The Consumer Financial Protection Bureau released a final version of its rules for payday loans on Thursday. “CFPB’s new rule puts an end to the payday debt traps that have plagued communities across the country,” said CFPB Director Richard Cordray. “Too often, borrowers who need money fast find themselves trapped in loans they can’t afford.”
The CFPB issued the rule after studying payday lending practices for five years; this published a proposed rule in June 2016which has received over a million comments online and has been revised into its current format.
The goal: To break a “cycle of taking on new debt to pay off old debt,” the CFPB wrote.
It will regulate loans that require consumers to repay all or most of their debt at once, including payday loans, self-title loans and “down payment on down payment” productswhich generally work by taking the repayment amount from the borrower’s next direct electronic deposit.
Some 12 million Americans take out payday loans every year, according to the nonprofit Pew Charitable Trusts, a nonprofit organization based in Philadelphia. But these consumers also spend $9 billion in loan fees, according to Pew: The average payday loan borrower is in debt for five months of the year and spends an average of $520 in fees to repeatedly borrow 375 $. (And they don’t help borrowers build credit like other options.)
Nearly 70% of payday loan borrowers take out a second loan within a month of their last, according to a CFPB study. While some praised the rule, others pushed back on it and said consumers will have fewer options when they find themselves in dire financial straits.
Here’s what the new rule will mean:
New rule outlines new restrictions on payday loans
There are some 16,000 payday loan stores in 35 states that allow payday loans, the CFPB said. Due to certain state laws, payday loans are already effectively illegal in 15 states.
The new rule requires lenders to perform a “full payment test” to determine if the borrower can make loan repayments. To complete this test, the prospective borrower should show proof of income.
It also limits the number of loans consumers can obtain; they can only get three loans “in quick succession”. Lenders will be required to use CFPB registered credit reporting systems to report and obtain information on these loans.
There are certain conditions under which borrowers are exempt from some of these rules.
Consumers are allowed to take out a short-term loan of up to $500 without completing the full repayment test, if the loan is structured so that the borrower makes payments gradually. This is called the “return of capital option”. But these loans cannot be granted to borrowers who have recent or current short-term or lump sum loans.
Loans that the CFPB deems “lower risk” to consumers do not require the full payment test, nor the “principal repayment option”. Those that are “less risky” include loans from lenders who make 2,500 or fewer short-term or lump-sum covered loans per year and derive no more than 10% of the revenue from those loans. These are usually small personal loans from community banks or credit unions, the CFPB said.
After two consecutive unsuccessful attempts, the lender can no longer debit the account without obtaining a new authorization from the borrower.
The reaction to the new rule
Some consumer advocates welcomed the new rule.
“Today’s CFPB action is a major step toward ending the predatory practices that drive borrowers to disaster,” said Joe Valenti, director of consumer credit at the Center for American Progress, a policy organization Washington, DC-based left-leaning public in a statement.
The final version of the rule is “a major improvement over the proposal” originally developed by the CFPB, said Alex Horowitz, head of research for The Pew Charitable Trusts. “It is designed to cover the most damaging loans while continuing to provide consumers with access to credit.”
But Dennis Shaul, CEO of the Community Financial Services Association of America, a trade group that represents non-bank lenders, called the rule “a blow to more than a million Americans who have spoken out against it.”
Where desperate consumers will go instead of payday loans
Richard Hunt, president and chief executive of the Consumer Bankers Association, a trade group for retail banks, said the rule could drive needy consumers to other poor alternatives, including pawnshops, offshore lenders, high-cost installment lenders or unreliable “rollovers”. night lenders”.
But Brian Shearer, a CFPB counsel, said the bureau had researched states where payday loans are illegal and determined that shouldn’t be a significant concern.
Horowitz, of Pew Charitable Trusts, said banks and credit unions would likely increase their low-value loan offerings, if “regulators let them”, which could save borrowers money, compared to what they paid to borrow payday loans.
The banks are “looking forward to expanding their reliable and responsible service offerings to these borrowers,” said Virginia O’Neill, senior vice president of the regulatory compliance center at the American Bankers Association, a trade group.
How the rule will be applied
State regulators will enforce the new CFPB rule, if it becomes effective, with the CFPB.
The final version of the CFPB rule must be published in the Federal Register, a government publication. Once it is, it will come into force 21 months later. But according to the Congressional Review Act, Congress can pass a joint resolution disapproving of the rule, which would prevent it from taking effect.
“Congress shouldn’t side with the payday lenders on this,” Horowitz said. “If Congress is to play a role here, it should tell bank and credit union regulators to provide guidelines for small installment loans. They should not overturn this rule.