Online lenders charging triple digit interest rates are dodging state laws banning such loans. The money is routed through banks that aren’t regulated at the state level to get around the rules.

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Consumer watchdogs say online lenders are dodging state laws that ban very high interest rate loans, some in excess of 100%. The lenders say they’re not doing anything wrong, but advocates say these loans are predatory and are asking federal regulators to crack down. NPR’s Chris Arnold reports.

CHRIS ARNOLD, BYLINE: OK, so let’s say that I’m an online lender charging 100% interest rates. Things are working pretty well for me here. I’m making money. But then the state of California passes a new law capping interest rates for many loans much lower – at around 38%. What do I do? Well, if I can find a partner – a real bank, one that’s not subject to the state of California’s rate cap – the loan money flows through that bank – and boom – I can get around the rate cap.

LAUREN SAUNDERS: Right. I mean, this is almost like money laundering, right? This is laundering, you know, basically the source of the money and the source of the loans.

ARNOLD: That’s Lauren Saunders, an attorney with the National Consumer Law Center. She says a lot of these online lenders are using what she calls rent-a-bank schemes. This lets them skirt state law because there’s no federal cap on interest rates, and most banks are not subject to the state rate caps. Saunders says this can work in different ways, but the simple version is this. The online lender does basically all the work to find the customers, approve the loans, collect on them, but right when someone gets a loan…

SAUNDERS: At the moment that the money actually goes to the consumer…

ARNOLD: That money comes from a bank that’s not covered by the interest rate limitations. So she says the online lender then immediately buys the loan back from the bank.

SAUNDERS: So it’s not really a bank loan. They’re just using banks as a fig leaf to make really high-cost loans – 160% interest – in states where those loans are illegal.

ARNOLD: Saunders says a lot more people are taking out online loans these days, and lenders are evading rate caps in 25 states. So she and 60 other consumer protection and civil rights groups have now sent letters to federal regulators, asking them to crack down. It seems clear that online lenders are evading state rate caps. On an earnings call before the California law passed, the company Elevate Credit Inc. talked about it openly. The interim CEO Jason Harvison talked about working with banks to get around rate caps.

JASON HARVISON: Similar to our recent experience in Ohio, we expect to be able to continue to serve California consumers via our bank sponsors that are not subject to the same proposed state level rate limitations.

ARNOLD: The online lenders, though, maintain that they’re not doing anything wrong. Elevate tells NPR in a statement that the letters from consumer groups, quote, “grossly mischaracterized our business and intent,” and that the company says its relationship with outside banks is in full compliance with all federal laws. So is dodging state interest rate rules illegal or just unseemly or just a creative way to keep serving your customers?

ADAM LEVITIN: We have a system right now that makes no sense.

ARNOLD: Adam Levitin is a law professor at Georgetown University. He says lawsuits in the works will likely help determine where the legal line is here. And he says Elevate, for example, does more sophisticated partnerships, which might be more legally defensible. So instead of the simple rent-a-bank scheme, in Elevate’s case – you might want to hang on to your brain here.

LEVITIN: The bank keeps the loan but sells a derivative interest in the loan – a 90% derivative interest – to a entity associated with Elevate.

ARNOLD: If that’s confusing, don’t worry. Levitin says the point is this whole complicated structure is being set up to get around the state rate cap. And he says the underlying problem is that some lenders have to play by one set of regulations, and banks get to play by another set of rules.

LEVITIN: The better way to do this really would be to have a national usury law.

ARNOLD: In other words, a nationwide rule that all lenders would have to follow. And today in Congress, lawmakers introduced a bipartisan bill to establish a national interest rate cap of 36%. Active duty military already have that protection. Some lawmakers want to extend it to the rest of the country. But plenty of financial firms are likely to lobby against it.

Chris Arnold, NPR News.

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