What just happened?
The Consumer Financial Protection Bureau (CFPB), the U.S. government’s consumer protection agency, has proposed new regulations that would affect payday lending in an attempt to end payday debt traps by requiring lenders to take steps to make sure consumers can repay their loans.
What loans would the new regulation apply to?
The proposed regulations would cover two categories of loans. The first is loans with a term of 45 days or less. The second is loans with a term greater than 45 days, provided that they (1) have an all-in annual percentage rate greater than 36 percent; and (2) either are repaid directly from the consumer’s account or income or are secured by the consumer’s vehicle.
In other words, the regulation would cover almost all “payday lending” and “car title” loans.
What does the regulation do?
The proposed regulation would have two main effects. The first effect is on lenders, The regulation would require that, before making a covered loan, a lender must reasonably determine that the consumer has the ability to repay the loan. Failure to do so would be considered an “abusive and unfair practice.”
It would also make it an “unfair and abusive practice” to attempt to withdraw payment from a consumer’s account for a covered loan after two consecutive payment attempts have failed, unless the lender obtains the consumer’s new and specific authorization to make further withdrawals from the account
The second effect is on consumers. They regulation would limit the number of short-term rollover loans borrowers can take in succession.
How would a lender determine the ability of a borrower to repay a loan?
The regulation would require a lender, before making a covered short-term loan, to make a “reasonable determination” that the consumer would be able to make the payments on the loan and be able to meet the consumer’s other major financial obligations and basic living expenses without needing to reborrow over the ensuing 30 days.
The regulation would specifically require a lender to:
• verify the consumer’s net income;
• verify the consumer’s debt obligations using a national consumer report and a consumer report from a “registered information system” as described below;
• verify the consumer’s housing costs or use a reliable method of estimating a consumer’s housing expense based on the housing expenses of similarly situated consumers;
• forecast a reasonable amount of basic living expenses for the consumer— expenditures (other than debt obligations and housing costs) necessary for a consumer to maintain the consumer’s health, welfare, and ability to produce income;
• project the consumer’s net income, debt obligations, and housing costs for a period of time based on the term of the loan; and determine the consumer’s ability to repay the loan based on the lender’s projections of the consumer’s income, debt obligations, and housing costs and forecast of basic living expenses for the consumer.
Why don’t banks simply provide loans for these consumers?
A few of the largest consumer banks in America were reportedly considering going to market with new small-dollar installment loan products. The banks were hoping that the CFPB would offer a “5 percent exemption” as part of the proposed regulations. The American Banker explains how that would have worked:
A mockup of what the product could look like would be a $500 five-month loan for a borrower with an annual income of $30,000 and monthly payments of $125 (or 5% of the borrower’s $2,500 average monthly income). After assuming a 6% loss rate (which would be comparable to similar installment loans currently on the market), automation expenses and servicing fees, a bank could net roughly $70 while the borrower would be on the hook for $125. The average cost of a similar payday loan product would be closer to $750.
“The 5% payment option is the only part of the CFPB proposal that could save millions of borrowers billions of dollars,” said Nick Bourke, director of the small-dollar loans project at the Pew Charitable Trusts. “It would enhance underwriting while minimizing compliance costs by capping the monthly payment at 5% of the borrower’s income with a term up to six months.”
But the new regulation did not include that exemption. “The CFPB’s small-dollar loan proposal misses the mark,” Bourke told The Atlantic. Additionally, Alex Horowitz, the senior officer of Pew’s small-dollar loan project agreed, telling The Atlantic that,
the longer-term, low interest-rate loans are good, but historically the use of those products is much too small to make a real difference. To be truly effective, he said, regulations would need to accomplish three things for borrowers: lower prices and fees, smaller installment payments, and quicker application processing. The new rules “provide more paperwork for the same 400 percent APR loan,” he says. “That’s not consumer protection.”
Who gave the CFPB the authority to make such regulations?
The CFPB is able to make the regulations because of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Public Law 111-203). The relevant sections they cite are1022, 1024, 1031, and 1032, the Bureau of Consumer Financial Protection (Bureau or CFPB). President Obama signed the Dodd-Frank Act into law in 2008 after the financial crisis.
When does the regulation go into effect?
Before issuing any new regulations, federal law requires agencies to solicit feedback from the public. The CFP will evaluate comments on the proposal for the next few months and issue the final regulations on September 14. After that, the regulations would likely take effect in early 2017.