Today the Consumer Financial Protection Bureau (CFPB) announced that it is proposing new regulations to protect consumers from predatory lending practices that the CFPB’s Director, Richard Cordray calls “debt traps” by requiring lenders to take steps to make sure consumers have the ability to repay their loans.

The cornerstone of the announcement is a nearly 1,500 page proposal outlining protections that would cover payday loans, auto title loans, deposit advance products, and certain high-cost installment and open-end loans. The CFPB also announced that it is launching an inquiry into other products and practices that may harm consumers facing cash shortfalls.

The full press release announcing the rule can be found here.

The complete proposal can be found here. Comments are due by Sept. 14, 2016.

Loans covered by the proposal include:

• Payday and other short-term credit products: Payday loans are generally due on the borrower’s next payday, which most often is within two weeks, and typically have an annual percentage rate of around 390 percent or even higher. Single-payment auto title loans, which require borrowers to use their vehicle title for collateral, are usually due in 30 days with a typical annual percentage rate of about 300 percent.

• High-cost installment loans: The proposal would cover loans for which the lender charges a total, all-in annual percentage rate that exceeds 36 percent, including add-on charges, and either collects payment by accessing the consumer’s account or paycheck or secures the loan by holding the title to the consumer’s vehicle as collateral. Some of the installment loans covered by the proposal have balloon, or lump-sum, payments required after a number of interest-only payments.

The Bureau proposes to exclude certain types of consumer credit from the scope of the proposal, including:

• loans extended solely to finance the purchase of a car or other consumer good in which the good secures the loan
• home mortgages and other loans secured by real property or a dwelling if recorded or perfected
• credit cards
• student loans
• non-recourse pawn loans
• overdraft services and lines of credit.

The proposed ability-to-repay protections include a “full-payment” test that would require lenders to determine upfront that consumers can afford to repay their loans without reborrowing. The proposal includes a “principal payoff option” for certain short-term loans and two less risky longer-term lending options so that borrowers who may not meet the full-payment test can access credit without getting trapped in debt.

Lenders would be required to use credit reporting systems to report and obtain information on certain loans covered by the proposal. The proposal would also limit repeated debit attempts that can rack up fees and may make it harder for consumers to get out of debt.

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 reborrow within the next thirty days. For payday and auto title installment loans without a balloon payment, full payment means affording all of the payments when due. The proposal would further protect against debt traps by making it difficult for lenders to push distressed borrowers into reborrowing or refinancing the same debt. 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 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 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. 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.

The Bureau studied the payday/short-term lending industry before proceeding. The CFPB research on these loans can be found here.

Industry, consumer groups, and legislators have issued initial statements on the proposal

The Independent Community Bankers of America® (ICBA):

“ICBA acknowledges the CFPB’s willingness to work with community banks to understand the processes and practices of responsible community bank character lending.  We continue to strongly urge that the rule include meaningful options for reliable lenders whose personal loans exhibit lower risk situations and excellent performance. The rule must allow community banks to continue to have the flexibility to provide access to small-dollar credit, free of numerical and costly requirements in the underwriting process. The CFPB should encourage responsible sources of small-dollar credit to consumers. Main Street community banks are very familiar with their customers’ financial condition, history and ability to repay loans and do not steer consumers to unaffordable loan products. ICBA looks forward to continuing to work with the bureau on this proposed rule.”

The PICO National Network (a national network of faith-based community organizations working to create innovative solutions to problems facing urban, suburban and rural communities):

“I have heard far too many stories about the impact of payday lending on my congregants, and the bottom line is this: Our faith instructs us very clearly that charging outrageously high interest rates is simply wrong. The regulation of predatory lending practices is not just an economic issue, it is an issue of morality and justice,” says Pastor Wes Helm, Associate Pastor at Springcreek Church in Garland, Texas. His first introduction to payday lending was an elderly man on a fixed income seeking help with his rent. He was paying $1,000 a month to cover the interest and fees.

The National Consumer Law Center (NCLC)

Lauren Saunders, associate director of NCLC, said: “It is sad that we need a rule to get lenders to be responsible, but high-priced payday and installment loans shouldn’t generate profits while plunging families into an unaffordable debt trap. The CFPB’s proposal should make loans significantly safer as long as it is tightened to prevent evasions. However, the proposal has worrisome loopholes. Lenders could make up to three back-to-back payday loans and could start the sequence again after only 31 days. Longer term loans could also have balloon payments that trigger re-borrowing. “All loans should meet ability to pay requirements, and reborrowing in only 31 days indicates a debt trap.”

The Pew Charitable Trusts

Nick Bourke, director of Pew’s small-dollar loans project, said: “Payday loan reform is urgently needed, but without changes, the CFPB’s draft regulation misses the mark. Pew’s research shows that borrowers want three things: lower prices, manageable installment payments, and quick loan approval. The CFPB proposal goes 0 for 3… “The rule also lacks the clear, simple guidance that would pave the way for better alternatives from banks and credit unions. Banks were preparing to offer loans at prices six times lower than payday lenders, but without the regulatory certainty of a clear product safety standard the CFPB’s proposal will stop that pro-consumer innovation in its tracks. As a result, the CFPB is missing an historic opportunity to save millions of borrowers billions of dollars.”

House Financial Services Committee chairman Jeb Hensarling (R-Texas)

“Just days after the Federal Reserve reported that almost half of American families say they would struggle to pay for emergency expenses of $400, here comes Director Cordray to make their struggle even harder.  Accountable to no one, he alone decides for all Americans whether they can take out a small-dollar loan to meet emergency needs.”

insideARM Perspective

This topic is highly controversial, with finger-pointing everywhere. The fact is that many consumers have little to no ability to respond to a short-term financial “crisis” to repair a car, repair or replace critical appliances, or pay unexpected medical bills. Consumers need access to credit to respond to emergencies.

It will be interesting to follow the causal effect, should the proposed rules become final.  For instance,

• Will the new regulations be a boon for the aforementioned National Credit Union Administration “payday alternative loans” program?
• While a given lender may be forbidden from making additional loans to the same consumer, will that consumer simply be able to go to a different lender?
• Will tougher rules governing these types of loans lead to a dramatic increase in sub-prime credit cards?
• Or, worst case, will consumers be forced to deal with illegal, unregulated “loan sharks” to obtain the necessary funds to respond to an immediate need for a loan?