WASHINGTON, D.C. — As expected, the Consumer Financial Protection Bureau (CFPB) used its field hearing today in Kansas City, Mo., to issue its proposed rule targeting what Director Richard Cordray called “payday debt traps.” It would require lenders in that segment to take steps to ensure consumers have the ability to repay their loans.
The proposed rule, which covers payday loans, auto title loans, deposit advance products, and certain installment and open-ended loans, would also cut off repeated debit attempts that rack up fees. The CFPB also announced it is launching an inquiry into other products and practices.
“Today, we are here to show everyone concerned our proposed new rule on payday loans, auto title loans, and certain high-cost installment and open-end loans,” Cordray said. “In such markets, where lenders can succeed by setting up borrowers to fail, something needs to change.”
Cordray said the bureau has serious concerns that risky lender practices in the payday, auto title, and payday installment markets are pushing borrowers into debt traps. Chief among these concerns, he added, is that consumers are being set up to fail with loan payments that they are unable to repay.
Loans covered by the proposal include payday loans that are generally due on the borrower’s next payday and typically have an annual percentage rate of around 390% or higher. Also covered are single-payment auto title loans, which usually due in 30 days and require borrowers to use their vehicle title for collateral. The typical annual percentage rate, according to the bureau, is about 300%.
Also covered are installment loans in which the lender charges a total, all-in annual percentage rate that exceeds 36%, including add-on charges, and either collects payment by accessing the consumer’s account or payment, or secures the loan by holding the title of the consumer’s vehicle as collateral.
The proposed rule contained ability-to-pay protections, including a “full-payment” test that would require lenders to determine upfront whether consumers can afford to repay their loans without reborrowing. The proposal also includes a “principal payoff option” for certain short-term loans and two less risky longer term lending options so borrowers who may not meet the full-payment test can access credit without getting trapped in debt.
Lenders would also be required to use credit-reporting systems to report and obtain information on certain loans covered by the proposal. The rule would also limit repeated debit attempts that can rack up more fees. Specifically, the proposal includes the following protections:
1. Full-payment test: Under the proposed full-payment test, lenders would be required to determine whether the borrower can afford the full amount of each payment when it’s due and still meet basic living expenses and more financial obligations. For short-term loans and installment loans with a balloon payment, full payment means affording the total loan amount and all the fees and finance charges without having to reborrow within the next 30 days.
For payday and auto title installment loans without a balloon payment, full payment means affording all payments when due. The proposal would further protect against debt traps by making it difficult for lenders to push distressed borrowers into reborrowing or refinancing the same debt. The proposal would also cap the number of short-term loans that can be made in quick succession.
2. Principal payoff option for certain short-term loans: Under the proposal, consumers could borrow a short-term loan of up to $500 without the full-payment test as part of the principal payoff option that is directly structured to keep consumers from being trapped in debt. Lenders would be barred from offering this option to consumers who have outstanding short-term or balloon-payment loans, or have been in debt on short-term loans more than 90 days in a rolling 12-month period. Lenders would also be barred from taking an auto title as collateral.
Additionally, as part of the payoff option, a lender could offer a borrower up to two extensions of the loan, but only if the borrower pays off at least one-third of the principal with each extension.
3. Less risky longer term lending options: The proposal would also permit lenders to offer two longer-term loan options with more flexible underwriting, but only if they pose less risk by adhering to certain restrictions. The first option would be offering loans that generally meet the parameters of the National Credit Union Administration “payday alternative loans” program, where interest rates are capped at 28% and the application fee is no more than $20.
The other option would be offering loans that are payable in roughly equal payment with terms not to exceed two years and with an all-in cost of 36% or less, not including a reasonable origination fee, so long as the lender’s projected default rate on these loans is 5% or less. The lender would have to refund the origination fees any year that the default rate exceeds 5%. Lenders would not be limited as to how many of either type of loan they could make per consumer per year.
4. Debit attempt cutoff: Under the proposal, lenders would have to give consumers written notice before attempting to debit the consumer’s account to collet payment for any loan covered by the proposed rule. After two straight unsuccessful attempts, the lender would be prohibited from debiting the account again unless the lender gets a new and specific authorization from the borrower.
“From the beginning, payday lending has been an important priority for the [bureau],” Cordray said. “In the statute creating this new agency, Congress authorized us to exert supervisory authority from the outset over all financial companies in only three specific areas — and one of these is the market for payday loans.
“In addition, we have the authority to enforce the law against all payday lenders,” Cordray added. “We have deployed this authority in a number of classes involving both storefront and online lenders … And we have the authority to write new rules to clean up unfair, deceptive, or abusive practices that harm consumers. That is the purpose of our discussion today.”
The proposed rule will enter the public comment period, which ends on Sept. 14, once it is published in the Federal Register. To view the bureau’s proposal, click here.