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There's a wild US ‘debt-to-jail pipeline' built by payday lenders

Payday loans aren’t just expensive and risky — they could also land you jail.

According to a new report by the non-profit Consumer Federation of America (CFA), high-cost lenders in Utah have been targeting people unable to repay debts by suing them in a small claims court.

When the debtor doesn’t show up, the lender obtains a bench warrant to have them arrested. And then for-profit constables approach these debtors, arrest them, take them to jail and ask for bail money.

“We estimate that Utah small-claims judges issue bench warrants for the arrest of over 3,100 high-cost borrowers per year and that 91 percent of all small-claims arrest warrants are issued in high-cost lending cases,” the report stated.

Read more: Payday loans: What you need to know

Using screen scraping software they designed, the authors dug into information collected from every small claims court hearing scheduled in the state of Utah for an entire year and also looked at a random sample of specific 377 cases.

“This study provides a troubling example of a ‘debt-to-jail pipeline,’” Christopher Peterson, Director of Financial Services of CFA and one of the authors of the report, said in a statement. “Some payday lenders are using the criminal justice system to collect triple digit interest rates from insolvent consumers.”

A customer leaves a payday loan store on Frederick Rd. in Gaithersburg, Maryland. (Photo: Michael S. Williamson/The Washington Post via Getty Images)

The study’s grim findings aren’t entirely surprising, though.

“In theory, debtors prisons have been outlawed... but over the past decade or so, there’s been reporting on the use by debt collectors and other creditors of the state court system process to almost criminalize debt,” Lisa Stifler, director of state policy at D.C.-based nonprofit Center for Responsible Lending, told Yahoo Finance.

What stood out to experts was the last part of this new process: Asking for bail money. Stifler noted that a 2014 rule passed in Utah allowed for creditors to actually take some of that bail money was particularly worrisome.

High-cost lenders flooding small claims courts

A small claims court is a part of the legal system where individuals can sue for money without a lawyer, hence avoiding lengthy and expensive lawsuits. 

It’s generally used for situations where low dollar value cases are involved, such as below $11,000 in Utah or $5,000 in New York. It’s usually used by creditors to collect on bad debt.

“In theory, they were created to allow people to pursue legal claims against other people without the need for the extensive [process], often intricate legal rules,” Stifler explained. “What has happened though is that in many states, companies are taking advantage of that.”

In one example, a borrower in Ogden, Utah had gone to a lender called Mr. Money for a loan.

When she failed to pay that loan back, Mr. Money filed a lawsuit against a borrower for $237 in 2011. The lender continued to sue the woman for over seven years.

Court filings indicate that Mr. Money’s most recent action was to seek a warrant to have her arrested for failing to appear in court for another hearing in the case. The case was still ongoing as of January 2020.

The study found that payday, vehicle-title, and similar high-cost lenders were the dominant plaintiffs in small claims courts, initiating two-thirds of all cases. They also found that 7 in 10 hearings scheduled in Utah’s small claims courts involved the collection of a high-cost loan.

Source: "Unwarranted: Small-Claims Court Arrest Warrants in Payday Loan Debt Collection"

High-cost lenders also litigated more aggressively: They sued for smaller amounts and litigated for much longer periods of time compared to other plaintiffs. They also routinely obtained arrest warrants against their clients from Utah small claims judges, the report added.

“Our data show triple-digit interest rate lenders account for over 90% of all the arrest warrants that are being issued by the small claims court system in the state of Utah,” Peterson said. “And that amounts to about over we estimate about 3,100 people per year are having arrest warrants issued for their arrest.”

On top of that, the data revealed that “nearly three in ten high-cost lender lawsuits result in a bench warrant for the arrest of the borrower for contempt of court,” the authors added. “Indeed, some borrowers face arrest on multiple occasions with respect to the same loan.”

Peterson added: “I suspect that states like Tennessee, Texas, Mississippi, Nevada, a lot of states around the country should anticipate that they may be having similar problems in their jurisdiction until there's proof otherwise.”

Congress banned debtors prisons in 1833

America has always been wary of high-cost interest rates. And Congress banned debtors prisons in 1833.

The authors also noted that for instance, when the country declared independence, all thirteen original American states actually imposed a cap on interest rates, as seen in the table below: 

Source: "Unwarranted: Small-Claims Court Arrest Warrants in Payday Loan Debt Collection"

While these limits were relaxed a little over time, states and the federal government were very cautious in allowing lenders to charge high interest rates.

But a 1978 U.S. Supreme Court decision upended this 200-year belief, ruling that if a national bank in one state makes loans across state lines, the bank’s home state usury law applies to prevent unreasonably high interest rates.

Hence, for example, if a bank from limit-free Utah charged a 300% interest rate to a borrower in New York, which has a usury limit of 10%, it doesn’t matter — that borrower will be charged under Utah’s usury laws.

“With the two-hundred-year-old edifice of American usury law cracked, non-bank finance companies became increasingly effective at lobbying state legislatures for new exceptions to traditional consumer credit price limits that exceed the conservative historical American norms,” the authors stated.

Stifler noted that payday lenders were separate from banks, and that these rules didn’t quite apply to them. Nevertheless, as states loosened rules on payday lending in particular in the 1990s, that gave rise to more predatory behavior.

State payday interest rates as of 2019. (Graphic: Center for Responsible Lending)

Utah case one to watch closely

While it may seem like the study’s focus on Utah depicts a state-specific problem, Peterson argued that what happens in Utah has national ramifications.

“Utah is a deregulated state that's the kind of state that lobbyists for the financial services industry often try to emulate,” he explained. “It tells us something about what the free market results in if we don't have reasonable consumer protection laws. So it's illustrative for policy debates all around the country and may directly influence lending environments, to the extent that Utah's regulatory environment is exported across the country.”

In the report, the authors added that what happens in Utah also has implications for the “future of consumer finance in a digital world.”

The cruel reality, according to Peterson, is that these high-cost lenders “are attempting to have these people arrested to coerce them to continue making payments and to stay in debt and to try to squeeze as much profit out of these families as possible.”

Aarthi is a writer for Yahoo Finance. She can be reached at aarthi@yahoofinance.com. Follow her on Twitter @aarthiswami

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