Sweeping new rules proposed Thursday by the Consumer Financial Protection Bureau (CFPB) could upend the payday loan industry, which consumer advocates say often traps cash-strapped workers into a vicious cycle of borrowing.
If enacted, the rules generally will require lenders to verify that borrowers can afford the loans and cap the number of times people can take out successive loans. The rules also would go beyond payday loans to target other costly short-term loans, including some high-interest installment loans and car title loans.
Here’s a little more about the rules and how consumers would be affected:
Why is this happening?
The CFPB says that because of the way the loans work now, borrowers who use them can often be overwhelmed by fees and trapped into a cycle of debt that forces them to skip important bills or make other difficult financial choices. For instance, the agency found that about 80 percent of payday loans are rolled over into a repeat loan, causing fees to pile up for borrowers. Roughly 45 percent of payday customers take out at least four loans in a row.
And each loan comes with steep fees. The CFPB found that payday borrowers pay a median $15 in fees for every $100 they borrow, amounting to an annual percentage rate of 391 percent on a median loan of $350. The rates on installment loans and auto title loans can be similarly high.
When borrowers fall behind on payments, they can face penalty charges from the lenders and from their banks. More than a third of online payday borrowers who faced overdraft fees were eventually shut out of their bank accounts, the agency found. And one in five people who take out auto title loans that are due in a single payment end up having their cars seized, according to the report. “Based on our research and what we hear around the country, we believe the harm done to consumers by these business models needs to be addressed,” said the CFPB’s director Richard Cordray in a statement.
What would the rules do?
Payday lenders and certain companies offering short-term loans would essentially need to look into borrowers’ finances and make sure that they could realistically afford the loans. Lenders would look at consumers’ income and credit report to decide whether they would be able to keep up with their monthly living expenses while making payments on the debt. If paying back that loan would leave a consumer with, say, a few bucks in the bank, that person would theoretically be rejected. The only exceptions where lenders would not have to look into borrowers’ incomes would be for loans under $500 or for loans with interest rates of less than 36 percent.
Still, even those loans would be subject to rules that put a cap on how often borrowers could roll over their debt into repeat payday loans. After the third loan, borrowers would need to enter a mandatory cooling-off period where they would not be able to take out another loan for at least 30 days.
For loans smaller than $500, which would not require the vigorous payment test, borrowers would be required to pay back part of their debt each time they rolled over the loan.
What types of loans are being targeted?
The rules would primarily target payday loans, high-cost short-term loans that borrowers take out with the expectation that they’ll repay the debt with their next paycheck. Borrowers will typically secure the loans, which are usually due within two weeks, by leaving behind a post-dated check. But if they don’t have the money to pay the loan back in full, it is common for them to take out a repeat loan.
Installment loans, which work differently from payday loans, would also be covered. These loans are usually paid back over time through a series of scheduled payments. But after all of the payments are factored in, some consumers may still face steep interest charges, consumer groups say. The rules would apply to installment loans that charge an interest rate higher than 36 percent or if they take payments directly out of a borrower’s bank account.
Auto-title loans that require borrowers to put their cars up as collateral would also be subject to the rules.
Don’t lenders already have to ask for income information?
No. Right now you can take out a payday loan by simply leaving behind a post-dated check. Companies that issue payday loans and other short-term loans may ask for proof of income but are not required to prove a borrower’s ability to pay.
How else could the rules affect borrowers?
The CFPB is also trying to cut down on the overdraft fees borrowers face when they fall behind on payments. Under the new rules, lenders would need to notify borrowers at least three days before making an electronic withdrawal for payment. And after two failed attempts to collect payment, lenders would be blocked from debiting the accounts again unless the borrower said it was okay. In a report released this year that studied online payday and installment borrowers for 18 months, the agency found borrowers faced an average $185 in overdraft fees when lenders made repeated attempts to collect payments from their bank accounts.
Aren’t there already laws in place that control these loans? Fourteen states and the District effectively ban payday loans by capping the interest rate that can be charged there. This would be the first time federal rules restrict how the loans operate.
Are these rules good for consumers? Some analysts say that if the rules are enacted, they could put many payday lenders out of business. While that would make it easier for consumers to avoid the high-cost loans, some people who don’t have access to a credit card or who can’t qualify for a loan through a bank may find themselves with limited options if they need cash.
When would the rules go into effect? The proposal needs to go through a comment period before a final version can be announced. It may be next year before the process is over.