|
This article was written by the Consumers Union Southwest Regional Office.
Juan L. of Harlingen borrowed $100 in March of 1995 from World Finance. His total finance charge was $30 (equivalent to 113% APR), and at $26 per month he should have paid off the loan by August. However, he regularly refinanced his loan at the time of his payment. Typically, he brought in $26, reducing his balance to $104. The lender gave him a $4 refund of unearned interest and paid off the remaining $100 balance with a new $100 loan. The new loan carried a new finance charge of $30, leaving him back where he began. By August, when he wrote to the Office of Consumer Credit Commissioner, he still owed $100.
"Every time I pay my payment of the month is $26," wrote Mr. L. "And like a week or two I go renew it because I need the money and they give me $4 every time." Mr. L. wrote to the Commissioner because during the summer he actually refinanced his loan only two weeks after the previous refinancing and got a larger refund. He did not write in to complain about the regular refinancings but only to understand why the amount they refunded to him varied.
Many finance companies offer only loans under $440 because they can charge very high interest rates. Called "signature loans," the typical borrower needs only walk into the finance company office, fill out the forms and walk out with money in hand˜nearly as convenient as a credit card but at a much higher cost. According to World Acceptance, one of the dominant small loan companies in Texas with 131 offices statewide, applications may also be taken by phone and staff approves the loan while the customer waits. World Acceptance requires each new customer to submit a list of personal property that will be pledged as collateral, but the company does not perfect its security interest in this collateral. Instead, in most states, it requires the consumer to purchase non-filing insurance out of the loan proceeds. Texas law prohibits the addition of a non-filing insurance fee to an Article 3.16 loan.
Refinancings are common. Like Mr. L., consumers often refinance their small loans many times in order to lower that month's payment by the amount of the interest refund, even though the refund is very small. According to World Acceptance, regular refinancing "increases the company's returns because the company is generally permitted to charge the full amount of fees, premiums, and other charges collected on the existing loans. The Company actively markets the opportunity to refinance existing loans prior to maturity, thereby increasing the amount borrowed and increasing the fees and other income realized." In fiscal year 1997, nearly 82 percent of World's loan originations were refinancings of existing loans.
Texas law (Texas Credit Code, Article 3.16) allows a lender to charge a $10 fee plus $4 each month for every $100 borrowed. At the time of the refinancing, the lender calculates the refund using the Rule of 78s (see main text for explanation of refund formulas). For loans of $100 or less, the initial $10 is fully earned and never refunded.
Under some circumstances, small loan companies will refinance delinquent loans, although delinquency is typically an indication that consumers may have accrued more debt than they can afford. World Acceptance "believes that refinancing delinquent loans for certain customers who have made periodic payments allows the Company to increase its average loans outstanding and its interest, fee and other income without experiencing a material increase in loan losses."
Finance companies make more and more very small loans every year, and in 1993 the number skyrocketed, according to data provided by the Office of Consumer Credit Commissioner. In 1985, Texans took just over 1.5 million small loans, increasing to 2.5 million by 1990. In 1993, finance companies advanced more than 4.2 million loans for a total of $1 billion dollars. By 1995 the numbers of small loans dropped back down to only 3.5 million for a total of $982 million. At an average loan size of only $255, this represents significant loan activity and even more significant interest earnings.
SOURCES: Consumer Complaint, Office of Consumer Credit Commissioner, August 1995; World Acceptance Corporation, Form 10-K Report for FY ended March 31, 1997; Tex. Civ. Stat. Ann. 5069 Art. 3.16; Office of Consumer Credit Commissioner, 10 Year Comparison Annual Report of Regulated Licensees, 1997
