DCBA Brief, July 2005 - Northern's Exposure: Payday Loan Laws: A Survey of Illinois' and Federal Law That Applies to Payday Loans

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July 2005

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Northern’s Exposure: Payday Loan Laws: A Survey of Illinois’ and Federal Law That Applies to Payday Loans

Northern's Exposure: Payday Loan Laws: A Survey of Illinois' and Federal Law That Applies to Payday Loans

By Julie Anderson

I. Introduction
“Payday loans” are small unsecured loans that are made to consumers for a short period of time.1 Consumers usually make these loans through writing personal checks that are held and presented at a later date.2 Payday loans are generally exempt from state usury laws, so lenders are able to charge customers extremely high interest rates.3 The liberty to charge high interest rates makes these loans potentially dangerous for consumers.4 Many consumers initially take out these loans to pay for necessary bills and expenses that are due before their next payday.5 The borrower frequently intends to pay the loan back when it becomes due, but is many times forced to “rollover,” or take out a new loan because of an inability to repay the principal plus the high interest that has accrued on the loan.6

This article will survey the Illinois and federal laws that are applicable to these types of “payday loans,” and should serve as a good starting point for a lawyer who is challenging a “payday loan.”

II. Illinois Law
Although “payday loans” are exempt from Illinois’ criminal usury laws, “payday loan” lenders must abide by the regulations of another Illinois’ law, the Consumer Installment Loan Act.7 This act requires all businesses that make loans for under $25,000 to obtain a license from the Illinois Department of Financial Institutions, if the business is charging an interest rate that is higher than what would normally be allowed if the business did not have such a license.8 The Consumer Installment Loan Act essentially can be applied to all small loan lenders who wish to make loans at a rate greater than the state’s usury rate (currently 25%).9

Lenders who do receive a license under this Act are allowed to charge any interest rate on the short term loan, so long as the borrower agrees to such a rate.10 In exchange for the ability to charge a higher interest rate, the lender must agree to disclose the interest rate to the buyer as an annual percentage rate (APR), and the loan must be repaid within 15 years and 1 month.11 The lender is also not allowed to loan the borrower more than $40,000 of these short-term loans at any one time.12

The Illinois Department of Financial Institutions Regulations is authorized under the Consumer Installment Loan Act to make further rules and regulations concerning short-term loans, such as “payday loans.”13 The current regulations from the department limit the amount that may be borrowed in each loan, and the number of times a consumer is able to “rollover” or refinance a short-term “payday loan.”14 Currently, the regulations provide that a short-term loan that is not title-secured cannot exceed $400 per loan; short-term loans that are secured through a title can be made up to $2,000.15 A borrower may also refinance these short-term payday loans up to two times, provided that the borrower pays at least 20% of the loan’s outstanding balance.16 When the borrower is entering into a new loan contract (not just refinancing or “rolling over” current debt), the borrower must wait at least 15 days after the end of the existing loan contract before he or she enters into the new loan.17 Because of the dangers these high interest rate loans may pose for consumers, the regulations also require lenders to provide borrowers with pamphlets that describe the borrower’s rights and responsibilities, and the availability of debt management services. 18

Claims of violations under the Consumer Installment Loan Act may be brought as a private civil action19 or by Illinois’ Director of the Department of Financial Institutions.20

III. Federal Law
“Payday loans” must also meet certain federal law requirements present in the Truth in Lending Act.21 The Truth in Lending Act (also referred to as Regulation Z), much like the Illinois Consumer Installment Act, also requires the lender to disclose certain information. These rules generally require the lender to disclose the annual percentage rate, the total amount of finance charges, payment schedule and late payment information. 22 In order to ensure that consumers understand all of the terms in the contract, the Truth in Lending Act also requires the lender to use these terms and also provide a description of them in plain language.23 For example, the creditor should describe APR as “the cost of your credit as a yearly rate,” and finance charges should be described in the contract as “the dollar amount the credit will cost you.”24 These terms must also be grouped together and conspicuously segregated from other information in the agreement so that they are not missed by the consumer.25

When a lender discloses all pertinent information, but does not make the disclosure in the conspicuous manner required by the statute, the borrower is only allowed to recover actual damages.26 When the lender, however, completely omits the information he/she is required to disclose under the Truth in Lending Act, the borrower will then be eligible for both actual and statutory damages.27 The Truth in Lending Act allows consumers to bring civil actions against creditors for violations of the act on either an individual or class action basis.28 When the claim is brought on behalf of an individual, the statutory damages are limited to no more than $2,000.29 When the claim is brought on a class action basis, recovery is limited to the lesser of $500,000 or 1% of the creditor’s net worth for class action suits.30

IV. Case Law on Payday Loans
The legal issues associated with “payday loans” generally center on whether the terms of the lending agreement have mislead the borrower in any way so that they would violate the Truth in Lending Act. The disputes over the wording of an agreement may seem trivial at first, but the courts have determined that “hypertechnicality reigns in the application of the [Truth in Lending Act].”31

The Seventh Circuit has found that while the Truth in Lending Act requires a lender to use the term “financing charges” to describe all fees and charges related to the initial transaction and subsequent refinancing, a consumer will not be mislead if “fee” (as opposed to “financing charge”) is used to describe the consequence of extending a payment deadline.32 A consumer should also not be misled when the lending agreement describes a post-dated check as “security” rather than a “security interest” in the payday loan.33

V. Policy—Do The Laws Do Enough?
While the payday loan industry has been around since the 1900s, it has grown dramatically since the 1990s.34 The increased popularity of these loans in recent years has also been accompanied by increased criticism and controversy. The high interest rates associated with these loans—with APRs often times exceeding 400-500%—makes these short-term loans difficult to pay off.35 This causes consumers to “rollover” the original payday loan into a new payday loan where they accrue more debt instead of working off their existing debt.36 A 1999 study found that the average Illinois payday loan borrower remained a customer for at least six months and paid an average APR of 533%.37 Another recent study of Illinois’ payday loan borrowers found that the average borrower had over 10 payday loan contracts during a two-year period of time, and one-fifth of the borrowers in the study had twenty or more loan contracts during that same period of time.38

The applicable Illinois and federal statutes provide no caps on the interest rates that can be applied to these loans; disclosure requirements are the main protections afforded to consumers. Since the state has usury laws that cap the interest rates on all other types of loans, one must wonder if the disclosure requirements on these loans are enough or if the state laws should also provide an interest rate cap on these loans as well. Many states do apply the state’s usury laws to the payday loan practice.39 It has been suggested that Congress should pass payday loan regulations that would follow suit in these states to place an interest rate cap on payday loans. One author suggests that a Congressional law regulating payday loans would provide consumers with uniform protection from the high interest rates and “rollover” dangers that can sometimes be associated with these laws.40 The statistics that show that these loans have been dangerous for many Illinois consumers show that more protection and regulation of this industry would be helpful in this state.

VI. Conclusion
Payday loans in Illinois are exempt from the state’s usury laws that place limits on the interest rates on loans. Consumers do receive protection and regulation of the payday loan industry through two laws—the Illinois Consumer Installment Loan Act and the federal Truth in Lending Act. The Illinois Consumer Installment Loan Act provides limitations on the amount and length of such loans. The federal Truth in Lending Act also imposes stringent disclosure requirements that apply to payday loans. Consumers who have taken out payday loans that violate the requirements of the Illinois Consumer Installment Loan Act or the Truth in Lending Act have a private civil cause of action against the lender. The statistics on the use of these loans in Illinois, however, shows that the disclosure requirements may not be doing enough to protect consumers. Since Illinois has no caps on the interest rates of these loans, the causes of action that arise under Illinois and federal law should be aggressively pursued, if violated, so that consumers will be ensure at least the limited protection these laws provide.

1 Smith v. Check-N-Go of Illinois, Inc., 202 F.3d 511, 513 (7th Cir. 1999)
2 Id.
3 Creola Johnson, Payday Loans: Shrewd Business or Predatory Lending?, 87 Minn. L. Rev. 1, 2 (2002). See also Michael S. Barr, 21 Yale J. on Reg. 121, 159 (Winter 2004) (discussing how the national average payday loan APR is 470%).
4 Johnson, supra note 2, at 2.
5 Id.
6 Id.
7 205 Ill. Comp. Stat. 670/1 (2004).
8 205 Ill. Comp. Stat. 670/1 (2004).
9 See Id. 720 ILCS 5/39-1 (2004).
10 205 Ill. Comp. Stat. 670/15(a) (2004).
11 205 Ill. Comp. Stat. 670/16 (2004); 205 ILCS 670/17 (2004).
12 205 Ill. Comp. Stat. 670/17 (2004).
13 205 Ill. Comp. Stat. 670/22 (2004).
14 Ill. Admin. Code. tit. 38 § 110.370 (2004).
15 Ill. Admin. Code. tit. 38 § 110.370(a) (2004).
16 Ill. Admin. Code. tit. 38 § 110.370(b) (2004).
17 Ill. Admin. Code. tit. 38 § 110.370(c) (2004).
18 Ill. Admin. Code. tit. 38 § 110.360 (2004).
19 205 Ill. Comp. Stat. 670/20.7 (2004).
20 205 Ill. Comp. Stat 670/22 (2004).
21 Johnson, supra note 2, at 2.
22 12 C.F.R. § 226.18 (2004).
23 Id.
24 Id.
25 15 U.S.C.A. § 1638(b)(1) (2004).
26 Davis v. Cash for Payday, Inc., 193 F.R.D. 518, 526 (N.D.Ill. 2000).
27 Davis v. Cash for Payday, Inc., 193 F.R.D. 518, 526 (N.D.Ill. 2000).
28 15 U.S.C.A. § 1640 (2004).
29 15 U.S.C.A. § 1638 (2004).
30 Id.
31 Smith v. Cash Store Management Inc., 195 F.3d 325 (7th Cir. 1999).
32 Jackson v. American Loan Co., 202 F.3d 911, 913 (7th Cir. 2000).
33 Hahn v. McKenzie Check Advance of Illinois, LLC, 202 F.3d 998 (7th Cir. 2000); Smith v. Cash Store Management, Inc., 195 F.3d 325 (7th Cir. 1999).
34 Barr, supra note 2, at 149.

Julie Anderson is a third year law student at Northern Illinois University College of Law and is on the Law Review Board of Editors. She received her undergraduate degree from Augustana College