On February 26, 2009, Senator Richard Durbin (D-Ill.) introduced SB 500, the “Protecting Consumers from Unreasonable Credit Rates Act.” SB 500 would establish a 36% per year usury cap on virtually all consumer credit transactions.
Unlike the Talent Amendment, which set a 36% rate cap on certain credit transactions involving military service members or their family members, SB 500 imposes a 36% rate cap on all consumer credit transactions subject to the Truth in Lending Act (TILA). The bill would establish a new, more inclusive, effective rate calculation, referred to as the “FAIR.” Moreover, if passed, the bill would:
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Possibly require creditors to disclose the FAIR instead of the traditional APR on installment sale and loan transactions.
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Cap the rate at 36%, as calculated in accordance with FAIR (which includes such items as credit insurance premiums, default fees, costs for ancillary products, etc.) on all consumer credit transactions subject to TILA.
The bill does not preempt more consumer-friendly state laws (in other words, states can enact a lower rate cap), and it enables state Attorneys General to enforce the rate limitation.
SB 500 provides that “no creditor may make an extension of credit to a consumer with respect to which the fee and interest rate . . . exceeds 36 percent.” Although at first blush some creditors may not find this limitation unreasonable, the devil is in the details, and there is plenty in SB 500 to worry all creditors. SB 500 imposes harsh penalties for violations of the substantive rate cap, including:
Criminal Liability of a maximum one year in prison and the greater of three times the amount of the total accrued debt, or $50,000.
Civil Liability. In addition to current remedies available to the consumer, under TILA section 130(a):
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Any obligation to pay a creditor or prospective creditor that violates the 36% rate cap is null and void, and not enforceable by any party in any court or alternative dispute resolution forum.
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With respect to any obligation that violates the 36% cap, the creditor or any subsequent holder of the obligation must promptly return to the consumer any principal, interest, charges, and fees, and release any security interest associated with such transaction.
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Notwithstanding any statute of limitations, consumers can always raise a violation of the rate cap as a matter of defense by recoupment or setoff to an action to collect such debt or repossess related security at any time.
In essence, SB 500 violations rescind or void the transaction by operation of law. In addition, consumers can attack a con-tract that complies with the rate cap at origination, but violates the rate cap during the life of the transaction as a result of new fees and charges for default and repossession, as usurious.
SB 500 defines “fee and interest rate” as “[a]ny payment compensating a creditor or prospective creditor for any fees for default or breach by a borrower of a condition upon which credit was extended, such as late fees, creditor-imposed not sufficient funds fees charged when a borrower tenders payment on a debt with a check drawn on insufficient funds, overdraft fees, and over limit fees.” The definition is extraordinarily broad when compared to the definition of “finance charge” under TILA or when compared to the definition of “interest” under most state laws. It includes all finance charges under TILA, plus any late fees, NSF fees and other fees triggered by a breach or default, plus any credit insurance premiums (whether optional or required) and plus any charges and costs for ancillary products sold in connection with or incidental to the credit transaction. Here’s why including these three items in the FAIR calculation is of particular concern, especially in vehicle or other personal property financing transactions:
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Default Fees. A creditor has no control over how many default fees the borrower will pay. Under SB 500, the FAIR calculation would include costs and fees associated with acceleration of a contract and repossession of the collateral. A transaction could exceed the 36% threshold simply because the creditor allowed the consumer to pay late fees frequently, rather than treating a late payment as an event of default and accelerating the debt. Or, if the creditor did accelerate, the FAIR calculation on the transaction could exceed the 36% threshold simply because the creditor passed on to the consumer repossession fees or attorneys’ fees and court costs during the collection process.
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Credit Insurance Fees. Currently, creditors can exclude optional credit insurance premiums from the finance charge under TILA and from the definition of interest under most state usury laws. SB 500 would include these charges in the calculation of the 36% rate cap.
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Ancillary Product Sales. Currently, creditors can exclude the cost of ancillary products from the finance charge under TILA and from the definition of interest under most statue usury laws. SB 500 includes “all charges and costs for ancillary products sold in connection with or incidental to the credit transaction” in the FAIR calculation. The 36% cap would include the cost of GAP coverage or debt cancellation agreements, property insurance, service contracts, theft deterrent devices, tire and wheel coverage, and the like. Though not necessarily intended, one can parse the language of SB 500 to include charges for title or registration fees in the calculation of the FAIR.
SB 500 excludes the following fees from the 36% cap on transactions with at least 3 fully amortizing payments and a term of at least 90 days:
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Late fees (up to a maximum of $20/month or payment);
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NSF fees (up to a maximum of $15) on checks (not on rejected ACH payments); and
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Application or participation fees (up to the greater of $30 or five percent of the credit limit, but not to exceed $120) provided:
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The creditor can exclude the fee from the finance charge under TILA;
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The fee covers all applications for credit extended or renewed by the creditor for 12 months; and
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The credit amount or credit limit equals or exceeds $300.
SB 500 does not automatically impose a new FAIR disclosure on consumer credit transactions; rather, it leaves that decision to the Federal Reserve Board. Regardless of whether a new disclosure requirement results, creditors will need to perform additional calculations to ensure that a given transaction does not violate, at least at origination, the 36% cap. Assignees and other servicers will need to recalculate the FAIR each time they assess a nonconforming late or NSF fee, and will have to monitor default fees very carefully, recalculating the FAIR each time before imposing a default fee.
Assuming the Fed decides to require additional disclosure of the FAIR, either as a stand-alone disclosure or to replace the APR, and restructure other associated disclosures (e.g., finance charge, amount financed), creditors will need to engage in costly and labor-intensive systems reprogramming to accommodate the new disclosures. Even if no new disclosures are required, reprogramming will still occur in order to calculate the FAIR on covered transactions.
SB 500 is a badly drafted, poorly considered, harsh new assault on consumer credit and the consumer credit industry. If passed as written, it would end the subprime and used car finance industry. It is unlikely that any finance company would purchase subprime paper after this law goes into effect. Prime finance companies will feel the effects as well, and both they and the rating agencies will need additional guidance on definitions and whether they must include default fees in the rate calculation. In his haste to help victims of predatory lending, Senator Durbin has not fully weighed the consequences of this bill on the people he wants to help. Draconian usury laws usually drive legitimate creditors out of the marketplace and leave consumers starving for legitimate financing sources.
Michael Benoit is a partner in the Washington D.C. office of Hudson Cook, LLP. Basis Points readers can reach Michael at 202-327-9705 or by email at mbenoit@hudco.com.