Those ‘unconscionable’ loans

TSupreme Court struck what seemed like an important blow for consumers this week, unanimously declaring that the rates on some consumer loans can be so burdensome and so onerous that they are illegal. Lenders, the court said, are not free to impose whatever interest rates and terms they please on desperate borrowers.

Yet the ruling provided no clarity at all on how to distinguish between a loan that’s merely burdensome and one that’s illegal. That’s a vital dividing line, yet state lawmakers have stubbornly refused to draw it.

California used to impose tough limits on the interest rates charged on “small dollar” installment loans of $2,500 to $10,000. But in a deregulatory push in the mid-1980s, lawmakers removed the interest rate caps on such loans, arguing that the market provided all the protection that consumers needed.

That may well have been true before broadband became ubiquitous and online lending by companies other than federally regulated banks exploded. Small-dollar lending has become a huge business; in 2017, almost 1.5 million loans worth $37.2 billion were made, the state Department of Business Oversight reported.

Yet it’s come at an unexpectedly high cost. Here’s a jaw-dropping data point: In 2016, 17 of the state’s most prolific small-dollar lenders charged almost all of their customers interest rates of 100% or more.

The one protection legislators added when they removed the interest-rate caps in 1985 was a ban on “unconscionable” loans. Citing that ban, two borrowers who’d gotten loans from online lender CashCall with interest rates of 96% or more sued the company in federal court, arguing that the loans violated California’s law against unfair business practices. That law forbids companies from selling illegal products.

A U.S. District Court judge in San Francisco preemptively ruled in CashCall’s favor, buying the company’s argument that a loan not subject to interest rate caps could not be unconscionable. The 9th Circuit Court of Appeals sent the case to the state Supreme Court, though, asking whether that was the right reading of state law. And on Monday, the Supreme Court ruled that loans above $2,500 could be considered unconscionable under certain circumstances.

Notably, the court didn’t decide whether CashCall’s loan terms were illegal. Instead, it said that determining whether a loan was unconscionable would be up to the courts on a case-by-case basis. Many factors come into play, including how the loans are marketed, the borrower’s negotiating power and ability to understand the terms, available alternatives, and the risk faced by the lender.

That all sounds reasonable enough, but it’s also too murky for lenders and borrowers alike. The role of the state here is not only to give lenders an opportunity to meet the demand for credit, but also to protect borrowers against predatory loans that send them into a debt trap. And the terms offered for small-dollar loans, combined with the way they are marketed in low-income and minority communities, show that there’s a real need for more protection.

Even without a clear picture of what constitutes an unconscionable loan, the court’s ruling should prompt the state Department of Business Oversight to review the marketing and terms imposed by high-interest small dollar lenders in California. In particular, it should help the department crack down on lenders and their agents steering people seeking loans of less than $2,500 into unregulated loans above that amount.

Meanwhile, the Legislature should revisit proposals such as Assembly Bill 2500 by Assemblyman Ash Kalra (D-San Jose), which would set clear interest rate caps on loans of $2,500 to $10,000, as 28 other states have done. Lenders shouldn’t have to guess what amounts to an unconscionable loan, and neither should consumers.