Federal usury law for service members: the Talent-Nelson Amendment

North Carolina Banking Institute, March, 2008 by Patrick M. Aul

I. INTRODUCTION

Imagine a nation currently involved in armed conflicts in two foreign countries. Now picture that nation having to revoke the security clearances of and possibly discharge active members of the armed forces because of their individual financial difficulties that, if not caused by, can be exacerbated by predatory lenders and other abusive credit products. (1) This is the problem Congress intended to address by enacting the Talent-Nelson Amendment (2) (Amendment) in October of 2006. (3)

However, as enacted, the well-intentioned Amendment's broad language had the potential to not only protect service members from predatory lenders and abusive credit products, but also to adversely affect the availability and cost of beneficial credit products currently available to service members. (4) Fortunately, the Department of Defense (DOD), which was given regulatory authority under the Amendment, (5) has largely listened to the concerns of the banking industry and has promulgated its subsequent regulations implementing the Amendment in such a way as to mitigate, if not totally avoid, these unintended negative consequences. (6)

Part II of this Note examines predatory lending and the military as well as explain the need for the Amendment. (7) Part III examines the Amendment as enacted, the potential for unintended negative consequences that arose due to the Amendment's broad language, and the DOD's subsequent regulations. (8) Part IV discusses the implications of not providing an exemption from coverage for depository institutions and shows how the DOD's approach has stayed true to the spirit of the Amendment, provided maximum protection for service members, and maintained the flexibility needed to modify the regulations as future problems arise. (9)

II. PREDATORY LENDING AND THE MILITARY: THE NEED FOR THE AMENDMENT

According to a recent report by the DOD entitled Report on Predatory Lending Practices Directed at Members of the Armed Forces and Their Dependents (DOD's Report) and several other recent studies, predatory lenders and other providers of abusive credit products are targeting military personnel and are geographically concentrating their locations around military bases. (10) The abusive credit products identified in the DOD's Report include payday loans, automobile title loans, installment loans, tax refund anticipation loans, and rent-to-own contracts."

A. The Unique Problem of Payday Lending and the Targeting of Service Members

Payday loans are defined in the DOD's Report as low value loans secured by the borrower's personal check or by an agreement to electronically withdraw payment from the borrower's bank account. (12) Payday loans average a couple of hundred dollars in amount, are due in full on the borrower's next payday, and are accompanied by annual percentage rates (APRs) ranging anywhere from a couple of hundred to eight-hundred percent (800%). (13) Due to its profitability, the payday loan industry has experienced fast growth in the last ten years, both in the number of stores and in the volume of business it handles. (14) In fact, the number of payday loan institutions almost tripled in a seven-year period between 1999 and 2006. (15)

Payday loans are especially risky for service members because they all potentially involve a "bad" check. (16) Under the Uniform Code of Military Justice, service members are penalized--they can be court-martialed--anytime they deliberately write a check that is not properly covered by funds on deposit. (17) To avoid these penalties, military borrowers take out more loans or continuously renew loans in order to keep the check used as security for the original loan from bouncing. (18) Thus, service members may not have any more reason than their civilian counterparts to take out a payday loan, but they do have an added incentive to remain in what can amount to a debt trap. (19) This also helps explain why payday lenders target service members. Payday lenders rely on the profit earned from repeat borrowers and "ninety-one percent (91%) of payday loans go to borrowers with five (5) or more loan transactions per year." (20)

Moreover, service members generally possess several characteristics that make them ideal targets for predatory lenders: (1) they are young and inexperienced in financial matters; (2) they lack adequate savings to survive an unforeseen financial crisis; (3) they are often receiving a regular paycheck for the first time in their lives; (4) they have a relatively high level of job security; and (5) the military emphasizes financial responsibility. (21)

As a result of these characteristics, predatory lenders, and the payday lending industry in particular, have not only physically located their facilities near military bases, (22) but have also used the Internet and affinity marketing techniques to target service members. (23) For example, "an online search for 'military loans' gets over thirty-eight million hits on Google, while 'military payday loan' fills over three million pages." (24) Furthermore, military loan sites often appear to be educational, use military names, display official looking seals, and ask for military documents to use as a basis for making their loans. (25) As a result, even a service member stationed in a state that has sought to protect their citizens from predatory lending has access to payday loans via the Internet. (26)