The Consumer Financial Protection Bureau (CFPB) is an independent agency of the United States government responsible for consumer protection in the financial sector. It has already gone after Payday and Car Title Lenders and now it has its sights on small-loan personal finance companies. Personal finance companies generally make small, unsecured loans (less than $3,000.00) for loan terms of 13 months or less. They also usually charge very high-interest rates, at least 100% or higher. Given the manner in which the CFPB went after Payday and Car Title Lenders, it is no surprise that they are now focusing their attention of these small-loan companies. Specifically, the CFPB is interested in two key areas of business of personal finance companies: the Refinancing Debt Trap and the Credit Insurance Scam.
The Refinancing Debt Trap
The typical loan for a small-loan personal finance company is a 13-month, $1,374.00 unsecured loan with an average interest rate of 100%. I know his sounds egregious on its own; however, this is only the tip of the iceberg. They typically compound this (no pun intended) by computing interest using the Rule of 78’s. The Rule of 78’s means that in the above loan scenario, 13/78 of the total interest due ($1,374.00) will be due in the first month, 12/78 the following month and so on. Thus, a very large percentage of the total interest due is collected very early in the loan process. In fact, roughly 42% of the total interest to be paid over the 13-month loan is paid during the first 3-months. Even more egregious is these small-loan personal finance companies aggressively push their clients to “refinance” their loan within the first three months, thus starting the very large interest payments over. Below is an example of a typical personal finance company loan and the amount of interest collected on this loan using their Refinancing Debt Trap.
|Number of Months:||13|
|Annual Interest Rate||99.83%|
|Month||Start Balance||Interest||Principal||End Balance||Cum. Int. Paid|
Thus, using the Standard Operating Procedure for these small-loan personal finance companies of having their clients refinance their loans after 3 months, the client ends up paying $2,351.52 in interest charges and they still owe $1,342.25 from the original loan amount of $1,374.00. This is effectively a 174% interest rate. If the CFPB is unhappy with the unscrupulous lending tactics of payday and title loan lenders, they going to have a field day with these small-loan personal finance companies. I anticipate that the CFPB will recommend similar new rules and regulations for these personal finance companies that they recommended for Payday and Car Title Lenders. I believe these new rules will, at a minimum, require the finance company to prove that a borrower has the ability to repay the loan before they make the loan by verifying income, expenses and credit history. I further believe the CFPB will put an end to this Refinance Debt Trap by restricting the number of times a borrower can refinance and to implement a 60-day “cooling off” period in which the debtor would not be allowed to have any loans with the company.
The Credit Insurance Scam
Credit Insurance is an insurance product that enables consumers to ensure repayment of loans if the borrower dies, becomes ill or disabled, loses a job, or faces other circumstances that may prevent them from earning income to service the debt. It is often called “Payment Protection Insurance” and is usually not a bad product for larger purchases, such as new cars or a home. The idea being that if you become unable to repay the loan, the insurance policy will pay the minimum amount required to keep your loan current for some period of time, typically 12-months.
However, this type of insurance is a terribly bad product for the small, usually unsecured, installment loans that these small-loan personal finance companies typically make. If you become unable to make your payments on an unsecured loan, the creditor can sue you, but they are not going to take your house or your car. Yet these personal finance companies aggressively push this insurance product on virtually every customer that borrows money from them, and for good reason, if you are the finance company that is.
Personal finance companies typically use a third-party insurance provider to issue the Credit Insurance and the insurance provider pays the finance company a commission on the premium, usually between 50% to 64%. You heard that right; these personal finance companies typically receive 50% to 64% of the entire Credit Insurance premium that a third-party insurance provider is underwriting. This tells me that the third-party insurance provider certainly doesn’t expect too many claims to be filed against their policy. In fact, they probably never pay any claims because the insurance provider typically pays the personal finance company a fee to “re-insure” a percentage of the loan defaults. Thus, these small-loan personal finance companies are basically forcing financially unsophisticated borrowers to purchase a worthless Credit Insurance policy on a small, unsecured loan, pocketing 64% of the entire premium for this worthless policy and getting an added “kick back” fee from the insurance company to not file claims against the policy. Yeah, the CFPB is going to have a field day with these personal finance companies. It is actually hard to imagine how this is not criminal.
The CFPB will almost certainly force these personal finance companies to pay restitution to its clients that bought this worthless product. The only real question is how far back the CFPB will go? The CFPB has already levied reimbursement payments on Discover Financial Service, American Express and Capital One of $200 million, $60 million and $114 million, respectively for selling similar credit insurance products. This does not include the tens of millions in fines levied against these companies.
Given that roughly 100% of revenue for these small-loan personal finance companies is derived from their Refinance Debt Trap and the Credit Insurance Scam, the end is in sight and I say good riddance.