Consumer Protection Gone Wrong

In these tough economic times, the last thing business needs are unreasonable impediments on the sale of goods and services. Hasn’t all the bailout and stimulus spending been focused on unfreezing credit markets so folks can spend money and boost the economy? Yet, our leaders persist in confounding their own efforts.

A recent bill introduced by Senator Dick Durbin (D-Ill.) — though filled with good intentions — will have a devastating impact on installment sale financing if passed in its current form. At first blush, it doesn’t seem too worrisome — it simply seeks to impose a national usury cap of 36 percent on all consumer credit transactions. How often have you had a transaction that even came close? Probably not many, if you’ve had them at all.

But, like all things that come out of Washington, the devil is in the details. If the calculation to determine whether one hits the 36 percent cap was identical to the current calculation for an annual percentage rate (APR) under the Truth in Lending Act, few would give this a second thought. Unfortunately, the APR calculation is irrelevant for this purpose. Instead, a new “fee and interest rate” (FAIR) calculation is being proposed.

The FAIR calculation includes all of the things a current APR calculation does, plus credit insurance premiums, which are excludable from the APR if properly disclosed.

Currently, the cost of ancillary products (GAP, service contracts, tire-and-wheel coverage, etc.) is excluded from the APR calculation. These amounts would all be included in the FAIR calculation.

“All default fees” are included in the FAIR calculation. These include late fees in excess of $20 and non-sufficient funds fees in excess of $15. It can also include costs of repossession and attorneys’ fees and other collection costs passed on to the consumer.

Where the APR calculation is a snapshot in time (i.e., the cost of credit at a point prior to the consummation of a transaction that assumes all payments will be made in accordance with the terms of the contract), the FAIR calculation cannot be calculated accurately until the termination of the contract and all claims against the consumer are satisfied. Instead of a snapshot, it is a moving target, controlled almost entirely by the consumer’s behavior.

That being the case, what respectable finance company will want to buy nonprime paper that could become subject to attack as a result of the collection charges passed on to a defaulting consumer? Who will be able to sell a service contract or credit insurance requested by the consumer if the very sale of those products will put the seller at risk of both civil and criminal violations of law? I can’t think of anyone.

Predatory lending is bad for consumers, and by logical extension, bad for business. But Sen. Durbin’s bill goes too far. It throws the baby out with the bathwater, and assumes that all ancillary products and default fees are predatory, and takes the extraordinary step of assuming that consumers, even with appropriate disclosure, cannot judge for themselves the value various products and services provide them.

In essence, Sen. Durbin is buying the consumer advocate’s position that risk-based pricing is bad and that everyone should pay the same for credit, no matter what. They would like to see folks with stellar credit pay more to subsidize the risk posed by borrowers with less-than-stellar credit. But we all know that won’t happen. The reality is that folks with less-than-stellar credit — the very folks the consumer advocates are trying to protect — will be denied access to credit so the low-risk borrowers can get credit at an appropriate price. Less credit availability means less business for you, and that’s good for the economy how?

I mean, really, is it worth going to jail for selling a service contract to someone who both wants it and would benefit from it? I’d hate to say that Mr. Durbin thinks so, but his bill has me scratching my head.

Michael Benoit is a partner in the Washington, D.C., office of Hudson Cook LLP. He is a frequent speaker and writer on a variety of consumer credit topics. He can be reached at [email protected]. Nothing in this article is intended to be legal advice and should not be taken as such. All legal questions should be addressed to competent counsel.