For the first time, there will soon be broad rules protecting U.S. borrowers from being stuck in a spiral of debt from loans that typically have rates of 390 percent and often higher.
The Consumer Financial Protection Bureau, the agency that Sen. Elizabeth Warren (D-Mass.) conceived, announced a proposed rule covering payday loans, as well as other high-interest lending products like auto and installment loans. Previously, these high-cost loans were mostly regulated at the state level.
The rule takes direct aim at the core business of payday lenders: giving people loans that they can’t afford to pay back without refinancing.
Turning a short-term lack of cash into a chain of unaffordable loans “is the core of the payday loan business model,” payday loan expert Nick Bourke at Pew Charitable Trusts told The Huffington Post in November. “To any objective, fair-minded reviewer, that’s not in question.” CFPB research has found that more than half of payday loans are made to people as part of a string of 10 or more loans.
It's a bit "like getting into a taxi just to ride across town and finding yourself stuck in a ruinously expensive cross-country journey," CFPB director Richard Cordray said in prepared remarks, to be delivered in Kansas City on Thursday.
The CFPB’s proposal contains two key measures aimed at ensuring that borrowing once does not throw consumers into a spiral of unpayable debt. The first measure requires lenders to assess if the borrower has the income to fully repay the loan when it is due without reborrowing. This idea, known as “ability to repay,” targets at the cycle of debt that unaffordable payday loans can trap people in.
The proposed rule also prohibits lenders from making more than two unsuccessful attempts to withdraw money from borrowers bank accounts. Repeated debit attempts cause consumers to be hit with overdraft fees from their banks. Such fees hit half of all online borrowers, costing an average of $185.
In private, the payday lending industry admits unaffordable lending products that force borrowers to take out new loans to pay off old ones are core to the industry's profits. “In practice, consumers mostly either roll over or default; very few actually repay their loans in cash on the due date,” wrote Hilary Miller, a key figure in the industry’s fight against regulation, in an email obtained by open records requests in November.
A 2009 Center for Responsible Lending study found that people taking out new loans to repay old ones make up 76 percent of the payday market. And studies from the Deloitte Financial Advisory Services and Charles River Associates estimated that the CFPB’s proposed rule could reduce the volume of industry loans made by 60 to 74 percent, an indication that the rule would cut significantly into this.
However, Bourke said it doesn't go far enough and doesn't encourage banks to provide low cost loans to needy Americans. “The CFPB has an historic opportunity to encourage safe, affordable lending—and they’re missing it. Its proposal makes it too easy for payday lenders to complete additional paperwork and issue a $500 loan with $600 in fees, while making it difficult for a bank to offer the same loan for $80.”
The National Consumer Law Center said that while the proposed rule is promising, it is concerning that “lenders could make up to three back-to-back payday loans and could start the sequence again after only 31 days.”
The payday lending industry immediately attacked the rule. It "presents a staggering blow to consumers as it will cut off access to credit for millions of Americans who use small-dollar loans to manage a budget shortfall or unexpected expense," chief executive of the Community Financial Services Association Dennis Shaul said in a statement.
Democratic presidential candidate Hillary Clinton applauded the proposed rule and assailed presumptive GOP nominee Donald Trump for wanting to repeal the entire bank regulation law that, among many other things, created the CFPB. "Working families deserve a president who will look out for them -- not payday lenders and special interests on Wall Street," she said.
The agency will accept comments on the proposed rule until Sept. 14, 2016. Those comments will then be examined and considered before the final rule is released.