Payday loan borrowers may finally be in for some relief. On Thursday, the federal Consumer Financial Protection Bureau released the outlines of new proposals that would impose restrictions on various high-interest lending products, including payday loans, which the bureau defines as any credit product that requires consumers to repay the debt within 45 days.
The proposals also contain new rules for longer-term loans, such as installment loans and car title loans, where a lender either has access to a borrower's bank account or paycheck, or holds an interest in their vehicle.
The CFPB's actions come as high-interest lending products have been receiving increasing scrutiny for trapping low-income borrowers in a cycle of debt. Payday loans, which typically last around 14 days, or until the borrower is expected to get his or her next paycheck, technically charge relatively low fees over their original term. However, many payday borrowers cannot afford to pay back their debt in the required time frame and must "roll over" the previous loan into a new loan.
As a result, the median payday customer is in debt for 199 days a year, and more than half of payday loans are made to borrowers who end up paying more in interest than they originally borrowed. Longer-term auto-title loans and installment loans have been criticized for similarly locking consumers in debt.
In order to protect borrowers from falling into such "debt traps," the CFPB's proposals include two general strategies for regulating both short- and long-term high-interest loans. For payday loans, one "prevention" alternative would require lenders to use the borrower's income, financial obligations, and borrowing history to ensure they had sufficient earnings to pay back the loan on time.
Any additional loans within two months of the first could only be given if the borrower's finances had improved, and the total number of loans would be capped at three before a 60-day "cooling-off" period would be imposed. Payday shops would also have to verify consumers did not have any outstanding loans with any other lender.
A second "protection" alternative would not require payday lenders to ensure their customers could repay their loan without further borrowing, but instead imposes a series of restrictions on the lending process. For example, under this plan, all loans would be limited to 45 days and could not include more than one finance charge or a vehicle as collateral.
Additionally, lenders would have offer some way out of debt. One method could be a requirement to reduce the loan's principal to zero over the course of three loans, so nothing more would be owed. Another option is a so-called "off-ramp" out of debt, which would either require loan shops to allow consumers to pay off debts over time without incurring further fees, or mandate that consumers not spend more than 90 days in debt on certain short-term loans in a 12-month period. The "protection" alternative would also include a 60-day cooling-off period after multiple loans and a ban on lending to any borrower with outstanding payday debt.
The bureau has proposed similar "prevention" and "protection" options for loans that exceed 45 days. The former would require similar vetting of a borrower's finances before a loan is given. The latter would include a duration limit of six months and either limit the amount that could lent and cap interest rates at 28%, or mandate that loan payments take up a maximum of 5% of a borrower's gross monthly income, in addition to other regulations.
Apart from new regulations on the loan products themselves, the CFPB also proposed new rules regarding collection. One regulation would require lenders to give borrowers advance notice before attempting to extract funds from their bank accounts. A second would attempt to limit borrowers' bank fees by limiting the number of times a lender could attempt to collect money from an account unsuccessfully.
Before any of the any of these proposals can become a bind rule, the bureau says it will seek input from small lenders and other relevant stakeholders. Any proposals would then be opened to public comment before a final rule is released.
The Consumer Financial Association of America, a national organization representing short-term lenders, responded to the proposals by stressing the need to keep credit available to unbanked Americans, even while increasing consumer protections.
"CFSA welcomes the CFPB's consideration of the payday loan industry and we are prepared to entertain reforms to payday lending that are focused on customers' welfare and supported by real data," said association CEO Dennis Shaul in a statement. But, Shaul added, "consumers thrive when they have more choices, not fewer, and any new regulations must keep this in mind."
The Center for Responsible Lending, a nonprofit organization dedicated to fighting predatory lending practices, released a statement in general support of the CFPB's proposals.
"The proposal endorses the principle that payday lenders be expected to do what responsible mortgage and other lenders already do: check a borrower’s ability to repay the loan on the terms it is given," said Mike Calhoun, the center's president. "This is a significant step that is long overdue and a profound change from current practice."
However, Calhoun said, the "protection" options were grossly inadequate, calling them "an invitation to evasion."
"If adopted in the final rule, they will undermine the ability to repay standard and strong state laws, which give consumers the best hope for the development of a market that offers access to fair and affordable credit," Calhoun added. "We urge the consumer bureau to adopt its strong ability to repay standard without making it optional."
According to the center, 21 states, including the District of Columbia, have significant protections against payday lending abuses. An interest-rate cap, which lending activists say is the most effective means to regulate payday lending, has been adopted by 15 states.
Earlier this month, MoneyMutual, a lead generator for payday loan products, was fined $2.1 million by the state of New York for advertising loan products with illegally high interest rates. According to New York law, unlicensed payday lenders cannot charge an interest rate over 16% per year, and licensed lenders are subject to a cap of 25%. MoneyMutual has acknowledged it advertised loans with an annual percentage rate between 261% and 1,304%.