Small loans cost consumers big bucks

(05/17/2010) Consumers are getting gouged by payday loans; auto title loans and small, unsecured installment loans because few states adequately protect them from high costs and the loan products come with few if any federal government protections

Only 10 states protect consumers against the abusive lending practices of all four, so called "small-dollar" loan products or come close to scoring high on the issue, according to "Small Dollar Loan Products Scorecard -- Updated" a new report by the National Consumer Law Center, Consumer Federation of America, and Consumers Union, publisher of Consumer Reports.

"Steep rates for short-term small loans trap borrowers in unaffordable debt," said Jean Ann Fox, director of financial services for Consumer Federation of America.

"As consumers struggle to make ends meet in a tight economy, they need protection against rate gouging," she added.

The four small-dollar loan products evaluated were payday loans; auto title loans (borrower use a car title as collateral); six-month, $500 unsecured installment loans; and one-year, $1,000 unsecured installment loans. States, rather than the federal government, traditionally regulate the rates and terms for these types of nonbank small loan products.

The report evaluated how well states are doing on curbing usury by examining the statutory maximum annual percentage rate (APR) of interest and fees for the small dollar loan products and whether these products' annual percentage rates (APRs) are limited by the state's criminal usury cap.

States received a "Passing" grade if the loan product's APR was 36 percent or less or if they prohibited payday or auto title loans. States that did not have a cap on the loan product's APR or those that allowed a loan product's APR to exceed 36 percent received a "Failing" grade.

The 36 percent rate cap is what consumer advocates say should be an industry standard. The 36 percent rate cap on small loan lending became civil law in most states by the mid-20th Century to address the widespread problem of loan sharking.

Federal legislation was introduced in both the U.S. House of Representatives and the U.S. Senate in 2009 to cap the cost of credit at 36 percent. In 2006, Congress enacted a 36 percent rate cap to protect military service members and their families from abusive lending. Thirty-six percent is also the limit set by the FDIC's Responsible Small Dollar Lending Guidelines and is double the cap for federally-chartered credit unions.

So how are states doing regulation small-dollar loans? Not so well.

In all but a few states, consumers had better read the small print that comes with small-dollar loans. Of course, even when there are more consumer protections in place, consumers must remain diligent about fully reading contracts before signing on the dotted line.

• Eight jurisdictions protect consumers against abusive lending practices for all four small dollar loan products: Arkansas, Connecticut, District of Columbia, Maryland, New Jersey, New York, Pennsylvania, and Vermont. Also Massachusetts and West Virginia came close to earning a perfect score, but fees added to low interest for $500 unsecured installment loans in those states push the APR to 37 and 38 percent, respectively.

• Fifteen states fail to protect consumers against abusive lending for all four products: Arizona, Delaware, Idaho, Illinois, Minnesota, Mississippi, Missouri, Montana, Nevada, New Mexico, South Carolina, South Dakota, Tennessee, Utah, and Wisconsin. When Arizona's payday loan law sunsets July 1, 2010, the state will get a passing grade on that product.

• Payday loans were the primary culprit for states that scored worst. Thirty-six states fail to protect consumers against high cost payday loans. Thirty-one states fail to protect consumers from high-costs for six-month, $500 unsecured installment loans and twenty states fail to protect consumers against expensive auto title loans.

• States are better at protecting consumers against expensive one-year, $1,000 unsecured installment loans. Twenty-eight states and the District of Columbia received a "Passing" grade in this area.

• Five states set no usury caps for small loans, including Delaware, Idaho, South Dakota, Utah, and Wisconsin.

"The 2010 Scorecard shows that consumers need effective loan protections at both the state and federal level," said Gail Hillebrand, manager of Consumers Union's campaign.

She added, "Congress should make sure that financial reform includes a strong, independent watchdog in Washington to protect consumers from unfair lending practices no matter what state they live in. And states should have the power to enforce the law and enact even stronger safeguards."

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