CFPB Proposes Rules to Protect Consumers From Payday Loan Debt Traps
Proposal Covers Payday Loans, Auto Title Loans, And Other High Cost Credit
WASHINGTON, D.C. (June 2, 2016) – New rules proposed today by the Consumer Financial Protection Bureau (CFPB) will help protect consumers from drowning in debt from payday loans and other forms of high cost credit, according to Consumers Union, the policy and advocacy division of Consumer Reports. Under the proposed rule, lenders would generally be required to make sure that borrowers are in a position to pay back their loans and would be barred from repeatedly debiting borrowers’ accounts, which can trigger costly overdraft fees.
“For too long, payday and other high-cost lenders have trapped millions of Americans each year into troubling cycles of debt,” said Suzanne Martindale, staff attorney for Consumers Union. “We applaud the CFPB for proposing the first-ever nationwide reforms that will help ensure borrowers don’t take out loans with unfair and unaffordable terms. The proposal is strong but contains exemptions that may still permit risky lending practices. We look forward to working with the agency to finalize rules that require sensible underwriting, promote fair pricing, and include safeguards to prevent repeat borrowing for all short-term and long-term loan products.”
The CFPB’s proposal covers payday loans, auto title loans, deposit advance products, and certain high-cost installment loans. Too often, these loans prove very difficult for borrowers to pay back and they end up defaulting, taking out another loan, or struggling to cover other financial commitments.
A CFPB review found that a typical payday loan of $350 carried a median fee of $15 per $100 borrowed and would come due after two weeks. The consumer would owe $400, which translates into a 391 percent APR. The CFPB found that many borrowers repeatedly roll over their payday loans or take out additional loans because they are unable to pay off the loan at the end of the two week term. Nearly half of payday loan borrowers have more than 10 transactions a year (14 percent had 20 or more transactions a year). Most borrowers who take out a new payday loan do so on the same day the old loan is closed or soon thereafter.
Pamela Banks, senior policy counsel for Consumers Union said, “Credit rollovers can trap consumers in debt that they can’t afford. Sound underwriting standards and strong protections against revolving credit extensions are critical. These rules are a step in the right direction that will help consumers avoid the dangers of debt traps. As the rule moves forward, we hope the CFPB will make these protections even stronger.”
The CFPB’s proposal includes a number of important reforms, including:
Ability to Repay: For payday loans and auto title loans without a balloon payment, lenders would be required to determine whether borrowers could pay off the loan in full when it is due while meeting other basic living expenses and financial obligations (known as the “full payment test”). For short term loans and installment loans with a balloon payment, lenders would have to determine that the borrower has the ability to repay without taking out another loan within 30 days. The proposal also caps the number of loans that can be made one after another.
Principal Payoff Option for Short Term Loans: Consumers could take out a short-term loan up to $500 without undergoing the “full payment test” by exercising the principal payment option, which is designed to help them avoid a cycle of debt. Under this option, lenders could offer two extensions of the loan, as long as the borrower pays off at least one-third of the principal with each extension. Lenders would not be allowed to offer this option if the consumer has an outstanding short term or balloon payment loan or if they have been in debt with a short term loan for more than 90 days over the course of 12 months.
Limiting Account Debits That Trigger Overdraft Fees: The CFPB’s proposal aims to prevent borrowers from incurring overdraft fees when lenders debit their accounts. Lenders would be required to notify consumers before attempting to debit the consumer’s account to collect payment. Lenders would be prohibited from debiting the account after two consecutive unsuccessful attempts, unless they get permission from the consumer.
Allowing Less Risky Longer-Terms Loans: Lenders would be allowed to offer longer term loans with more flexible underwriting that meet the National Credit Union Administration’s “payday alternative loans program,” which caps interest rates at 28 percent with an application fee of $20 or less. Lenders would also be allowed to offer loans with flexible underwriting if the loans are payable in equal payments for up to two years with costs capped at 36 percent plus a reasonable origination fee.
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Consumers Union is the public policy and advocacy division of Consumer Reports. Consumers Union works for health reform, food and product safety, financial reform, and other consumer issues in Washington, D.C., the states, and in the marketplace. Consumer Reports is the world’s largest independent product-testing organization. Using its more than 50 labs, auto test center, and survey research center, the nonprofit rates thousands of products and services annually. Founded in 1936, Consumer Reports has over 8 million subscribers to its magazine, website, and other publications.