The federal government’s consumer watchdog agency is proposing landmark rules to protect borrowers from “debt traps” created by payday loans, auto title loans and other forms of short-term credit.
The long-awaited move takes aim at financial products that are sharply criticized by consumer advocates, but are used regularly by millions of Americans.
“The Consumer Bureau is proposing strong protections aimed at ending payday debt traps,” Consumer Financial Protection Bureau Director Richard Cordray said in an announcement of the rules. “Too many borrowers seeking a short-term cash fix are saddled with loans they cannot afford and sink into long-term debt.”
According to a Federal Reserve report, 46 percent of adults can’t cover an unexpected expense of $400. The proposal intends to keep emergency loans available without allowing them to become a cycle of recurring debt, the CFPB said.
The rules’ major provisions would require lenders to:
- Examine customers’ ability to repay. For short-term loans of more than $500, lenders must undertake a full-payment test to determine if the borrower can repay the full amount when it’s due and still meet basic expenses and other financial obligations, without re-borrowing within 30 days.
- Cap the number of short-term loans that can be made at three loans within 30 days of each other.
- Protect borrowers from repeated overdraft fees caused when payday lenders attempt to collect. Lenders must give customers written notice before accessing their bank accounts for repayment. After two unsuccessful collection attempts, a lender would be blocked from the account until customers renew their authorization.
Lenders can skip the full-payment test for short term loans under $500 with certain payback terms, according to the CFPB’s summary. The repayment terms allow two extensions of the original, with one-third of the principal repaid each time, avoiding a cycle of loan renewals. The exemption could cover most payday loans, since the typical amount borrowed is $350. Longer term loans with rates capped at 28 percent and application fees of $20 or less may also skip the full-payment review.
Lenders would also be required to report information on loans to credit reporting systems, and review information about customers’ borrowing.
The proposal follows the general outline of payday loan restrictions the agency first floated in March 2015. The agency will take comments on the proposal until Sept. 14, after which it will begin work on final regulations. The proposed effective date will be 15 months after the final rule is published in the Federal Register.
Lenders say credit will shut off
The proposal “presents a staggering blow to consumers as it will cut off access to credit for millions of Americans who use small-dollar loans to manage a budget shortfall or unexpected expense,” Community Financial Services Association of America CEO Dennis Shaul said in a statement. Lenders say it is too costly to perform ability-to-repay analysis on small loans.
About 20,600 payday advance locations provide short-term credit to 19 million U.S. households, according to the payday industry group. Thirty-six states allow high-cost payday loans. As for car title loans, about 2 million American adults access that form of credit annually, according to a March 2015 study by the Pew Charitable Trusts. More than 8,000 title loan locations operate in the 25 states that permit title lending.
The CFPB scheduled a public hearing in Kansas City, Missouri, on Thursday, with consumer advocates and lending industry representatives scheduled to have their say.
“We look forward to a strong rule that will protect consumers from the well-documented abuses of an industry that has made every attempt to evade meaningful oversight,” Consumer Federation of America Director of Financial Services Tom Feltner said in a statement in advance of the hearing.
In addition to payday and title loans, the proposed rule covers deposit advance products offered by banks, high-cost open-ended loans and installment loans. Other financial products including mortgages and credit cards are excluded.
“By putting in place mainstream, common-sense lending standards, our proposal would prevent lenders from succeeding by setting up borrowers to fail,” Cordray’s statement said.
Nearly half of payday borrowers are heavy repeat customers who take out 10 or more payday loans a year — and they account for three-quarters of the industry’s total fees, the consumer bureau found in a 2013 study. The interest rate for the typical loan comes to 390 percent annually. One in five auto title loans result in the borrower’s vehicle being repossessed, the CFPB found.
However, an analysis by the Federal Reserve Bank of New York found that consumers bounced more checks and complained more about debt collectors in states that banned payday lending, indicating that short-term financial problems persist in the absence of payday loans.
Banks seek return to small-dollar lending
Banks say they are seeking an opportunity to get back into the small-dollar lending business, after guidelines by bank regulators effectively ended their deposit advance business. That move in 2013 sent borrowers to the less regulated, higher cost payday industry, according to the Consumer Bankers Association.
“Regulatory agencies live in a utopian world where they believe if they can eliminate the product, they can eliminate the demand,” CBA President Richard Hunt said in a press call Wednesday in advance of the CFPB announcement. He said the rule as proposed will force banks to stay on the sidelines of small-dollar lending. But the bankers group will use the comment period to try to make a place for emergency bank loans in the final rule. Unlike payday lenders, banks have an ongoing business relationship with depositors who take out deposit advances, Hunt said, giving them insight into borrowers’ financial footing and ability to repay.
Hearing exposes divisions
The CFPB’s public hearing in Kansas City, Missouri, on Thursday highlighted the deep divisions surrounding small dollar loans and the agency’s plans to reform them.
“Business as usual payday loans must end,” said Kerry Smith, a consumer attorney at Community Legal Services of Philadelphia. “They are the equivalent of throwing a leaded anchor to a drowning man.” Smith said all payday loans should be required to look at the borrower’s ability to repay, or predatory lenders will take advantage of a potential loophole for loans under $500.
Kinecta Federal Credit Union CEO Keith Sultmeier said the rule would hurt his institution’s effort to offer safe small-dollar loans, and called for an exemption for small credit unions. The California lender offers payday consolidation loans at 18 percent interest, designed to help consumers escape a cycle of high-cost borrowing. “Our objective is not to maximize profits,” he said. “We question the need for including us in this regulation.”
The regulation will also puts a heavy burden on traditional installment lenders — and their customers, who need access to short-term loans quickly, said William Himpler, executive vice president of the American Financial Services Association. “Requiring underwriting that is on par with a 30-year mortgage will not work for the typical installment loan customer,” he said.
QC Holdings President Darrin Andersen said customer surveys show high satisfaction rates with his short-term loan company. Customers will have to turn to unlicensed and illegal funding as payday lenders exit the business, he said. “What will replace payday lending when the bureau regulates us out of existence?” Andersen said.
But opponents said they see high-cost, repeat payday loans hollowing out families and undermining neighborhoods as borrowers struggle to come up with fee after fee to renew their loans. “Access can be a red herring that obscures the fundamental nature of predatory loan products,” said Galen Carey, vice president of government relations for the National Association of Evangelicals.
See related:Study: Payday loans trigger overdraft fees