Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It may not have been previewed, commissioned or otherwise endorsed by any of our network partners.
Updated on Monday, July 27, 2015
Today, American Banker reported about a ruling by a New York court that has the potential to change the credit card and personal lending landscape dramatically. The court ruled that the ability to charge a higher interest rate than the state cap does not transfer to purchasers of debt. This could prove extremely difficult for credit card companies that sell debt to collection agencies, marketplace lenders that buy loans from banks and any other lender selling or purchasing debt.
Today, most states have a legal maximum interest rate. However, banks are allowed to charge their home state’s interest rate to borrowers across the country. There is a reason credit card companies raced to set up in Delaware: the lack of a meaningful usury cap. South Dakota is equally generous. So, even if you live in a state with a lower usury cap, like Arkansas, you can still end up paying a higher interest rate, because your credit card company is based in Delaware and can charge Delaware rates.
If a consumer stops paying their credit card bill and defaults, credit card companies often sell the debt to third party collectors. The New York ruling becomes very important in this condition. It means that the maximum rate used at the time of the original loan no longer applies. Instead, the state usury cap would kick in. That could make the debt much less valuable to potential purchasers of debt. It also raises interesting questions: what happens if a borrower moves states during the life of the loan, and before the debt purchase?
While many credit card lenders have set up shop in Delaware, many marketplace lenders have been forming partnerships with WebBank in Utah. If you take a loan from LendingClub, you are actually signing a contract with WebBank. The loan sits on WebBank’s books for two days. It is then sold to LendingClub, which proceeds to sell the loan to the investors. The rate cap for Utah therefore applies to the entire country. In many cases, the Utah rate cap is higher than the usury cap in states where the customers live. If sale of the debt removes the protection of the rate cap, it could make life difficult for lenders like LendingClub and Prosper.
This ruling opens a lot more questions than it answers. And it is being challenged. In the short term, it leaves a lot of open questions that may concern investors. In the longer term, it could have the potential to change the debt sale practices of consumers or the business models of marketplace lenders.
Given how much money is at stake, we can expect creative legal solutions to be created by banks and marketplace lenders. Delaware became a credit card boomtown thanks to the Supreme Court case (Madden v. Midland Funding) that allowed credit card companies to export Delaware laws nationally. If the New York case is upheld, the banks and marketplace lenders will not give up. Instead, we can expect new structures and potentially some surprising new locations and branch offices.