Can New Payday Loan Rules Keep Borrowers From Falling Into Debt Traps?

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Nearly one in four consumers continue to turn to high-cost, short-term financial products like payday loans, auto-title loans and other pricey alternatives when struggling to make ends meet, even though research shows these expensive lines of credit often leave consumers worse off than when they began. After nearly three years studying the issue, the Consumer Financial Protection Bureau is now announcing its first attempt to protect consumers from predatory lenders.

The CFPB is set to propose new rules for companies that provide payday loans, vehicle title loans, deposit advances, and certain high-cost installment and open-ended loans. The guidelines are intended to reduce the likelihood of borrowers falling victim to the vicious — and often devastating — cycle of debt associated with these financial products by preventing lenders from making loans that can’t be repaid.

The Bureau is also taking aim at payment-collection practices that take money directly from bank accounts in a way that frequently hits the borrower with hefty fees.

“Today we are taking an important step toward ending the debt traps that plague millions of consumers across the country,” CFPB Director Richard Cordray says in a statement. “Too many short-term and longer-term loans are made based on a lender’s ability to collect and not on a borrower’s ability to repay. These common sense protections are aimed at ensuring that consumers have access to credit that helps, not harms them.”

Ending Debt Traps For Short-Term Loans

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Short-term, high-interest loans offer borrowers a quick influx of cash to cover unexpected costs. Essentially, when a consumer takes out a payday loan, they are making a promise to repay that debt with their next paycheck or within 10-14 days, whichever comes first.

However, more often than not, payday loan borrowers — who tend to be among the country’s most vulnerable consumers with few other credit options — are unable to repay the full debt plus interest and fees in such a short time frame; or repaying in full leaves them unable to pay the bills for the next few weeks. That’s why payday lenders allow the borrowers to rollover their debts for an additional two weeks, while tacking on more fees of course.

Last year, the CFPB found that only 15% of borrowers were able to repay their debt when it was due without re-borrowing. By renewing or rolling over loans the average monthly borrower is likely to stay in debt for 11 months or longer.

The CFPB’s proposal to end this debt trap covers not only payday loans, but any credit product that requires consumers to pay back the loan in full within 45 days, so that also includes deposit advance products, certain open-ended lines of credit, and some vehicle title loans.

The CFPB is considering rules that would give lenders two ways to extend short-term loans without causing borrowers to become trapped in long-term debt.

Debt Trap Prevention

The first option for lenders is to eliminate debt traps by determining at the outset whether or not a consumer can repay the requested loan while maintaining their other major financial obligations and living expenses.

Other requirements of the rule would likely include:
• Lenders would generally have to adhere to a 60-day cooling off period between loans.
• The consumer could not have any other outstanding covered loans with any lender.
• To make a second or third loan within the two-month window, lenders would have to document
that the borrower’s financial circumstances have improved enough to repay a new loan without re-borrowing. They would have to verify, for example, that the consumer’s income had increased following the prior loan.
• After three loans in a row, all lenders would be prohibited from making a new short-term loan to
the borrower for 60 days.

Debt Trap Protection

Under the protection rule consideration, lenders would eliminate debt traps by providing affordable repayment options and by limiting the number of loans a borrower could take out in a row and over the course of a year.

This protection would include the following restrictions:
• The loan could not exceed $500, last longer than 45 days, carry more than one finance charge, or require the consumer’s vehicle as collateral.
• The consumer could not have any other outstanding covered loans with any lender.
• Rollovers would be capped at two – three loans total – followed by a mandatory 60-day cooling-off period.
• The second and third consecutive loans would be permitted only if the lender offers an affordable way out of debt. To achieve this, the Bureau is considering two options: (1) require that the principal decrease over the three-loan sequence so that it is repaid in full when the third loan is due; or (2) require the lender to provide a no-cost “off-ramp” if the borrower is unable to repay after the third loan, to allow the consumer to pay the loan off over time without further fees.
• The consumer could not be more than 90 days in debt on covered short-term loans in a 12-month period.

Ending Debt Traps For Longer-Term Loans

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While short-term loans are most often associated with the devastating debt traps, the CFPB’s proposed rules would also cover longer-term loans that carry the same three-digit interest rates and unaffordable payments.

The proposed rules would apply to credit products of more than 45 days where the lender collects payments through access to the consumer’s deposit account or paycheck, or holds a security interest in the consumer’s vehicle, and where the all-in annual percentage rate is more than 36%.

According to the CFPB, this classification includes longer-term vehicle title loans, some high-cost installment loans, and similar open-end products.

Much like the proposed rules for short-term loans, the proposal to end the debt trap associated with longer-term loans provides two alternative means of lending practices.

Debt Trap Prevention
Under the prevention requirements for longer-term loans, the CFPB would mandate lenders to determine whether or not the consumer can make each payment on the loan including interest, principal, and fees for any add-on products without defaulting or re-borrowing.

For each loan – whether initial or rollover – the lenders would have to verify the consumer’s income, major financial obligations, and borrowing history to determine whether there is enough money left to make payments on the loan after covering other major financial obligations and living expenses.

Other stipulations under the prevention rule would include:
• Lenders would be required to determine if a consumer is able to repay the loan each time the borrower seeks to refinance or re-borrow.
• If the borrower has been delinquent on a payment, the lender would be prohibited from refinancing into another loan with similar terms without documentation that the consumer’s financial circumstances had improved enough to be able to repay the loan.

Debt Trap Protection 

For the debt trap protection requirements, the CFPB is considering two options for loans that would have a minimum duration of 45 days and a maximum duration of six months.

Under the first approach, lenders would have to adhere to many of the same terms offered under the National Credit Union Administration program for “payday alternative loans.” These requirements include:
• The loan principal is between $200 and $1,000, and the balance decreases over the loan term.
• The lender could not charge an interest rate higher than 28% and an application fee higher than $20.
• The consumer has no other covered loans.
• The lender would only be able to provide two of these loans to a consumer within six months, and the consumer could only have one at a time.

The second approach mandates that longer-term lenders could only issue lines of credit if these specific conditions are met:
• The amount the consumer is required to pay each month is no more than 5% of the consumer’s gross monthly income.
• The consumer has no other covered loans.
• The lender does not provide more than two of these loans to the consumer in a 12-month period.

Putting An End To Harmful Collections

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While the CFPB’s proposed rule outline for short-term and long-term loans provides unique requirements for different lenders, the Bureau also tackled one of the more egregious and devastating aspects of small-dollar lending: collection practices.

Currently, both short-term and longer-term lenders often require access to consumers’ checking, savings or prepaid accounts before issuing credit. Such access allows the lender to collect payments directly from consumers in the form of post-dated checks, debit authorizations, or remotely created checks.

While this payment method may be convenient, it often leads to additional debt, as borrowers incur charges like insufficient funds fees, returned payment fees or account closure fees.

To alleviate additional debt burdens associated with short-term and long-term loans, the Bureau is considering certain restrictions on collection practices.

Requiring borrower notification before accessing deposit accounts

The CFPB would require lenders to provide consumers with three business days advance notice about the payment collection before submitting a transition to consumer’s bank, credit union or prepaid account for payment.

This proposal would cover payment collection attempts through any method and would help consumer better manage their deposit accounts and overall finances, the CFPB says.

Limit unsuccessful withdrawal attempts that lead to excessive deposit account fees

The second harmful debt collection proposal under consideration would limit the number of unsuccessful direct account collection attempts to two. After this point, the lender would no longer be able to attempt a collection directly from a checking, savings or prepaid account unless given a new authorization from the borrower.

The CFPB anticipates this requirement would limit fees incurred by multiple transactions that exacerbate a consumer’s financial woes.

It’s A Long Time Coming

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After waiting years for the CFPB to release details about a possible payday lending rule, consumer advocates from across the country were quick to embrace the preliminary rule outline, while pointing out areas of concern.

“The time is long past due for federal rules to protect payday loan borrowers from abusive practices,” Suzanne Martindale, staff attorney for our colleges at Consumers Union, tells Consumerist. “Today’s announcement is a step forward to promote safe and responsible lending practices.”

Representatives with the National Consumer Law Center say the proposal could go a long way in making small dollar loans safer for consumers.

“The CFPB has recognized that payday lenders must do what any responsible lender does: consider the borrower’s ability to repay the loan while meeting other expenses without needing to reborrow,” NCLC associate director Lauren Saunders says in a statement. “The CFPB has made clear that ensuring that a loan is affordable is the cornerstone of fair and responsible lending in the small dollar loan market, as in all credit markets.”

While the long-awaited proposal does span a range of loan products, Saunders says loopholes in the rules could permit some unaffordable high-cost loans to stay on the market.

“The CFPB has taken an ‘either/or’ approach: ‘prevention or protection,’” Saunders says. “But borrowers need both. Lenders must be judged both on whether they evaluate affordability before making a loan and also on whether those loans default, roll over or are refinanced in significant numbers.”

Additionally, NCLC questions the message the CFPB sends by allowing even one rollover for small-dollar loans.

“The proposal would permit up to three back-to-back payday loans and up to six payday loans a year,” Saunders says. “Rollovers are a sign of inability to pay and the CFPB should not endorse back-to-back payday loans.”

It’s Not Over Yet

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The rule-making process for short-term and long-term small-dollar loans is far from over for the CFPB.

Following today’s publication of the outline of the proposals under consideration, the CFPB will convene a Small Business Review Panel to gather feedback from small lenders.

In addition to the panel, the Bureau will continue seeking input from stakeholders in the lending industry before issuing a proposed rule.

Once the Bureau issues its proposed regulations, the public will be invited to submit written comments which will be carefully considered before final regulations are issued.

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