Let's get ready to rumble!
OK, maybe not rumble — but probably have some pretty spirited discussion.
The Consumer Financial Protection Bureau, after almost a year of anticipation, has finally dropped its proposed rules on payday lending. The purpose of the rules as described by the CFPB?
"Ending payday debt traps by requiring lenders to take steps to make sure consumers have the ability to repay their loans."
The new rules, though referred to as payday lending rules, will actually govern a host of lending products that fall under the general heading of short-term/high-interest, including auto title loans, deposit advance products and some forms of high-interest installment and open-end loans.
“The Consumer Bureau is proposing strong protections aimed at ending payday debt traps,” said CFPB Director Richard Cordray. “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, commonsense lending standards, our proposal would prevent lenders from succeeding by setting up borrowers to fail.”
And to make the issue easier to understand, the CFPB even released an explanatory animated video (above).
For those unable to watch the video, the CFPB's chief concern is that borrowers in need are being set up to fail in loans that can not be rationally repaid in the time they are allotted with the cost structure as it stands today. That can lead to impossible choices between default, reborrowing or bailing out of other financial commitments (food, rent, medical care). The CFPB also notes that consumers face penalty fees, bank account closures or even the loss of their vehicle when short-term lending arrangements go pear-shaped.
So, what are the new rules that are meant to ward off these worst-of-the-worst consequences?
- The full-payment test: Under the new rules lenders would be required to determine whether or not borrowers can afford their full payment amounts when due without bringing on other financial hardships. For short-term loans with a balloon payment at the end (typical payday loan structure), full payment means affording the total loan amount and all the fees and finance charges without having to reborrow within the next 30 days. Under the full-payment test, it would also be more difficult to push borrowers into loans that would almost necessarily have to be rolled into a reborrowing situation. This part of the proposal also caps the number of short-term loans that can be made in quick succession.
- Principal payoff option for certain short-term loans: This rule exists as an exception to the rule above for consumers that borrow $500 or less, as it allows borrowers to make payments against the principal on their debt (thus preventing interest from racking up and running out of control). As part of the principal 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.
- Less risky, longer-term lending options: This proposal offers lenders two ways to avoid some regulation by offering one of two alternative versions of a short-term loan. The first option would be offering loans that generally meet the parameters of the National Credit Union Administration “payday alternative loans” program. The other option would be offering loans that are payable in roughly equal payments with terms not to exceed two years and with an all-in cost of 36 percent or less, not including a reasonable origination fee, so long as the lender’s projected default rate on these loans is 5 percent or less.
- Debit attempt cutoff: Going forward, lenders would have to give consumers written notice before attempting to debit the consumer’s account to collect payment for any loan covered by the proposed rule. After two failed attempts, the lender would be prohibited from debiting the account again, unless the lender gets a new and specific authorization from the borrower.
With the rules now out and about, the open comment period begins, and the lengthy period of debate and negotiations officially kicks off. The CFPB is also launching an inquiry into other potentially high-risk loan products and practices that are not specifically covered by the proposed rules.
Check back with PYMNTS tomorrow (June 3). We'll have our take on the new rules and how the industry, on all sides, is looking at them.
Spoiler alert — the early buzz? No one is happy. And probably, the consumer-in-need is the least happy of all.
Which, if you think about it, might count as progress. It is the first thing that all interested parties have agreed about in some time.