by Scott Nelson
Oregon Governor Ted Kulongoski yesterday signed into law a package of bills designed to protect consumers against abuses by the payday lending industry and other short-term lenders that target vulnerable borrowers with high-interest loans. Together, the new laws will, among other things, cap interest rates, limit rollovers of short-term loans, and attempt to regulate internet transactions. Importantly, the interest rate caps are not limited to specific loan products -- which would facilitate evasion as lenders responded by modifying their loans to take them outside the laws' restrictions -- but apply to all consumer finance loans involving amounts less than $50,000.
The new laws should significantly ease the triple-digit interest rates charged by payday lenders and their cousins, auto title lenders. Indeed, payday lenders say the new laws will drive them out of the state altogether. Whether that is so remains to be seen, but the laws still allow payday lenders, through a combination of interest rates and "origination fees," to charge effective annual interest rates of well over 150% on one-month loans.
Background of the New Laws
Oregon, like many other states, had effectively repealed its usury laws in 1981, when a law imposing an interest rate cap of 36% on consumer loans was repealed. In recent years, the payday lending industry had taken full advantage, charging interest rates that often exceeded 500% annually. One frequently cited measure of the industry's penetration of the Oregon market is that the number of payday lenders operating in the state substantially exceeds the number of McDonald's franchises (though this is true in most other states as well, according to a researcher at California State University - Northridge).
Concerns about excessive interest rates being paid by Oregon consumers to payday lenders led a special session of the legislature to enact legislation last year that would limit interest on payday loans to a 36% annual rate (not including "origination fees" that could total as much as $10 for each $100 loaned). The law also provided that payday loans could not be made for periods shorter than 31 days, that existing loans could only be renewed twice, and that a "new" loan could not be made within seven days of the expiration of a prior loan.
But the law only applied to payday loans, which were defined as loans for periods of 60 days or fewer. And its effective date was postponed until July 1, 2007, so its interest rate caps have yet to take effect.
The payday loan industry responded in two principal ways. First, lenders reportedly began restructuring their products to avoid the interest rate cap and other provisions by extending their loan periods to more than 60 days. Second, the industry began a PR offensive aimed at weakening or repealing the law (or at least not broadening it) before it ever went into effect. The industry's principal theme was that the law would put all payday lenders out of business and deprive less well-off consumers of a needed financial service.
Meanwhile, legislators and consumer activists became focused on a couple of major gaps in the 2006 legislation: Its inability to reach payday lending over the internet, and its failure to cover "auto title loans," which charge similarly inflated interest rates but were excluded from the definition of "payday loans" because they are secured by motor vehicle titles.
The 2007 Legislation
With that background, and a fall election that put Democrats in control of both houses of the legislature, the stage was set for a new battle over payday lending in the 2007 legislative session. At issue was whether the various loopholes open for exploitation in the 2006 law would be closed, or whether it would go into effect with the industry already positioned to avoid many of its limitations.
In the end, reformers largely won the day. A set of three measures regulating consumer lending were passed and signed into law by the governor. Although the three laws are made somewhat complex by their confusing cross-references to each other, their key features can be summarized briefly. The first provides that restrictions imposed by Oregon law on payday and auto title loans apply to loans that Oregonians enter into via the internet, over the phone, or by mail from Oregon, even if the lender is located elsewhere.
The second extends the 2006 law's interest rate cap on payday lenders to auto title lenders as well. Thus, auto title loans, too, will be limited to a 36% annual interest rate (plus a one-time origination fee for "new" loans of up to $10 per $100 borrowed). The minimum loan period will be 31 days, only two renewals will be permitted, and a "new" loan cannot be made within seven days of a prior loan's expiration.
The third of the new laws aims at preventing payday lenders from getting around the interest rate cap by restructuring their products to avoid falling within the definition of "payday loans" or "auto title loans." It provides an interest rate cap applicable to all consumer finance loans involving principal amounts less than $50,000. The cap is different from the cap on payday and auto title loans in two respects. It is set not at 36%, but at 36% or 30 percentage points above the discount rate on 90-day commercial paper at the Federal Reserve Bank in San Francisco, whichever is greater. But while that gives other lenders the potential ability to charge a higher nominal APR than payday lenders, lenders other than payday lenders and auto title lenders are not permitted to exclude "origination fees" from the percentage rate cap; rather, the cap covers all amounts that are included in computing finance charges under TILA.
In addition to these measures concerning consumer lending, a fourth companion bill, also passed by the legislature and signed by the governor, regulates another side of the payday lending industry by requiring licensing of check-cashing companies and limiting the fees they can charge to either $5 per check or a percentage of the face amount of the check ranging from 2% to 10% (depending on the nature of the check).
Whither Payday Lending?
The laws' passage has consumer activists applauding and the payday lending industry predicting its own doom. Proponents of the new laws seem uncertain whether the proper response to those predictions is skepticism or a simple "Good riddance."
But one point that I haven't yet seen in the discussion is that the interest rate caps still permit payday lenders and auto title lenders the unique privilege of earning whopping effective rates of interest on short-term loans, because they exclude from the cap "origination fees" in amounts of up to 10% of the nominal amount of the loan.
To see how this works, imagine taking out a payday loan for $100 for the minimum one-month period permitted by the law. Right away, the lender takes out $10 as an "origination fee," so you really get a loan of only $90 cash. But you have to pay back $100 next month, plus interest at a $36 percent annual rate (or 3% a month, which is $3 on a $100 loan). In other words, you borrow $90 and in one month pay back $103, for a total finance charge of $13.
Thirteen dollars is 14.44% of $90. A 14.44% monthly interest rate equates to an annual rate of 173.33%. That's quite a nice return on anyone's money. Why, one wonders, can't payday lenders stay in business charging rates substantially exceeding 150%?
Of course, it's not quite that simple. A payday lender can only charge the origination fee once for each new loan, so if it renews the loan once or twice (the maximum number of renewals permitted), its effective annualized interest rate goes down -- to about 107% for a two-month loan or 85% for a three-month loan. Still, those are pretty good returns themselves.
Critics of the industry, however, suggest that it makes most of its money not off consumers who pay back their loans in a month or two, but off those who can't and therefore have to keep rolling over their loans. So maybe the high effective rates that lenders can make off those consumers who pay off promptly won't be enough to keep the industry afloat, and the limits on rollovers will limit the exploitation of those who can't promptly repay in full, which is where the industry really makes its money. If that's so, however, the demise of the industry might not be a bad thing at all. Any industry whose best argument is that it can only make money by exploiting the worst of its credit risks, and keeping them in a never-ending cycle of renewals and interest payments, doesn't seem to have much going for it.
Anyway, with the laws set to go into force next month, we'll see if payday lenders in Oregon indeed go the way of the dinosaurs. I'm betting they won't, but who knows?
Now if they could just do something about all those McDonald's ....