Last month, the Center for American Progress submitted comments to the U.S. Department of Defense regarding its proposed rule on limiting the availability of high-cost credit products to military service members and their families. Read the full comment letter here.
In response to a Pentagon report noting that high-cost predatory loans damage not only the financial security of military families but also the nation’s military readiness, Congress passed the Military Lending Act, or MLA, in 2006. This law limits the spread of predatory loans among military service members and their families by capping interest rates at 36 percent per year instead of the triple-digit annual interest rates often charged by payday and auto title lenders. This is an important step given the financial vulnerability of many young service members. While lenders themselves cannot threaten disciplinary actions, service members can lose their security clearances if they have trouble managing their debts. Indeed, prior to the MLA’s passage, an estimated 80 percent of revoked or denied security clearances in the U.S. Navy resulted from sailors’ financial issues. Moreover, as CAP has noted since the bill was first introduced in Congress, the MLA’s protections against predatory lending make sense not just for the nation’s troops but also for all Americans. The Department of Defense’s proposed rule would strengthen the law by covering a wider range of financial products and closing loopholes that were used to overcharge service members.
The initial implementation of the law was not comprehensive. At first, the MLA only applied to three types of loan products: payday loans, which are loans pledged against one’s next paycheck; auto title loans, which are loans pledged against the value of one’s car; and refund anticipation loans, which are loans taken out against a future tax refund. Thankfully for consumers, refund anticipation loans, which were once a billion-dollar industry, have largely left the market due to administrative changes made by the Internal Revenue Service and bank regulators. And the MLA has effectively addressed many problems with payday and auto title loans made to service members.
Unfortunately, some lenders continue to target service members by exploiting loopholes, such as offering high-cost loans with longer repayment periods that do not meet the MLA’s existing definitions for these three products. In some states, predatory lending that explicitly conflicts with the MLA is perfectly legal. For example, auto title loans under the MLA require a clear car title showing that the car is paid off. But in Arizona, title loans only require the vehicle registration—and using this document does not meet the MLA’s definition of a title loan. Even when states have made good-faith efforts to crack down on high-cost lending to their residents—such as Ohio, where voters strongly supported legislation to end payday lending in a 2008 referendum—the laws have not always been airtight. Many of Ohio’s payday lenders rechartered themselves as mortgage lenders to evade the new law, a move recently upheld by the Ohio Supreme Court.
The newly proposed rule would take a more comprehensive approach. It would expand the MLA’s 36 percent interest rate cap to virtually all loans made to service members and would include nearly all fees when calculating the annual interest rate charged on a loan, except for some reasonable fees associated with credit cards. Including fees better portrays the true cost of credit. For example, while the maximum annual rate on a payday loan in Virginia is 36 percent, two additional fees lead to an average annual interest rate of 289 percent, though rates can be as high as 819 percent.
The proposed rule would also protect service members in the financial marketplace by ending forced arbitration in service members’ consumer credit disputes. Many financial product contracts include mandatory arbitration clauses, which require consumers to give up their right to sue and instead resolve disputes through arbitration firms selected by the sellers. These clauses deprive consumers of their day in court in favor of a rigged process in which the financial provider pays for the judge and the jury.
Ken Chicosky’s story, as recently reported by The New York Times, demonstrates the significance of these loopholes, which affect military and civilian borrowers alike. Chicosky, a 39-year-old Army veteran in Austin, Texas, was charged $9,346 for a $4,000 title loan that was intended to pay for necessary car repairs. As a veteran, he is not covered under the MLA. But even if he had been nominally covered, the loan he was offered had a 24-month term, far beyond the 181-day limit for loans subject to the MLA. To make matters worse, while he might have been protected under a local ordinance prohibiting title loans that last more than three months, the lender told him he needed to complete the transaction in another town in an effort to evade the three-month limit. The challenges faced by local and state governments in addressing predatory lending practices demonstrate why federal action is needed.
Each year, millions of cash-strapped Americans turn to high-cost loans when they are unable to make ends meet, but the predatory products they use often only make matters worse. By closing loopholes in the MLA, the Department of Defense’s proposed rule would better protect service members from being taken advantage of in the financial marketplace. This rule also sets an example of solid consumer protections against high-cost lending that should apply to all Americans.
Joe Valenti is the Director of Asset Building at the Center for American Progress. Lawrence J. Korb is a Senior Fellow at the Center.