COMMENTS OF THE ILLINOIS CONSUMER JUSTICE COUNCIL, INC.
DOCKET NO. R-1050
REGULATION Z -- TRUTH IN LENDING
TO: Jennifer J. Johnson, Secretary, Board of Governors of the Federal Reserve System, 20th Street and Constitution Avenue, N.W., Washington, D.C. 20551
The Federal Reserve Board should make clear that "payday loans" are extensions of credit subject to the Truth in Lending Act ("TILA") and Regulation Z, and that this statement represents existing law. In addition, the Board should (i) require that payday lenders consistently disclose that the postdated checks which they obtain from borrowers constitute a security interest, but only in the check, not the underlying account, (ii) require "payday lenders" to make disclosures for the intended length of time the credit will remain outstanding, rather than for an artificial series of two-week periods that both parties intend and expect will be renewed for months or years, and (iii) make clear that failure to comply with the "conspicuousness" requirements of TILA and Regulation Z is subject to statutory damages under 15 U.S.C. 1640.
I. WHAT PAYDAY LOANS AND TITLE LOANS ARE
"Payday loans" are short term, very high interest rate loans. The loans are nominally two to four weeks in duration. In fact, as discussed below, this does not represent the real term of the loan.
The lender usually obtains either a postdated check, in an amount equal to the principal plus interest and dated for the due date of the loan, or an equivalent electronic funds transfer authorization. At the end of the original term, the customer will usually "roll over" the loan for an additional period by paying the interest. Annual percentage rates range from 300% to over 2000%.
The "payday lender" generally does not run credit checks, making the loans attractive to those who have, or think they have, bad credit. Typically the loans are made to anyone who brings in a photo ID, a bank account statement, and a pay stub.
The payday loan industry lures borrowers with catchy names ("Check 'n Go", "Quik Cash") and by advertising that the loans cost $x per $100 and that they are easy to get. The consumer often does not see the annual percentage rate until he or she is presented with the loan proceeds.
Many of the advertisements used by payday lenders violate the credit advertising provisions of the Truth in Lending Act and Regulation Z. Until recent lawsuits against payday lenders, they often did not advertise the annual percentage rates even though they stated the duration of the loan, finance charge as a dollar amount, and other "trigger" terms.
The loans are almost invariably "rolled over" on multiple occasions. A September 1999 report by the Illinois Department of Financial Institutions (attached as Appendix A) concludes:
Customers rarely borrow a single time, in fact, repeat business is the main source of revenue. A single licensee may have a limited customer base, but if the customer regularly refinances a loan the store may be quite profitable.
While the payday lending industry claims that the loans are short-term transactions, the Illinois Department of Financial Institutions concluded that the average customer "remains a customer for at least 6 months". This corresponds closely with industry analysts, who state that the average customer obtains 11 loans per year. Moreover, many consumers greatly exceed the average: "the [IDFI] examiners were finding customers who were borrowing continuously for over a year on their original loan."
Payday lenders affirmatively encourage repeat transactions. The Illinois Department of Financial Institutions report found that "in fact, repeat business is the main source of revenue" for payday lenders, and that 'having customers who make regular payments without paying down their principal balance helps to ensure profitability for short term lenders". At the same time, "[t]he high expense of a short term [sic] loan depletes the customer's ability to catch-up, therefore making the customer 'captive' to the lender".
A recent survey by the Indiana Department of Financial Institutions found that 77.2% of all payday loan transactions are rollover transactions, that the average customer had 10 renewals and one had as many as 66. Newspaper articles indicate that some people have payday loans outstanding for 2 to 3 years.
Further, in addition to rolling over loans with one company, many persons obtain concurrent loans with two or more companies. We have seen some borrowers get loans from as many as eight to ten payday lenders at once, and roll them over for more than a year.
If the lender charges $20 per $100, or a 521% annual percentage rate -- a very common rate -- a borrower who has 10 rollovers or refinances on a $500 loan will pay a total of $1100 in interest to have the use of $500 for 4 months -- and still owe the $500 principal!
"Title loans" are similar loans made on the security of automobile titles, generally for one month terms. The lender will lend a fraction of the book value of a fully paid-for automobile. If the loan is not repaid, the lender will repossess the automobile. The law requires that the car be sold and any surplus be returned to the borrower, but some loan documents purport to provide that the lender can simply keep the car.
The number of "payday loan" and "title loan" establishments is increasing exponentially. There were no "payday loan" establishments in Illinois until 1997; as of September 1999 there were 548. In Indiana, payday lending has increased from 15 locations with $13 million loan volume in 1994 to 454 locations with $296 million loan volume in 1998. A recent report states that there are 8,000 payday loan outlets in the United States.
According to the September 1999 Illinois Department of Financial Institutions report, the average annual percentage rate charged on "payday loans" in Illinois was 533%. The highest we have seen is 2,007.5%, charged by a Springfield, Illinois lender. The Indiana Department of Financial Institutions reports that a consumer was charged 7,300% for a one day loan.
"Title loan" rates average 290%, which is extraordinarily high for fully secured credit.
II. PAYDAY LOANS ARE EXTENSIONS OF CREDIT SUBJECT TO TILA
It is quite clear from the foregoing that all payday loans and title loans are extensions of consumer credit subject to TILA. The contrary statements in the Mason Steinhardt and Frascogna comments (nos. 1 and 11) should be rejected.
As those comments underscore, payday and title lenders have been attempting to evade TILA and state usury limitations by claiming that they are engaging in "deferred deposit" or "deferred presentment" transactions, not making loans. They contend that they charge a "fee" rather than "interest" or "finance charges" and that the federally-required disclosure of the annual percentage rate is misleading or inappropriate as applied to a short-term loan. One industry official stated that "such cash advances are not loans in part because of their short term nature."
Existing caselaw makes clear that this subterfuge is not effective to avoid TILA. The complete failure to provide any disclosures in connection with a "payday loan" or "deferred deposit" transaction is a clear violation of the Truth in Lending Act.
Efforts to characterize payday loans as something other than an extension of credit have also been successfully challenged under state usury laws. In the absence of a specific exemption, the charges for a "payday loan" or "title loan" constitute interest for usury purposes, no matter what name may be used to describe the charges. "In determining whether an item is to be treated as interest the court may disregard the form of the agreement and consider the substance of the transaction." As one court held: "In looking at the substance of the transactions between the Hamiltons and HLT, as opposed to the form, the Court finds that the transactions were nothing more than interest bearing loans. HLT was not cashing the Hamiltons' checks, but rather, it was giving them short-term loans that could be deferred for an additional 10% per week." (This represents an annual percentage rate of 521%.)
The definition of "finance charge" under TILA is broader than, but inclusive of, the common-law concept of "interest" for usury purposes. Accordingly, it is clear that all payday loan and title loan charges are, and have been, finance charges.
III. WHO ARE THE BORROWERS
The Board should be aware that payday loan and title loan borrowers are particularly vulnerable and particularly in need of accurate disclosures. The Illinois Department of Financial Institutions report concluded, based on a survey of customer files by its examiners, that "the average customer is usually a woman in her middle thirties earning just over $24,000 a year", and that "people living on fixed incomes are also targeted due to their inability to keep pace in a world of rising costs". An informal industry survey indicated that the average customer is a white female earning between $14,500 and $20,000 per year, 28 years old, and employed in the service or health care industry. The second largest group of borrowers is African American.
One owner of a "payday loan" establishment attributed the sudden growth of cash advances to a cash strapped, lower middle-class. "More and more people earning $ 25,000 to $ 30,000 with two or three kids, a car payment and insurance payment, are living from payday to payday."
Payday lenders deliberately target working class borrowers. A press release issued by the parent of Payday Check Advance, Inc., which claims to be the largest payday lender in the Chicago area, with 32 locations as of March 31, 1999, states that "we target stores in working-class neighborhoods. All things being equal, the higher the concentration of our target demographic in the neighborhood the more productive the store location will be."
IV. WHY PAYDAY LOANS AND TITLE LOANS ARE A PROBLEM
"Payday loans" are generally made to consumers facing financial emergencies. However, once a consumer obtains a "payday loan," he or she will often be unable to pay it off except from the proceeds of additional "payday loans." "Instead of using a loan once in an emergency, borrowers tend to get on a treadmill of repeated loans they can't get off . . . . It's almost a pattern . . . It really is people who are desperate for money."
Statistics show that a substantial number of borrowers will not be able to repay the loans as agreed. Published reports indicate that the incidence of default on these loans is in the 20-25% range. Helen Huntley, "Short loans, high rates, regulator questions," St. Petersburg Times, Oct. 25, 1998 If a payday lender claims a lower incidence of default, it is often because it is failing to take into account the effect of re-financings. If a borrower refinances three times and then defaults, the incidence of default for that borrower is 100%, not 25%. Because of the high incidence of rollovers, it is not appropriate to divide the number of defaults by the total number of loans and rollovers; if the average customer gets 11 loans and rollovers per year, doing that understates the default rate tenfold.
Frequently, the "payday loan" store is the last stop prior to bankruptcy court. In many cases, the consumer is driven into bankruptcy by the payday loans -- they can handle their other debts, but not the interest on the payday loans.
The harmful effect on other creditors can be expected to increase with the proliferation of payday loan establishments. We are already seeing instances in which banks and credit card issuers are having their obligations wiped out because payday loans force a borrower into bankruptcy. In California, banks have been hit so badly by payday loan defaults that they are now supporting regulation of payday lenders.
Payday loans and title loans are inherently predatory. Most lenders are required by law to assess the creditworthiness of their borrowers and to make loans only if they expect the borrower to repay. Banks, savings and loans, credit unions, and other conventional lenders are required to engage in prudent lending practices. This is why they require borrowers to fill out loan applications which state how much they make and how much they spend. The lender looks to the proportion of the debtor's income that will be spent after the loan is made, and analyzes whether it is sufficient to repay the loan.
Conventional financial institutions are examined by federal and state officials charged with the task of making sure that they are adhering to such standards. In the case of real estate loans, recent amendments to the Truth in Lending Act make it unlawful to engage in a pattern of making loans that can be collected only through foreclosure.
On the other hand, payday lenders do not assess whether their borrowers can repay the loans. In fact, they make loans which by definition leave the borrower unable to repay all of his or her debts. The typical borrower is someone living from paycheck to paycheck who has a sudden need for money. The payday lender requires the borrower to turn over 1/4 to 1/2 of his next paycheck to repay the loan. If the borrower's paycheck is barely sufficient to meet living expenses and has not allowed the borrower to build up any sort of reserve for emergencies, how can he turn over 1/4 to 1/2 of his paycheck to the lender and still pay for food and rent? Obviously, he cannot. "If you need money bad enough to go to one of these stores, you're probably not going to have the money to pay it off." The key to payday lending is that the lender believes that it can coerce the borrower into repaying the payday lender ahead of paying for food, rent, and other debts.
Payday lenders do this by obtaining postdated checks. When borrowers fail to pay or renew the loans, they deposit the checks. If the check does not clear, the lender threatens to enforce or does enforce the bad check statutes, even though the Illinois laws do not apply to a postdated check known to be worthless when issued, both because such a check is not within the terms of the statute and because the lender intends to extend credit, and does not rely on any representation by the borrower that there is money or will be in the account, and understands that there is a high degree of risk.Hartke v. Illinois Payday Loans, Inc., No. 99-3119, 1999 U.S. Dist. LEXIS 14937, *9 (C.D.Ill. Sept. 13, 1999)State v. Stout, 8 Ariz. App. 545, 547, 448 P.2d 115, 117 (1968)People v. Mazeloff, 229 App.Div. 451, 453, 242 N.Y.S. 623, 625 (1st Dept. 1930)Commonwealth v. Kelinson, 199 Pa.Super. 135, 184 A.2d 374, 376 (1962) By threatening the borrower with quadruple damages or criminal prosecution, the payday lender insures that it will be paid ahead of any other creditors.
Industry sources openly acknowledge that the postdated checks are used as a means of coercing borrowers who cannot pay all of their debts to pay the payday lender first -- or, at least, to pay the interest for two weeks and "roll over" the loan. A recent brokerage house report touting the desirability of investing in the "payday loan" business states:
Structure Enhances Collections/Minimizes Losses - While the consumer may not have enough money to pay everyone he owes, we believe the structure enhances the probability that the payday lender will be the first debtor [sic -- creditor] paid. Depending on the state, the payday lender can often deposit the customer's check (often after the consumer has deposited his paycheck) if he does not go to the storefront to pay off the loan. Again, the potential for future NSF charges, and/or loss of check-writing privileges, will likely motivate the consumer to pay off his loans.
The postdated checks are not in fact used as a mechanism for obtaining repayment of the loans. The Illinois report concluded:
The post dated checks are rarely cashed, due to high rates of insufficient funds, so customers are asked to make cash payment every two weeks or until the loan is paid in full . . . .
The use of the bad check laws greatly exacerbates the harm to the borrower. In one case, a borrower obtained a $200, two-week loan. The stated finance charge was $40. When the loan was not repaid on time, the lender sued under the Illinois bad check statute and got a default judgment for (i) $240, plus (ii) a $720 penalty, and (iii) $300 attorney's fees. Thus, the cost of borrowing $200 was $1,260! This is quite usual where borrowers fail to pay and are sued under bad check statutes.
The payday loan industry attempts to justify its charges as simply the result of amortizing a one-time fee for originating the loan over a very short period. This is not accurate. It costs about $8 to set up a payday loan account. This might justify charging $8 plus a reasonable rate on the money loaned. It does not justify charging $20 per $100 lent on a $500 two-week loan, which represents an annual percentage rate of 521%. It does not justify continuing to apply the 521% interest to the outstanding balance if the borrower defaults or rolls the loan over.
In fact, for most borrowers the payday lender does in fact collect 500% or more interest on credit that remains outstanding for a substantial period. This happens in two ways. First, many consumers obtain a succession of rollovers or refinancings. "[E]ven bad loans may be profitable because some customers pay for months before giving up." Second, in the event of a default, the lender keeps the interest running at the stated annual percentage rate.
Notwithstanding the extraordinarily high default rate, "payday lending" is very profitable. A study by the State of Tennessee (attached as Appendix B) shows that when litigation settlements are excluded, the return on equity that payday lenders enjoy exceeds 30%, which is 2-3 times the national average for banking and industrial firms. A recent brokerage house report states that the return on investment may exceed 40%. Any claims by payday lenders of lesser profitability need to be carefully examined to see if they take into account the fact that many of these lenders are opening new stores and ploughing their profits back into the business.
Payday Check Advance, Inc., which claims that it is the largest payday lender in the Chicago area, states that "the low fixed costs have allowed new Payday stores to quickly turn profitable" and that "our target is to achieve an average monthly pre-tax profit of $4,000 per location."
The profitability of payday lending is underscored by the fact that many payday lenders are growing into national chains. For example, Check Into Cash opened its first office in 1993 and now has 320 outlets, with $21.4 million in revenue during 1997 and as much again during the first six months of 1998; it is planning to go public. Another "payday lender," Advance America, has nearly 500 outlets. Ace Cash Express, a publicly-held chain with over 800 outlets, collected $10.1 million in payday loan fees during fiscal 1998. Another major chain is Check & Go, operated by CNG Financial Corporation of Cincinnati. A local Chicago chain, Sonoma Financial Corporation, which does business as Payday Express, recently announced a merger with Virginia-based Easy Money Group; the combined operations will have more than 150 payday loan stores in 18 states. Another large Chicago-area payday lender, Instant Cash Advance (One Iron Ventures) was recently acquired by a public company. At the present time, about 1/3 of all payday loan outlets are owned by 6 chains.
Clearly, given the nature of the "payday loan" and "title loan" business, accurate TILA disclosures are essential.
V. ADDITIONAL ISSUES THAT THE BOARD SHOULD ADDRESS
A. POSTDATED CHECKS AS COLLATERAL
The Truth in Lending Act and Regulation Z require accurate disclosure of a security interest, if one is taken. There has been a substantial volume of litigation concerning when the postdated checks that payday lenders obtain from their borrowers create a security interest. In Smith v. Cash Store Management, Inc., the Seventh Circuit Court of Appeals addressed this issue, indicating that its resolution turns on whether the check gives the lender rights beyond those conferred by the note.
The Board should adopt a clear, uniform requirement that a payday lender disclose (i) that it is obtaining a security interest in the form of a postdated or other check, (ii) but that it is not obtaining a security interest in the bank account on which the check is written. The Uniform Commercial Code makes clear that a security interest in a deposit account cannot be created by a check or by agreement between the depositor and secured party; the consent of the depositary is required.810 ILCS 5/3-408(1) Thus, a lender which "discloses" that a postdated check creates a security interest in the underlying account, or which makes a "disclosure" that could be so construed, violates the Truth in Lending Act.
B. TERM FOR WHICH DISCLOSURES SHOULD BE REQUIRED
It is evident from the foregoing discussion that the notion of a payday loan as a two-week extension of credit is fictional, and that in fact it is mutually understood that the loans will continue for substantially longer periods. Disclosure of the finance charge for a two-week increment, which is then renewed repeatedly, tends to camouflage the extraordinarily high cost of these loans.
The Board should stop this pernicious practice immediately. The lender should be required to inquire when the borrower in fact expects to be able to repay the loan, and from what source, and make disclosures accordingly. This will make clear to the particularly vulnerable and unsophisticated borrowers that obtain these loans that a 500% interest rate means that if they borrow $100 for a year, they will have paid $500 in interest and still owe the $100.
C. FAILURE TO COMPLY WITH CONSPICUOUSNESS REQUIREMENTS
Payday lenders frequently fail to (i) make the federal disclosures clearly and conspicuously, (ii) make the finance charge and annual percentage rate more conspicuous than any other required disclosure or (iii) conspicuously segregate the federally-required disclosures from all other matters, which is generally done through use of a "federal box". This has led to a substantial volume of litigation concerning which violations of the Truth in Lending Act and Regulation Z carry statutory damages.
Several cases have ruled that violations of the "conspicuousness", "more conspicuous" and "segregation" requirements do not carry statutory damages. These rulings are inconsistent with other decisions, and are incorrect.
Section 1640(a) provides for civil liability of creditors under the Truth in Lending Act. The section imposes liability on "any creditor who fails to comply with any requirement imposed under this part . . . ." 15 U.S.C. 1640(a)(emphasis added). "This part" refers to "Part B - Credit Transactions." Part B contains 1631-1649. These sections include 1632, which requires that information be clearly and conspicuously disclosed, and 1638, which contains the "segregation" requirement.
The fourth sentence in 1640(a)(2) provides: "In connection with the disclosures referred to in section 1638 of this title, a creditor shall have a liability determined under paragraph (2) [statutory damages] only for failing to comply with the requirements of paragraph (2)..., (3), (4), (5), (6), or (9) of section 1638(a) of this title . . . ." 15 U.S.C. 1640(2). The quoted language applies only to allegations made under 1638 of the Truth in Lending Act. It does not somehow exempt creditors from liability under the rest of Part B. Section 1640 imposes liability for all of Part B; this part of the section only specified what a creditor could be liable for in connection with 1638. The plain meaning of the statute is that a creditor is liable for statutory damages for violations of any requirements of Part B, except that only certain requirements in 1638 carry statutory damages.
The Board should provide clarification and expressly provide that failure to disclose the finance charge and annual percentage rate clearly, conspicuously, accurately, and more conspicuously than any other disclosure triggers statutory damage liability.
Sincerely yours,
Daniel A. Edelman
Secretary, Illinois Consumer
Justice Council, Inc.
