predatory products. In July 2020, in the middle of a global pandemic recession, the Consumer Financial Protection Bureau (CFPB) relaxed payday loan regulations, leaving struggling Americans even more susceptible to predatory lending practices.

The dilemma facing credit unions regarding higher interest rates is understandable. Throughout their history, credit unions have proudly put the financial needs of their members high above short-term shareholder profit. Beyond being member-owned nonprofits, many credit unions were indeed founded by their members and have similar backstories to this one from Washington State Employees Credit Union (WSECU). Some were even founded by employees who pooled their funds to buy necessary work supplies their employers wouldn’t provide. The idea, then, of raising interest rates during difficult times is anathema to credit union values.

A hand holds a cell phone, selecting something unseen on the screen.
In the debate about small dollar loan rates, it’s all about responsibility and affordability.

Reasonable, Responsible Small Dollar Lending

As Morales puts it, “This issue around APR and what’s the appropriate rate, what is reasonable, what is responsible, what is predatory… These are terms that are used when we talk about the rates that credit unions could charge for their small dollar loan programs.” But terms like “responsible” and “reasonable” likely don’t come up when predatory lenders discuss their interest rates.

According to Morales, that highlights a point that may get missed in these internal credit union discussions.

“The alternative, if you want to consider that, is: What is the predatory lending market charging for current loans today? Today, it’s anywhere from 400 to 600% APR… I would have to say that, grappling from 18 to 28%, if you do not produce this type of loan, then the option we leave for our members is to go to the 400 to 600% APR market.”

In other words, if credit unions don’t offer affordable alternatives to predatory payday loans, members will have nowhere else to turn. If credit unions find they can’t afford to offer these small dollar loans with interest rates as low as 18%, then charging a higher rate simply to keep these loan products available is worth it. Certainly, a 28% interest rate on a short-term, small dollar loan is preferable to the 500% (or higher) members would be charged elsewhere.

What Is The Right Small Dollar Loan Rate? The Decision Is Yours

While all credit unions tend to operate on the same core values — the financial health and well-being of their members and their community at large — each credit union is different. There are true neighborhood credit unions, while some have members across their state or even nationwide. There are credit unions with small, medium and large membership numbers, and their business plans can be just as varied. Just as credit unions understand there is no one-size-fits-all solution for their members, neither will one interest rate work for all small dollar loan products from all credit unions.

Morales continues, “Each credit union needs to evaluate [the question] on its own, based on its own cost structure, to understand… the right rate.”

Fortunately, in the hard times currently facing us all, many credit unions continue finding new ways to serve their members and ensure the financial well-being of their communities. As people begin to recover from the ravages of the COVID-19 pandemic, many will feel the need to turn to short-term, small dollar loans as a means to cover occasional or emergent financial gaps. As they have been doing for a century, American credit unions will continue to be there to help their members.

Small dollar lending platforms developed by fintech companies like QCash Financial can help provide customized tools that are right-sized for each credit union, to allow them to offer the short-term, small dollar loans their customers need in difficult times. Quick decision-making based on relationships, rather than profit-driven metrics like credit scores, keep overhead down, thus enabling lower interest rates in line with credit unions’ core values. Those same core values drive QCash Financial every day.

As Morales summarizes, “At the end of the day, what we want to be able to do is have all credit unions provide a small dollar loan solution that is sustainable for the long run; [so] that in good times and bad times, these loans are able to stay on the shelf for their members that need them most.”

The QCash Financial blog regularly features articles about the various financial issues facing our entire community as we move beyond the difficulties of the past year. For more information on how QCash Financial’s small dollar lending platform can help you and your members, please contact us.

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