California Governor Gavin Newsom signed the Fair Access to Credit Act into law on October 11, 2019. Effective January 1, 2020, the Act will impose several significant changes to the small consumer loan (under $10,000) provisions of the California Financing Law, including rate caps, limits on the maximum/minimum loan term, and new reporting and customer education requirements, each of which will apply prospectively to newly made loans.
Although the Fair Access to Credit Act (AB 539) (the Act) primarily targets payday lenders, its provisions are worded broadly to reach lenders (or purchasers) of small consumer loans (under $10,000) in California. The changes the Act will impose warrant additional diligence by parties to securitization transactions that include small dollar consumer loans to California borrowers, lest any noncompliance trigger the onerous penalties available under the California Financing Law (CFL) for consumer loan violations, e.g., forfeit of interest or voiding of the loan contract.
Provisions Applicable to Consumer Loans of Less Than $10,000
Consumer installment loans and consumer open-end lines of credit of $2,500 or more but less than $10,000 will be subject to the following new requirements.
Rate Caps/Limit on Charges
The permissible interest rate is capped at an annual simple interest rate of 36% plus the federal funds rate. Charges that would exceed that rate are prohibited, other than an “administrative fee” provided for by the statute. The administrative fee is capped at $75 for loans having a principal balance of more than $2,500 (the cap for loans of $2,500 or less is 5% of the principal amount or $50, whichever is less) and also is subject to frequency limitations, e.g., it is not chargeable on a loan refinancing unless one year has elapsed since the borrower paid any previous administrative fee.
Mandatory Minimum/Maximum Term
Other than open-end loans and certain student loans, the minimum consumer loan term is set at 12 months. Maximum terms are also now specified, e.g., consumer loans of at least $3,000 but less than $10,000 (except for loans secured by real property of a bona fide principal amount of at least $5,000) will have a maximum term of 60 months and 15 days.
Affirmative Reporting/Offer of Consumer Education
All finance lenders must report consumer borrowers’ payment performance to at least one national credit bureau; newly licensed finance lenders not already approved as data furnishers to a consumer reporting agency will have up to one calendar year to obtain such approval. Finance lenders also must offer consumer borrowers, prior to funds distribution, a free credit education program approved by the commissioner of the California Department of Business Oversight, although the consumer need not accept the educational offer.
The above provisions apply to all loans with an original principal under $5,000 and consumer loans of less than $10,000; commercial-purpose loans of $5,000 or more are not subject to these new requirements.
- A “consumer loan” in California includes both (1) any loan that has a principal amount of less than $5,000, absent a contrary, signed statement from the borrower and (2) any loan, regardless of amount, for which the proceeds are intended to be used primarily for personal, family, or household purposes.
- Most of the Act’s provisions, e.g., rate caps, will apply to all consumer-purpose installment loans, including personal loans, car loans, student loans, and auto title loans, as well as open-end lines of credit where the amount of credit is $2,500 or more but less than $10,000.
- The CFL already caps rates and imposes additional consumer protections on consumer-purpose loans of less than $2,500.
- Other provisions, e.g., the maximum/minimum terms, do not apply to open-end loans or certain student loans.
- The CFL generally exempts loans made by a nonlicensee under a credit card program, so the Act will not apply to most credit card receivables.
- The Act’s provisions apply equally to licensees and nonlicensees (e.g., purchasers of loans originated by a licensee), but do not apply to entities exempt from the CFL (e.g., banks and insurance companies).
- For bank-originated loans purchased by a fintech company, a “true lender” analysis should be conducted to ensure that the fintech company will benefit from the bank’s exemption from these provisions.
- The language of the Act’s rate cap provisions—reaching those who “collect or receive” payments—raises the concern that such caps may apply to the future collection or receipt of payments on previously originated loans. Our view is that the California DBO should not seek to apply these rate cap provisions, in a quasi-retroactive fashion, to previously originated loans or to securitized pools of such loans.
- The Act uses none of the language of retroactivity, e.g., asserting that statutory changes are “declaratory of existing law,” that is typically included where the legislature intends for a statute to apply retroactively.
- Further, California’s courts require clear legislative intent (not present here) to rebut the judicial presumption against the retroactive application of a statute. See, e.g., In re Marriage of Buol, 705 P.2d 354 (Cal. 1985). This is true especially where, as here, such a backward-looking application arguably would offend constitutional considerations, including by impairing either (1) the obligation of a contract or (2) vested property rights. Id.
New Restrictions for Open-End Consumer Loans of Less Than $10,000
Various provisions that formerly applied only to open-end loans of less than $5,000 will now apply equally to open-end loans with a principal amount of less than $10,000. Those restrictions include the following:
- Restrictions on the methods available for calculating charges
- Permissible amount of fees, costs, and expenses
- The minimum monthly payment requirement
- The amount of loan proceeds that must be delivered to the borrower
No Prepayment Penalties on Consumer Loans of Any Amount
This prohibition upon consumer loan prepayment penalties applies without regard to loan amount, but does not apply to commercial-purpose loans or to real estate–secured loans.
Key Compliance Considerations
As noted previously, entities that are exempt from the CFL, e.g., banks and insurance companies, are not affected by these changes. However, nonbank lenders should incorporate these new requirements into their compliance programs. And nonbank purchasers of bank-originated loans should either comply with these provisions or confirm that the transaction is structured so as to benefit from the originating entity’s exemption.
With respect to prospective securitizations that include California small dollar loans made by nonbank lenders, the new rate limitations and prepayment penalty restrictions may reduce the profitability of newly securitized pools (holding all other factors equal) as compared to prior securitized pools with a similar concentration of CFL-covered loans. Further, additional due diligence in securitization transactions will be required to ensure the continued enforceability of nonexempt loans. With respect to consumer loans, any nonwillful violation of the CFL, in addition to potential civil money penalties, may carry a statutory remedy of forfeit of all interest and charges on the loan. Willful violations, in addition to potential civil money penalties and incarceration, carry a statutory remedy of voiding the loan contract entirely, eliminating the right of any party to collect or receive any principal, charges, or recompense in connection with the transaction.