Regulatory Updates for Consumer Finance
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April 2021 Update
THE ALL-IN 36% APR: WHAT FINANCE COMPANIES NEED TO KNOW
You may be hearing about an “all-in 36% APR” potentially threatening the finance company business. What’s it all about?
The traditional APR. As you know, an Annual Percentage Rate (APR) is the cost of credit to a borrower expressed as an annual rate. The federal Truth-in-Lending Act (TILA) and its implementing Regulation Z sets out precise calculations and the components that make up the APR (“TILA APR”). Essentially, the APR includes periodic interest, plus any “finance charge” imposed by the creditor. “Finance Charge” includes “any charge payable directly or indirectly by the consumer and imposed directly or indirectly by the creditor as an incident to or a condition of the extension of credit”. It does not include any charge of a type payable in a comparable cash transaction. TILA and Reg Z also set forth a list of charges specifically excluded from the “Finance Charge” and the APR. The cost of credit insurance and other ancillary products is specifically excluded if they are voluntary, the cost is disclosed, and the borrower affirmatively elects them.
The all-in APR. In recent years, we have seen a rise in advocacy for a 36% all-in APR. Not only does this require creditors to calculate an APR that includes all fees, even ones excluded by TILA, it caps the APR that can be charged to borrowers at 36%. This means the cost of voluntary protection products must be included when calculating and charging the borrower.
What are some examples of all-in 36% APRs?
The federal Military Lending Act (MLA) is the prime example. Expanded in 2017 to include essentially any type of non-mortgage loan to active military members and spouses, the MLA has a highly complicated definition and application of the all-in 36% cap.
Since the MLA passed, state legislatures have jumped on the bandwagon. The most recent example is Illinois’ passage of SB 1792, the “Predatory Lending Prevention Act”, effective March 23, 2021. New Mexico also proposed a 36% all-in cap in 2021 but ended their recent session without this bill passing, due in large part to significant lobbying efforts from the industry.
Where did the 36% all-in APR cap originate from?
The origins of the cap can be traced to consumer advocates’ and regulators’ criticism of payday loans. Payday loans are short-term loans (e.g., 14-30 days) that must be repaid in one lump sum, together with a one-time fee. Long considered by consumer advocates and regulators to be “predatory loans”, the argument is that payday lenders prey on the most vulnerable consumers with little or no ability to repay and that 36% is not “affordable credit”. The Consumer Financial Protection Bureau (CFPB) under Director Richard Cordray (2012 – 2017) declared its intent to eliminate the industry, and states have long sought to regulate or eliminate that industry in their states by passing legislation that caps the rates at 36%. This rate is too low for payday lenders or subprime lenders to stay in business.
Why is the 36% all-in APR cap such a threat?
- Such caps will harm many consumers. No longer restrained only to payday loans, rate caps restrict safe, affordable access to mainstream credit for higher risk borrowers, many of whom simply do not qualify for a loan at a lower percentage rate.
- Many finance companies will not be able to stay in business at a 36% all-in cap. Margins are thin in the high-risk near-prime and sub-prime loan segment, and a 36% all-in cap does not accurately take into account the cost of providing such loans.
- An all-in rate cap does not accurately reflect the true cost of credit. TILA’s disclosure requirements were carefully crafted to reflect the true cost of credit; that is, interest and charges that a consumer must pay to obtain credit. Ancillary products such as credit insurance are voluntary, and their charges are for the additional product or service provided apart from the cost of the loan. Purchase of such products is a choice, not a requirement, and therefore should not be part of the cap. At a higher rate, financial institutions will likely forego offering ancillary products that help to protect them and mitigate default and delinquency risk and therefore consumers aren’t able to purchase the valuable protection.
What other developments have occurred?
- A new trade group has been formed by fintechs to advance a 36% all-in MLA-like rate cap (among other priorities).
- LendingClub Corporation announced on March 3, 2021 that the Marketplace Lending Association (MLA), which it co-founded, will merge with the Online Lending Policy Institute ("OLPI") to form the American Fintech Council ("AFC"). The stated mission of AFC is “to promote policies that advance responsible innovation and inclusivity within financial services.”
- The AFC has formed a “Community Advisory Board”. One founding member is the Woodstock Institute, the consumer advocacy group responsible for the Illinois 36% All-In, Military Lending Act look-alike bill.
- On Wednesday, March 10, 2021, the House Financial Services Committee held a virtual hearing, “Justice for All: Achieving Racial Equity Through Fair Access to Housing and Financial Services”. Rep. Jesus “Chuy” Garcia (D-IL) stated that he soon will be introducing the Veterans & Consumers Fair Credit Act (all-in 36% MLA rate cap). He specially mentioned the Illinois bill in his remarks.
- Numerous other bills are pending in about 13 states.
What actions are Allied and Securian taking?
We know that several of our finance company clients have self-imposed at 36% but want to be able to continue to sell ancillary products. Allied and Securian are actively engaged with industry advocacy groups and our finance company clients to review pending legislation and take action where appropriate.
With the proper engagement and focus, we can prevail on a 36% + product platform while protecting non-prime and subprime consumers of all colors and economic standing, as well as defeating other rate cap bills.
What action can your financial institution take?
Contact us to learn more about partnering on advocacy and education efforts. We’d like to hear from you regarding the impact of these bills on your consumers and your lending institution.
The information presented is intended for informational purposes only and should not be construed as legal advice or a legal opinion and it may not reflect the most current legal developments. You should seek the advice of legal counsel of your choice before acting on any information provided.