Encourage responsible credit for financially vulnerable consumers

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Millions of Americans are financially vulnerable. Yet the credit options available to borrowers in some cases further reduce their financial security.

The story of 60-year-old Arizona woman Susan Fronczak shows how expensive and risky consumer credit can be. She borrowed $ 2,000 from an auto title lender – a company that provides loans backed by a car title and spare key set – at an annual interest rate of 182%, under an agreement that would cost him at least $ 3,860 to repay the $ 2,000 loan. . In the end, she couldn’t afford the monthly payments and her car was repossessed. By the time she was able to get her car back, she had paid the lender over $ 5,000.

Unfortunately, many Americans could easily find themselves in Fronczak’s place. Twenty-seven percent of Americans say they have no emergency savings at all. About two in five American families say they would “probably not” or “definitely not” be able to find $ 2,000 in 30 days to deal with an emergency, according to the 2012 National Financial Capability Study. For Latinos, African Americans, and young people between the ages of 18 and 34, that figure rises to half of all families. Among families in the bottom third of the income distribution, 68% said they would not be able to find money in an emergency.

At the same time, the deceptive advertising is chock-full of easy cash flow through loans with no “no credit checks needed” and “same day approval”. It is perhaps not surprising that many people are turning to these high cost short term loans – like payday loans and auto loans – in response to financial setbacks. These loans are secured against a future paycheck or car keys and are infamous for high fees and predatory practices.

These forms of expensive loans have all but disappeared from traditional banks in recent years. Pushed by financial regulators such as the Federal Deposit Insurance Corporation, or FDIC, and the Office of the Comptroller of the Currency, banks that offer high-cost deposit loans have largely left the market for cash advances secured by future income. of a borrower. . These two banking regulators adopted new common sense guidelines in November 2013 that require banks to take into account the ability of borrowers to repay small short-term loans based on their banking history over the past six months and to impose a “cooling”. period that would prevent consumers from getting trapped in a cycle of debt. Even several banks that are not subject to action by these two regulators announced in January that they would also voluntarily end their deposit advance programs.

While the departure of banks from this predatory market is a step forward, financially vulnerable consumers are still the target of predatory lenders who typically offer bogus promises of financial aid to deal with financial emergencies. Payday lenders who allow consumers to receive money up front in exchange for an agreement to repay principal, interest, and fees in the near future – sometimes as quickly as the next payday – stay legal in 36 states. And in 21 states, auto title loans – or the promise of a spare car title and set of car keys in exchange for quick cash – is another option. If the loan is not repaid quickly, the borrower’s car can be repossessed. Internet lenders have also entered the market, some of which are located offshore or on Native American tribal lands in order to evade state and federal laws, even as states have sought to regulate them.

Regulators and policymakers have increasingly paid attention to the needs of financially vulnerable borrowers and are taking action both by protecting consumers from bad products and by supporting cheaper alternatives. The 2007 Military Loans Act dramatically reduced payday loans, car titles and prepayments for active-duty military personnel by capping interest rates on loans made to military borrowers and their families. The FDIC has led banks to experiment with affordable small dollar loan programs with some success, and some credit unions and nonprofits also offer affordable loans. Employers have also put in place financial health programs that include short-term credit options, although it is not clear whether these loans will ultimately be of help or a hindrance for consumers.

But regulators and policymakers must go further to protect consumers:

  • Congress should extend the 36% annual interest rate cap that currently applies to military families to all Americans, and the Office of Consumer Financial Protection should make sure small loans really hold up. account of the borrower’s repayment capacity.
  • State governments should adopt and enforce annual interest rate caps of 36%, including all fees, and local governments should use their zoning powers to restrain the growth of high-cost predatory lenders.
  • State and federal agencies should continue to use various enforcement mechanisms to target illegal lending activity.
  • Congress and financial regulators should encourage lenders to develop and market affordable alternatives to financially vulnerable consumers.

This report explains why existing payday loan and auto title options are often harmful. It then describes the existing alternatives and future measures that can be taken to better protect consumers.

Joe Valenti is the Director of Asset Creation at the Center for American Progress.

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