The Consumer Financial Protection Bureau proposes new regulations today that seek to end the recurring cycle of debt from payday loans that prevents borrowers from closing out their loans while racking up excessive fees.
The proposed rules also would halt repeated debit attempts that cause mounting fees. The new regs cover car-title loans, advance deposit products and certain high-cost installment and open-ended loans as well.
“Too many borrowers seeking a short-term cash fix are saddled with loans they cannot afford and sink into long-term debt,” CFPB Director Richard Cordray says.
Consumer debt traps
The CFPB is concerned that payday and car-title loans and other high-cost lending products are forcing consumers into “debt traps,” the agency says.
“Faced with unaffordable payments, consumers must choose between defaulting, reborrowing, or skipping other financial obligations like rent or basic living expenses like food and medical care,” according to the CFPB statement.
On its website, the CFPB offers this video on how payday loans work:
Loan rates exceed 300%
Ultimately, this problem can lead to steep penalty fees, bank account closures and car seizures.
Payday loans are often due on the borrower’s next payday, usually within 2 weeks, at an annual percentage rate of 390%. Car-title loans are due within 30 days with an APR of 300%. The CFPB says 4 in 5 short-term loans are reborrowed within a month because the borrower can’t cover the loan total.
The CFPB proposal would put in place:
- A full-payment test: Lenders would be required to determine whether the borrower can afford the full amount of each payment when it’s due and still meet basic living expenses and major financial obligations, without having to reborrow within the next 30 days. The proposal also would cap the number of short-term loans that can be made in quick succession.
- Principal payoff option for certain short-term loans: Consumers could borrow a short-term loan up to $500 without the full-payment test as part of the principal payoff option structured to keep consumers from being trapped in debt. Lenders would be barred from offering this option to consumers who have outstanding short-term or balloon-payment loans or have been in debt on short-term loans more than 90 days in a rolling 12-month period. Lenders also would be barred from taking a car title as collateral.As part of the principal payoff option, a lender could offer a borrower up to 2 loan extensions, but only if the borrower pays off at least one-third of the principal with each extension.
- Less risky longer-term lending options: Lenders would be allowed to offer 2 longer-term loan options with more flexible underwriting, but only if they pose less risk by adhering to certain restrictions. The 1st option would be offering loans that meet the parameters of the National Credit Union Administration “payday alternative loans” program with interest rates capped at 28% and an application fee of no more than $20.The other option would be offering loans that are payable in roughly equal payments with terms not to exceed 2 years and with an all-in cost of 36% or less, not including a reasonable origination fee, as long as the lender’s projected default rate on these loans is 5% or less.
- Debit attempt cutoff: Payday lenders would have to give consumers written notice before attempting to debit the consumer’s account to collect payment. After 2 straight unsuccessful attempts, the lender would be prohibited from debiting the account again unless the lender gets a new authorization from the borrower. A CFPB study found that half of online borrowers had at least 1 debit attempt that overdrafted or failed, and more than one-third of borrowers with a failed payment lost their account over 18 months.
Industry group: New rule will hurt consumers
The industry association that represents payday lenders decried the bureau’s proposal, saying the new regulation would hurt consumers.
“The CFPB’s proposed rule 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,” says Dennis Shaul of the Community Financial Services Association of America, the national payday lenders’ organization.
“It also sets a dangerous precedent for federal agencies crafting regulations impacting consumers,” Shaul says in a news release.
The payday lenders’ association says the rule will eliminate 84% of loan volume, and quoted a figure reported last week by the Federal Reserve that 46% of Americans can’t pay for an unexpected $400 expense, or would sell something to cover it or borrow money.
“What is missing in the bureau’s rule is an answer to the very important question, ‘Where will consumers go for their credit needs in the absence of regulated nonbank lenders?'” the CFSA release says.
The consumer agency will take comments on the proposal until Sept. 14 before issuing final regulations.