May 31, 2023

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Legislator wants to force banks to make subprime loans

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Remember the subprime loan fiasco associated with the 2008 housing crisis and the resultant economic recession?  HB 2254 submitted by Rep. Tim Hodges, D-North Newton, would require banks to lend at least five percent of banks’ capital for subprime loans.  The bill defines a subprime loan as a loan “made to a borrower who has either a non-existent credit score or a credit score of less than 620.

The rise of subprime lending in the 2000’s had a direct impact on the collapse of the housing market in 2008. Yet, HB 2254 defines subprime loans strictly based on the borrowers credit score without taking into account what a subprime loan is. “Subprime” is a loan offered at above the prime rate to individuals who do not qualify for prime rates. The subprime part actually refers to the interest rate at which the loan is being offered from the lending institution to the borrower.  The prime rate is set by the Federal Reserve and it’s a major factor in setting the interest rates that banks chargs borrowers.

Consumers with good credit are offered loans at interest rates near the prime rate. By definition subprime loans are higher than prime rates. Subprime loans cost consumers more money. As result, should the bill be passed, banks will be required to offer a certain amount of loans at a higher interest rate to consumers.

Ira Rheingold, The Executive Director and General Council of the National Council of Consumers Advocates, believes the bill is encouraging loans to be made to those who struggle to get loans, but that the definition of subprime in the bill is wrong.

“The definition of subprime loan seems awfully odd. That’s not really what a subprime loan is,” says Rheingold. “Subprime loan is a loan that is more expensive.”

Representative Hodges says that though “subprime loan” is written in the bill, what he meant to do with the bill was bring back signature loans from local banks.

“The name on the bill is unfortunate. It is more in the line of signature loans,” says Hodges. “The idea is so that people can go to their local bank and get a signature loan versus down the street at the payday lender.”

A signature loan, also known as a character loan, is a loan made on a borrower’s signature and with no collateral. The interest on this type of loan is typically higher than prime rates because there is no collateral put up to guarantee the loan. This puts them in the category of unsecured loans. It is not a subprime loan as the bill repeatedly mentions.

Hodges says the bill was meant to give borrowers an option for access to money instead of going to payday lenders. In Kansas payday loans are limited to $500 with loan terms from 7-30 days. Interest rates for payday loan average 390% APR. The interest rates are high but that is due to the short-term immediate credit that borrowers pay for. Payday loans are not subprime loans, but Hodges bill to address them makes no mention of payday lenders.

A key point Rheingold brought up was the legal jurisdiction of banking laws. The bill as it is written would more than likely apply to banks that are only state licensed. Yet, most banks are federally licensed and therefore outside the purview of state laws. HB 2254 would potentially not apply to a vast number of banks in Kansas. Hodges says that he is unaware of the impact of the bill.

“I don’t know what the interplay with the federals is going to be. I just know state regulators would relax on the bank to do what was called in the olden days a signature loan.”  ‘Relax’ is an odd description applied by Hodges, given that the bill ‘requires’ banks to make unsecured loans.

Rheingold notes that encouraging loans to be made to people who are typically struggle to get them is not a bad idea, but the bill struggles to clarify that.

“When you say subprime loans what you are saying is that’s a loan that is more expensive and maybe not fairly priced,” says Rheingold. “A lot of the act from what I looked at did not really seem to talk about that at all.”

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