The Consumer Financial Protection Bureau proposed long-awaited rulemaking last week to protect consumers from falling into the trap of ever-spiraling debt for taking out a short-term “payday loan.”
The proposed rule generally would cover loans with a term of 45 days or less, but it also would cover loans with a term greater than 45 days, provided they (1) have an all-in annual percentage rate greater than 36 percent; and (2) either are repaid directly from the consumer’s account or income or are secured by the consumer’s vehicle.
The CFPB noted that such loans can come with interest rates as high as 300 percent and trap consumers into endless debt.
In general, the proposed rule would require that, before making the loan, a lender would need to reasonably determine the borrower has the ability to repay it, including restrictions when a consumer has recently faced outstanding loans. Lenders would have some options to provide payday loans without satisfying the ability-to-repay requirements, but only if the loans meet certain conditions.
The proposal would discourage lenders from withdrawing payments from a consumer’s account for a loan after two consecutive payment attempts have failed, unless the lender gets a new, specific authorization from the borrower to make further withdrawals. Lenders would be required to provide notice to the consumer before attempting to withdraw payment for a loan from the borrower’s account.
The proposal would also set up processes and criteria for information systems that would store loan information and consumer reports.
The CFPB is soliciting comments on the proposed rule and is already hearing objections from the payday loan industry, along with praise from consumer groups.
The Bureau was a product of the Dodd-Frank Wall Street Reform and Consumer Financial Protection Act of 2010, and one of its first mandates was to crack down on predatory loans. The CFPB began researching payday loans soon after it was established. It found that nearly 70 percent of payday loan borrowers need to take out a second payday loan within a month. One out of five new borrowers ends up taking out at least 10 or more loans, one after the other. With each new loan, the consumer typically ends up paying more money in fees and interest on the same debt.
Repeated attempts by online lenders to automatically collect payments from a borrower’s checking account can add significant costs to online payday loans. The CFPB’s research found that half of online borrowers are charged an average of $185 in bank penalties.
Over one-third of payday installment loans default, sometimes after the consumer has already refinanced the loan or re-borrowed money at least once. Nearly one-third of auto title installment loan sequences end in default, and 11 percent end with the borrower’s car seized by the lender.
Auto title loans often have issues that are similar to payday loans, the CFPB noted, including high rates of consumer re-borrowing, which can create long-term debt traps. A borrower who cannot repay the initial loan, which typically lasts 30 days, often needs to re-borrow or risk losing their vehicle. One out of five short-term auto title borrowers lose their vehicle because they fail to repay the loan.
The payday loan rule may prove to be controversial and is sure to provoke industry opposition. The Labor Department’s recent fiduciary rule and overtime rule are also encountering outcries in the financial services industry and the business community. However, the proposal is attempting to correct abusive practices that continue to bedevil borrowers who were forced to turn to payday lenders in the aftermath of the financial crisis when consumer credit was in short supply. Many borrowers continue to turn to payday lenders to keep themselves afloat, even if it's means drowning in increasing levels of debt. Accountants may be able to help their clients recover their financial stability with the help of regulations that curb abusive lending practices.