ALABAMA S STATUTORY HIGH COST CREDIT PRODUCTS Payday and Title Pawn Loans

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1 Shay Farley, legal director, Alabama Appleseed Center for Law & Justice ALABAMA S STATUTORY HIGH COST CREDIT PRODUCTS Payday and Title Pawn Loans Stephen Stetson, policy analyst, Alabama Arise Stephen@alarise.org; Introduction The Alabama Legislature should modify the Deferred Presentment Services Act and enact a statutory authority adequate to regulate title pawn transactions, establishing in both a 36% APR interest rate cap. A clear, uniform rate of interest will improve the lives of our fellow Alabamians and create a level playing field for all lenders. The 36% APR originally established by Alabama s Small Loan Act 1 has been set by several states, is considerably higher than the national average interest rates charged by credit cards ( %), 2 and is similar to the regulations set and enforced by the FDIC and Federal Reserve. Further, a 36% APR cap was adopted by Congress when it addressed the allowable interest on loan products extended to active duty military members and their dependents in a bill signed by President George W. Bush. 3 By placing all consumer lenders on equal footing, the Legislature will free up limited regulator resources by simplifying consumer lending laws. Most importantly, by acting swiftly, Alabama will reinforce the commitment of Congress to protect service members and, by establishing a statewide, uniform interest rate, could do what Congress failed to do: extend that protection universally to all Alabama s residents including our 400,000 veterans 4, limited-income elderly and disabled, and those least able to pay exorbitant interest rates. Overview Prohibitions against usury date back to Biblical times. In Alabama, small dollar loans have ranged over history from those provided by rural country grocery stores to those provided by loan sharks using unseemly (occasionally illegal) collection tactics. Contemporary generations of lawmakers have sought to ensure that access to credit is available for all, while minimizing exploitation. Other states show that profits of lenders can be reasonably balanced with robust consumer protections. When it was enacted, Alabama s Small Loan Act more than quadrupled allowable interest rates on consumer loans under $1000. In 2003, when the Legislature passed the Deferred Presentment Services Act, the legal interest rate skyrocketed to 456% APR, a rate almost 13 times prior limitations (and only applicable to loans under $500). Simply stated, in less than 50 years, lawful interest rates on small dollar consumer loans have jumped absent any justification from 8% to 456%. An examination of the legislative findings enumerated in the Small Loan Act evidences the Legislature s deep consideration of consumer need for small dollar loans and resolved that, despite the foreseeable at risk classification of some, all borrowers deserved protections from exploitation. 5 1 The Small Loan Act, adopted in 1959, sets a rate not exceeding three percent a month on loans for less than $1,000 (Sec (a). The legislative findings section of that act outlines the need for such a cap. See infra footnote 5 2 Information updated 11/14/2012 at national average and bad credit rates 3 The Military Lending Act of University of Alabama Data Center (a) The Legislature finds as facts and determines that:

2 Background: Payday Lending The payday lending industry grew significantly in our state, just as it did across the nation, during the 1990s. Flying largely under the radar, storefronts quietly charged interest rates far beyond the thenallowable 36%. On July 7, 1994, the Attorney General issued an opinion that payday loans are loans covered by the Alabama Small Loan Act, the Mini-Code, and subject to Truth in Lending disclosure requirements. No action to enforce the 1994 opinion was taken until July 1, 1998, when the Banking Department issued 150 cease and desist orders against lenders violating the interest cap. In 2002, the legislature modified the Small Loan Act to provide an alternative rate schedule (Sec (m)), increasing allowable loans to approximately 190% APR. [This is an important loophole that should also be addressed.] The legislature acted again in 2003, carving out additional exceptions for small dollar loans. The result was the Deferred Presentment Services Act (Sec. 5-18A-1, et seq.) allowing 456% APR. In 2005, the Alabama Supreme Court held that deferred presentment services were subject to the Small Loan Act, but only prior to the passage of the Deferred Presentment Services Act. Austin v. Alabama Check Cashers Assoc., 2005 Ala LEXIS 197 (Ala. 2005). Since its adoption in 2003, there have been only two attempts both in the same session to address the Deferred Presentment Services Act. In 2007, Sen. Bradley Byrne introduced a bill with 23 bipartisan co-sponsors to repeal the Act, while Sen. Lowell Barron filed a bill to modify the Act with mostly industry-supported adjustments. A few meetings were held to discuss the bills with representatives of Appleseed and Arise supporting Sen. Byrne s bill and several industry lobbyists standing with Sen. Barron. The session ended without any movement on either bill. How Payday Loans Work Deferred presentment transactions, commonly referred to as payday lending, are used by borrowers who need loans to bridge the gap until their next paycheck clears. In such transactions, a lender accepts a postdated check from a borrower written for the loan amount plus a finance charge (Alabama law says $17.50 per $100 loaned). The borrower receives the loan amount and has a certain period of time in which to redeem the check amount (typically 2 weeks, but Alabama law establishes the loan period between days). Unlike traditional loans, there are no underwriting requirements and no examination into the borrower s ability to repay the loan. If the borrower is unable to repay the loan at the end of the period, Alabama law allows the borrower to roll over the transaction for another period by paying another finance charge. However, in such situations, the borrower is frequently in need of more money, and so will present another check for a new loan as well. In this fashion, the borrower (1) There exists among citizens of this state a widespread demand for small loans. The scope and intensity of this demand have been increased progressively by many social and economic forces; (2) The expense of making and collecting small loans, which are usually made on comparatively unsubstantial security to wage earners, salaried employees and other persons of relatively low incomes, is necessarily high in relation to the amounts lent; (3) Such loans cannot be made profitably under the limitations imposed by existing laws relating to interest and usury. These limitations have tended to exclude lawful enterprises from the small loan field. Since the demand for small loans cannot be legislated out of existence, many small borrowers have been left to the mercy of those willing to bear the opprobrium and risk the penalties of usury for a large profit; (4) Interest charges are often disguised by the use of subterfuges to evade the usury law. These subterfuges are so complicated and technical that the usual borrower of small sums is defenseless even if he is aware of the usurious nature of the transaction and of his legal rights; (5) As a result, borrowers of small sums are being exploited to the injury of the borrower, his dependents and the general public. Charges are generally exorbitant in relation to those necessary to the conduct of a legitimate small loan business, trickery and fraud are common and oppressive collection practices are prevalent; and (6) These evils characterize and distinguish loans of $ or less. Legislation to control this class of loans is necessary to protect the public welfare. (b) It is the intent of the Legislature in enacting this law to bring under public supervision those engaged in the business of making such loans, to eliminate practices that facilitate abuse of borrowers, to establish a system of regulation for the purpose of insuring honest and efficient small loan service and of stimulating competitive reductions in charges, to allow lenders who meet the conditions of this chapter a rate of charge sufficiently high to permit a business profit and to provide the administrative machinery necessary for effective enforcement.

3 quickly becomes trapped in a cycle of debt that is difficult to break as evidenced by the typical borrower taking an average of 9 loans per year. Background: Title Pawn Loans In a 1993 decision, the Alabama Supreme Court classified title lenders as pawnbrokers, which allowed them to be covered under the Pawn Shop Act. This was a peculiar holding since title lenders do not retain possession of the vehicles and the statute defines a pawn transaction as [a]ny loan on the security of pledged goods or any purchase of pledged goods on condition that the pledged goods are left with the pawnbroker and may be redeemed or repurchased by the seller for a fixed price within a fixed period of time. However, the Court ruled that a certificate of title held by a lender counts as a pledged good, making title loans subject to pawn transaction rules. Floyd v. Title Exch. & Pawn, Inc., 620 So. 2d 576, 579 (Ala. 1993). In 2006, a Circuit Court judge in St. Clair County ruled that parts of the Pawn Shop Act were unconstitutional, holding that the discrepancy in allowing title loan companies to charge up to 300 percent interest while restricting other lenders to much lower rates violated the equal protection clause. The Alabama Supreme Court has not readdressed this issue since its 2003 Floyd ruling. How Title Pawn Loans Work An automobile title loan is a loan in which a car s title (and usually a spare key) is held as collateral. Car title lenders may look or feel like a pawnbroker or a used car dealer. Borrowers put at high risk an asset that is essential to the well-being of working families: their cars. A lender will lend a borrower an amount of the value of the car; in practice that amount is usually no higher than 50%, meaning that most car title loans are oversecured. The borrower has to repay the entire amount of the loan plus fees in one lump sum at the end of 30 days. If the consumer can t repay when the loan is due, he or she can either pay another fee to roll the loan over, or the lender will come and take the car and, after a 30 day redemption period, sell it. Alabama law does not require the lender to return the surplus to the borrower. The Facts: Payday and Title Pawn Lending Research shows that the short-term lending industry: - Is designed to trap a borrower in a cycle of debt; - Doubles the risk that the borrower will end up in bankruptcy within two years; - Doubles the risk of being seriously delinquent on credit card payments; - Makes it less likely that borrowers can pay other bills and get healthcare; and - Increases the likelihood that consumers bank accounts will be closed involuntarily. Predatory loans are high interest, short-term loans that take advantage of a borrower s economic desperation and are extended without consideration of the borrower s ability to repay the loan on time. They also often are loans offered for larger amounts than the borrower originally requested, worsening the consumer s long-term financial picture. These loans and lenders include, but are not limited to: payday loans (including storefront and online/internet locations), title pawn loans, refund anticipation loans, check cashers, pawnshops, and rent-to-own services.

4 In Alabama, lenders are permitted to charge interest rates of 17.5% percent for payday loans, typically over a two-week period, and 25% per month on title loans. This means that consumers are paying annual percentage rates (APRs) of up to 456% for payday loans and 300% for title loans. Predatory loans are overwhelmingly concentrated among those that can least afford them: lowwealth individuals, elderly, limited-source income earners, and communities of color. Payday loans must be less than $500 in Alabama. However, these fringe financial products, by design, encourage repeat borrowing (i.e. loan churning), by charging high interest rates and setting a loan period that does not allow a meaningful opportunity for repayment. This faulty design triggers an unhealthy dependence on borrowing money at high costs, wreaking havoc on the economic security of borrowers, their households, and on community security. Additionally, the $500 cap is not meaningfully enforced because lenders do not use a common database to track existing loans for customers. High cost credit options are financial quicksand; short-term solutions creating long-term problems. The average borrower remains in payday loan debt for 212 days of the year. On a $500 loan, this translates to approximately $1313 in interest over that time period. There is no maximum amount for title loans in Alabama. These loans are extended based on the value of the car, and thus can be thousands of dollars, but lenders never examine credit and typically do not even ask for proof of income. For a $3000 title loan, borrowers could be paying $750 per month in interest despite the fact that title loans are secured loans carrying little risk and therefore do not justify the exceedingly high fees. Like payday loans, most consumers cannot afford to pay more than the interest every month, and thus pay only the interest for months or even years. When they can no longer afford to pay the interest, the lenders repossess and sell their cars - taking away many Alabamians only means of transportation, and do not even return to the customers the surplus from the sale (i.e., the amount of the sale proceeds that exceeds the amount owed plus the lender s repossession/sale costs). Other SE states have laws that limit interest rates on consumer loans to 36% or less--arkansas and North Carolina, on both payday and title loans; Georgia, on payday loans; and Florida and Kentucky, on title loans. These states have proven that it is possible to maintain a pro-business climate while insulating borrowers from exploitative interest rates. It s time for Alabama to do the same. Guiding Principles: Why Reform 1. There is no legitimate justification for loans from 300%-456% APR. Usury is generally defined as lending money at an unconscionable and exorbitant rate. This is usury, plain and simple, and this immoral activity should be outlawed. Debates over usury are among the earliest recorded conversations about ethics. The practice is scripturally and doctrinally forbidden by our Judeo- Christian faiths. Interest rates, without concrete specification, are susceptible to loopholes and exceptions, running the risk of extremely varying rates for every conceivable lending situation. In the Biblical context, the main moral argument is that usury creates excessive profit and monetary gain without justification, such as one s labor, but rather from avarice and manipulation of the vulnerable. There are at least 15 biblical injunctions against usury.

5 2. People facing financial problems should not be exploited. Our free market-based economy encourages profit-earning, and lenders have the right to extend credit at a profitable interest rate. However, there is no right to engage in usury. Alabama lawmakers have an obligation to protect the most vulnerable citizens from those looking to exploit them. 3. Providing clarity and uniformity among all consumer lending transactions regardless of product or lender is best for the people of Alabama and reflects our true values. Various Southern, pro-business states have followed the national trend towards ensuring increased consumer protections through legislation. North Carolina, Georgia, and Arkansas are among states that have, through various methods, eliminated payday lending without causing a crisis for lowincome borrowers. Further, most states, including Alabama, allow government regulations to cap profits on necessities during natural disasters. These anti-gouging principles should be extended to loans, which are seen as necessary by consumers during times of financial crisis. 4. Alabama consumers deserve loan products that can meet their financial needs, without further deepening financial strain. Lending institutions must offer responsible lending products that uplift individual and family security, enable the building of household wealth, and encourage asset accrual. 5. The cycle of dependence on harmful loan products cannot be broken through financial counseling instruction alone. To maintain Alabama s economic stability we must reform Alabama s lending laws and promote policy and practices that ensure all Alabamians have access to viable credit options. 6. Safe, strong and vibrant communities depend on the economic security of its residents. Predatory loan products undermine the achievement of economic security for communities through exploitation of vulnerable borrowers. Payday lending storefronts drive down property values and are associated with crime. Payday lenders impede other businesses, like utility companies and landlords, from collecting debts, because their claims are secondary to lenders holding post-dated checks or debit authorizations. It hurts society and the economy to have people sending huge chunks of every paycheck to a lender without making any progress towards paying off the loan. The Pentagon realized that consumer debt was hurting military readiness and morale and the damage to consumer credit was destroying the domestic lives of our fighting men and women. The same is true of civilians. Payday lending costs Alabama $224 million every year in predatory fees paid mostly to out-of-state companies. 6 States with two-digit interest rate caps save their citizens nearly $2 billion per year. 7 Pre-empting Industry Counter-Arguments Payday lenders can t operate at 36% interest. If true, this demonstrates a flaw in the business model of payday lenders. While high credit risks may require higher interest rates, the only rationale for triple digit interest is a desire to turn gouging into profits. All other credit providers, including credit cards, are able to function within a 36% APR. Government shouldn t create loopholes to prop up faulty business models. If a rate cap drives payday lenders from the state, other lenders will (as they have done in other states) flourish in the vacuum. 6 Uriah King, Financial Quicksand, Center for Responsible Lending, 11/30/06 7 Springing the Debt Trap, Center for Responsible Lending, 12/13/07

6 Hurting the industry will cost Alabama jobs. Low-wage, low-skilled jobs are not the kind of jobs that Alabama should be fighting to protect. Payday storefronts employ few people and experience astronomically high turnover rates. Finally, any enrichment to the tax base caused by a few jobs is more than offset by the economic damage caused by the payday loans stripping wealth from communities. Payday loans are a crucial source of credit for low-income consumers. Presence of demand for a product doesn t mean that society must approve of that product. Illegal drugs are forbidden, despite high demand for them. Most importantly, the states that have driven off payday lenders have not experienced a surge of citizen outcry to abandon the prohibition. A UNC study of former payday customers in North Carolina concluded the absence of storefront payday lending has had no significant impact on the availability of credit for households in North Carolina. When payday lenders are gone, additional viable alternatives whether new lenders or altered borrowing habits (borrowing from family and friends, for example) will emerge. State regulations won t stop payday lending. It is undeniable that loopholes to the law will persist, including the availability of payday loans on the Internet and industry-led efforts to reclassify loans. Nonetheless, imperfections in enforcement should not be allowed to derail needed reforms. If problems persist subsequent to reform, those can be addressed as they occur. Conclusion Simply put, payday and title loans exploit borrowers and are bad for business because those lenders get paid first, even before basic living expenses such as rent, utilities and child support payments. In a manner of speaking, the payday lender is holding the borrower s checking account hostage, thus having the effect of a super priority lien, and a title borrower cannot afford to risk vehicle repossession, particularly when their loan value is significantly lower than the vehicle is worth. Consumer lending rules have been revised to create an uneven playing field. Fringe lenders can charge more for loans than mainstream, traditional lending institutions whose products are governed by the Small Loan Act. The Alabama Legislature should revoke the inexplicable and incomprehensible authorization of 300% and 456% APR allowed under the laws governing title pawn and payday lending. Such modification does not target any specific industry or business; it removes barriers to lending by reversing the special interests carve outs and ensure small dollar loans are affordable to all borrowers. "And the theory in the business is you've got to get that customer in, work to turn him into a repetitive customer, long term customer, because that's really where the profitability is." Dan Freehan, CEO, Cash America at Jeffries Financial Services Conference, June 2007