We all love to get piping mad about how terrible and predatory pay-day lenders are with rates – annual percentage rates (APR) – of 400%, 500% and up.  It sounds unconscionable, doesn’t it?

I believe APR is an inflammatory and completely ineffective way to evaluate or understand short-term loans.  APR stifles innovation; it’s irrelevant to the consumer; and worst of all, APR is an incredibly poor proxy for whether a loan is “good” for someone, however you define good.  So I’m starting a movement to kill APR, and to replace it with TRUST.

First, let me make clear I’m not an apologist for pay-day, title, pawn, cash advance, or any kind of high priced subprime-loans.  I’d love to turn the whole field on its head.  We can and must do better.  But we have to do so based on real-world factors, not simply an aspiration to offer relief to those who use the products.  Here is why APR, rather than creating transparency and a level playing field, should be banned when it comes to short-term credit:

The reason this APR business matters is because if regulators decide to cap APR for short-term loans at some arbitrary number it will hurt poor people, badly.  Access will disappear and less regulated, worse products will appear in their place.  This will leave more people without emergency liquidity and/or paying even more for some off-shore or “non-loan” loan.

APR makes no sense for short-term credit, because it an annual metric.  It’s like quoting a hotel room rate on an annual basis.  I would not patronize a hotel with the rate of $55,000 (instead of $150 per night).  Of course, APR is borrowed from long-term products, like credit cards, mortgages, business and educational loans.  For an annual product an annual rate makes sense.

APR is counterproductively inflammatory because any number over 20% has a significant contingent of people who believe it is reprehensible, predatory and usury, regardless of anything.  It’s a knee-jerk reaction presumably based on interest rates for mortgages, business loans, student loans and credit cards.  And yes, compared to most of those products, anything over 20% is incredibly high.  So even 36% APR, which the pro-consumer FDIC Chairman, Sheila Bair, has declared a “responsible” rate for short-term loans easily conjures that usury judgment.

APR says little about quality.  If you ignore whether it’s possible to earn even 1 cent on unsecured short-term loans at “responsible” APRs, and simply look whether an unconscionable APR deteriorates people’s financial lives, you’ll see it just ‘aint so for an overwhelming number of people.  $20 for every $100 borrowed – average pay-day prices – will set someone back $20 to borrow $100.  Is it pretty? No.  But do most low income people have access to $20? Or $80 (if they borrowed $400)? Yes. (And note that the average pay-day customer today earns $40k annually).  Again, I’m not suggesting we can’t and shouldn’t do better – we can and should – but I am suggesting that APR, in itself, has little bearing on whether a loan deteriorates, let alone ruins, someone’s life.

So what is a good metric?  Well, it’s complicated.  Personally, I think it’s the structure of a loan, significantly more than the APR, that makes it “responsible” or “fair” or “good.”  After much listening and discussion, I’ve come up with a new acronym: TRUST, a new measure of short-term credit quality we can all trust:

Term flexibility – suit the loan to fit various users’ needs

Repaid fully – design the loan to be payable without rollover

Understandable – make the terms and fees clear and transparent

Selective – good loans should be priced according to risk

Transitional – offer a graduation path for good performance

I would guess there are relatively few lenders who you can TRUST.  By design, these ideas are flexible and not prescriptive.  It’s more important we offer borrowers the choice of repayment period, rather than mandating 30 or 120 days.  Eliminating roll-overs will in practice spare low-income people from unforeseen financial hazard significantly more than limiting APR.  Demanding clarity and transparency for the customer (not a bureaucrat) will protect the financially frail more than expressing a loan in APR (it is shocking how little people understand what APR means at all, so much so that in a focus group I attended EVERY SINGLE person thought $10 fee for $100 borrowed for 2 weeks was a better deal than 20% APR).  I could go on.

TRUST has a lot of ideas behind it, actually, so I will write about this more.  In the interim, I realize this is likely heresy to all the reasonable and caring people who are looking out for the poor, or at least the 6 who read my blog, so I encourage you to write me or leave a comment.  But more importantly, I encourage you to shift your paradigm.  I’ll flesh out TRUST in greater detail in subsequent installments.  Trust me, this is better for people and for business, both.