Personal Finance

How High-Interest ‘Rent-a-Bank’ Loans Sidestep State Rate Caps

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An online search for “online loan” returns a list of low-interest personal loans alongside no-credit-check loans with high interest rates. The latter might not be available in many states if it weren’t for the “rent-a-bank” business model.

This method of lending involves financial technology companies that partner with banks to distribute installment loans with triple-digit annual percentage rates to consumers who may not qualify for lower-interest loans.

Though they’re most popular online, you could also encounter rent-a-bank loans at retail stores, auto repair shops or pet stores, says Lauren Saunders, associate director at the National Consumer Law Center, which advocates for consumers and against rent-a-bank loans.

States have tried to curb high-interest lending by setting interest rate caps, but the rent-a-bank model allows loans with APRs of 150% or higher to reach people across the country. Consumer advocates and researchers say such loans can leave borrowers in long-term debt that’s difficult to repay.

How do rent-a-bank loans work?

Most states have laws limiting the maximum interest rate lenders can charge, but exceptions are often made for banks, Saunders says.

This means that when a state lowers its maximum interest rate, nonbanks like payday lenders are often affected, but banks that issue high-cost loans may not be. Currently, state rate caps range from 17% to 59% on two-year, $2,000 loans, according to the NCLC. The median APR is 32%.

For example, Washington state limits interest rates on two-year, $2,000 loans to 29%, but consumers there can still get a loan with a 100% APR.

When a financial technology company, or online lender, wants to offer expensive loans to consumers across the country, it works with a bank, rather than lending under individual states’ rate caps, like a nonbank lender would.

Hence, the term “rent-a-bank”: The online lender is seen as renting the bank’s charter to make high-cost loans.

Consumer advocates say the fintech company should be treated like it’s making the loans, which would force it to follow state rate caps.

“The rent-a-bank lenders are obviously trying to get around the will of voters and the will of legislatures who don’t want predatory lending in their state,” Saunders says.

But some in the lending industry say the arrangement is a beneficial collaboration, not just a rental.

The fintech company brings expertise in marketing, design and managing applications, while the bank can navigate complex lending regulations, says Scott Pearson, head of the consumer financial services group at the law firm Manatt, Phelps and Phillips LLP.

Pearson, who has represented banks and fintech companies and helps them navigate regulatory issues, says the term “rent-a-bank” is misleading.

“The suggestion is that you’re just going to pay a bank to let you use their charter, and that’s just completely inconsistent with the way these things work,” he says. “The banks are very actively involved in these partnerships.”

How rent-a-bank loans can be harmful

Rent-a-bank loans make it possible for high-interest loans to reach consumers in states where those rates aren’t legal.

Some say these loans provide necessary access to credit for people with low credit scores or incomes that would keep them from qualifying for lower-cost options like personal loans and credit cards.

“While consumers have the oceanfront of companies and products, not every consumer qualifies for every product, primarily because of poor credit or higher credit risk,” says Andrew Duke, executive director of the Online Lenders Alliance, which represents the fintech companies that partner with banks in offering short-term online loans. “The rate reflects a higher risk that the consumer poses to a lender.”

But consumer advocates say the loans do more harm than good.

A September survey from the Center for Responsible Lending called rent-a-bank loans “some of the most predatory on the market,” citing rates from 100% to 189%.

A loan example in the survey shows a $3,000 rent-a-bank loan repaid over about nine months at a 159.33% APR. The borrower paid $2,355 in interest, more than half of what was borrowed.

A key finding from the survey concluded, “The burden of repaying high-cost loans often caused borrowers to miss payments on other obligations, resulting in additional debt or a larger financial deficit — aggravating, rather than alleviating, preexisting financial challenges.”

Alternatives to high-interest loans

  • Seek help from local nonprofits and charities for help with groceries, gas or utility bills.

  • If bills are piling up, ask your creditor, landlord or utility company to put you on a payment plan. Ideally, this is an interest-free way to temporarily cut costs.

  • Though doing so may be difficult, consider reaching out to friends or family for a low- or no-interest loan to bridge an income gap or cover an unexpected expense.

What to do if you have a high-interest loan

The Consumer Financial Protection Bureau and states’ attorneys general sometimes take action against lenders for predatory practices. If you’re stuck in a high-interest loan, Saunders recommends filing a complaint with both.

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