The Checkout

Payday Lending & the Military: Part 2

Just when you thought Congress had dealt with this issue, it just keeps comin' back.

A quick recap: After a push by the Pentagon and consumer groups, Congress passed legislation capping the annual interest rate lenders could charge members of the military at 36 percent. The reason: An increasing number of service members were losing their security clearances because they had fallen into debt, in part because of reliance on payday lenders and online lenders that target members of the military, charging them fees and interest rates on loans that, when added up, reach APRs well into the triple digits.

Payday lenders tried to argue they are simply offering credit to folks who otherwise couldn't get it and the fees and interest they charge reflect the risk they assume as well as their costs. Their argument, suffice it to say, didn't prevail though, at least not when it comes to service members.

Since the law passed, two major banking trade groups, the American Bankers Association and Independent Community Bankers of America, have gone to the Pentagon to ask to be exempted from it, saying it would hamper them from offering alternatives to payday loans. Comments by industry were due today. (Feb. 5)

Let's take a look at some of the banks' arguments:

* The 36 percent interest rate cap would limit the size of a late fee charged on a small credit card balance.

* Fees charged for bounce protection programs and for overdrafts could also breach the cap.

* It's hard to identify members of the military, not to mention their dependents.

* The new law is unnecessary.

What I find curious about the banks' stance is that they are trying to have it both ways. They are saying their products should not be lumped in with payday loans, yet at the same time, they want to be able to keep charging what in many states counts as usurious interest rates! (Federally insured and state chartered banks are already exempt from state interest rate caps. That's why Citibank can still charge me 29 percent interest on my credit card even though interest rates are capped at 6 percent in D.C.)

Upon closer examination, the so-called payday alternatives some banks offer aren't much in the way of alternatives at all.

* First Bank of Delaware offers installment loans through the Internet provider PurposeLoans.com aimed at the "frequent customer of cash advance" that can carry an APR of 350 percent for a $300 loan.

* Wells Fargo Bank and U.S. Bank offer a "direct deposit account advance" with high up-front fees, repayable on payday with an advertised APR of 120 percent.

Supporters of the law concede there could be alternative loan products that might run afoul of the 36 percent interest rate cap, but they argue that regulators can easily write individual exceptions for those products and that a carve-out for an entire set of institutions is not necessary. The point of the law, after all, is to protect military borrowers, not existing credit practices.

Worth noting is the stance taken by the National Association of Federal Credit Unions, which include those associated with the various wings of the military such as the Naval Federal Credit Union, which are often on the front line when it comes to providing payday loan alternatives to service members.

"We did not seek out a carve-out during the legislative process and are not today seeking one," said NAFCU president Fred Becker.

Now, if it were up to consumers, rather than regulators, I reckon the banks would have a harder time convincing anyone of their "need" to charge late fees that add up to an APR higher than 36 percent. Ditto for bounced check and overdraft fees. But it's not up to consumers. It's up to the Pentagon, which is supposed to draft regulations and implement the law starting in October. We'll see how it shakes out.

By Annys Shin |  February 5, 2007; 9:00 AM ET Consumer News
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Comments

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Why should this be limited to the Military? I mean, it's at least the start of a good idea, working towards a world in which the financial institutions aren't busy raping those who can least afford it, but why not make these system-wide?

Posted by: Anonymous | February 5, 2007 9:24 AM

Right, as prior military, I was lucky enough to avoid all these crazy interest rates on loans, but there are still unreasonable charges and high interest rates that can get slapped on for little to no reason. Where is the common sense? Why does obscene greed run the system, and why has it taken so long to put it in check? I will never forget getting a very high and very wrong automatic bill that cleaned out my account, and when all my normal bills went through they bounced and I got dinged for every last one. My credit rating went down, my interest rates skyrocketed, and my payment amounts went up- which made living very tough for a while because of course I had to cover a lot more on a lot less, and it took me years to recover. These people are greedy and ruthless. As much as I love the idea of free trade, there need to be some common sense controls to protect everyone from abuse.

Posted by: Chris | February 5, 2007 9:45 AM

The reason is in the article, to cut the risk of personnel not qualifying for security clearances due to high debt to income ratios. Military because military salaries aren't necessarily based upon free market enterprise and a large number of junior enlisted personnel and their families qualify for food stamps, which is a shame b/c they are on the American payroll. They fall prey to these predatory lenders because they have few other alternative to make ends meet in an emergency(ie, the military discourages 2nd jobs). Again, I don't think ANYONE should be subject to a 350 percent interest rate on a $300 loan, but especially not the military members who put their lives on the line to protect democracy and free enterprise.

Posted by: tlawrenceva | February 5, 2007 9:46 AM

State anti-usury laws with what we would now call low interest rate caps (6 or 8 percent was common) used to cover just about everything. Nowadays they have more loophole than substance and rarely apply to anything. You can blame that partly on industry lobbying, partly on a period of high inflation which made the effective rates negative and would have shut down the credit markets, and partly on the consumer (who isn't greed-free either).
Liberal credit probably generates more wealth overall but exposes individuals to more risk.
I'd like to see an absolute cap at something like 18% plus an inflation index. Loans which can't be made profitably at that rate just shouldn't be made.

Posted by: WW | February 5, 2007 10:13 AM

For folks looking to pay off their payday loan debt with a traditional fixed rate loan (at a much lower interest rate), check out http://www.prosper.com It's a person to person lending marketplace (think eBay for loans) that was started by Chris Larsen, who previously founded E-Loan.

Also take a look at http://www.squidoo.com/prospertips for more information and tips for writing your listing from a Prosper lender.

Posted by: mac | February 5, 2007 10:30 AM

Annys Shin raises a good point about credit alternatives. It seems as though all short term credit alternatives are well above the 36% rate cap. That's just a function of short-term credit. Anyone whose ever needed to write a check for something TODAY, but doesn't get paid until next week, understands this. If I bounce a check it costs me $39. Pay a credit card bill late, same thing. I think payday loans run about $15 per one hundred. Short-term credit is costly, there is no way getting around it. Sure, a 36% rate cap sounds like a good idea, but it doesn't work when applied to short term credit. If you take all of the options away, what will people do? If banks can't charge fees, they'll probably close any account that is ever overdrawn. Same goes for credit card companies. You can't regulate short-term credit the same way you do long term credit. It just doesn't work.

Posted by: Lillian | February 5, 2007 11:30 AM

Never mind the collection of laws and rules that "govern" usury. As long as there is no reason to avoid taking too much in interest from anyone, lenders will charge whatever they can get away with. I have a brilliant idea how to form a regulated system without actual regulation. Let the tax code change so that anyone, natural or incorporated, loaning money to anyone has to file that income on a separate schedule, which shows the principal loan amounts and the total of repayments. If the repayments add up to more than, say, 110% of the principal, then the filer is subjected to a tax surcharge of 99% of the amount in excess of 110%. Oh wait a minute. If we were allowed to subtract interest payments from our taxable incomes (as we were before the Reagan tax reforms), maybe lenders would not dare to charge the kind of money they do. Maybe consumers should stop spending money (after all, the personal savings rate in 2005 and 2006 was a negative number) with credit/plastic/debit and actually save a few dollars.

Posted by: Guy Sherr | February 5, 2007 12:18 PM

Frankly, I think the real scandal is that the military folks are paid so poorly as to be stuck in this position in the first place! Something is not right.

Posted by: Occasional reader | February 5, 2007 12:34 PM

"If we were allowed to subtract interest payments from our taxable incomes (as we were before the Reagan tax reforms), maybe lenders would not dare to charge the kind of money they do."

Guy, what on god's earth are you talking about? That'd make the problem even worse by making debt more attractive.

Posted by: Anon | February 5, 2007 12:44 PM

Lillian,

"If I bounce a check it costs me $39. Pay a credit card bill late, same thing."

Paying a credit card bill late can have an adverse affect on your credit (i.e. Buying a house, refi, loans). Bouncing multiple checks can have the same affect if you are dealing with the same bank for a loan, but it doesn't go much further than that.

Why ruin your credit for something that if was managed better, a person would not be in that position to have to make that choice.

Posted by: I 8 the C | February 5, 2007 1:01 PM

Annys--
do you really have a credit card charging 29% interest? Even if you pay it off every month, you are enabling this sort of excess interest charge. Get one from a credit union--the rate will be much lower.

Posted by: larry | February 5, 2007 2:25 PM

Short term interest rate managing is possible, the idea that banks wife shut down accounts if they can't charge what ever they want to is comedy.

Posted by: greg | February 5, 2007 2:42 PM

Back before I was an adult, before teenagers could get credit cards, and before the Reagan tax reforms in 1984-1986, ALL consumer credit interest could be subtracted from ordinary income. I do realize that it makes debt more attractive, however, it also makes it more fairly taxed. First, you borrow money from a lender that has been taxed already. Second, you repay the lender with interest, paying tax on all the income you earned to repay them. Finally, the lender is taxed on the net interest AGAIN. If we strip off the interest paid on any consumer loans, the government would have a mighty incentive to stop the high fees, and put an end to credit cards that take a lifetime to pay off because the tax on corporations is, dollar for dollar, lower than it is on people.

Posted by: Guy Sherr | February 5, 2007 4:48 PM

Payday lending, tax refund anticipatory loans, and the like, is usury preying on the poor or irresponsible, and interest rates and fees should be limited. Military men and women should not be victimized by these lending companies. Banks should not be allowed to charge $35 fees on a bounced check. The only reason these things have not been outlawed, is that the "public servants" who represent us in government are not the poor or working class who struggle with their finances, so they have no understanding of how punishing these excessive fees are to the ordinary person using the services.
It's disturbing to me that a secret government clearance is essentially a credit check, based on the notion that someone with bad credit would compromise themselves for a few easy bucks. A late phone bill, a missed credit card payment, and suddenly you are regarded as suspicious. Credit ratings can have a major impact on your life, in achieving clearance as mentioned; in getting an apartment (ironically, landlords often check credit before approving an application, yet do not report your timely rent payments to credit agencies); in getting credit cards at a fair rate without excessive annual fees.
I think credit is an obstacle in equality, poor credit ratings unfairly hamper people in competing in the marketplace, in renting a home, in qualifying for a mortgage. It makes it hard to acquire or keep a credit card, in a retail world that all but requires a person to have credit.
The fact that the military is finally having to take action to protect it's people is a sign that eventually all credit reporting practices, and the way those ratings are used will have to be reevaluated.

Posted by: Jive | February 5, 2007 5:26 PM

Banks wants to limit the 36%APR cap to $200 payday loans but exempt their own $20,000 credit card balances and overdraft charges...how dumb is that! Since APR changes wildly on micro amounts for short periods of time, no bank is going to deal with any persons covered under this new law. ie, if you charge someone in the miliary a 2 CENT fee to loan them $1.00 for 14days you can be charged as a crimial.
$1.00x36%=.36 divided by 26 weeks (14days) = .0139. So charging someone 2 cents instead of 1.39cents becomes. criminal. 2 cents is 52%apr. The law is silent about dollars, just APR! Any banker that understands the law will make the military bankless!

Posted by: allan jones | February 7, 2007 9:57 PM

A payday loan with a $15 fee is far better than bouncing a check or maxing out a credit card. A payday loan won't affect your credit rating, and as long as you pay it off on time--as any responsible borrower should--it is a more practical credit solution than the alternatives.

Posted by: jay | February 8, 2007 9:58 AM

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