The attorney general for the District of Columbia is suing online lender Elevate to protect residents from "predatory, high-cost loans."
The lawsuit, filed Friday, June 5, by Attorney General Karl Racine, is the latest salvo in an ongoing battle between consumer advocates and lenders around short-term, unsecured loans that opponents argue can be overly expensive and risky.
Elevate dismissed the lawsuit, saying in a statement to CNBC Make It that the company planned to defend itself against "this frivolous lawsuit that lacks merit and ignores well-established federal lending laws. Elevate will continue to be the reality of access to credit for millions of Americans."
The dispute comes at a time when Americans are increasingly looking for credit. One out of three of Americans have lost income because of the coronavirus pandemic, according to the Financial Health Network's 2020 U.S. Financial Health Pulse, a survey of over 2,000 U.S. adults fielded between April 20 and May 7, 2020. Among Americans who report losing income, 3% of survey respondents say they've had to borrow money using a payday loan, deposit advance or pawn shop loan.
In fact, to help consumers and small businesses affected by the coronavirus pandemic, federal regulators — the Federal Reserve System, Consumer Financial Protection Bureau, Federal Deposit Insurance Corporation, National Credit Union Administration and Office of the Comptroller of the Currency — have actually encouraged banks and credit unions to "offer responsible small-dollar loans to consumers and small businesses in response to Covid-19." Regulators say that banks and financial institutions could structure these new loans in a variety of ways, including open-end lines of credit, installment loans paid back over a set duration or single payment loans.
While increasing the number of institutions making smaller loans may help some Americans get access to much-needed funds, it could also lead to more predatory lending. "The FDIC has let the banks it supervises launder loans for predatory lenders, so it is up to the states and D.C. to step up and protect their families from these outrageous and illegal loans," says Lauren Saunders, associate director of the National Consumer Law Center.
"The last thing we need during the Covid-19 crisis is more predatory lending," Saunders adds.
Why experts say small, unsecured loans can be risky
While small, unsecured loans can be easy to get, they can be very hard to pay off. A payday loan, for example, is a type of small loan you can generally take out by walking into a lender offering these with just a valid ID, proof of income and a bank account. Unlike a mortgage or auto loan, there's typically no physical collateral needed. But they aren't available in every state. Currently Arizona, Arkansas, Georgia, Maryland, Massachusetts, New Jersey, New York, North Carolina, New Mexico, Pennsylvania, Vermont, West Virginia and D.C. ban these types of loans entirely. Additionally, 37 states have specific statutes that allow for payday lending, but with restrictions, such as interest rate caps and maximum loan amounts.
Most lenders that offer payday loans and installment loans require borrowers to pay a "finance charge" (service fees and interest) to get the loan, the balance of which is due two weeks later, typically on your next payday. Installment loans are very similar to payday loans, but they can have longer repayment periods, usually four to 60 months, according to Pew Charitable Trusts. Roughly 10 million Americans use installment loans annually.
Both types of loans can be extremely expensive, with many lenders routinely charging interest rates between about 100% and 400%. That's compared to personal loan rates that range from 10% to 28% on average, based on your credit. Or credit cards, which charged an average of roughly 15% interest as of February, according to the St. Louis Federal Reserve.
Lenders argue the high rates are necessary because payday loans are risky to finance. But borrowers often can't pay back these high-cost loans right away, so they get sucked into a cycle of borrowing and racking up finance charges.
Research conducted by the Consumer Financial Protection Bureau found that nearly 1 in 4 payday loans are reborrowed nine times or more. Plus, it takes borrowers roughly five months to pay off the loans and costs them an average of $520 in finance charges, The Pew Charitable Trusts reports. That's on top of the amount of the original loan.
At a time when many Americans may not know when their next paycheck is coming, using a lender who is offering a short-term loan that charges triple-digit APR is a bad idea, says Rebecca Borné, senior policy counsel for the Center for Responsible Lending. "Avoid these lenders, they are trouble," she says.
Recent lawsuit aims to eliminate 'unscrupulous' loans
Over the past several years, Elevate made over 2,500 loan agreements with D.C. residents for two types of loan products that carried extremely high rates, according to Friday's lawsuit. Rise, which is an installment loan, charges an interest rate of 99% to 149%, according to Racine's office. Elevate also offers a line of credit called Elastic, which effectively charges APRs between 129% and 251%, Racine found.
Yet D.C. does not permit payday loans and is one of the 45 states and jurisdictions in the U.S. that cap interest rates on installment loans and credit lines, restricting the maximum APR that licensed money lenders can charge at 6% or 24%, depending on the type of loan. Elevate's top interest rates are 42 times the legal limit, the lawsuit claims. To get around the rate restrictions, the lawsuit claims Elevate partnered with two state-chartered banks, which are not subject to state interest rate limits. But Elevate was ultimately controlling the loans, taking the risks and getting the profits, the lawsuit contends.
"District law sets maximum interest rates that lenders can charge to protect residents from falling prey to unscrupulous, exploitative lenders. We're suing to protect D.C. residents from being on the hook for these illegal loans and to ensure that Elevate permanently ceases its business activities in the District," Racine said in a statement.
Advocates say lenders are using these "rent-a-bank schemes" as a loophole more and more, originating the high-cost loans through a FDIC-regulated bank before buying them back in order to continue to charge exorbitant interest rates. In fact, the National Consumer Law Center has compiled a watch list of companies engaging in these tactics.
"Interest rate caps are the most effective tool states have to protect their residents from predatory lenders and companies should be held accountable for knowingly and deceptively evading those caps," says Rachel Weintraub, legislative director and general counsel with the Consumer Federation of America.
Elevate defended its business strategy of partnering with banks. "During a time when federal regulators are asking banks to step up and provide more options for nonprime Americans, Elevate is facilitating access to transparent and responsible credit," the company said. "By licensing our financial technology, FDIC regulated banks are able to serve customers they could not otherwise, including 160 million nonprime and credit invisible Americans."
Racine's office issued a cease and desist letter in April 2020, but says it filed the lawsuit to permanently stop Elevate from "engaging in misleading business practices, require Elevate to void the loans made to District residents, return interest paid by consumers as restitution and pay civil penalties." Elevate does not currently offer loans in D.C.