The Consumer Financial Protection Bureau (CFPB) recently advised that regulation should restrict payday loan debt trap.
Houston, Texas —The Consumer Financial Protection Bureau (CFPB) recently advised that regulation should restrict payday loan debt traps. The rule would require lenders to ensure that consumers could pay back their loans, and put costly repeated debit attempts to an end. The suggested change would affect auto title loans, payday loans, deposit advances, and some expensive installment and open-end loans.
CFPB Director Richard Cordray said, “The Consumer Bureau is proposing strong protections aimed at ending payday debt traps. Too many borrowers seeking a short-term cash fix are saddled with loans they cannot afford and sink into long-term debt. It’s much like getting into a taxi just to ride across town and finding yourself stuck in a ruinously expensive cross-country journey. By putting in place mainstream, common-sense lending standards, our proposal would prevent lenders from succeeding by setting up borrowers to fail.”
The CFPB is concerned that certain credit products are aimed at the most financially vulnerable customers, and high-risk practices in the payday and auto title loan industry are forcing borrowers into debt traps. When a borrower faces an unaffordable loan payment, he/she has to decide between reborrowing, defaulting, or skimping on other financial commitments, like rent, medicine, and food. According to the CFPB, this could lead to even more havoc in consumer's lives when they are hit with steep penalty fees, closed bank accounts, and vehicle seizures.
Loans that would be effected by the proposal include:
Payday loans which are typically due on the borrower's next payday, and have a hefty annual percentage rate of 390 or even higher. Single-payment auto title loans, which require that the customer's vehicle title is used for collateral, are commonly due in 30 days and often have an APR of 300 or higher. It is common for consumers to reborrow within a short period of time or roll over when payments for these short-term loans are due. Each time the consumer reborrows, they pay more in fees and interest, which is what changes a short-term loan into a long-term debt trap. According to CFPB research, one-in-five payday loans end up in default and one-in-five auto title loan borrowers have their vehicle seized by the lender for failure to repay. More than four-out-of-five single-payment loans end up being reborrowed within a month's time.
High-Cost Installment Loans where the lender charges a total, all-in annual percentage rate above 36%, including add-on charges, and guarantees payment by holding the borrower’s vehicle title as collateral or accessing the borrower’s paycheck or bank account. The Bureau’s research concluded that over one-third of loan sequences are defaulted on in the end, sometimes, even after the borrower has refinanced or reborrowed. Also, one-third of auto title installment loan sequences end in default.
The CFPB is proposing a rule that would end debt traps. Here is what the rule specifies:
Full-payment test Lenders would have to make the determination whether the customer can afford to pay the full amount of each payment on its due date and continue to afford basic living expenses and other financial obligations. For short-term loans and installment loans with a balloon payment, this means affording the total payment along with any fees and finance charges, without having to reborrow within a month. For payday and auto title loans without a balloon payment, this means being able to afford all of the payments when they are due.
Principal payoff option for certain short-term loans Consumers could borrow a short-term loan up to $500 with no full-payment test as part of the principal payoff option (which is designed to keep borrowers from getting trapped in debt). Another part of this proposal is that the consumer could have a maximum of two loan extensions IF they pay at least one-third of the principal amount with each payment. Consumers who have outstanding loans (either short-term or balloon-payment) or have been in debt for more than 90 days in a year would not be eligible for such extensions. Lenders would not be allowed to accept a title to a vehicle as collateral.
Less risky longer-term lending options Lenders would have two loan choices with more adjustable underwriting, but only if they pose a lower risk to the consumer, and they must adhere to certain restrictions. One option would be offering loans where interest rates are capped at 28%, and the application fee can be no more than 20$. The other option would be offering loans that consumers could pay in relatively equal payments, not to exceed two years, and with a complete cost of 36% or less. Lenders would also be limited as to how many of these loans they could make per customer every year.
Debit attempt cutoff Lenders would be required to give borrowers written notice before making an attempt to debit the borrower’s account, and, after two straight unsuccessful tries, the lender would not be allowed to try to debit the account again unless they get a new authorization from the borrower.
Stakeholders and the general public are invited to send their written input on the proposal, which must be received by September 14, 2016. Before final regulations are issued, all input will be weighed carefully and taken into consideration.