Partners (Number 2, 2007)

Predatory Lending and the Military

Predatory lending is always problematic, but it's a special concern when military personnel are preyed upon during active duty. A new law will help curb abuses, and the Federal Reserve is playing a regulatory role alongside the Department of Defense (DOD).
predatory lending and the military graphic

Protective provisions within The John Warner National Defense Authorization Act for Fiscal Year 2007 (Warner Act) were signed into law in October 2006 and will become effective October 1, 2007. Also known as the Talent Amendment, the new legislation will protect servicemen and women and their families from some of the worst practices of loan sharks.

Early in 2005, legislation was proposed to limit predatory lending practices targeting military personnel. The Servicemembers Anti-Predatory Lending Protection Act sought to limit the annual percentage rate (APR) to 36 percent, enhance disclosure of loan terms and restrict automatic loan roll-overs. (See Partners Vol.15, No.2.) Although this bill didn't become law, it paved the way for the new legislation.

Effects of predatory lending
Over the last several years, DOD has been increasing financial education for members of the military. Over 40 percent of military service personnel are under the age of 25, and many are not experienced in financial matters. Thus they are easy targets for predatory lenders.

A 2005 survey of servicemembers rated personal finances more stressful than deployments, health concerns, life events and personal relationships. The most common traps have been payday loans, vehicle title loans, military installment loans, tax refund anticipation loans and rent-to-own purchases.

Financial stress not only affects the well-being of individual service members but also the operation of the armed forces as a whole. Financial strain is so systemic that many members have become unqualified for strategic security clearances, thereby compromising the ability of the armed forces to conduct their missions. As a result of these concerns, the DOD developed a strategic plan to reduce the stress related to financial problems, increase the personal savings of its members, decrease its members' dependence on unsecured debt, and decrease the prevalence of predatory lending practices.

Even though the DOD has been partnering with a number of organizations like the FDIC to provide financial education, these efforts have not been sufficient to stem the tide of predatory lending. DOD therefore pressed Congress to provide greater legal protections from predatory lending practices.

New rules to curb abuses
Section 670 of the Warner Act, "Limitations on Terms of Consumer Credit Extended to Service Members and Dependents," is designed to curtail abusive practices associated with payday lending and other predatory lending practices targeted at military personnel.

The law applies to both service members and their dependents. It stipulates that the APR of a covered extension of credit cannot exceed 36 percent, and it mandates disclosures and terms mirroring the Truth in Lending Act. It also includes a provision against any state or federal preemption, unless those laws provide even greater protections.

Other provisions include the following prohibitions:

  • Lenders may not roll over, renew, refinance or consolidate credit unless the new transaction results in more favorable terms to the borrower.
  • Borrowers cannot be required or allowed to waive the right to legal recourse.
  • In the case of dispute, lenders cannot require the borrower to submit to arbitration or impose onerous legal notice provisions.

The Warner Act provides specific definitions of the terms "interest," "APR" and "consumer credit." For example, its definition of APR includes all fees and charges connected to the loan, including single-premium credit insurance and other products sold in connection with the transaction. Some of these fees and charges are exempt from standard APR calculations so the new method of calculation is being called the "Military APR" or "MAPR."

Prior to becoming obligated through the transaction, each applicant must be provided with a clear and conspicuous "covered borrower identification statement" that must be signed by the borrower.

It should be noted that the law does not apply to residential mortgage loans and loans to purchase vehicles. Residential mortgage loans are defined not only as purchase money but also refinancing, home equity loans and home equity lines of credit.

For covered loans, servicemembers should expect to receive the following at the loan closing:

  1. A disclosure containing the MAPR and the total dollar amount of all charges;
  2. Any disclosures required by the Truth in Lending Act;
  3. A clear description of the payment obligation; and
  4. A "covered borrower identification statement."

Framing the regulations
The new legislation assigns DOD the responsibility of issuing regulations and implementing them. However, it also stipulates that DOD must consult with the Federal Reserve and other primary banking regulatory agencies as well as the FTC and NCUA. This will be the first time DOD has been involved in drafting regulations that will affect the banking industry. Proposed regulations were published in the Federal Register on April 11, 2007, and the comment period ended in June 2007.

Comments acknowledge that significant protections are added into law by the stated provisions, but they also cite challenges, including crafting language that does not present contradictions or create confusion with regard to existing laws and regulations. For example, some believe that disclosing an APR and a MAPR might be confusing to consumers, or that the definition of "consumer credit" might be too narrowly stated.

Others argue that installment loans should be included. Still others note that open-ended credit such as credit cards, bank overdraft loans and payday loans over 91 days were not addressed. Furthermore, some are concerned that predatory lenders will restructure loan terms to get around the regulation's definition of "consumer credit" in order to continue their predatory practices.

An important debate
Enhancing consumer protections for servicemembers is clearly beneficial. But some have argued that in terms of personal finance our servicemembers are no different than the rest of us, and that consumers as a whole could benefit from stronger protection against predatory practices. At the same time, regulatory bodies must walk a fine line to avoid undue restriction against access to credit. While the debate continues, all parties agree upon the value of having financial education in making wise financial choices.

This article was written by Michael Milner, regional community development director in the Atlanta Fed's Birmingham Branch.