This post is written by Lead Articles Editor Alexa E. Wainscott[i]. Opinions and views expressed herein are those of the writer alone.
Advertised as convenient solutions for cash-strapped consumers seeking to cover an unexpected expense between paychecks, such as a car repair or medical expense, payday, auto title, and other short-term loans regularly become long-term problems for borrowers. Although purportedly intended to cover temporary, emergency expenses that will be repaid in weeks, payday loans are often used to cover ordinary or recurring expenses, such as utilities and credit card bills, and the average borrower spends five to seven months out of the year in “short-term” indebtedness.[ii] Interestingly, lenders often disseminate advertisements warning that payday loans are not long-term financial solutions, while simultaneously offering incentive programs that offer discounts after increasing numbers of loan transactions, keeping consumers hooked in a dangerous cycle.[iii]
Preying on financially vulnerable populations—due to the widespread availability of the loans, despite consumer credit deficiencies— lenders charge sky-high interest rates and require prompt repayment, which can force borrowers to take out additional loans, trapping them in cycles of debt. Roughly four out of five short-term borrowers end up re-borrowing within a month, according to the Consumer Financial Protection Bureau (CFPB), and more than a quarter eventually re-borrow more than eight times.[iv] Many argue “that consumers are being set up to fail,” because unaffordable loan payments force them to “choose between defaulting, re-borrowing, or skipping other financial obligations like rent or basic living expenses.”[v] In addition to repeat borrowing, other problems commonly associated with short-term loans include defaults, vehicle seizures, bank penalty fees (for insufficient funds, etc.), and bank account closures.
The most common types of short-term loans in this context are payday and auto title loans. Payday loans are for small amounts and due in full at the time of the borrower’s next paycheck, generally two to four weeks.[vi] These loans usually carry absurdly high interest rates of well over 300%, and borrowers typically allow the lender access to their bank accounts to electronically debit the payments when due.[vii] Auto title loans are similar, but the borrow must put up her vehicle title as collateral for the loan. According to CFPB research, one out of five single-payment auto title loans end up in vehicle seizure for failure to repay.[viii]
The CFPB and New October 2017 Short-Term Lending Rules
To help regulate federal consumer protections and combat predatory lending activity, including high-risk short-term loans, the Consumer Financial Protection Act created the CFPB in 2010.[ix] The CFPB is charged with broad rulemaking authority under Title X, subject to few restrictions.[x] In October 2017, the CFPB promulgated a new rule[xi] aimed at forcing lenders to determine if borrowers can actually repay their loans, which expressly applies to single-payment short-term payday and auto title loans—i.e. loans that require the borrower to repay all or most of the borrowed amount at once.[xii]
One part of this rule requires a “full-payment test.”[xiii] Lenders are required to collect enough financial information from prospective borrowers to determine if they have sufficient income to repay the loan and meet all major financial obligations and cover living expenses during the term of the loan and for thirty days thereafter.[xiv] Household members’ income may be taken into account if the borrower has verified access to the income.[xv] Two other protections include: (1) a requirement that lenders must offer a thirty-day “cooling-off period” after the third covered loan taken out in quick succession; and (2) a “debit attempt cut-off,” meaning that after two unsuccessful attempts to debit the borrower’s account (for insufficient funds, or whatever reason), the lender is prohibited from debiting the account again without the consumer’s consent.[xvi] The rule provides that it is in addition to any state protections afforded to consumers.[xvii]
A second part of the rule allows an exception to the full-payment test “if [the loan] is structured to allow the borrower to get out of debt more gradually.”[xviii] Under this principal-payoff option, the consumer can repay the loan in one payment, or she can have up to two subsequent loans where the principal is slowly paid down.[xix] This option is restricted to lower-risk situations, up to $500 for an initial loan, and lenders cannot take vehicle titles as collateral.[xx] Additionally, lenders are barred from lending to consumers with other recent outstanding short-term loans.[xxi] Lenders also may not make more than three loans of this sort in quick succession, and this option does not apply if the consumer has already had more than six short-term loans or been in debt for more than ninety days on short-term loans over a rolling twelve-month period.[xxii] Also, the lender can only offer extensions under this option if the borrower has paid off at least one-third of her original principal per extension, a provision specifically aimed at combatting the debt trap.[xxiii] Lastly, the lender must disclose all terms of the option to consumers in plain language.[xxiv]
Ohio’s Short-Term Loan Protections: Mere “Smoke and Mirrors?”
The Ohio Legislature has also attempted to address predatory payday lending, passing the Short-Term Lender Act (STLA) in 2008.[xxv] Under the STLA, lenders may not issue short-term loans over the phone, by mail, or through the internet, and the maximum allowable loan amount is $500, with a minimum duration of thirty-one days.[xxvi] Additionally, the interest rate is capped at 28% APR, and the amount due under the loan cannot exceed 25% of the borrower’s gross salary.[xxvii] The STLA requires payday lenders to register as short-term lenders under the Act.[xxviii] However, under the current state of Ohio law, it is relatively easy for lenders to escape the Act’s requirements by—legally— circumventing its registration requirement.[xxix]
The Ohio Supreme Court ruled in 2014 that the STLA did not prohibit Mortgage Loan Act (MLA) registrants from making short-term single payment loans, and the traditional single-installment payday loan is alternatively covered under the MLA as an interest-bearing loan.[xxx] Thus, payday lenders have been able to evade the requirements of the STLA by registering as MLA lenders, bypassing the STLA’s consumer-protection restrictions. Additionally, many lenders avoid the MLA’s caps by tacking on substantial additional fees for their services in assisting the consumer in “finding” the loan, as the lender is characterized as a Credit Service Organization under Ohio Law.[xxxi]
In the Ohio Neighborhood Finance case, the lender had been previously licensed under the now-repealed Check-Cashing Lender Law, but he failed to register under the STLA when it was enacted. He was, however, licensed under the MLA, under which he could charge amounts less than those under the Check-Cashing Lender Law, but still greater than permitted under the STLA.[xxxii] The borrower asserted that payment was not required because the lender was not authorized to make short-term single-installment “payday” loans.[xxxiii] The questions presented to the Ohio Supreme Court were: (1) whether the MLA permits single-installment, interest-bearing loans; and (2) if so, whether the MLA prohibits lenders from making short-term loans of this sort.[xxxiv]
The court reasoned that the unambiguous statutory language of the MLA compelled the conclusion that registrants under it could issue payday-style loans, and the existence of the STLA does not preclude them from doing so freely.[xxxv] Recognizing the obvious weakness of the STLA, but careful not to exceed the bounds of its judicial authority, the court reasoned that “[i]f the General Assembly intended to preclude payday-style lending of any type except according to the requirements of the STLA, our determination that the legislation enacted in 2008 did not accomplish that intent will permit the General Assembly to make necessary amendments to accomplish that goal now.”[xxxvi] In his concurrence, Justice Pfeifer lamented the failure of the legislature to effectively combat the issue of predatory payday lending: “How can the General Assembly set out to regulate a controversial industry and achieve absolutely nothing? Were the lobbyists smarter than the legislators? Did the legislators realize that the bill was smoke and mirrors and would accomplish nothing?”[xxxvii]
The Ohio Neighborhood Finance case is an example of the lengths to which lenders will go to bypass strict lending restrictions, and it should serve as a reminder that, as a result, legislators must be responsive to courts’ intervention to facilitate the protections that the legislation was originally intended to provide. Accordingly, despite the hopeful outlook surrounding the CFPB’s October 2017 rules strengthening consumer protections against short-term predatory lending at the federal level, consumer optimism must be qualified and somewhat reserved. As in the case of the STLA in Ohio, there are almost always loopholes to be exploited in legislation and administrative regulations, and, in the case of payday and vehicle title loans, predacious lenders stand at the ready to find them.
[i] Alexa E. Wainscott is a third-year student at Chase College of Law and the Lead Articles Editor of the Northern Kentucky Law Review.
[ii] The Pew Charitable Trusts, Payday Lending in America: Who Borrows, Where They Borrow, and Why 15 (2012) http://www.pewtrusts.org/~/media/legacy/uploadedfiles/pcs_assets/2012/pewpaydaylendingreportpdf.pdf.
[iv] Jackie Wattles, New Payday Loan Rules: What You Need to Know, CNN Money (Oct. 7, 2017, 5:52 PM ET), http://money.cnn.com/2017/10/07/pf/payday-loans-cfpb-rule/index.html.
[v] Consumer Financial Protection Bureau, CFPB Finalizes Rule to Stop Payday Debt Traps 1 (Oct. 5, 2017) http://files.consumerfinance.gov/f/documents/201710_cfpb_fact-sheet_payday-loans.pdf.
[viii] Id. at 2.
[ix] See Prac. Guide to Consumer Fin. Protection Bureau Regs. § 3:1; see also Title X § 1002(14), 12 U.S.C. § 5481(14).
[x] See Prac. Guide to Consumer Fin. Protection Bureau Regs. § 3:3; see also Title X § 1022(b)(4)(A), 12 U.S.C. § 5512(b)(4)(A).
[xi] See 12 CFR Part 1041. The text of the rule is available at: http://files.consumerfinance.gov/f/documents/201710_cfpb_final-rule_payday-loans-rule.pdf.
[xii] Consumer Financial Protection Bureau, CFPB Finalizes Rule to Stop Payday Debt Traps 1 (Oct. 5, 2017) http://files.consumerfinance.gov/f/documents/201710_cfpb_fact-sheet_payday-loans.pdf.
[xiii] Id. at 3.
[xvi] Id. at 3, 6.
[xvii] Id. at 3.
[xviii] Id. at 4.
[xxv] Short-Term Lender Law (Payday Lending Law), Ohio Rev. Code Ann. §§ 1321.35– 1321.48.
[xxvi] Payday Lending in Ohio: How Lenders Get Around the Rules, Nolo Legal Encyclopedia (2017), https://www.nolo.com/legal-encyclopedia/restrictions-payday-lending-ohio.html.
[xxx] Ohio Neighborhood Fin., Inc. v. Scott, 139 Ohio St.3d 536, 547 (Ohio 2014).
[xxxi] Payday Lending in Ohio: How Lenders Get Around the Rules, Nolo Legal Encyclopedia (2017), https://www.nolo.com/legal-encyclopedia/restrictions-payday-lending-ohio.html.
[xxxii] Ohio Neighborhood Finance, 139 Ohio St.3d at 540.
[xxxiv] Id. at 541.
[xxxv] Id. at 547.
[xxxvi] Id. at 546.
[xxxvii] Id. at 547–8.