The Shriver Brief : Poverty Law Commentary & Insights : Sargent Shriver National Center on Poverty Law : Affordable Housing, Healthcare Reform

How are states working to promote asset building among their residents? A recent paper I wrote for The New America Foundation, “An Assets Agenda for the States,” highlights state asset building trends during 2012 in four policy areas: (1) promoting savings; (2) increasing access to the mainstream financial system; (3) consumer protection; and (4) financial education.

Promoting Savings. States are promoting savings in several ways. First and foremost is through the elimination of asset limits in public benefit programs. Currently, six states have removed asset limits in their state’s Temporary Assistance for Needy Families (TANF) programs, 25 states have removed them from their Medicaid programs, and over 40 states have removed them from their Supplemental Nutrition Assistance Programs (SNAP). The Illinois General Assembly, for example, recently passed a bill that will eliminate asset limits in Illinois’s TANF program.

A second way states are promoting savings is by providing families with mechanisms to effectively build college savings accounts. All 50 states have some type of 529 college savings plan; however, since only 9% of existing 529 account holders earn less than $50,000 per year, it is clear that such plans are not being used by low-income people. Some states have begun collecting data on 529 plan participants in an effort to demonstrate the necessity for program changes. For instance, after Texas began gathering 529 college participation data, it found that only 17% of participants in its 529 prepaid tuition plan during 2008-09 were African-American or Hispanic, even though together these populations represent a majority of Texans under age 18. Moreover, only 5.4% of such accountholders had incomes below $50,000, even though 41.4 percent of Texas families earn less than $50,000 per year. RAISE Texas, a prominent Texas asset building coalition, used this information to develop suggestions for making the state’s 529 program more accessible to these populations, which lead to the recent launch of the Texas Match the Promise Foundation, which will supply matching scholarships to participants in the state’s prepaid tuition fund. 

Similar to 529 programs, states are also considering policy proposals such as children’s savings accounts (CSAs). Under most CSA proposals, children would be given savings accounts that would be seeded with an initial deposit from the government, often with supplemental amounts available for low-income families, and states would also offer matching funds, up to a cap, for contributions made by family, friends and children themselves. Numerous pilot studies of CSA plans over the last decade have demonstrated such accounts’ usefulness and in 2012 San Francisco expanded its Kindergarten to College pilot program to all San Francisco elementary schools. Under the program children are provided with an initial deposit of $50, matching funds of up to $100 for the first year, and children receiving free or reduced lunch receive an extra $50.   Additional incentives include a $100 bonus when families sign up for auto-deposit of a minimum of $10 every month for six months. 

Another way states are promoting savings is by expanding access to retirement savings opportunities. Currently only about 50% of all workers have access to employer-sponsored retirement savings accounts. In 2012, California passed the first comprehensive state bill to address this issue. The bill lays the groundwork for establishing an automatic enrollment IRA program for employees in California. Illinois has also introduced legislation to create an Illinois automatic IRA program, though the bill has to yet to make it out of committee.

Finally, incentivizing savings accounts through programs like D2D’s prized-link savings have also started to gain traction in states. In prize-linked savings programs, consumers are given lottery ticket equivalents for each deposit they make. The opportunity to win prizes encourages them to continue to save money. Results from initial pilot studies in Michigan have been very promising.

Increasing Access to Mainstream Financial Services. Asset building advocates’ efforts to increase access to mainstream financial services continue to focus on programs that help bank the unbanked. According to the Federal Deposit Insurance Corporation (FDIC), approximately 8.2% of U.S. households are unbanked. This represents 1 in 12 households in the nation, or nearly 17 million adults. Low-income households, with incomes of $30,000 or less, constitute nearly 82% of unbanked and nearly 41% of underbanked households, and minorities are more likely to be un/underbanked—nearly 63% of unbanked and 40% of underbanked households are African American or Hispanic. Bank On programs, which began in San Francisco in 2006, are collaborations between governmental agencies (e.g., cities or states), financial institutions, and community groups, wherein the financial institutions offer low-cost basic transaction accounts to unbanked individuals. Since Bank On programs are low-cost initiatives, states can still implement such programs despite existing budget crisis. The Bank On model has been replicated in more than 30 cities, 4 states, and two regions, with dozens more programs in development. 

Another way to provide access to mainstream financial services that states are exploring is alternative data reporting. An estimated 50 to 70 million Americans do not have a credit score. They are considered “thin file” meaning that the “big three” U.S. credit bureaus (TransUnion, Experian, and Equifax) do not have enough information about these individuals' finances to assign them a credit score, whether good or bad. Without a credit history, it is difficult, if not impossible, to qualify for a mortgage, obtain a credit card, buy a car, or finance a small business. Increasingly, even employment, rental housing, and real property insurance decisions hinge on credit information. Whether the inclusion of such nontraditional credit information will be helpful or harmful to those with thin files or no score at all is controversial. Although research has shown that using alternative credit data reporting increases the number of people able to be scored, it is not clear what such scores will be. Thus, more research is needed to determine the effect of alternative credit reporting. In the meantime, states seem to be focusing on other problems within the credit reporting system.  As of December 2011, legislation had been introduced in 26 states, up from 16 states in 2009, regarding insurance scoring and other aspects of the credit industry, such as preventing the use of credit scores in employment decisions.  Given that credit, for good or ill, is a fundamental part of our country’s economic DNA and an essential part of asset building, such efforts should be encouraged.

Protecting Consumers Against Predatory Financial Products. Usurious payday and auto-title loans perpetuate a cycle of debt for low-income Americans. With interest rates as high as 400%, 12 million Americans are caught in a long-term debt cycle created by payday loans each year. Additionally, banks have entered the short-term, high-cost loan market by offering so called “deposit advance loan products,” which are basically payday loans with another name. Yet, currently only 19 states ban payday loans or cap interest rates. On the federal level, it appears that we may be closer than ever in obtaining more comprehensive federal payday and auto-title regulation as the Consumer Financial Protection Bureau (CFPB) continues to study the issue and publish guidance, such as its Short-Term, Small Dollar Lending Procedures guide, a field guide that CFPB examiners will use to ensure that payday lenders are compliant with federal consumer protection laws. In the meantime, states continue to introduce legislation to cap payday and auto-title loan interest rates, particularly at the municipal level, as well as encourage mainstream financial institutions to provide affordable and safe small dollar loans as alternatives to payday and other predatory loans.  

State asset building advocates are also looking to increase consumer protections on prepaid cards and other payment products used by the low-income and asset poor populations. A growing number of unbanked Americans, instead of using checking account debit cards or credit cards, which have consumer protections provided under the Electronic Fund Transfer Act and Regulation E, are using prepaid cards instead. Prepaid cards are fraught with higher and less transparent fees than traditional credit and debit cards, frequently resulting in consumers spending more for such products than they should or can afford to. As a result, state asset building groups are paying close attention to the marketing of these products and looking for ways to ensure that consumers do not wind up in a cycle of debt.

Improving and Increasing Financial Education. Arguably nothing is more important than improving financial education. Currently, 44 states include personal finance in their education standards, up from 40 states in 2007 and 21 states in 1998. While, 13 states require high schoolers to take a personal finance course in order to graduate, the majority of states do not have such a requirement. Thus, state asset building advocates continue to encourage more states and school boards to adopt curricula that include comprehensive financial education.

To learn the current status of all of these and other asset building policies in each states read my report, “An Asset Agenda for the States,” recently published by New America. The paper, which includes a comprehensive appendix that provides charts which outlay the status of each asset building policy by state, is a very useful tool for organizations trying to get a sense of what is happening around the country when it comes to asset building.

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A large body of research shows that payday loans place households at financial risk. For instance, two recent Pew Charitable Trust reports on payday lending (2012 and 2013) show that 12 million Americans use payday loans annually, spending a total of $7.4 billion. Moreover, these reports show that 86% of borrowers cannot afford to repay the average payday loan on time, which leads the average borrower to take out eight loans of $375 each per year and to spend $520 on interest. The five groups of people most likely to use payday loans, and therefore most likely to be harmed, are people without a four-year college degree, home renters, African Americans, people earning below $40,000 per year, and people who are separated or divorced.

Yet, until recently the harmful effects of the payday lending industry on the national economy were not known. A recent report by the Insight Center for Community Economic Development (Insight Center) now reveals new statistics on the negative impact of payday loans on the national economy as a whole. According to the report, in 2011 households paid a total of $3,309,926,773 in interest on payday loans. While this approximate $3.3 billion in interest payments to payday lenders added a total of $5.5 billion and 65,122 jobs to the overall U.S. economy, the report found that payday loans actually caused a net loss of $773 million and 14,094 jobs. According to the report, if private households had held on to the $3.3 billion that they paid to payday lenders, they would have generated $6.3 billion and 79,216 jobs for the overall U.S. economy. Additionally, the report found that, because payday loan borrowers are five times more likely to file for bankruptcy compared to the average American, payday lending leads to an increase in bankruptcies. Since the average bankruptcy costs $3,000. and there were a total of 56,250 bankruptcies due to payday lending, the report estimates that the total cost of bankruptcies due to payday lending in 2011 was $169 million. 

On a state-by-state basis, the report reveals that every state’s economy suffered due to the payday lending industry—from a low of $330,000 lost in Hawaii to a high of $135 billion lost in California. Every state also lost jobs as a result of the amounts households paid to payday lenders—from a low of 5 jobs lost in Hawaii to a high of nearly 2,000 jobs lost in California. For instance, according to the study, Illinois was the fifth worst state for payday lending with a total interest in 2011 of $237 million and a loss to the economy of $55 million and 810 jobs. 

When all losses are calculated, payday lending costs our overall economy about $1 billion per year. Now that the evidence is so clear regarding the economic damage that payday loans have on individuals and on society at large, it is time to legislate a ban on payday loans. A new report by published by the Woodstock Institute highlights the need for strong action by federal and state regulators and lawmakers. The report shows the historical strength and success of the payday lending lobby, but reminds us that consumer protections against payday lending have gained traction in several state legislatures in recent years. The Stopping Abuse and Fraud in Electronic (SAFE) Lending Act is the latest federal level bill to stop payday lending. Although many states have already successfully implemented state level bans and others have proposals on the table, a national ban is needed to ensure that all Americans, as well as the national economy are protected. 

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When people who lack access to mainstream financial services, primarily the unbanked or underbanked, need an infusion of cash, they often take out payday loans. Payday loans are typically marketed as two-week credit products for temporary needs, with annual interest rates set at around 400% and often more. Payday loans, which are advertised as quick way to obtain needed funds, appeal to disadvantaged members of society for many reasons. Payday loan stores are everywhere, with more locations than all of the McDonalds and Starbucks locations combined, and practically anyone can walk into a payday loan store broke and walk out with $300 cash in a matter of minutes. 

Although if paid back within a two-week period, borrowers can avoid the 400% interest, according to the latest Pew Charitable Trust report on payday lending, Payday Lending in America: How Borrowers Choose and Repay Payday Loans, the people who borrow payday loans are not prepared to pay them back in such a short period. 

According the report, 86% of borrowers cannot afford to repay the average payday loan on time. The first Pew Charitable Trust report on payday lending, Payday Lending in America: Who Borrows, Where They Borrow, and Why, found that 12 million Americans use payday loans annually, spending a total of $7.4 billion. According to that report, the average borrower takes out eight loans of $375 each per year and spends $520 on interest. The five groups of people most likely to use payday loans are people without a four-year college degree, home renters, African Americans, people earning below $40,000 per year, and people who are separated or divorced.  

The two Pew reports show the extent to which the payday loan industry attracts vulnerable customers: people who are financially desperate, people who are ill-equipped to understand the ramifications of payday loans, and people who are ill-equipped to repay payday loans in time. Payday loans are bad products, and they exist only because struggling people feel like they have nowhere else to turn. 

So who is at fault? Obviously the payday lenders themselves are engaging in morally reprehensible behavior, but the fact is that these lenders are enabled by mainstream banks.

Although the major banks are not literally distributing payday loans, they are an integral part of the payday lending market. Banks such as Wells Fargo, U.S. Bancorp, and JPMorgan Chase bankroll the payday lending industry providing more than $2.5 billion in credit to the payday lending industry. These banks earn approximately $70 million annually lending money to payday lenders.

In addition, banks profit directly from payday loan borrowers.  Many banks including JPMorgan Chase, Bank of America, and Wells Fargo authorize payday lenders to withdraw funds from borrowers’ bank accounts. Given what we know about the population that obtains payday loans, it is not surprising that when banks provide payday lenders access to borrowers’ bank accounts to repay the loans, there are usually insufficient funds available. As a result borrowers’ accounts are often overdrawn. In fact, according to the latest Pew report, 27% of payday loan borrowers overdrew their accounts. To add insult to injury, since paydayloans are rarely one-time purchases—the average borrower takes out eight per year—these fees help trap people in a cycle of debt. Even in states where payday loans are illegal, consumers that used online payday lenders are faced with overdraft fees from their banks due to online payday loans. In 2012 alone, banks earned $31.5 billion on overdraft fees, charging a median fee of $29 per overdraft. 

Thus banks are benefiting just as much as payday lenders.    

There is one piece of recent good news for consumer advocates. Two days after the publication of a front page New York Times article exposing these unfair overdraft practices, Jaime Dimon, the CEO of JPMorgan Chase, said that he would change how the bank deals with internet-based payday lenders that automatically withdraw payments from borrowers’ accounts. Additionally, as discussed in a previous blog, the Stopping Abuse and Fraud in Electronic (SAFE) Lending Act of 2013 (S. 172) was recently reintroduced. This bill attempts to address the issue of online lenders who have designed abusive products in order to evade state consumer protections.

To become part of the effort to stop predatory lending in Illinois, join the Illinois Asset Building Group.

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Since their creation nearly 150 years ago, national banks have had to comply with state consumer protection laws. During the past two decades, however, an expansion of federal preemption of state consumer protection laws allowed banks to avoid state consumer protection laws.

In 2004, the Office of the Comptroller of the Currency (OCC) issued sweeping preemption rules providing that national banks and their operating subsidiaries were not subject to state laws that “obstruct, impair or condition” a bank’s exercise of its federally authorized powers to make loans or take deposits. This aggressive preemption of state consumer protection oversight and enforcement figured prominently in the recent economic crisis. In response, Section 1044 of the Dodd-Frank Act included preemption reforms to clarify when state consumer protection laws can be preempted.

The law now makes clear that state laws that provide greater protection than federal law are not necessarily preempted. According to the statute, the OCC may only preempt laws if (1) they discriminate against national banks; (2) a given law “prevents or significantly interferes with the exercise by the national bank of its powers,” as stated in the Barnett Bank case; or (3) the state law is preempted by another federal law. Additionally, the law requires that preemption determinations must be made on a case-by-case basis with respect to particular state laws and that regulators can no longer rely on blanket preemption determinations like the OCC’s 2004 regulations. Also, prior to making a preemption decision the OCC must consult with the Consumer Financial Protection Bureau (CFPB) and take its views into account.

In 2011, the OCC’s released its final preemption rules, which completely ignored the changes required under Dodd-Frank. These rules permit the OCC to preempt state laws if they merely “obstruct, impair, or condition” bank operations—a standard that is clearly broader than Dodd-Frank allows. Following the rulemaking, many believed that the OCC would merely revert back to its previous broad interpretation of its preemption authority.

It was therefore surprising when in September 2012 the OCC ruled that stricter state consumer protection regulations were not preempted by more lenient federal banking regulations. The OCC found that the Urban Trust Bank (UTB) of Florida violated state usury caps in Ohio and Arizona and that these usury caps were not preempted by the National Banking Act. UTB was issuing prepaid cards, called Insight cards, to the payday lender CheckSmart, which CheckSmart then used to make payday loans in Arizona and Ohio that exceeded the usury rates in those states of 36% and 28% respectively. The rate on CheckSmart’s credit product was 401%, and its overdraft loan had a 390% annual interest rate. In a settlement agreement by and between UTB and the OCC, UTB agreed to correct these legal violations and to submit to the OCC an analysis of its prepaid card program that “fully assesses the risks and benefits of this line of business.”

At the time, it was hoped that this decision might signify a new willingness by the OCC and courts to take their consumer protection responsibilities seriously. Unfortunately this doesn’t seem to be the case. In December 2012, a federal appellate court ruled that Wells Fargo bank could skirt a California consumer protection law because it is preempted by federal law. Thus, due to preemption, it is legal for national banks to reorder transactions in order to maximize overdraft charges even though the state explicitly bans this practice. 

In a somewhat similar situation, although North Carolina state law explicitly states that payday loans are illegal, Regions Bank began distributing payday loans in the state. As a national bank, Regions could offer such loans since the National Banking Act preempted North Carolina law’s prohibition against payday loans. 

Consumer rights advocates in North Carolina, finding no success in overturning the assumption of preemption, turned to a different approach. With help from the North Carolina Attorney General Roy Cooper and other state leaders, consumer rights advocates were able to convince Regions Bank to voluntarily stop offering its payday loan product. While for the moment Regions has stopped offering its loans, it could begin selling them again at any time and it would be perfectly legal. 

It is, therefore, important that the issue of federal preemption be addressed once and for all. The OCC and courts must be forced to comply with the Dodd-Frank preemption standard. Applying this standard to Regions Bank for instance, preemption should not apply.  First, banning payday loans does not discriminate against Regions Bank since all financial entities in North Carolina are equally prohibited from offering payday loans. In fact, allowing certain entities to offer payday loans while banning others should constitute discrimination against local banks. Second, banning payday lending does not prevent or significantly interfere with the exercise by a national bank of its powers. Banning payday loans in North Carolina will not significantly diminish the banks’ overall business. Moreover, payday lending isn’t even Region Bank’s primary financial product. Third, North Carolina’s law is not preempted by another federal law so there is no other basis for preemption. 

While it is great news for consumers that Regions Bank stopped offering payday loans on its own accord, it’s troubling that banks can maneuver around state laws so easily and that courts and the OCC allow them to do so despite Dodd-Frank’s clear test for preemption of state laws. Thus, while Regions Bank’s payday loans have ceased for the moment, as the recent Wells Fargo case shows, if Regions Bank elected to recommence its payday loan business in North Carolina, it is likely that a court would ignore Dodd-Frank’s preemption test. Since relying on banks to regulate themselves has never worked, we must work to ensure that state-specific consumer protection laws are not summarily preempted.  

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Senator Jeff Merkley (D-OR), Richard Blumenthal (D-CT), Dick Durbin (D-IL) and Tom Udall (D-NM) recently reintroduced the Stopping Abuse and Fraud in Electronic (SAFE) Lending Act. This bill attempts to address the issue of online lenders who have designed abusive products in order to evade state consumer protections.

As state legislatures across the country continue to crack down on abusive practices, such as triple digit interest rates and unfair payment and debt collection practices, the SAFE Lending Act will ensure that consumers get the same protections regardless of whether they take out a loan from a storefront payday lender or a lender operating online.

According to the Pew Charitable Trusts’ newest report and the Pew's first-ever nationally representative telephone survey, Payday Lending in America: Who Borrows, Where They Borrow, and Why, Americans spend $7.4 billion per year on payday loans, including an average of $520 in interest per borrower for eight $375 loans or extensions. Payday loans, which are marketed as two-week credit products for temporary needs, are in fact predatory short-term, high-interest loans, with borrowers paying an average of $520 in interest for eight $375 loans or extensions. According to the report, average consumers are in debt for five months and are using the funds for ongoing, ordinary expenses—not for unexpected emergencies.

In order to prevent payday lenders from evading the growing number of state consumer protection laws capping interest rates, U.S. regulators and Congress have begun scrutinizing some of the ways that payday lenders do business. For example, a number of payday lenders have partnered with Native American tribes in an attempt to evade the increasing number of restrictions being placed on payday lenders through state legislation, since tribal enterprises are not subject to states or federal law. In other words, these online payday lenders claim immunity from enforcement of state laws that cap interest rates and provide other borrower protections based on their partnerships with Native American tribes. Similarly, national banks that offer deposit advance loans at high rates with short repayment terms are also currently not subject to state consumer protections. 

The SAFE Lending Act would allow states to petition the federal Consumer Financial Protection Bureau (CFPB) to stop lending by tribes in states where payday loans are illegal. That way, states would not directly litigate against tribes, thus preserving sovereign immunity. Specifically the SAFE Lending Act would:

• Require all online small-dollar lenders (such as payday lenders) to comply with state law if it provides better consumer protections than federal law;
• Prevent banks from making payday loans in violation of the state law where the consumer resides;
• Provide new federal enforcement measures to protect consumers from online payday lenders that seek to evade state consumer protection laws, such as by locating their businesses off-shore, or affiliating with a Native American tribe and claiming the right to assert the tribe’s sovereign immunity; and
• Empower Native American tribes to enlist the help of the CFPB where needed to protect their members from abusive payday lending on the reservation, and respect tribal laws that provide stronger consumer protections than are available under state law.

The SAFE Lending Act would also protect consumers’ bank accounts by:

• Closing the single payment loophole in the Electronic Fund Transfer Act and ensure that consumers have control over how lenders access their bank accounts for payment and collections of high-cost loans;
• Safeguarding consumers’ personal information by banning “lead generators” who collect information like Social Security numbers, income data, and bank account information; and
• Prohibiting lenders from using a borrower’s bank account numbers to create unsigned checks used to withdraw funds, even when consumers have opted out of making payments electronically. 

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Asset building advocates talk a lot about the predatory nature of payday loans and other alternative financial services. The alternative financial services industry generates $320 billion a year. Nationally there are just 3 Starbucks coffee shops and 4.3 McDonalds restaurants for every 10 payday lenders. Payday lending sites are especially pervasive in low-income, high-crime areas, and payday lenders are known to target low-income, minority, and underserved communities. By charging exorbitantly interest rates, such loans trap people in a cycle of debt seriously hindering their asset building potential. 

To combat this problem, asset building advocates have thus far focused on two primary strategies: (1) passing laws that cap interest rates on payday loans, and (2) encouraging more people to move into mainstream financial services, also known as “banking the unbanked.” Unfortunately only 19 states have capped payday lending interest rates at or below 36%, and there are still 34 million Americans who are unbanked or underbanked. Yet, a new method for dismantling the predatory loan industry using free market principles appears to be gaining traction. Specifically, entrepreneurs and computer specialists coming out of high tech companies like Google are developing low-cost payday loan products that purport to be safe and transparent for the borrower and profitable for the lender. 

The key to these new payday loan products is that they do not rely on traditional credit rating techniques or underwriting. They work on the assumption that the riskiness of the loans, and the high interest rates and annual percentage rates (APRs) that must be charged to make the loans profitable, decrease if lenders are able to more accurately assess borrowers’ risks of default and credit worthiness. Currently, in order to determine a person’s credit worthiness, most payday lenders rely solely on two points of data: income and expenditures. This information does not provide a clear picture of credit risk, so payday lenders charge everyone interests rates that are through the roof. 

To facilitate better credit decisions by payday lenders, new firms, such as ZestFinance, have developed alternative credit rating systems to judge potential borrowers' credit worthiness. Approximately 50 to 70 million Americans are currently un-scored or have a thin credit file, meaning that the credit bureaus do not have enough information about these individuals' finances to assign them a credit score. Following Google’s model of gathering thousands of points of public data on users in order to carefully target advertising, ZestFinance uses 70,000 variables in order to determine credit worthiness. For example, ZestFinance examines phone numbers as a sign of credit worthiness, since individuals’ whose phone numbers are constantly changing may be letting their phone accounts lapse. According to ZestFinance, examining factors that don’t play into standard credit scoring — and are therefore ignored by traditional banks — can help bring the underbanked into the financial mainstream.

Another payday loan model that uses large data sets to determine credit worthiness is LendUp. Some of the nontraditional variables that LendUp uses to determine credit worthiness are borrowers’ Facebook profiles and utility bills payment records. Additionally, LendUp provides transparent pricing information. The first thing you see when visiting their website is a movable sliding scale of loan amount and loan length. Prospective borrowers can quickly and transparently see how much various loans will cost. LendUp also provides incentives for borrowers to exhibit responsible financial behaviors. Borrowers can earn lower interest rates for future loans if they make payments on time or complete a financial education course.   

While these new developments may be promising, existing strategies may still be better. For example, instead of using these new broader underwriting systems to provide payday loans, perhaps they could be used by traditional financial institutions to provide to access mainstream banking products?  As the FDIC’s Small Dollar Pilot Loan program demonstrated un/underbanked people are actually a profitable market to tap into — something that payday lenders already know and continue to capitalize on. Yet, as the recent FDIC survey of banks’ efforts to serve the unbanked indicates, banks are not taking the time or dedicating the resources necessary to provide such products. Thus, while these new companies may be better than existing payday lenders, it is still important that mainstream financial institutions be encouraged to meet the needs of this market as well. 

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The Protecting Consumers from Unreasonable Credit Rates Act, S. 3452, introduced in the Senate by Senator Dick Durbin (D-IL) would create a national interest rate cap of 36 percent. The bill, which would affect payday and car title loans, along with various other types of credit, is a response to the persistent triple digit interest rates common among payday loan and other high-cost loan products.

Essentially, Durbin’s bill establishes a new FAIR, Fee and Interest Rate calculation that includes all fees and creates a rate cap at 36%. The rate is similar to usury caps that are already active in many states and in place for the military and their family members.

To protect consumers from predatory lending practices and to help consumers use credit more wisely, the legislation would:

• Establish a new Fee and Interest Rate (FAIR) that incorporates all interest, fees, finance charges, and related costs of credit.
• Institute a federal maximum annualized FAIR limit equal to 36% and apply this cap to all open-end and closed-end consumer credit transactions, including mortgages, car loans, credit cards, overdraft loans, car title loans, refund anticipation loans, and payday loans.
• Encourage the creation of responsible alternatives to small dollar lending, by providing tolerances for initial application fees and for ongoing lender costs such as insufficient funds fees and late fees.
• Ensure that this federal law does not preempt stricter state laws.

At the same time that Senator Durbin is proposing this needed legislation, the payday loan industry is attempting to deregulate payday lending at the national level. Two proposals, H.R. 6139 and H.R. 1909, have picked up support in the House on the false grounds that they will expand access to credit in underserved communities. Both bills propose to create a new national charter for payday lenders similar to the national bank charter that would allow payday lenders to operate throughout the country, evade existing interest rate caps, and curtail disclosure requirements.

Yet, simply legitimizing payday lenders and other fringe financial services without reforming their products will not provide safe and viable banking solutions to the unbanked/underbanked.  Similarly, these bills, unlike Durbin’s bill which would encourage banks to make alternative small dollar loans, do not ensure credit opportunities.  

Unfortunately, a similar rate cap proposal that was introduced by Senator Durbin in 2009 failed.  Given the payday loan industry’s current attempts to enact pro-industry federal legislation, advocates and consumer groups will need to rally support to ensure that S. 3452 passes instead of  H.R. 6139 or H.R. 1909. So contact your senators and representatives today to support fair lending!

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The Consumer Financial Protection Bureau (CFPB), which was created when Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act, recently celebrated its one-year anniversary. The CFPB, which officially opened on July 21, 2011, has the sole mission of ensuring that markets for consumer financial products and services work for Americans — whether they are applying for a mortgage, choosing among credit cards, or using any number of other consumer financial products. To achieve this mission, the CFPB has the authority to write and enforce consumer protection rules for banks and non-bank financial firms such as payday lenders, debt collectors, and consumer reporting agencies.

The CFPB had a slow start. The confirmation of the appointment of its Director, Richard Cordray, was held hostage by 44 Republican senators, who refused to confirm anyone unless the agency’s powers were weakened. In fact, although the agency officially opened its doors July 21, 2011, until Cordray was confirmed it was unable to fully protect consumers since, by statute, it could not enforce laws against “non-bank financial intuitions such as payday lenders” and other members of the predatory fringe financial markets until a director was confirmed. President Obama finally appointed Cordray in a recess appointment in January of 2012. Since then, the CFPB, despite continued attempts by some legislators to diffuse its power, has been actively looking out for American consumers, something that previous banking regulators had clearly failed to do

Among the CFPB’s many accomplishments, the following ten are noteworthy examples of its efforts to support consumers:

1. Financial Product Complaint System: The CFPB established a system for complaints about mortgages, student loans, bank accounts, car loans, and credit cards that is already getting results. The credit card complaint system is the first to be added to a new publicly available complaint database so consumers can not only have their complaints investigated, but can also compare firms based on complaints. Soon, this searchable database will add mortgage, overdraft, debit card, payday loan, and other consumer complaints.

2. Remittance Rules: Each year immigrants send, or remit, a portion of their income to family members in their home countries. Yet, the regulations, if any, governing remittance providers were lax. The CFPB recently issued new regulations regarding remittances, making it safer for consumers sending money to their families in other countries. The rules require companies to disclose the exchange rate, fees and the total amount being delivered. Other protections enable consumers to cancel a payment within 30 minutes, require companies to investigate consumer reports of problems with transfers, and mandate that companies are responsible for mistakes made by employees.

3. Credit Bureaus and Debt Collectors: The CFPB has the authority—the first time any agency has been given such authority—to investigate and examine the largest credit bureaus. Credit bureaus—and the credit reports they generate and the credit scores derived from such reports—help determine whether and how much a consumer will pay to get credit, insurance, a bank account, a place to live and, increasingly, whether they can even get a job. Yet, studies have shown as many as 25% of credit reports contain errors serious enough to prevent a consumer from obtaining a loan, home, or a job. Using this new authority, the CFPB can ensure that there is accurate credit reporting. 

Similarly, the CFPB is completing a rule to allow it to fully regulate the largest debt collectors, whose unfair practices usually lead the “Top Ten” complaint lists at both the Federal Trade Commission and state attorneys general offices. About 30 million Americans have debt under collection, and the average amount under collection is $1,400. Under the proposed rule, debt collectors with more than $10 million in annual receipts from debt collection activities would be subject to supervision. Based on available data, the CFPB estimates that the proposed rule would cover approximately 175 debt collection firms—or 4 percent of debt collection firms—and that these firms account for 63 percent of annual receipts from the debt collection market.

4. Student Loans: The CFPB has helped students with its “Know Before You Owe” loan tool, which helps students understand their options and provides answers on how to repay student loans. The CFPB, in conjunction with the Department of Education, just released a report examining the private student loan industry. According to the report, private student loan debt has become a tremendous burden on American families, and there is more than $8.1 billion in defaulted private loans and even more loans that are delinquent.   

5. Veterans: The CFPB’s Office of Service Member Affairs, along with states’ attorneys general and the Department of Defense, have also created the Repeat Offenders Against Military Database (ROAM) to track companies and individuals who repeatedly target the military community with financial scams. They have also stepped up mortgage and servicing protections for service members who are facing problems with their loans because they are required to move for military duty.

6. Mortgage Reforms: The CFPB is also preparing important mortgage servicing reforms so that companies’ responsibilities to borrowers are clear. These reforms will require firms to respond to mortgage modification requests in a more timely fashion. The forthcoming CFPB ability to pay rule (Qualified Mortgage) and other mortgage reforms will ensure that lenders cannot market unaffordable, unsustainable, unfair mortgages.

7. Payday and Other Lenders: For the first time in history, a federal agency—the CFPB—has full supervisory authority over high-cost non-bank payday lenders. The CFPB has already issued an examination manual and collected public comments on payday loan issues. For bank payday loans (often called Direct Deposit Loans), the CFPB also has authority to supervise and examine the largest banks that offer these products for compliance with federal credit protections. 

8. Enforcement Actions and Penalties: On July 18th, the CFPB announced its first enforcement action, requiring Capital One to pay $140 million to two million of its customers and pay a $25 million penalty for using deceptive marketing strategies, including misleading customers to purchase “add-ons” such as credit monitoring and payment protection when they called to activate a credit card.

9. Prepaid Cards: Despite their popularity, the prepaid card market is unregulated at the federal level and leaves many consumers vulnerable. Prepaid cards often have high fees and, depending on how they are structured, may not have FDIC insurance, which protects deposits up to $250,000. Recently the CFPB requested comments on general purpose reloadable prepaid cards (GPR). In particular, the CFPB asked for comments about the appropriate scope of regulatory coverage, product fee disclosures, product features, whether a savings component should be required, and other GPR-specific consumer protections.

10. Overdrafts: Consumer groups have urged CFPB to ban overdraft fees for debit card purchases and ATM withdrawals, urged use of reasonable and proportional penalty fees, and urged full coverage under the Truth in Lending Act. The CFPB is completing an investigation into such unfair overdraft practices.

In sum, the CFPB has achieved a lot during its first year, but much more remains to be done.  Let’s hope year two is even better than year one. 

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Although the Consumer Financial Protection Bureau (CFPB) has been in existence since July 2011, it wasn’t until January 2012, when Richard Cordray was confirmed as its director, that it got its full powers to oversee all financial markets and provide the utmost in consumer protections.

On January 5th, 2012, the CFPB launched the first ever program to supervise nonbank financial institutions. This supervision is an extension of the CFPB’s bank supervision program that began last July and will ensure that banks and nonbanks follow federal consumer financial laws. Essentially, the CFPB will approach nonbank examination the same as it does for banking institutions.

It is crucial to provide consumer protections from nonbank financial institutions. For instance, it is estimated that 20 million Americans use payday loans, roughly 200 million Americans rely on credit reporting agencies to report their credit histories accurately, 14 percent of consumers have one or more debts in collections, and nonbank lenders originated 10% of mortgages.

A “nonbank” is a non-depository business that offers financial products or services but does not have a bank, thrift, or credit union charter. Nonbanks include mortgage lenders, payday lenders, debt collectors, money service companies and others. 

Despite the large portion of the financial industry that nonbanks cover, prior to passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the law that created the CFPB, there was no federal program to supervise nonbanks. Other federal regulators examined banks, credit unions, and thrifts to make sure they were complying with the law, but generally the primary tool used to address issues with nonbanks was “after-the-fact” law enforcement.

The CFPB recently requested comments on a proposed rule to establish procedures for determining whether a nonbank is engaging in activities that pose risks to consumers and, therefore, should be supervised. Under the proposed rule, a nonbank that is being considered for supervision, because the CFPB has reasonable cause to determine that it poses risks to consumers, will be notified. The nonbank is given a reasonable opportunity to respond both in writing and orally, if requested by the nonbank. After considering the response, the CFPB would make a final determination either subjecting the nonbank to its supervision or not.

The proposal also permits a nonbank to voluntarily consent to the CFPB’s supervisory authority either by singing the consent agreement attached to the original notice or at any time during the proceedings. There is also a mechanism for nonbanks to file a petition to terminate supervision authority after two years, however, when a nonbank has voluntarily submitted to the CFPB’s jurisdiction for a specified period of time, it is not entitled to petition for early termination.

The CFPB has asked for comments from the public on how to enforce these rules and how to best protect consumers from all participants in the financial market. 

Please submit your comments to the CFPB by July 23, 2012. Learn more about how to submit comments. 

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Governor Quinn has closed a gaping loophole in the laws regulating payday loans by signing H.B. 537. Beginning in March, 2011 nearly every short-term credit product sold in the state of Illinois will be regulated.

Governor Quinn, Senator Lightford, Representative Lang, and the members of the Monsignor John Egan Campaign for Payday Loan Reform should be congratulated for the bill’s passage. In particular, the new regulations for loans with terms of six months or more will provide crucial protections for Illinois borrowers. However, the new law is not perfect. The 99% interest rate cap on some loans falls far short of the 36% that is considered safe for consumers. Even with the new protections, payday and consumer installment loans are still best used only as emergency loans of last resort.

As we have discussed in previous posts, H.B. 537 mandates significant reforms. Loans with terms of less than six months have rates capped at $15.50 per $100 borrowed every two weeks. Longer term loans over six months are capped at 99% APR for loans less than $4,000 and at 36% APR for loans more than $4,000. The rates will be calculated in accordance with federal Truth in Lending legislation that ensures lenders cannot use hidden fees to deceptively increase the cost of the loan.

Just as importantly, the new law prohibits balloon payments for all consumer credit products, regardless of the term. With a balloon payment structure, a borrower is typically not allowed to make a partial payment and must either pay the loan in its entirety at the end of the term or, as is often the case, roll the loan over and continue paying interest. Soon all short-term consumer loans in Illinois will allow borrowers to make equal payments over the term of the loan, paying down the principal over time, so that consumers are debt-free at the end of the term.

Lenders will also have to consider a consumer’s ability to repay the loan before extending credit. Monthly payments will be limited to between 22.5% and 25% of a borrower’s gross monthly income. Lending money without taking into account an individual’s ability to repay is a hallmark of predatory lending practices. Finally, and because these regulations will be meaningless if they are not enforced, H.B. 537 creates a consumer reporting service to ensure that lenders comply with all consumer protections.

The hard work of the Monsignor John Egan Campaign for Payday Loan Reform has finally paid off for Illinois consumers.

Hannah Weinberger-Divack co-authored this article.

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The key to limiting the damage caused by payday lenders is tough regulations. Yet, the reason that payday lenders have proliferated in the first place is that there is a large need for small dollar loans. So, in addition to regulating payday lending we also need to increase access to safe, affordable alternatives. Expanding and promoting such alternatives will help to alleviate the financial burden on low-income and low-asset families.

Alternative small dollar loans need to be more than just payday loans lite. Instead they must be structured to ensure that they are safe and affordable. Not all payday loan alternatives are created equal. A new study from the National Consumer Law Center, which evaluated over one hundred existing products, found that there is a wide range of product quality from genuine alternatives and ones that come close to products that are merely payday loans disguised in a different name. Credit unions dominate the genuine alternatives, but some banks are also offering beneficial products.

The authors argue for a real alternative to payday loans that will fill a need for convenient, emergency credit without leaving consumers in worse financial shape than they began. The study clarifies several myths regarding alternative payday loans:

• Just because a product is slightly cheaper does not make it good. A real alternative must be truly affordable.
  
• A small profit margin does not equal a good product. Loans should be judged by their impact on the borrower.
  
• An alternative does not need to be structured like a payday loan. In fact, the classic high fee structure and short repayment period cannot be replicated if we are to create a genuine alternative.
  
• Expensive loans should not be tolerated because there is consumer demand. In many cases payday loans delay tough choices needed to get one’s personal finances back on track and instead can serve to make a bad situation worse.
  

Instead the report suggests that alternatives should contain the following characteristics:

• A genuine payday loan alternative must have no greater than a 36% annual rate, including interest and fees.
  
• A minimum of 90 days loan repayment term in manageable installments.
  
• Must not employ a security method such as electronic access to a bank account that puts money for food and rent at risk. 

Hannah Weinberger-Divack coauthored this post.

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Illinois came one step closer to reforming its payday lending laws this week with the passage of H.B. 537. 

Currently, Illinois law has a toxic loophole as big as the fissure gushing at the bottom of the Gulf, which payday lenders have used to avoid consumer protections. Previous attempts to reform payday lending in 2005 imposed a cap on interest rates for loans less of than 120 days and restricted the number of loans a borrower could take out to two per year. Payday lenders evaded these restrictions by simply increasing the term of their loans. 

Payday loans are predatory short-term, high-interest loans that allow an individual to use a post-dated personal check as collateral. Payday lending is a growing problem; in the mid-1990s there were only a few hundred payday lending stores in the country, and by 2009 over 20,000 payday lending stores were opened in neighborhoods across the U.S.

Measures to limit the cycle of debt that traps many payday loan consumers are sorely needed. An informative and entertaining report from NPR’s Planet Money estimated that 60% of payday lenders’ revenue comes from repeat customers who continuously rollover their loans and rack up huge fees in the process.

On Wednesday, May 26th, a law to close this loophole, H.B. 537, was passed by both houses of the Illinois General Assembly with just one "no" vote. This piece of compromise legislation will overhaul two state laws, the Consumer Installment Loan Act and the Payday Loan Reform Act, to provide strong consumer protections for high-cost installment loans.

H.B. 537 would close the loophole because it:

• Ensures reasonable rates of 36% for installment loans over $4,000, 99% for small consumer loans, and maintains the current rate of no more than $15.50 per $100 per two weeks for payday loans. 
• Limits the cycle of debt by ensuring that lenders cannot make a payday loan to a consumer that would result in more than 180 days of continuous indebtedness. 
• Establishes a consumer reporting database to ensure that consumer protections for payday loans and small consumer loans are enforced.

Illinois has the chance to correct this mistake and finally rein in the predatory lenders. Consumers should urge Governor Quinn to immediately sign H.B. 537. 

This post was co-authored by Hannah Weinberger-Divack.

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