Resources for Policymakers

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Mortgage Lending | Payday Lending | Overdraft Loans | Credit Cards | CRL Testimony | Debt Settlement

MORTGAGE LENDING

A key priority is foreclosure prevention efforts to assist current borrowers.  However, a recent study by the National Consumer Law Center found that many state foreclosure laws are now "tilted against homeowners" and acting as a little-understood factor that is helping to accelerate the U.S. home foreclosure crisis.

In addition, now is the time to address the market incentives that are responsible for the proliferation of predatory loan products.  The Center for Responsible Lending has identified the following as key policy areas as prime areas for reform:

First and foremost, it is important that the interests of mortgage brokers and their clients be aligned, both in creating a duty that brokers consider the best interest of their clients and in prohibiting abusive yield spread premiums, which provide brokers with a kickback for making the loan more costly to the borrower.

 

Meaningful origination protections also include the prohibition of practices like steering, which direct borrowers into more expensive loans, and flipping, where a lender refinances a loan (typically to generate fees for the lender) without providing the borrower any net benefit from the transaction. 

 

Another way to ensure that borrowers are placed into affordable and sustainable loans is to require brokers and originators to verify the borrower’s ability to repay the loan based on verification of income and require the escrow of taxes and insurance.  The Federal Reserve recently enacted rules to ensure that lenders making subprime loans use sensible underwriting standards to make sure loans are affordable.

 

It is also important to ensure that borrowers can pay off their loans early without a penalty. Prepayment penalties operate as an exit tax, trapping borrowers in unsustainable loans.

 

Although all parties in the mortgage origination chain bear some responsibility for the foreclosure crisis, perhaps nothing exacerbated the crisis as much as Wall Street's demand for predatory loans.  As the subprime market grew, investment bankers sought more and more of these loans offering high-risk investments with the potential for higher returns.  The best way to prevent a reoccurence of Wall-Street-fueled bad lending is for the secondary market to fear adverse consequences for purchasing (and thereby fueling the demand for) abusive or unsustainable mortgages.  If investors want the hight returns that come with purchasing risky loans, they shold agree to bear some of the risk of the loans as well.  Accountability must follow the loan all the way through the chain.

 

Both the Federal Reserve and the states have taken action to regulate some of these practices, but there is still a great amount of work to be done. For a comparison of recent state predatory lending laws and the 2008 Federal Reserve Rules check out our quick reference chart. It is important to note that many of the enacted reforms are limited to only high cost or subprime home loans. Comprehensive reform would expand protections to all home loans.

For an in-depth discussion of the role of unscrupulous lending in the current financial crisis, read Testimony of Eric Stein, CRL Before the U.S. Senate Committee on Banking, Housing and Urban Affairs "Turmoil in the U.S. Credit Markets: The Genesis of the Current Economic Crisis" October 16, 2008.

 

PAYDAY LENDING

The Product: The payday lending industry's profitability is built on two ingredients: triple digit interest rates and repeat borrowers. Deceptively marketed as a quick and easy solution to unexpected expenses, payday loans are small, short-term loan of up to $500 secured by the borrower's personal check and are generally due in about two weeks.

All that is needed to qualify is a form of identification, a checking account, and proof of income either from a job or government benefits like Social Security. The customer simply writes a personal check for the amount of cash they are receiving that day plus the fee. If the loan is not repaid when due, the lender can cash their personal check as repayment.

The Problem: Because the entire loan amount, plus the fee, is due in two short weeks, borrowers typically find it hard to pay back a payday loan and also meet their regular expenses. As a result, borrowers must either extend their loan by another two weeks by paying an additional fee, or pay back their loan and then take out another a few days later when their money runs out. This is the start of the payday lending debt trap, trapping borrowers who intended to take only one loan in a cycle of indebtedness. In addition, debt trap disproportionately impacts communities of color, with payday storefronts heavily concentrated in African-American and Latino neighborhoods.

The Solution:  The only proven strategy to protect borrowers from the threat of payday lenders is to cap the triple digit interest rates.  Many states limit interest rates on payday loans to 36% annual interest, and Congress recently enacted a law that says small loans to military personnel and their families must be below a 36% APR cap. When challenged about their lending practices, the payday lending industry is quick to suggest a handful of empty "reforms" including capping the maximum loan term at 35 days, a single loan cap, a 24-hour cooling off period between loans, and optional repayment plan. Though they may sound promising, the experience of states in regulating payday lending has demonstrated that reforms short of a rate cap are ineffective.

 

Overdraft Loans

Fee-based overdraft loans cost Americans $17.5 billion each year – more than the $15.8 billion institutions extend in the loans themselves.  Small debit card overdrafts are the single largest cause of overdraft fees, although they could be easily denied at the point-of-sale at no cost to the account holder.  Most institutions automatically enroll consumers in the most expensive overdraft program available without obtaining their affirmative consent.  Moreover, many overdraft fees are shouldered by those least equipped to recover from them.  Read our quick facts on overdraft loans, which are derived largely from CRL's research.

Institutions should be required to obtain consumers' affirmative consent, or "opt-in," before covering their overdrafts in exchange for a fee. H.R. 1456, the "Consumer Overdraft Protection Fair Practices Act" sponsored by Rep. Maloney would extend the Truth in Lending Act to cover fee-based overdraft programs and require customers' affirmative consent before being enrolled in them (read an overview of H.R. 1456).

In addition, Federal Reserve Board is currently considering two very different alternatives for addressing overdraft practices related to debit card purchases and ATM transactions.  The first alternative would require institutions to allow consumers to opt out of fee-based overdraft for these transactions—which would do little to alter the status quo.  The second, far stronger alternative would require institutions to obtain consumers' affirmative consent, or "opt-in," before enrolling consumers in such programs for these transactions. Read CRL's comment letter on the Fed's proposed rule. 

Finally, an April 2009 CRL nationwide survey on overdraft loans showing that of the overwhelming majority of consumers who want a choice about overdraft, 80% prefer opt-in over opt-out for debit card purchases and ATM transactions.

 

Credit Cards

The Credit CARD Act of 2009 outlawed certain pricing strategies, making the marketplace better for borrowers. However, where reform closed the door on abuses, clever credit card issuers opened a window to foil the new law – using multiple tricks.

Rules on penalty fees issued by the Federal Reserve Board – as part of CARD Act implementation – don't go far enough. In 2010, CRL research found that penalty late fees have no relationship to card company losses and instead are just another way to raise costs for their customers.

Regulators, through examinations and enforcement actions, should help consumers by maintaining strong standards for appropriate and fair penalty fees and re-evaluation of rate increases. It should be a high priority for the new Comptroller of the Currency, especially, whose agency regulates the largest credit card issuers in the country, to work with the new Consumer Financial Protection Bureau to put the card industry on notice that the goals of the CARD Act will be achieved and reassure American families of the law's effectiveness.

To that end, consumer advocates are monitoring market developments closely and sharing their findings with regulators. Specific concerns include some cases where issuers seem to have disregarded provisions of the CARD Act, high fees related to balance transfers and cash advances, “reasonable” and “proportional” penalty fees, limited interest rate increases imposed as penalty, permanent interest rate hikes, account closures and line reductions without advance notice, ambiguous disclosures of terms, and the lack of protection for small business cards.

 

DEBT SETTLEMENT

Debt relief scams, or “debt settlement,” is a rapidly growing industry in which companies advertise they can eliminate consumer debt by negotiating reduced payoffs with creditors. The catch is that debt settlement companies usually ask their cash-strapped customers for big up-front fees, and the data show that few consumers benefit, while many are harmed.

The Federal Trade Commission and 41 state attorneys general agree that any significant fees paid to debt settlement companies before they actually do any work are unjustified and harmful to consumers. The FTC has proposed a complete ban on compensation until the provider actually settles a consumer’s debt.

Our brief overview of the debt settlement industry describes its flawed business model, provides industry performance data, and refutes common industry arguments for advance fees.

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