By Kate Bulger and Doug Lewis | December 20, 2021
California has long been a leader in student borrower protection. In 2016, the state passed the Student Loan Servicing Act, creating key protections for borrowers against pervasive abuses by the private-sector firms that manage their loans. In 2020, California enacted the landmark Student Borrower Bill of Rights, which added further layers of prohibitions on harmful practices by student loan companies. Along the way, California has taken aim against bad actors, deceitful practices, and all other manner of schemes and failures that have harmed borrowers.
But the work to protect student loan borrowers in the Golden State is not finished.
In particular, today we released a new memo outlining how California’s Department of Financial Protection and Innovation (DFPI) can protect California borrowers from a risky type of emerging private student debt: income share agreements (ISAs). Written in response to a request for comment from the DFPI, our memo identifies and describes the risks that these financing arrangements pose to students who use them, and shows how the Department can use the expansive authorities already at its disposal to install robust consumer protections and further hold bad actors accountable in this rapidly growing market.
A copy of our new memo is available here.
Income share agreements are a form of private student loans that students repay by pledging a percent of their income each month after graduation. Though the market for ISAs is expanding quickly, a growing body of lawsuits, investigations, and dire warnings by academics, lawmakers, and personal finance experts alike indicate that these products carry extreme consumer risks.
In particular, ISA providers have been caught relying on deceptive marketing, charging borrowers illegal prepayment penalties, and even appearing to engage in outright racial discrimination. These companies hide behind the spurious argument that their product is not a loan or a form of consumer credit, and that they therefore do not have to comply with basic consumer protection laws and regulations at the state or federal level.
California has been at the forefront of the work to put these dubious arguments to rest and take ISA companies to task for their predatory behavior. For example, in August, 2021 the DFPI announced a landmark consent order with the ISA originator and servicer Meratas. This action indicated that the company had violated the state’s Student Loan Servicing Act by collecting on ISAs without first securing a license to act as a student loan servicer. The DFPI’s move set the stage for even broader intervention at the federal level by the Consumer Financial Protection Bureau, which issued a consent order against an ISA provider in September, 2021 citing a host of consumer protection violations—including falsely representing that its ISA products were not loans.
In November, 2021 the DFPI followed up by developing and inviting comments on draft rules to govern the conduct of “education financing” providers, including ISA lenders. The memo we released today responds to the DFPI’s draft regulations identifying key areas of consumer risk and outlining that the agency must take at least the following badly needed steps to protect ISA borrowers in California:
- Weed out deception and consumer harm. The DFPI can and must make clear through rulemaking that it is a deceptive practice under the law for ISA providers to erroneously claim that their product is not a form of credit, to misstate the cost of an ISA by not following well-established disclosure requirements related to loan APRs, or to otherwise deceive borrowers when presenting how an ISA compares to other financing options. As past investigations make clear, all of these practices are currently endemic to the ISA market. Once ISA APR disclosures are in place, the DFPI can use its authorities to clarify that ISA APRs over 10 percent are unconscionable under California law, setting the stage for the DFPI to finally stamp out usury across the market.
- Double down on holding bad actors accountable through the courts. As the Meratas case cited above makes clear, the DFPI already has the authority to take legal action against ISA companies. The DFPI should build on the momentum of its action against Meratas by comprehensively utilizing its power to take legal action and seek financial penalties and statutory damages against bad actors. At the top of the list should be companies that deploy misleading marketing materials, collect on unenforceable loans, or otherwise violate state or federal prohibitions on unfair, deceptive, or abusive acts and practices.
- Give borrowers the tools to get the fullest remedies possible for industry harms. California’s Student Borrower Bill of Rights gives individual borrowers the right to sue student loan companies that fail to comply with the law. Accordingly, the DFPI should clarify what constitutes an adequate remedy under the law for borrowers who have been wronged—and it should ensure that those remedies are substantial. This step would ensure that borrowers get the fullest relief possible when they take ISA companies to court for abusive practices, and it would deter bad actors from stepping into the ISA space in the first place.
California is a proven leader in the fight to protect student loan borrowers. Right now, the state can use the clear roadmap laid out above to follow through on its work to end the Wild West era in the ISA market. It’s time for the Golden State to once again pave the way in private student loan borrower protection.
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Kate Bulger is a first-year law student at Berkeley interested in the legal implications of emerging technology. Before starting law school, Kate worked in data analytics and strategy at Capital One and at HireVue, a Utah-based HR tech company.
Doug Lewis is a first-year law student at Berkeley interested in consumer financial protection law. Before law school, Doug worked in criminal justice policy and research at FWD.us.