We study the effects of interest rate ceilings on the market for automobile loans and find, surprisingly, that binding usury limits do not lead to rationing of high-risk borrowers. Instead, loan contracting and the organization of the loan market adjust to facilitate loans to risky borrowers. When usury restrictions bind, automobile dealers finance a greater share of their customers’ purchases, which allows them to price credit risk through the mark-up on the product sale rather than the loan interest rate. Despite having little effect on who receives credit, usury limits therefore have a substantial effect on who provides credit and on the terms of credit granted. By encouraging dealers to price credit risk through product mark-ups, usury limits may hinder enforcement of fair lending laws and harm defaulting borrowers, who face greater liabilities in default than they would if loan contracts were unconstrained.
Melzer, Brian T. and Aaron Schroeder, Loan Contracting in the Presence of Usury Limits: Evidence from Auto Lending, Consumer Financial Protection Bureau Office of Research Working Paper No. 2017-02, April 2017.