The government’s consumer watchdog on Thursday proposed a set of new rules designed to rein in the practices of American payday lenders, taking aim at a profit-making model that involves staggeringly high fees and often leaves serial borrowers with spiraling debt.
The proposal from the Consumer Financial Protection Bureau marks the first attempt by the federal government to regulate shorter-term loans, which also include auto title and installment lending.
The rules still face months of review — and potential court challenges — but if they take hold they could dramatically transform and shrink an industry that provides cash to borrowers in a pinch. Some lenders say that under the new rules fewer loans will get made; they’ll have no choice but to close up shop. Yet consumer advocates see this as an opportunity for borrowers to turn to safer options — without having to pay triple-digit annualized interest rates.
At their core, the CFPB’s new rules would put a stop to lengthy, repeated borrowing — what the agency has often called the “long-term debt trap” — by requiring a cooling-off period after three consecutive payday loans. Those repeat loans are a pillar in the payday industry’s business model, where fees and interest can rack up and sometimes exceed $1,000 for an initial $350 loan.
While even the scenario of three successive loans may sound extreme, consumer advocates say that many borrowers roll over their loans far more frequently. In such a case, a borrower who took out a single loan to handle an unexpected expense — say, a flat tire or a hospital stay — then needs subsequent loans to handle other expenses, because the lender is reaching into the borrower’s paycheck to collect the principal and fees. According to CFPB data, roughly 45 percent of payday customers take out four loans or more in succession. Some 15 percent take out 10 or more.
“It’s much like getting into a taxi just to ride across town and finding yourself stuck in a ruinously expensive cross-country journey,” Richard Cordray, the CFPB’s director, said in a statement. Cordray said the agency’s proposal would “prevent lenders from succeeding by setting up borrowers to fail.”
Consumer advocates say that payday lenders have shown an ability to adapt and find loopholes in states that have tried to crack down. But those in the industry say the CFPB’s regulations are needlessly muscular and show little regard for consumers who are being helped.
Even softer limits on repeat lending have severely contracted the industry. Starting in 2010, the state of Washington limited borrowers to eight payday loans in a year. Before the law, there’d been 603 payday locations in the state. By 2014, nearly 450 of those had been shuttered.
“This is less reform than an attack on the operators,” said Dennis Shaul, chief executive of the Community Financial Services Association of America, a trade association. Shaul, citing CFPB research, said the industry could be “annihilated,” with loan volume reduced by as much as two-thirds.
With its proposal, the CFPB is also forcing lenders to more thoroughly vet borrowers — looking at credit and income statements — to see whether they can repay while still handling daily expenses. Lenders can only opt out of that vetting process in certain situations — for instance, if the loan amount is $500 or below, or if the borrower is deemed as being low-risk. No matter how lending companies evaluate their customers, they will have to obey the cooling-off period after a third loan.
The CFPB was created in the aftermath of the Great Recession, in part to address potential areas of financial abuse. But the agency is controversial, and some lawmakers have recently introduced bills that could weaken or undercut the payday rules. Currently 14 states, as well as the District of Columbia, place tight caps on interest rates; in practice, that amounts to an unofficial ban on payday lending. But the CFPB is not allowed to limit interest rates and has looked at other ways to take aim at the industry.
For installment loans with higher interest rates and fees, lenders, under the new rules, would also be required to determine whether borrowers can make the repayments. Lenders would have to use a credit reporting system to report and obtain information about the loan.
For payday lenders, the average APR is roughly 320 percent, according to CFPB data. Installment loans, which have grown in popularity in recent years, often carry similar interest rates.
Mike Calhoun, president of the Center for Responsible Lending, said the short-term lenders have long neglected to determine whether their borrowers can repay, and instead profit when borrowers are unable to. When making the initial loans, they are given either a postdated check or access to the borrower’s bank account.
“The combination of the lender having the ability to seize the borrower’s bank account, along with high interest rates, means that the ideal customer is one who will get caught in a debt trap,” Calhoun said.
For Bridget Hughes, a borrower in Kansas City, Mo., the debt trap began with a trip in October 2014 to a Quik Cash store. At the time, she said, she had no other way to pay her light bill. She refinanced the loan only once, but in the process the fees piled up. Recently, a lawyer called her mom, listed as a reference on the loan, and said Hughes had five days to pay $497. Otherwise she’d go to court.
Hughes, who makes $8.75 per hour at Wendy’s, devoted her next paycheck to pay off the debt. But she’s had to scramble for everything else. She’s tried to get money from churches. She’s skipped meals. She talked to her landlord and said she couldn’t immediately pay the rent.
“I’m still juggling to get caught up,” Hughes said.