The Consumer Financial Protection Bureau on Thursday unveiled a new plan that it said would help rein in the $50 billion payday lending industry and prevent low-income borrowers from facing spiraling levels of debt.
The proposal, which still must face months of review, marks the first attempt by the federal government to regulate payday lenders, whose loans — designed to help borrowers in a pinch — often come with triple-digit annualized interest rates.
The CFPB, in its plan, suggests that payday lenders from the outset should determine whether borrowers have the ability to repay without defaulting or re-borrowing. That notion takes aim at a pillar of the payday business model, because lenders have long made profits from a far more desperate scenario, where borrowers take out new loans, often many times over, to pay back the initial loans and their fees. Borrowers could in some circumstances still roll over loans, but not ad infinitum; after three loans there would be a 60-day cooling off period.
Still, some consumer advocates say the CFPB plan doesn’t go far enough. Under the CFPB proposal, lenders can avoid vetting their borrowers if they instead apply a series of additional safety nets to the loan. Either the principal must decrease with each loan, or lenders must provide what the CFPB calls an “off-ramp” after the third loan, where borrowers can pay back what they owe without accumulating further fees.
“Despite the strong fundamentals of the CFPB’s approach, loopholes would permit some unaffordable high-cost loans to stay on the market,” Lauren Saunders, an associate director at the National Consumer Law Center, said in a statement. “The CFPB has taken an ‘either/or’ approach: ‘prevention or protection.’ But borrowers need both.”
In a typical payday loan, available both in storefronts and online, a consumer must provide either a personal check to the lender or authorize access to his bank account for the collection of the principal and fees. At that point, said Richard Cordray, the CFPB director, lenders gain a “stranglehold” over borrowers’ funds, potentially draining their accounts and forcing them to choose between “repaying the loan and paying rent or covering food or medicine or other pressing needs.”
The CFPB, created in the aftermath of the Great Recession to curb financial abuses, does not have the authority to cap interest rates.
Payday lenders have long been targeted by state rules, which sometimes include usury caps, but the industry has proven chameleon-like, capable of adapting amid regulatory efforts, consumer advocates say. After Ohio passed a law in 2008 placing a tight interest cap on short-term loans, many lenders shifted into the “mortgage” business — while still offering $500 loans under similar terms.
Payday lenders say their services are being unfairly targeted by regulators, who risk choking off credit to low-income and some middle-class Americans. In addition to payday lending, the CFPB rules also target installment and auto title lenders — business that have grown more popular in states that have tried to curb payday lending.
Dennis Shaul, chief executive of the Community Financial Services Association of America, a payday lending trade group, said in an interview that the CFPB was arbitrarily targeting lenders without proof that the loan terms cause harm. The CFPB said in 2013 that the median payday borrower had an income of $22,476. More than 20 percent of initial loans grow into a series of seven or more loans.
The CFPB proposal "would be particularly damaging to the existing business model and to those who rely on the service or product as a means to smooth out their expenses,” Shaul said.
Though many months could pass before the CFPB issues any firm rules, the proposal offers a glimpse at the agency’s thinking as it faces lobbying from consumer advocates and the payday industry. The proposal released Thursday will still be subject to a review by small business representatives and a public comment period.