The Consumer Financial Protection Bureau on June 2, 2016 proposed new regulations to protect consumers from predatory lending practices that the CFPB’s top regulator calls “debt traps.”
The new rules would cover a variety of small-dollar loans marketed to financially vulnerable consumers, such as payday loans, auto title loans (where the vehicle is used as collateral), high-cost installment and open-ended loans.
CFPB director Richard Cordray acknowledged in a statement that people who live from paycheck to paycheck may need a loan to cover unexpected expenses or a drop in income, but said the credit products marketed to these consumers should help them, not hurt them.
“The way these products are structured, it’s very difficult to repay the loan, and therefore people end up borrowing again and again and paying far more in fees and interest than they borrowed in the first place,” Cordray told NPR news on the day the proposed rules were announced.
Under the proposed rule, so-called “payday,” “auto-title” and other short-term lenders would be required to determine that people they loan money to can make the payments and fees when they come due, and still meet basic living expenses and major financial obligations.
With interest rates sometimes exceeding 300 percent and higher, these lenders have for years fallen under scrutiny at both the state and federal level.
The payday loan industry says these loans are needed to help working Americans through a cash squeeze and the new regulations are unwarranted. “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,” said Dennis Shaul in an interview with the New York Times. Shaul is the CEO of the payday lending industry group, the Community Financial Services Association.
However, regulators say in providing these types of loans that the terms are so burdensome many borrowers can’t afford to pay the loans back — and still have enough for their rent and other essentials.
Because of that, borrowers end up taking out another loan, and then another loan after that — again and again for months or sometimes years — sinking deeper into a quagmire.
According to the CFPB, a study commissioned to examine the payday lending industry before crafting the proposed rule found that four out of five of these single-payment loans are re-borrowed within a month.
In the case of auto-title loans, where borrowers put their cars up as collateral, one in five borrowers ends up having a car or truck seized by the lender for failure to repay.
Specifically, the proposal includes the following protections:
Full-payment test: Under the proposed 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.
For short-term loans and installment loans with a balloon payment, full payment means affording the total loan amount and all the fees and finance charges without having to re-borrow 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: Under the proposal, consumers could borrow a short-term loan up to $500 without the full-payment test as part of the principal payoff option that is directly structured to keep consumers from being trapped in debt.
Lenders would also be barred from taking an auto title as collateral. As part of the principal payoff option, a lender could offer a borrower up to two extensions of the loan, but only if the borrower pays off at least one-third of the principal with each extension.
Less risky longer-term lending options: The proposal would also permit lenders to offer two longer-term loan options with more flexible underwriting, but only if they pose less risk by adhering to certain restrictions.
The first option would be offering loans that generally meet the parameters of the National Credit Union Administration “payday alternative loans” program where interest rates are capped at 28 percent and the application fee is no more than $20.
The other option would be offering loans that are payable in roughly equal payments with terms not to exceed two years and with an all-in cost of 36 percent or less, not including a reasonable origination fee, so long as the lender’s projected default rate on these loans is 5 percent or less. T
The lender would have to refund the origination fees any year that the default rate exceeds 5 percent. Lenders would be limited as to how many of either type of loan they could make per consumer per year.
Debit attempt cutoff: Under the proposal, lenders would have to give consumers written notice before attempting to debit the consumer’s account to collect payment for any loan covered by the proposed rule.
After two straight unsuccessful attempts, the lender would be prohibited from debiting the account again unless the lender gets a new and specific authorization from the borrower.
Repeated unsuccessful withdrawal attempts by lenders to collect payment from consumers’ accounts pile on insufficient fund fees from the bank or credit union, and can result in returned payment fees from the lender.
A CFPB study found that, over a period of 18 months, half of online borrowers had at least one debit attempt that over-drafted or failed, and more than one-third of borrowers with a failed payment lost their account.
These proposed rules will now go through a public vetting that will last through the middle of September 2016. After that, the CFPB will issue its final version of the new regulations.
For more information on how the proposed rule changes may affect you or your business, please call Resnick Law attorney Carina Kraatz at (248) 642-5400 or contact her online.