WASHINGTON—Taking a step toward dismantling debt traps, the Consumer Financial Protection Bureau (CFPB) recently finalized rules to protect consumers who take payday loans, auto title loans, deposit advance products, and longer-term loans with balloon payments. These loans have interest rates upward of 300% and create cycles of poverty where consumers must choose between defaulting on repayment, re-borrowing, or falling on economic hardships and struggling to pay for food or medical care.
“The CFPB payday lending rule will undoubtedly result in fewer people and families facing financial ruin,” said Marcy Bowers, executive director at the Statewide Poverty Action Network. “This is an important step towards disrupting the abusive payday lending business model, which thrives on trapping people with low incomes in high-cost cycles of debt.”
The CFPB has spent the last five years developing this rule; it includes their research, outreach, and a review of more than one million comments on the proposed rule from payday borrowers, consumer advocates, faith leaders, payday and auto title lenders, tribal leaders, state regulators and attorneys general, and others.
Their research found that more than four out of five payday loans are re-borrowed within a month, usually right when the loan is due or shortly thereafter. And nearly one-in-four initial payday loans are re-borrowed nine times or more, with the borrower paying far more in fees than they received in credit. The aftermath of repeated re-borrowing and defaulting is staggering; consumers accrue recurring fees and service charges and are often hounded by debt collectors. They may have their car repossessed or their bank accounts closed due to insufficient funds penalties.
The new rules are complex, designed to curb the worst abuses in the industry without directly addressing high interest rates, which the Bureau does not have the authority to regulate. The core of this rule is the common sense idea that lenders should confirm a borrower’s ability to repay before lending money. Under the new rules:
• Lenders could make a single loan of up to $500 with few restrictions, but only to borrowers with no other outstanding payday loans. For larger or more frequent loans, lenders will have to follow “the full payment test,” a complex set of underwriting rules designed to ensure that customers have the means to repay their loans.
• Lenders will be limited in their ability to repeatedly debit payments from a borrower’s bank account. The rules include a “debit attempt cutoff” for any short-term loan, balloon-payment loan, or longer-term loan with an annual percentage rate higher than 36 percent that includes authorization for the lender to access the borrower’s checking or prepaid account. After two unsuccessful attempts, the lender cannot debit the account again unless the lender gets a new authorization from the borrower.
• Consumers may take out a short-term loan of up to $500 without the full-payment test if it is structured to allow the borrower to get out of debt more gradually. Under this option, consumers may take out one loan that meets the restrictions and pay it off in full. For those needing more time to repay, lenders may offer up to two extensions, but only if the borrower pays off at least one-third of the original principal each time. These loans cannot be offered to borrowers with recent or outstanding short-term or balloon-payment loans, nor can they make more than three of these loans in quick succession. They also cannot use this option if the consumer has already had more than six short-term loans or been in debt on short-term loans for more than 90 days over a rolling 12-month period.
Not included in the final rule are ability-to-repay protections for all of the longer-term loans, such as installment loans, that were covered under the draft version of the rule. The CFPB has stated that they would like more time to study the issue and understand the impact of installment loans in communities.
In Washington state, consumers are protected by a set of reforms passed in 2009, which limit lenders to giving no more than eight loans to a borrower in a 12-month period and provide borrowers with a no-cost repayment plan. Since the law went into effect, it has saved Washington consumers over $800 million in fines and fees.
Washington state currently does not allow installment lending, however, with the passage of the 2009 reforms, payday lenders in Washington state have attempted to pass legislation that would allow them to morph their business plan toward schemes like expensive long-term installment loans. Advocates have successfully defeated these attempts, plan to continue their opposition, and look forward to the Bureau extending its consumer protections to that market in the future.
“We hope the CFPB moves quickly to develop regulations that protect consumers from abusive long-term, high-cost loans,” said Bowers. “In the meantime, we will continue our work to ensure that Washington maintains its commitment to protecting low-income consumers from high-cost debt traps that perpetuate poverty in communities across our state.”
