Dismantling Unjust Interest Rates for Debt Collection Judgments

The costs of credit and debt collection, which are inextricably linked, are frequent battlegrounds for consumer financial products and services regulation.

Over time, these industries have gained outsized importance in the United States. For example, as of 2019, over 75 percent of all consumers have at least some debt. Moreover, about a third of all consumers have some of this debt under collection.

Debt collection through the courts has become rather ubiquitous. From 1993 to 2013, the number of debt collections actions filed nationally more than doubled—totaling an estimated 4 million. It likely has continued to rise. As of 2020, the debt collection industry consisted of over 7,000 agencies with $13 billion in revenue.

In this context, reforming pre- and post-judgment interest rates for consumer debt collection actions could make a real difference in the consumer financial services regulatory landscape. State legislators have the power to implement these reforms, and there are compelling reasons for more states to take bold action.

In 2021, the New York legislature enacted groundbreaking regulatory reform to reduce the pre- and post-judgment interest rates on consumer debt judgments. The legislature recognized how significantly out of step the 9 percent statutory rate was in the record low interest rate environment. It lowered that rate from 9 percent to 2 percent.

Some facts and numbers demonstrate the important context that compelled the New York legislature to act. The 9 percent statutory rate in New York went into effect more than 40 years ago, in June 1981. From December 1980 to June 1981, the average one-year Treasury constant maturity rate—a relatively conservative benchmark rate and the post-judgment interest rate applied to federal judgments in civil actions—averaged 14.6 percent. At the time that the legislature set the 9 percent rate, the judgment interest rate was less than the benchmark or market rate. But, on average, the 9 percent judgment interest rate has been more than 4 times the benchmark or market rate over the last 20 years. That rate has averaged less than 2 percent.

In the same 20 years, the legislature estimated that millions of consumer debt actions were brought in New York’s civil courts. In the early 2000s, these actions in New York City had a default rate as high as 79 percent, which is not surprising because irregularities in service of process—namely, outright failure to serve consumer debt defendants with a summons and complaint—were rampant and well-documented.

One scholar estimates that judgments for consumer debt actions entered in New York City’s civil courts amounted to $800 million in 2006 alone. Those judgments can still be collected today in New York. At a 9 percent post-judgment interest rate, the $800 million of judgments in 2006, if unpaid, would multiply to a staggering $1.88 billion in 2022—2.35 times the original amount.

Nationally, organizations are studying and reporting how debt collection litigation drains wealth and how its processes have been abused. Debt collection lawsuits are far more common in Black communities than white ones, even when accounting for income.

The structural racism that makes it more likely that Black communities have lower income, are targeted with predatory financial products, pay more for credit, and have shockingly less wealth also makes Black communities more likely to be targeted by a debt collection lawsuit and face the attendant debilitating consequences.

Debt buyers who traffic these judgments, old and new, can find judgment debtors—or someone who is responsible for the debt—through public data sources and information subpoenas to employers and banks. They can garnish wages—withholding portions of paychecks until the debt is paid—or freeze bank accounts for as long as a judgment is collectible under state law—a minimum of 20 years in New York.

Garnishments hit low-wage households that have little or no wealth like a bomb. Because garnishments can be based on judgments that are 10 to 20 years old, the judgment balance has often multiplied by the time a person has recovered from a financial shock and has income again. Garnishments can plague middle and low-income working individuals for years.

Every state legislature with a high fixed rate or a rate that is tied to a benchmark rate but adds a fixed amount by statute must lower its judgment interest rate for consumer debt judgments. From a policy perspective, an interest rate set by the state is different from one set in the market—the government is not motivated by profit and has an obligation to act in the interest of its people.

Most people who are sued for consumer debt and have judgments against them have low to no income and little to no wealth. Most consumers who are sued in these contexts expected to continue making payments on their debts but, for one reason or another, were not able to do so. They are not holding on to large sums of money and avoiding payment of judgments.

The argument that a low judgment interest rate will encourage investment in the market in lieu of paying off a judgment is not rational when applied to people who often struggle to pay for basic necessities.

Another common argument is that reducing returns on credit in any way—no matter how distant from the origination of the credit—will reduce the availability of credit. In fact, reform to litigation requirements for debt collection actions, which presumably increase the total cost of collection, did not decrease the availability of credit.

The New York legislature, consistent with its authority and with careful consideration, went one step further: The legislature retroactively changed the statutory interest rate from 9 percent to 2 percent for outstanding consumer debt judgment amounts.

By doing so, the legislature took a bold and significant step in ameliorating the harm caused by the 9 percent rate on judgments entered over the last 20 years with balances that have multiplied due to interest, especially in the current unprecedented economic environment. The 9 percent rate has provided an outdated windfall for debt collectors who can continue to collect on judgments that were entered when systemic irregularities in debt collection litigation were essentially unchecked.

The retroactive change is limited to avoid disruption to money that has changed hands and judgments that have been entered. Lawmakers clarified that interest amounts paid prior to the effective date will not be returned or applied to the principal judgment amount to reduce it.

In addition, judgments that incorporate 9 percent pre-judgment interest will not be reopened or altered. But the change will bring significant relief to those people whose judgment balance continues to balloon because their monthly payments or the amount of their wage garnishment is insufficient to cover the full amount of interest being added to their balance by the statutory 9 percent rate.

The idea of a retrospective change in the law can be a source of discomfort because it raises the question of a taking under the Fifth Amendment of the U.S. Constitution and under many state constitutions.

The Fifth Amendment, however, does not mandate that states accept the operation of economic laws that are unjust and that have perpetuated structural inequities. The Fifth Amendment’s protection of property from regulatory takings requires compensation when the government infringes on a property owner’s rights so severely that the government’s action is effectively a physical seizure.

This analysis requires factual inquiries that allow “careful examination and weighing of all the relevant circumstances.” Plaintiffs arguing that they have suffered a regulatory taking face a high bar to get relief in court.

The Supreme Court has declared that “government hardly could go on if, to some extent, values incident to property could not be diminished without paying for every such change in the general law.” The Court has also recognized accordingly that often “government may execute laws or programs that adversely affect recognized economic values” without conflicting with the Fifth Amendment.

This moment in history demands that policymakers take affirmative steps to dismantle unjust structures that will continue to siphon income and potential wealth from people who are historically marginalized and can least afford it. High judgment interest rates on consumer debt are one such structure that needs dismantling.

Karuna B. Patel is the Deputy Director of the Feerick Center for Social Justice at Fordham Law School.