By Juan-Pablo Velez
June 21, 2010
Governor Pat Quinn on Monday signed a landmark payday loan reform bill closing a legal loophole that had kept much of the industry unregulated.
In 2005, the Illinois General Assembly passed the Payday Loan Reform Act, which capped interest rates on payday loans with terms under 120 days. “What we saw within a matter of months was the industry modifying loans to 121 days or longer, in effect going back to a completely unregulated industry,” according to Tom Feltner, a consumer lending researcher with the Woodstock institute.
The new bill, which becomes law Jan. 1, closes this loophole, extending interest rate caps and other consumer protections to the longer-term loans. Though these consumer installment loans had longer terms than payday loans, they shared the same extremely high interest rates and often contained much higher principals. 700% APR loans were common, according to the Woodstock institute.
What the new bill does:
– Caps APR at 99% for loans under $4,000 and at 36% for loans over $4,000. Until now, these consumer installment loans were unregulated. Some lenders were charging upwards of 1,000% APR on loans largely targeted to low-income people.
– Limits monthly payments to 22.5% of the borrower’s monthly income. This creates a reasonable expectation that borrowers will be able to repay the loan.
– Prohibits balloon payments, which teases borrowers with low, interest-only payments for the first 11 months. Borrowers would then be hit with the entire principal in the last month. Some who couldn’t pay would take out other short-term, high-interest loans to pay back the original one. Others would file for bankruptcy after being sent to collection agencies by lenders.
The bill seeks to create amortized loans that allow borrowers to pay off both the interest and principal with each monthly payment. Also, payments are uniform from month to month preventing lenders from luring people in with a low initial payment rate.
In sum, the bill attempts to protect borrowers in need of emergency credit from falling into a debt trap by reducing their initial debt burden, smoothing out their payments, and making sure they actually have the ability to pay.