A man walks into a payday loan business Wednesday, February 1, 2006, in Tacoma, Washington. Last year, the legislature passed a law prohibiting payday lenders from contacting the boss of a military borrower to collect an overdue payment. This year, under Senate bills sponsored by Senator Darlene Fairley, D-Lake Forest Park, the military seeks to cap annual interest at 36%, limit borrowers to a bond of $ 500 at a time and prohibiting a lender from granting loans to a spouse of the borrower.
Payday lenders have long marked the landscape of low-income communities across the country. Their no credit check loan, which offer short-term credit at exorbitant interest without taking into account the borrower’s repayment capacity, often come with difficult repayment terms and aggressive collection practices.
For years, policymakers and consumer advocates have worked to prevent borrowers from getting trapped in a long-term debt cycle. But a recent development, online payday loans, raises new policy challenges and poses a particular threat to state-level consumer protection efforts.
Fourteen states and the District of Columbia have effectively banned payday loans. Other states have taken steps to counter the worst abuses, for example by limiting the number of back-to-back loans. Meanwhile, a growing number of lenders have taken to the Internet; and many now claim the right to market their products wherever they see fit, totally ignoring state consumer protection.
As policymakers and consumer advocates continue their efforts to cap interest rates and tackle the worst abuses, it is crucial to prevent online gamblers from circumventing state laws and ensuring that banks cannot facilitate their efforts to do so.
Applying for a payday loan is easy – dangerously. The borrower provides their name, social security number, employment history, monthly income, and other basic information. The lender also obtains the borrower’s bank account and routing numbers. The loan proceeds are then deposited into this account and payments are withdrawn on or around the borrower’s payday.
Whether it’s a storefront or an online loan, the lender relies on direct access to a bank account to collect payments. Unlike store payday loans, however, online loans are usually repaid in installments; and instead of leaving a post-dated check on the lender’s file, borrowers allow lenders to make electronic withdrawals directly from their bank accounts.
This permission can lead to serious problems later in the life of the loan. When borrowers agree to let a lender debit payments directly from their checking account, authorization is often difficult to revoke. Consumers have complained about being harassed at work. Lenders often make multiple attempts to debit the same payment, resulting in multiple overdraft fees, which can worsen a borrower’s already precarious financial situation. Unlike credit cards or auto loans where a borrower has some control over when to pay the bill, these payments are automatically withdrawn. Borrowers can find themselves without money to pay their mortgage or rent bills, or for groceries or other necessities.
In the event of default, some loan contracts even allow lenders to recover the full amount owed, often through the little-known practice of checks created remotely. Remotely created checks, unlike paper checks used to secure in-store payday loans, are generated by the lenders themselves and not signed by the borrower.
These payments are largely unmonitored, and lack strong fraud prevention mechanisms necessary to protect consumers from telemarketing and other scams. In part because of these fraud prevention limitations, remotely created checks have been largely replaced by better regulated forms of electronic payment, and some advocates have requested a ban on their use in transactions with consumers.
Problems with payment and collection tactics aside, more and more payday lenders are outright breaking state consumer protection laws. Currently, at least 16 tribes and many offshore lenders have started online operations. These tribal and foreign lenders regularly market and issue loans across the country, including states where payday lending is effectively prohibited. In states that allow payday loans, they claim to be exempt from basic licensing and consumer protection requirements. Even in situations where loan companies are owned and operated by tribes, these lenders are still required to follow state and federal laws when granting loans.
Until these consumer protection concerns are resolved, borrowers benefiting from online payday loans will continue to face abusive practices and limited remedial options if they encounter any problems. Ensuring that all lenders follow the same set of rules and that consumers can make informed choices about their credit options means both tackling payment and collection abuse and cracking down on lenders seeking to evade. much needed and hotly contested state consumer protection laws.
Federal banking and consumer protection agencies play an important role in protecting consumers from abusive or illegal online payday loans and have started to take notice. Recently, the Consumer Financial Protection Bureau announced that it had started researching the online loan industry. The office also launched a separate survey in the practices of a number of online lenders claiming tribal sovereign immunity from state laws.
Other regulators have also intervened. Last month, the Federal Deposit Insurance Corporation published a letter advising the banks it oversees that processing payments for online payday lenders and other high-risk merchants could expose them to legal and reputational risks. While the scrutiny of the enabling role of banks is in line with the long-standing prudential expectations of federal banking regulators, this announcement comes at an important time. State regulators in California, new York, Maryland and other states have recently turned their attention not only to lenders who violate national consumer protection laws, but also to banks which make illegal lending possible. The Ministry of Justice, the Federal Trade Commission, and the Office of the Comptroller of the Currency have also taken steps to prevent online payday loan abuse.
There is still more to do. The online loan market is changing rapidly and new consumer protection tools are needed to keep consumers safe. Allowing the continuation of abusive practices or the outright circumvention of the current law will erode more than a decade of successful state efforts to protect consumers from the problems associated with high cost loans. To eliminate the worst online lending abuses, we need tough regulations for both lenders and the banks that encourage them. And Washington must play a role.
Last spring, Democratic Senator Jeff Merkley of Oregon introduced the Combating Electronic Lending Abuse and Fraud Act 2013. Merkley’s proposal, and a similar bill sponsored by Oregon Democratic Rep. Suzanne Bonamici, would require all lenders, both online and in-store, to comply with state consumer protections. It would also restrict the use of remotely created checks and ban the use of so-called lead generators – brokers who collect information about consumers’ jobs and bank accounts and sell it to lenders online. These protections, and continued vigilance on the part of banking and consumer protection agencies, are essential to ensure consumers are protected, whether they take out a payday loan in a store or online.
Tom Feltner is director of financial services at the Consumer Federation of America, a member of the Americans for Financial Reform.
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