Lenders offering payday loans and other small advances to cash-strapped consumers must first determine whether borrowers can afford to repay the debt under a long-awaited federal rule finalized Thursday.
The rule, passed by the Consumer Financial Protection Bureau, would also reduce repeated attempts by lenders to debit payments from borrowers’ bank accounts, a practice that racks up escalating fees and can trigger account closures.
“These protections bring needed reform to a market where lenders have too often succeeded by failing borrowers,” CFPB Director Richard Cordray told reporters on a conference call.
The rule will go into effect 21 months after it is published in the Federal Register.
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Representatives of the retail banking sector criticized the new requirements.
“It’s hard to believe that just days after the CFPB reported that more than four in ten Americans were struggling to pay their monthly bills — often due to unforeseen or urgent expenses — the Bureau would be leading Americans to lenders on pawnbrokers, offshore lenders, high-cost installment lenders and stealth entities,” said Richard Hunt, CEO of the Consumer Bankers Association.
Dennis Shaul, CEO of the Community Financial Services Association of America, said, “Millions of American consumers are using small-dollar loans to manage budget shortfalls or unexpected expenses. The CFPB’s misguided rule will only serve to cut them off. access to vital credit when they need it most.”
The CFPB, which proposed the new constraints in 2016 after four years of study, found that 62% of all payday loans go to consumers who repeatedly extend their repayments and ultimately owe more fees than what they originally borrowed. Half of borrowers who later received similar high-interest loans online were hit with an average of $185 in bank penalties for overdraft and insufficient funds charges, according to another CFPB analysis.
And more than 80% of auto title loans — in which consumers pledge their vehicles — are rolled over or extended on the day they’re due because borrowers can’t afford to pay them in full, the agency found. .
Payday loans are usually up to $500 and are due in full by the borrower’s next paycheck. They carry annual interest rates of 300% or more.
“Faced with unaffordable payments, cash-strapped consumers must choose between defaulting, re-borrowing, or skipping other financial obligations like rent or basic living expenses,” Cordray said.
Many borrowers repeatedly refinance or refinance loans, each time incurring costly new fees. More than four in five loans are reborrowed in a month, and nearly one in four are reborrowed nine or more times, according to the CFPB. The agency describes these episodes as “payday debt traps”.
According to the new rule:
• Lenders should determine if the borrower can afford to repay the loan within two weeks or one month, including finance charges and fees, while meeting basic living expenses and other financial obligations. For longer-term loans with lump-sum payments, borrowers must be able to pay the costs for the month with the highest total payments due. Additionally, the number of loans that can be issued in quick succession is capped at three.
• Consumers can take out a short-term loan of up to $500 without passing this test if the loan allows for more progressive repayments. However, this option cannot be offered to consumers who have repeatedly incurred payday debt or other short-term debt.
• After two unsuccessful attempts to access the borrower’s account, the lender can no longer debit the account unless the borrower authorizes it. This gives consumers the ability to dispute unauthorized or erroneous debit attempts and cover unexpected payments, says CFPB.
The restrictions are lifted for less risky short-term loans typically made by community banks or credit unions to existing customers who were members, and some loans authorized by the National Credit Union Administration.
Contributor: Kevin McCoy
