WASHINGTON After releasing successive studies on the payday industry over the past two years, the Consumer Financial Protection Bureau is finally set to unveil Thursday sweeping proposals that could fundamentally change the business of short-term loans and other products.
The agency, which gave reporters a summary of the agency's plan beforehand, said the rules under consideration must still be examined by a Small Business Review Panel before being formally proposed. Federal law requires officials to gather feedback from small businesses on developing rules that could have a significant economic impact.
Yet the agency appears finally ready to pull the trigger on federal rules for an industry that, while targeted by states and heavily criticized by consumer advocates, has largely escaped national regulation.
"After much study and analysis, we are taking an important step toward ending the debt traps that are so pervasive in both the short-term and longer-term credit markets," CFPB Director Richard Cordray said in remarks prepared for an agency field hearing on payday loans taking place Thursday in Richmond, Va.
The agency's plans are already gaining nationwide political attention. President Obama is slated to speak on Thursday in Alabama, one of the states where payday lending is the most prevalent. Even before the plans were unveiled, meanwhile, Republicans have been warning the agency not to go too far in choking off a business that many lower-income Americans have come to depend upon.
The proposals are almost certain to engender a fierce debate among political partisans, consumer advocates and the financial industry at large over whether the CFPB has gone too far. There is no doubt they are the most ambitious attempt yet by the federal government to change how payday loans are made.
Overall, the proposals would include everything from income verification requirements to limits on how many loans a consumer can borrow in a given time period. But lenders could choose from among various sets of requirements which to follow.
The rules would generally be divided into three sections: short-term loans, long-term loans and restrictions on collection practices.
For both short-term and long-term products, lenders could choose from two different sets of requirements to follow. One approach, which is intended to "prevent" debt traps, would require the lender to follow a list of rules to determine borrowers' ability to repay when making a loan, including verifying their income. The alternative approach to "protect" consumers from debt traps would involve a different set of restrictions to foster affordability, such as limits on loan amounts or maximum numbers of rollovers, for example.
Products subject to the requirements would include typical short-term payday loans, deposit advance products, vehicle title loans, high-cost installment loans and open-end lines of credit.
Following is a more detailed cheat sheet on what the CFPB proposals would require:
- The agency said it is considering 45 days as the duration defining a "short-term" loan.
- Under the "prevention" approach for short-term loans, a lender would have to verify income, other financial debts and credit history to judge if the borrower can repay, and a loan cannot be made to a borrower with any outstanding loans subject to the rules that came from another lender.
- The "prevention" requirements impose a 60-day "cooling off period" between loans. However, subsequent loans could be made within that window if the lender showed the borrower's finances had sufficiently improved. Yet, overall, no more than three loans could be made during that period.
- Short-term loan providers could alternatively choose to follow "protection" requirements that, the CFPB said, would limit "the number of loans that a borrower can take out in a row and [require] lenders to provide affordable repayment options."
- Under the "protection" approach, loans lasting no more than 45 days could not exceed $500, exceed one finance charge or force the borrower to use their vehicle as collateral. Like the "prevention" approach, borrowers could not have other outstanding loans that were provided by another institution.
- This approach would cap rollovers at two so totaling three loans and a mandatory 60-day cooling off period would then follow.
- However, those rollovers would be allowed only if "the lender offers an affordable way out of debt," the CFPB said. Here, the agency said it is considering two different paths: either requiring a principal reduction over the course of the three loans, or the lender providing a "no-cost 'off-ramp' if the borrower is unable to repay after the third loan" to avoid additional fees.
- The proposals generally define longer-term products as those lasting more than 45 days where a lender can access a borrower's deposit account or paycheck, or share ownership of the consumer's vehicle, in order to get repaid, and the "all-in" annual percentage rate including fees exceeds 36%.
- Like with the short-term loan requirements, the debt-trap "prevention" approach for longer-term products would require verification of income, other debts and credit history to determine at the outset of the loan if it can be repaid.
- Lenders choosing the "prevention" approach would have to determine a borrower's ability to repay each time the borrower tried to refinance or take out another loan. A lender could not refinance a borrower into another loan if the borrower had been delinquent on a payment and the lender had not shown that the consumer's financial situation had improved.
- The agency said it is considering two options for the "protection" approach governing longer-term products. One option follows a model used by the National Credit Union Administration for so-called "payday alternative loans."
- Under the NCUA model, a loan with principal between $200 and $1,000 and a decreasing balance would be capped at a 28% interest rate and a $20 application fee. A consumer could only take out two such loans within a six-month period.
- The agency said it is also considering a "protection" option whereby a consumer cannot be required to make payments each month that exceeds 5% of the borrower's monthly income. The borrower also could not take out more than two such loans within a 12-month period.
Restrictions on Collection Practices
- For products covered by the CFPB rules, the agency said it is considering requiring lenders to give borrowers three business days' notice before attempting to collect payment through a deposit or prepaid account.
- To limit fees that result from repeated transactions, a lender could not attempt a third withdrawal from a consumer's deposit account if the two prior attempts were unsuccessful.