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

Auto-title loans are very common non-bank loans in which borrowers use their cars as collateral for the loan. A new report, Driven to Disaster: Car-Title Lending and Its Impact on Consumers, by the Center for Responsible Lending (CRL) and the Consumer Federation of America (CFA), reveals the predatory nature of auto-title lending, and just how damaging such loans can be for consumers. According to the report, borrowers pay $3.6 billion each year in interest on $1.6 billion in loans, renewing such loans an average of 8 times and paying $2,142 in interest on a $952 loan.

Auto-title loans are asset-based loans, meaning that lenders make the loan based on the value of the collateral rather than the ability of the borrower to repay the loan. According to the report, there are 7,730 car-title lenders across the county. Like all alternative financial services (AFS), auto-title loans are mainly used by people outside of the financial mainstream—the un- and underbanked.  About half of car-title borrowers are unbanked, and the average borrower is more likely than the average U.S. resident to earn less than $30,000, be unmarried, have less than a high school degree, rent a home, and be a foreign-born Spanish speaker.    

Compared to payday loans, it appears that car-title loans may be even more damaging to consumers.  According to research form the Pew Charitable Trust, the average payday loan borrower takes out 8 loans of $375 each per year and spends $520 on interest. Twelve million Americans use payday loans annually, spending a total of $7.4 billion. Yet while the payday lending market is much larger than the car-title loan market (12 million payday loan borrowers compared to 1.7 million car-title loan borrowers), the car-title loan market earns more money in annual interest than the payday loan market ($3.6 billion auto-title loan interest compared to $3.3 billion payday loan interest) since car-title loans are typically much larger than payday loans. In addition, whereas payday loans damage borrowers’ credit and could cause additional indebtedness through bank overdraft fees, car-title loans often result in borrowers’ cars being repossessed. According to the report, 1 in 6 borrowers had their cars repossessed. Not only does repossession impact many borrowers’ ability to work, since their transportation is gone, but the value of the car that is repossessed is significantly higher than the value of the original loan (on average loans were 26% of the value of the car). To add insult to injury borrowers are then hit with $350 to $400 repossession fees, which put them in even more debt.

Just as with payday lending, the legislative landscape for auto-title lending varies across states. While 38 states have specific statutes that allow for payday lending, only 21 states explicitly authorize car-title loans, 17 of which allow for triple-digit annual percentage rates (APRs). Even in certain states that have laws against usurious car-title loans such as Kansas, South Carolina, and Louisiana, the report points out how easy it is to get around these laws. 

On the federal level, in March of last year the Consumer Financial Protection Bureau (CFPB) launched its complaint database for auto loans with large banks; however, complaints involving small banks or nonbanks are still referred to other federal agencies with the authority to handle such complaints. More recently, in March the CFPB released a bulletin explaining that certain lenders that offer auto loans through dealerships are responsible for unlawful, discriminatory pricing. The bulletin provides guidance to indirect auto lenders within the CFPB’s jurisdiction on how to address fair lending risks. According to the CFPB, it will closely review the operations of both depository and nondepository indirect auto lenders, utilizing all appropriate regulatory tools to assess whether supervisory, enforcement, or other actions may be necessary to ensure that the market for auto lending provides fair, equitable, and nondiscriminatory access to credit for consumers. While neither of these actions addresses car title lending directly, the CFPB has previously indicated that auto-title lending is among its priorities.

In order to end predatory lending that preys on the underserved, we need a two-pronged approach consisting of laws that restrict predatory lending on both the state and federal level and continued efforts by both the CFPB and states ensure consumers are not driving down dangerous roads by using auto-title loans.

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This year is providing a growing opportunity for mainstream financial institutions to offer affordable small-dollar loans while proving to be a difficult one for predatory lenders. First, Illinois passed legislation closing a gaping loophole in payday lending regulation. Now, the Dodd-Frank Wall Street Reform and Consumer Protection Act, signed into law by President Obama on July 21st, has the potential to significantly increase the number of affordable small-dollar loans available to consumers. Title XII of the Act “encourage[s] initiatives for financial products and services that are appropriate and accessible for millions of Americans who are not fully incorporated into the financial mainstream.” Specifically, the Act will incentivize financial institutions to offer low-cost, small-dollar loans that serve as safe alternatives to payday loans.

Rather than regulating high-cost payday lenders, the Dodd-Frank Act seeks to provide financial incentives to institutions to offer more competitively priced small-dollar loan products through loan loss reserve funds, technical assistance funding, and other programs and grants to promote financial access and education. The Act authorizes the Secretary of the Treasury to establish grants to eligible entities to provide low-cost small-dollar loans. In this case, eligible entities include any federally insured depository institution, state, local or tribal government entities, community development financial institutions (CDFI) and 501(c)3 organizations. In order to receive a grant, the loan provider must offer financial literacy and educational opportunities to each small-dollar loan consumer.

The Act also includes several provisions that are exclusive to CDFIs. A CDFI is a financial institution that expands the availability of credit, investment capital, and financial services in economically distressed communities. The new legislation allows for the creation of loan loss reserve funds in order to help defray the costs of any defaults. Concerns regarding defaults are one of the primary obstacles cited by bankers who have expressed interest in starting a small-dollar loan program. However, after offering small-dollar loans for two years, the charge-off ratios were in line with industry standards for unsecured loans to individuals and charge-off rates compared favorably with credit cards. In order to qualify for the grant, the CDFI must offer a small-dollar loan program that offers loan amounts of $2,500 or less, to be repaid in installments with no pre-payment penalties, as well as any other requirements established by the fund administrator. As blogged previously, not all payday loan alternatives are created equal. Therefore, it is necessary to define the parameters of the eligible loan programs in a way that creates products that are truly safe, reasonable, appropriate, and accessible for consumers.

One tool to help create a consumer-friendly product is the template proposed in the FDIC’s Small-Dollar Loan Pilot Program. According to the FDIC, the essential elements of safe, affordable and feasible product design include:

• Loan amount of $2,500 or less;
  
• Term of 90 days or more;
  
• APR of 36% including fees;
  
• Streamlined underwriting with proof of identity and income;
  
• Credit report (but not necessarily score) to determine loan amount and repayment ability.
  

This two-year pilot program, completed in the fourth quarter of 2009, included 28 participating banks that made more than 34,400 small-dollar loans with a principal balance of over $40 million, all with an APR of 36% or below, including any fees.

Three banks headquartered in Illinois participated in the FDIC study: Community Bank – Wheaton/Glen Ellyn, Lake Forest Bank & Trust, and State Bank of Countryside. Lake Forest Bank was able to earn a small profit on the loans and intends to develop long-term relationships with performing borrowers. Losses on their small-dollar loan product were no higher than those on other consumer loans. Lake Forest Bank reported one of the most successful changes made to its program was reducing the minimum loan amount to $250 to accommodate borrowers who did not need large amounts of credit. Also on the state level, the Illinois Asset Building Group (IABG), a diverse statewide coalition invested in building the stability and strength of Illinois communities through increased asset ownership and asset protection, is working to promote alternative small-dollar loans in Illinois. For more information, see the IABG brief Alternative Small-Dollar Loans in Illinois: Creating Sound Financial Products Through Regulation and Innovation. With 2010 just half over, there are even more changes on the horizon for the alternative small dollar loan landscape. Stay tuned!

This article was coauthored by Hannah Weinberger-Divack.

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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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Thousands of homeowners will be getting relief soon if they took out a loan with Countrywide Financial before 2008. Charges against Countrywide, now a subsidiary of Bank of America, are part of the largest mortgage-servicing case ever to come before the Fair Trade Commission (FTC), and one of the largest overall judgments. The New York Times reported that Bank of America will pay $108 million to families who were charged inflated “cost of service” fees such as lawn mowing and property inspection.

Over the past few years, Countrywide has become the poster child for the predatory lending industry and has received much of the blame for the housing crisis. Reports of abuses include the inadequate underwriting of adjustable rate mortgages or ARMs, unhelpful customer service, abysmal record keeping, abusive origination fees, and making false and defaming claims against homeowners who filed for bankruptcy protection.

As part of the monetary settlement, the FTC is requiring Bank of America to establish internal procedures and to use an independent third party to verify that bills and claims filed in Countrywide’s ongoing bankruptcy proceedings are valid. Countrywide also faces a criminal investigation by the Federal Fraud Enforcement Task Force into the defamation charges against it.

Unfortunately, Countrywide is only one of many lenders accused of predatory lending and consumer abuses. Although the FTC has played an integral role in holding Countrywide accountable, these predatory practices still abound in the mortgage industry. We need strong laws that protect consumers; that is why the Shriver Center supports an independent consumer protection agency which will prevent these abuses from happening in the future.

For more information contact the Community Investment Unit at the Shriver Center.

This article was co-authored by Susan Ritacca.

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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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