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US: States to Protect Borrowers Who Turn to Cars for Cash

Several states are putting curbs on loans backed by car titles—short-term, high-interest debt that critics say too often results in consumers losing their vehicle when they can't keep up with the payments.

Auto-title lending, where the owner of a car hands over its title as collateral, will become illegal in Wisconsin later this year. Virginia will impose new regulations Oct. 1, structuring the loans to keep consumers from falling into a cycle of debt. Illinois last year capped car-title loans at $4,000 and slapped numerous restrictions on the industry.

At least six other states have implemented new regulations since 2007.

Many states have banned auto-title loans historically by capping the interest rates that can be charged at relatively low levels or through other restrictive laws. The new batch of states cracking down on the lenders—which often charge triple-digit interest rates—comes as more cash-strapped borrowers turn to the industry amid economic hard times.

In addition to the state laws, the Consumer Financial Protection Bureau, part of the finance overhaul passed by Congress, will regulate the industry nationwide, and likely add its own restrictions.

"I think they should ban it entirely," said Leon Brantley of Hampton, Va., who traded the title to his 2000 GMC Yukon to borrow $1,500 in late 2008 to help pay his rent. After making five $600 monthly payments and not making a dent in the loan's principal, Mr. Brantley fell behind last year, and his lender seized his car. The 31-year-old barber said he lost work as a result and couldn't pay rent or other bills, then ended up in jail for 30 days for missing child-support payments. "It really messed up a lot for me," he said.

Car-title loans are shorter and more expensive than a typical auto loan used to buy a vehicle. Auto-title lenders generally offer one-month loans of up to half the value of the vehicle, through borrowers often extend them for months, adding rounds of interest. A lender can seize a car if a borrower fails to keep up on the payments; borrowers sometimes get money back after a seized car is auctioned off.

Critics say the structure leaves borrowers, often struggling to pay other bills, vulnerable to losing a vehicle that allows them to get to work and earn an income.

"The title loan really takes precedence over other obligations," said Leslie Parrish of the Center for Responsible Lending, a consumer-advocacy group. "But paying that back in a short period of time is really hard. For the most part, what they end up doing is paying the fee over and over again each month because they can't tackle that large principal payment."

The industry says title loans can keep borrowers from selling their cars or using lenders that are more expensive or even illegal. "Title lenders give consumers and small-business owners an option to use an asset they own to solve their immediate financial needs while maintaining use of the vehicle," said Katie Grove, a board member for the American Association of Responsible Auto Lenders, which represents the industry's largest firms.

Ms. Grove said the group backed "sensible legislation"—citing Virginia's new law as an example—"that allows the industry to continue to operate while codifying reasonable consumer-protection provisions." For instance, the group supports principal-reduction rules that require loans be paid off in a fixed period, but generally opposes rate caps, she said.

In May, Wisconsin's governor struck authorization for car-title loans from a broader bill that allowed payday lending with some restrictions, making car-title lending illegal starting in December. Illinois regulators, in addition to limiting the principal on title loans to $4,000, last year banned "balloon" payments that pushed the largest payments to the end of the term and often forced borrowers to take out a new loan. The state also launched a database of auto-title loans in October and prohibited title lenders from making a loan to a borrower who had an outstanding title loan within the preceding 15 days.

Arizona lawmakers this spring put the payday-loan industry, which lends at high interest rates against future paychecks, out of business as of July 1. Both industry lobbyists and consumer groups expect these lenders to shift to car-title lending, as occurred in Virginia after it restricted payday lending. "They moved to the car-title model because they realized there were hardly any requirements," said Dana Wiggins of the Virginia Poverty Law Center, an advocacy group for low-income people that pushed for the new state laws. "It was kind of like a newfound treasure trove. You saw all of these folks who used to have payday loans were being moved into car-title loans by payday lenders."

The Virginia law will institute a tiered cap on interest rates for loans, up to 264% a year. It will require that loan payments are distributed equally to principal and interest, and are designed to pay off within a year. The rules are designed to provide clearer terms to borrowers at the outset.

Mr. Brantley, the Virginia barber who lost his Yukon last year, said he rushed through the paperwork and didn't expect to pay as much interest as he did. "I thought I'd do it for three or four months until I got back on my feet," he said. "But it never went away."

He said he eventually paid $8,000—partly using money he borrowed from a family member—to his lender, Cash-N-A-Flash, over the course of the loan and got his vehicle back. Cash-N-A-Flash didn't respond to a phone message or a letter seeking comment.

The Virginia attorney general sued the company in May for not providing the required 25-day grace period on some loans, a case that is still pending. Since 2007, the attorney general's office said, it has negotiated settlements with eight auto-title lenders to provide refunds or relief on interest-rate charges of almost $8 million.

This article was printed in the Wall Street Journal on July 19th, 2010 and was written by Sudeep Reddy.