The Consumer Financial Protection Bureau will propose sweeping new rules for short-term, small-dollar loans Thursday, threatening the existence of the payday lending industry as it now exists and capping off one of President Obama’s late-tenure administrative efforts.
Richard Cordray, the bureau’s director, said in a statement provided to reporters Wednesday that the rules would be “aimed at ending payday debt traps,” or situations in which people desperate for cash turn to a series of high-cost loans and fall further into debt.
“By putting in place mainstream, common-sense lending standards, our proposal would prevent lenders from succeeding by setting up borrowers to fail,” Cordray said.
Cordray’s agency will hold an event in Kansas City, Mo., Thursday to announce the proposed rule. After it is introduced, businesses will be able to submit comments on it.
The rules would cover not just loans from payday stores, but also other forms of short-term credit, including auto title loans, deposit advance products and other loans. They would add to all of the diverse existing regulatory schemes that exist at the state level.
The regulatory plan features two separate sets of rules under which lenders could offer short-term loans. It also creates two regimes for longer-term loans that would feature more “flexible” underwriting, according to the bureau.
For short-term loans, similar to payday loans that typically are due within two weeks to a month, the first option would be for lenders to conduct an ability-to-repay test, analogous to ones required under post-crisis rules for mortgages. The company would have to establish that the borrowers could afford to repay the loan and still meet basic living expenses, a standard the industry has said is inappropriate because payday borrowers are already barely meeting day-to-day expenses. Then, if a borrower sought to roll over the loan, the lender would have to establish that the customer’s financial position had materially improved, and that he was not simply sinking further into a debt trap.
The second option would allow the lender to skip the ability-to-repay test but would limit borrowers to less than $500 and block lenders from taking auto titles as collateral or offering the loans to people who are already deep in payday debt. Borrowers wouldn’t be able to take out successive loans under this option unless they paid down at least a portion of the principal, preventing them from falling into a debt “trap.”
Under both scenarios, lenders would be required to report data on loan performance to the bureau.
Alternatively, lenders could offer longer term loans that met certain specifications, a possibility meant to spark bank and credit union interest in serving the customers who have been using payday services. One possibility would be for lenders to structure loans according to parameters sketched out by the National Credit Union Administration that limits interest rates to 28 percent. In comparison, the annual percentage rate equivalent for many payday loans now exceeds 300 percent.
Those terms, said Dennis Shaul, head of the Community Financial Services Association of America that represents payday lenders, would be a “staggering blow to consumers as it will cut off access to credit for millions of Americans.”
In speech text prepared for Thursday’s event, however, Cordray says that “the vast majority of borrowers would still be able to get the credit they need in an emergency,” but with stronger protections.
Yet Nick Bourke, a payday lending researcher at the Pew Charitable Trusts, said in a statement that the proposal “misses the mark” because it will still allow lenders to issue loans with APRs over 400 percent, while not making the more specific and far-reaching standards that are needed to draw banks and credit unions into the market, such as capping payments at 5 percent of borrowers’ income.
In addition to the new requirements on loans, the bureau will try to prevent borrowers from being hit with bank overdraft fees by restricting when lenders can reach into their accounts to collect payments.
Advocates, including civil rights and religious groups, have long pushed for the bureau to propose the rule. Meanwhile, the industry views it as an existential threat and has been looking beyond the rule’s introduction toward potential legislative and legal challenges.
