Once again, consumer advocates and lenders are facing off in Sacramento over how best to meet the financial needs of Californians ignored or shunned by conventional banks. It’s not simply a question of how to entice lenders to serve these consumers, many of them lower-income Latinos or African Americans. It’s also how to guard borrowers against predatory business models and unscrupulous lenders who have a perverse incentive to make loans that can’t be repaid.
Lawmakers have introduced a smattering of bills this year that would either tighten or loosen the rules for loans of $10,000 or less. All are aimed at the challenge presented by “unbanked” or “underbanked” borrowers — people who can’t qualify for a credit card or a conventional bank loan with single- or low-double-digit interest rates. Today, these borrowers are served by two types of operators: payday lenders for amounts up to $300, and “consumer finance lenders,” many of them online, for larger amounts. Each of these makes credit available to borrowers with few other options, but also poses real financial hazards.
Located primarily in neighborhoods with higher-than-average poverty rates, payday lenders assess fees of up to $45 per loan and require full repayment in two to four weeks. That translates to annual interest rates of almost 400%. Worse, people living paycheck-to-paycheck often do not have enough disposable income to pay off their loans that quickly, forcing them to take out more loans and run up even higher fees as they struggle to get out from under the debt.
Unlike payday lenders, consumer finance lenders offer installment loans that can be paid off over time — usually at a high price. More than half the loans worth $2,500 to $5,000 in 2015 carried rates of more than 100%, according to state reports. Not surprisingly, the failure rates were egregious as well; by the end of the year, 40% of those loans were in default or past due.
State law limits interest charges only on loans between $300 and $2,500, imposing a cap of about 32%. That limit is no lower than the ones in more than a dozen states that impose interest-rate caps, yet some lenders complain that it discourages them from lending to people with poor credit histories because there’s not enough margin to cover defaults. In response, the state launched a pilot project in 2011 that allowed 36% interest (and higher fees) on installment loans up to $2,500 from lenders that took steps to prevent consumers from taking out loans they couldn’t repay — something state law didn’t require of other lenders — and to help their customers improve their credit scores. The pilot, which also lets lenders pay “finders” to line up borrowers for them, has made more credit available while keeping defaults comparatively low.
Lawmakers have filed at least three competing proposals this year to change the rules for consumer credit. One seeks to let lenders in the pilot project offer larger loans with a 36% interest cap. Another would let payday lenders offer bigger loans and raise the interest-rate cap on loans under $2,500. The third would slap a 24% interest cap on all consumer installment loans under $10,000. Getting lower-interest lenders into the market for loans larger than $2,500 would be a win for consumers, as long as lawmakers guard against marketing and sales practices that reward businesses for the number of loans issued, even if they can't be repaid.
Assemblyman Matt Dababneh (D-Woodland Hills), who chairs the Assembly Banking and Finance Committee, wants to delay action on the bills and work jointly on a comprehensive reform to the state lending law. A coherent approach is a good idea, if that's what Dababneh is genuinely committed to producing, and there’s no rush to expand the pilot program. But Dababneh also wants to put a hold on AB 1636, a bill by Assemblywoman Cecilia Aguiar-Curry (D-Winters) to require the state to disclose the data it collects from individual payday lenders, rather than keeping it secret. That measure is a wholly separate and welcome reform, and it shouldn’t be held hostage to the pursuit of better consumer lending rules.
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