Court closes payday-loan loophole

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Ohio’s check cashing businesses found a loophole almost immediately in the Short-Term Loan Act, passed in June 2008, which placed limitations on short term loans known as payday loans.

Payday lending consists of small loans with big interest rates and lots of fees, and it’s big business. According to the Coalition on Homelessness and Housing in Ohio, in 2006 there were 183 payday lenders in Franklin County alone that generated over $37 million in fees. The average borrower takes out 12 loans a year, and about 318,000 people make use of payday loans throughout Ohio.

Critics saw payday loans as traps for low-income people that locked them into a never ending cycle of high interest loans. The Ohio Coalition for Responsible Lending concluded that the average two week loan in 2007 was $328 and the average cost of that loan was $49. If a borrower needed to take out another loan to repay the first and did so five times, he would be obligated to pay nearly $300 in fees in just ten weeks.

The Short-Term Loan Act replaced the Check Cashing Lender Law, which permitted loans of up to $800, interest of five percent “per month or fraction of a month,” and loan origination fees. Borrowers typically submitted a post-dated check in exchange for the loan. If a borrower defaulted, the lender deposited his check. When a borrower was unable to repay the loan, his loan would be rolled over into a new loan with additional interest and more fees—a typical situation for many borrowers according to the Coalition that continues under the Short-Term Loan Act.

The Short-Term Loan Act required that payday loans be less onerous. Loans cannot exceed $500 and  must have a repayment period of at least 31 days. Lenders cannot charge more 28 percent interest, that must be calculated in accordance with the federal law, and can assess only a single $20 check collection charge.

Instead of obtaining licenses under the Short-Term Loan Act, however, lenders have circumvented the law by applying for licenses under two other lending laws that allow for more fees and, hence, more profit. Ohio Division of Financial Institutions records show that approximately 1500 lenders are now licensed under these two laws, and no licenses are issued under the Short-Term Loan Act.

Payday loans might make sense if used only for emergencies, but Linda Cook, an attorney with the Ohio Poverty Law Center, believes they are used mostly by low income workers to fill in for income gaps. “People who can’t afford these loans in the first place end up becoming serial borrowers. They get trapped in a cycle of increasing debt. No surprise that repeat business is key to profitability for the lenders.”

No one challenged the lenders until the Elyria Municipal Court took a hard look last June at what one lender was doing.  Ohio Neighborhood Finance, Inc., which does business as Cashland, filed suit against Rodney Scott for his failure to repay a $500 loan when due two weeks later. Cashland sought to recover the $500, fees and interest of $112, and attorney fees, though the claim for attorney fees was later withdrawn.

Cashland claimed that its loans were all “payday” style loans that are to be repaid within 14 days, but Cashland wasn’t licensed to make the payday type loans envisioned by the Short-Term Loan Act. Instead, Cashland was licensed under a law that governs second mortgage loans and argued that its second mortgage loan license permitted it to make payday type loans.

The court was not persuaded. It didn’t help Cashland’s case that the Short-Term Loan Act had been approved by referendum on November 5, 2008. Issue 5, as it was known, stated that “all short term lenders, including check cashing lenders, would be subject” to the new act. Finding that Cashland had violated the Short-Term Loan Act, the court allowed Cashland to recover only eight percent interest, not the 25 percent it claimed, and denied all fees.

The court’s decision is noteworthy. “This court will not nullify the will of the legislature and voters and read into the second mortgage loan law some previously unnoticed, implied authority for a type of lending historically the subject to special usury legislation.”

Cashland appealed the decision, and the court of appeals affirmed the trial court’s decision.  Now we have a precedent for other courts to invalidate similar loans, which will likely result in lobbying by the payday loan companies for new legislation.

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