In recent years, many states, including Illinois, have enacted or introduced legislation capping annual percentage rates (APRs) on small-dollar credit products offered by alternative financial services (AFS) lenders. These policies try to eliminate the downsides of borrowing for consumers by regulating the cost of accessing AFS credit. However, research has generated conflicting evidence on the role of APR caps in supporting consumer financial well-being.

Overall, our empirical evidence suggests that implementing a state-level APR cap like Illinois’s for AFS loan products may not worsen or improve consumer credit health for consumers who use these products over the long term but may alleviate the financial pressures on consumers with subprime credit by modestly decreasing the share of consumers with debt in collections.

Why This Matters
 

Access to affordable, high-quality, small-dollar credit can be a valuable lifeline for families to weather unexpected events or financial emergencies. However, small-dollar credit products that allow consumers to borrow a hundred or thousand dollars at a time can be risky for both financial service providers and consumers.

Given the varied findings on how APR caps affect consumer-level outcomes, it is unclear what role such policies can play in supporting overall consumer financial well-being. This study addresses an important gap in the existing research by empirically assessing the effects of the Illinois Predatory Loan Prevention Act (PLPA) on borrowers’ debt and credit outcomes and can inform practitioners’ and policymakers’ efforts to develop legislation that holistically supports consumer financial well-being.

What We Found
 

In this study, we found the following:

• The PLPA is associated with a small, short-term increase in the share of consumers with debt in collections among past AFS loan users in Illinois. But that increase dissipated 1 year and 1.5 years after the policy was implemented, relative to similar peers in states allowing AFS lenders to provide small-dollar loans at higher APRs.
• For past AFS loan users with subprime credit scores (or VantageScores below 600), the PLPA is associated with a small decrease in the share of consumers with debt in collections, relative to similar peers in states with high APR
• The PLPA is not associated with a significant change in credit scores among Illinois consumers who used AFS loans, relative to peers in states with high APR caps.
• Similarly, Illinois consumers with subprime credit who used AFS loans did not see a change in credit scores after the PLPA was implemented, relative to similar peers in states with high APR caps.

Drawing on prior research and evidence on consumers’ financial coping strategies, the following are possible interpretations of our empirical findings:

• The share of past AFS loan users with debt in collections may have increased temporarily as these users struggled to repay their mainstream debt obligations after the PLPA for these possible reasons: past AFS loan users may have struggled to repay both their AFS and mainstream debt obligations simultaneously; lost a source of liquidity used to repay debt or meet basic needs; or experienced fast repayment of AFS loans that limited their ability to pay other debt obligations. Despite these short-term challenges, over the long term, we suspect that past AFS loan users may have identified nonmainstream-credit financial coping strategies to meet their debt obligations and financial needs.
• Small changes in the share of past AFS loan users with debt in collections induced by the PLPA may not have been significant enough to induce changes in overall credit scores in the context of consumers’ overall credit reports and debt.
• For past subprime AFS loan users, changes in debt in collections may not have been significant enough to change their overall credit scores. At the same time, decreases in the share of past subprime AFS loan users with debt in collections could be interpreted in a few ways. One possibility is that post-PLPA past subprime AFS loan users may have taken on less debt from AFS lenders and faced fewer price pressures in repaying loans at high interest rates, and thus been better able to pay existing debt or bills (e.g., utility bills and child support payments) on time. Another possibility is that the decrease is counterintuitive—as some may expect consumers with subprime credit to have experienced more significant liquidity constraints—and requires further research to fully understand.

How We Did It
 

Leveraging data from one of the major credit bureaus, together with linked administrative data to identify AFS borrowers, we examined policy impacts among consumers who previously used AFS loans, focusing on effects on their credit scores and debt in collections. We estimated policy impacts using a matched event study design to identify the impact of the PLPA 6 months, 1 year, and 1.5 years after implementation on past AFS loan users. For AFS borrowers with subprime credit, we estimated policy impacts using a matched difference-in-difference design to assess policy impacts over the 18 months following the PLPA.