Weekly Briefing

Many of the worst have gone, but North Carolina is still home to hundreds of high-cost lenders

North Carolina public officials have received a lot of well-deserved praise in recent years for their efforts to protect consumers from predatory loans that sock those who can least afford them with exorbitant fees and interest rates. The state's 1999 anti-predatory mortgage lending law became a national model and helped give birth to a new national consumer advocacy group with roots in North Carolina.

Since that time, the state has been at the forefront of the battle to stop high cost, "subprime" lenders from extracting wealth from lower and middle income working neighborhoods. Just last month, Governor Easley (who has been one of the most aggressively pro-consumer governors in state history) signed three new bills into law that should work to help stem the tide of mortgage foreclosures and expand state-level efforts to assist homeowners in dire straits.     

The state has also fought for consumers at the other end of the lending spectrum. In 2001, state lawmakers allowed a law that had legalized so-called "payday lending" to expire and initiated a multi-year battle to cleanse the state of what amounted to legalized loan sharking. Today, North Carolina is essentially free of the worst of these bottom feeding parasites and thousands of people who had become addicted to what some called "the lending equivalent of crack cocaine" have been "detoxed."

Only batting .500?

So, with all these successes, can North Carolina consumer advocates declare victory in the fight against predatory lending and move on to some other worthy objective? Unfortunately, the answer is "not just yet."

Confirmation of the challenges that remain in this area (and of the resiliency of the low-end lending industry) comes through in a new "Small Dollar Loan Products Scorecard" released late last month by a trio of national consumer watchdog groups: Consumers Union (publishers of Consumer Reports), the Consumer Federation of America, and the National Consumer Law Center.

According to the scorecard, North Carolina gets a passing grade for its bans on high cost "payday loans" and so-called "car title loans" (a product that has never been legal in the state). The report even singles North Carolina out with specific praise for its long and hard fought victory over the payday crowd.

Unfortunately, on two other types of smaller transactions (a six-month $500 unsecured installment loan and a one-year, $1,000 unsecured installment loan), the report gives North Carolina a failing grade (though to be fair, the state just misses on the latter).

Unfinished business

Here's the basic problem: For decades North Carolina has capped the interest rate that can be charged on small, unsecured loans at 36%. Though obviously quite generous to the lending industry, this has long been accepted by various national experts (including the scorecard authors) as the maximum fair interest rate for small, higher risk loans.

Unfortunately, lenders in North Carolina succeeded years ago in obtaining an additional per loan origination fee on top of the 36% that can drive the effective interest rate higher on very small loans. According the scorecard, the effect of this fee is to drive the real interest rate on the six-month $500 loans to 54%. For the $1000 loans, the rate is just above the accepted cap at 37%.

To make matters even more complicated and confusing, North Carolina allows two different "blended" rate caps. Lenders must choose whether to make loans under one of two statutory schemes. Here's how they work:

Scheme #1 allows lenders to make loans of up to $3,000. The interest rate is calculated by applying the 36% rate to the first $500 and 15% to the remainder. Lenders then get to charge an additional fee on every loan.

Scheme # 2 allows lender to make loans of up to $10,000. The interest rate is 30% on the first $1,000 and 18% on the remainder.

 As a practical matter, it can be more advantageous on most mid-sized loans for the lender to operate under the second scheme (the so-called "optional rate") because the overall blend will be higher on all but the smallest loans.

The bottom line on all of this is that a lot of companies are extracting a lot of profits from vulnerable borrowers in North Carolina - enough to support and maintain 555 separate loan offices throughout the state at last check. 

So what can and should be done?

According to the Small Dollar Loan Products Scorecard, nine jurisdictions (Arkansas, Connecticut, the District of Columbia, Maryland, New Jersey, New York, Pennsylvania, Vermont, and West Virginia) protect consumers against abusive rates in all four small dollar loan products surveyed. In Pennsylvania, for instance, the maximum rates on the $500 and $1,000 loans are 26% and 22%, respectively.

In addition, several other states that do a poor job on payday loans and/or car title loans actually do a better job than North Carolina on small consumer loans. In North Dakota, for example, the maximum rates are 28% and 25%. Indeed, fully 36 states maintain at least one interest rate cap that's lower than the two reported for North Carolina.

In short, there appears to be plenty of room for improvement in North Carolina when it comes to protecting vulnerable consumers of modest means - without getting out of step with the rest of the country. Unfortunately, at this point there's little indication of any positive legislative momentum for such an outcome.

Indeed, in recent years, industry lobbyists have actively pushed for legislation that would further loosen North Carolina's rate caps. And while Governor Easley has always loomed as a formidable and determined roadblock to such efforts, neither of the two people competing to succeed him next year has given much of an indication that there share the Governor's passion for this issue.

Meanwhile, over at the General Assembly, the House has recently appointed a study committee long sought by lending industry lobbyists on "unbanked and underbanked consumers." And while, the Speaker's appointments to the group do not give any indication of a predisposition to do the industry's bidding, the group will certainly bear watching - if for no other reason than to make sure that industry lobbyists are not able to successfully promote the idea that storefront loans of 37% or 54% (or higher) are in any way a reasonable alternative to traditional banking products for people of modest income.

Going forward

The issue of how and when to provide credit at fair rates to people of low income has long plagued civilized society. In recent years, the explosive growth of a new class of predatory lenders seems to have sparked a reformist counter-wave that could, with a little luck and hard work, transform the lending landscape in a positive way for decades to come. Let's hope that North Carolina lawmakers continue to help lead the way and resist industry appeals to retreat.

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This entry was posted on Wednesday, September 10th, 2008 at 8:20 am and is filed under Weekly Briefing. You can follow any responses to this entry through the RSS 2.0 feed.