Fact Checked

“Unexpectedly harsh” high-interest consumer loans could face increased scrutiny, California court rules

Hands counting us dollars with calculator and digital tabletImage: Hands counting us dollars with calculator and digital tablet
Editorial Note: Intuit Credit Karma receives compensation from third-party advertisers, but that doesn’t affect our editors’ opinions. Our third-party advertisers don’t review, approve or endorse our editorial content. Information about financial products not offered on Credit Karma is collected independently. Our content is accurate to the best of our knowledge when posted.

Payday lenders suffered a potentially serious blow last week in California.

The Supreme Court of California determined that it’s possible for payday lenders to charge an interest rate so high (on consumer loans for $2,500 or more) that it’s considered “unconscionable” and in violation of California law. But despite the ruling, the court declined to weigh in on the question of whether Orange County–based payday lender CashCall’s (the defendant) practices were unconscionable.

The question of whether CashCall’s interest rates — which in some cases hit 135% during the period in question — are considered “unconscionable” is still undetermined.

The case has drawn attention to the issue of small-dollar consumer loans and might have a ripple effect on other payday lenders. It also provides an opening for California lawmakers and regulators to crack down on interest rates from the state’s billion-dollar industry.

What does this mean?

California law sets caps on interest rates for small-dollar consumer loans less than $2,500. But payday lenders may try to skirt the law by reserving higher interest rates for larger loan amounts, some of which exceed the legal limit by just $100. For example, CashCall charged a 96% annual percentage rate on unsecured loans of $2,600 during the period in question.

Originally, the case was brought before the U.S. District Court in San Francisco, which sided with CashCall. But the borrowers challenged the ruling, taking it to the 9th Circuit.

The 9th Circuit turned the case over to the California Supreme Court, which determined that the interest rate on consumer loans of $2,500 or more can, in fact, be deemed “unconscionable,” and left it up to the courts to determine whether interest rates on consumer loans are unconscionable on a case-by-case basis.

California courts may set a precedent for lower courts to follow in determining just how high interest rates can climb before they become “unconscionable.” 

The ruling could also nudge state lawmakers and regulators to take action.

In the California state legislature, Assemblymember Ash Kalra (D-San Jose) is pushing a measure that would cap interest rates on small-dollar loans of at least $2,500 but less than $5,000.

California wouldn’t be the first state to do so. According to the Los Angeles Times, 28 other states have already set interest-rate limits on small-dollar consumer loans.

Why does this matter?

The Supreme Court of California’s ruling could be the beginning of serious limits on payday lenders in the Golden State. And depending on what else other courts in the state deem to be “unconscionable,” the interest rates charged by payday lenders could be rolled back significantly, which could reverberate across the payday industry.

The CashCall case could also have broader implications, encouraging other states to set interest rate caps on consumer loans.

Though it’s unlikely that interest rate limits will be set for payday lenders at the federal level during the tenure of the regulation-averse Trump administration, the CashCall class-action lawsuit could serve as a bellwether for payday lenders across the country.

Going forward, it may cause other payday lenders to stop and think before continuing to charge high interest rates on consumer loans. And even if lawmakers in California neglect to set specific limits, interest rates could still feasibly be capped by future court decisions against payday lenders.

What can you do?

Payday lenders have become notorious for trapping low-income borrowers in cycles of debt. But they can also provide an option to people who desperately need cash to make ends meet, whether they’re having car problems, owe rent or need groceries to feed their family.

Regardless of the outcome of the CashCall case, you may be able to avoid turning to a payday lender by creating an emergency fund. We know it’s not easy to put money aside when you’re already struggling financially, but save what you can. A little bit here and there can add up over time.

If you find yourself in a situation where you need money fast and don’t have any emergency savings, you might feel like you have no other option than to borrow from a payday lender. But remember that there are other options out there. If you do turn to a payday lender, make sure you read the fine print so that you know exactly what you’re getting into and can adequately budget to pay back the loan.

You can also contact your state and federal representatives to voice your opinions on payday-loan interest caps.

About the author: Tim Devaney is a personal finance writer and credit card expert at Credit Karma. He’s a longtime journalist who prides himself on being a good storyteller who can explain complex information in an easily digestible wa… Read more.