Consumer protection agency takes first steps to reform payday loan market.
Consumer demand for quick credit has fueled the growth of a payday loan industry that, according to the Consumer Financial Protection Bureau (CFPB), imposes significant costs on those borrowers least likely to be able to afford them. The CFPB is concerned that these small, short-term, high-interest loans – which the borrower is expected to repay with his or her next paycheck – are forcing individuals into spiraling cycles of debt. This March, after months of debate, the Bureau released an outline of a proposed payday loan rule designed to protect borrowers from debt traps while preserving access to quick credit.
The outline of the proposed rule gives lenders two options for meeting CFPB requirements aimed at preventing short-term loans from becoming debt traps for borrowers. Lenders can choose either to meet certain verification requirements prior to granting loans, or to accept some limitations on the terms of the loans they offer.
Lenders opting to meet pre-loan eligibility verification requirements would be obligated to verify a prospective borrower’s ability to repay a loan based on his or her income, financial obligations, and credit history before making a loan. The outlined rule would also require borrowers to submit documentation of their improved financial situation and ability to repay before receiving a second or third loan within a 60-day period. Lenders could not make loans to consumers who have outstanding loans covered by the borrower’s collateral, or who have taken out three short-term loans in the preceding 60 days.
Alternatively, lenders could meet the proposed requirements by offering only loans with terms that protect borrowers from accumulating insurmountable debt. These requirements would prohibit loans over $500 and loans that keep borrowers in debt for more than 90 days in a one-year period. Additionally, lenders would be required to provide affordable repayment options before making a second or third loan during a 60-day period.
The CFPB outline also proposes requirements for higher-cost, longer-term credit products, including loans where the annual rate exceeds 36% and the loan provider holds an interest in the borrower’s car or can access his or her paycheck or bank account for repayment. Mirroring the outline’s proposal for payday loans, longer-term loan lenders could satisfy the requirements by making eligibility determinations at the creation of each loan or by offering only loans with terms that protect against debt traps. The CFPB is still considering possible restrictions on the amount, length, and repayment terms of these longer-term loans to accomplish this purpose.
The Bureau will also seek to protect consumers from debt traps by preventing lenders from collecting money from borrowers’ bank accounts without warning. When a loan is executed today, many lenders obtain permission to collect automatic payments directly from a borrower’s bank account. These collection attempts frequently result in overdrafts, subjecting the borrower to fees imposed by both the financial institution and the lender. The proposed rule would require lenders to notify consumers three days before accessing their bank accounts and limit the number of withdrawals a lender could make without renewed authorization. The CFPB expects this to reduce borrowers’ accumulation of fees for unsuccessful withdrawal attempts, thereby reducing the potential for debt traps.
On the same day the CFPB released the outline of its proposed rule, CFPB Director Richard Cordray held a field hearing to discuss the proposal. Consumer groups, industry representatives, and members of the public attending the hearing expressed divergent opinions about the proposal.
Consumer advocacy groups’ concerns focused on payday loan debt traps. In remarks delivered at the field hearing, Paulina Gonzalez, Executive Director of the California Reinvestment Coalition, illustrated this concern with a story about a borrower’s skyrocketing debt as the interest and late fees on his small loan rapidly accumulated. Data from the Center for Responsible Lending (CRL) show that a borrower taking out a loan with a repayment period of between two weeks and one month will, on average, remain trapped in debt for seven months. Although consumer groups generally support the CFPB’s proposal, some would like it to go further, requiring lenders always to ensure the borrower’s ability to repay. Many consumer groups have expressed concern that lenders will exploit “loopholes” to continue making unaffordable loans.
Consumer loan providers, on the other hand, criticized the CFPB’s proposal as unduly restricting lending, making credit less accessible. The Community Financial Services Association of America called for the Bureau to balance access to credit and consumer protection better, and to base regulations on “rigorous research, not anecdote or conjecture.” Similarly, Edward D’Alessio, Executive Director of the Financial Service Centers of America, expressed concern that “customers will lose many of the credit options available to them.” He asserted that consumers are intelligent and capable of making rational decisions about loans.
The CFPB plans to seek comments from industry representatives, advocacy groups, and government officials through a Small Business Review Panel. Once the CFPB publishes its proposed rule, the public may submit written comments, which the CFPB will consider in developing a final rule.