Consumer bureau releases short-term lending rule meant to curb debt traps

The Consumer Financial Protection Bureau released a long-anticipated rule Thursday that’s meant to protect short-term, high-interest loan customers from being trapped with debt.

The CFPB’s action targets lenders that offer small loans with short payback timeframes and interest rates, often called “payday” loans. Such loans, which sometimes use car titles as collateral, are often used by low-income customers in need of extra money to cover basic expenses.

The CFPB’s rule is the final step of a years-long effort to hold payday and car title lenders to stricter standards that could hamper much of the industry. CFPB Director Richard Cordray called the rule “a stop to the payday debt traps that have plagued communities across the country.”

{mosads}“Too often, borrowers who need quick cash end up trapped in loans they can’t afford.” Cordray said. “The rule’s common sense ability-to-repay protections prevent lenders from succeeding by setting up borrowers to fail.”

The rule creates new restrictions and standards for small-dollar lenders before they offer loans. Lenders will have to confirm that customers could afford to pay off any lump sum loan, plus all fees, within two weeks. Customers would have to be able to afford highest monthly payments for longer-term loans.

Customers seeking short-term loans of less than $500 would be given longer timelines to pay off their debt. Borrowers would be given a month to pay off such loans, and lenders can give up to two extensions to customers in need of more time. Only customers who’ve paid off one-third of the loan’s principal would be eligible for extensions. The longer timeframe does not apply to car title loans.

“Loans like these are heavily marketed toward financially vulnerable consumers,” Cordray said during a call with reporters. “They will probably face the same cash shortfall when they get their next paycheck, only now they have the added cost of loan fees.”

These provisions are meant to protect customers from landing in cyclical debt, Cordray said. CFPB studies have found that four of every five short-term loan customers re-borrow the loan with added fees and interest and that the average short-term loan is re-borrowed nine times.

Lenders are also banned from offering three such loans “in quick succession” and cannot make loans under the longer repayment option if the customer already took out more than six short-term loans or owed money on short-term loans for more than 90 days over a rolling 12-month period.

“Our research has shown the business model for payday and auto title lenders is built on miring people in debt,” Cordray said. “Lenders actually prefer customers who will reborrow repeatedly.”

The rule also places limits on how far lenders can go to collect money owed for short-term loans. Lenders would only be allowed to unsuccessfully charge debtors accounts’ twice before requiring further permission from the customer. That provision is meant to prevent bank overdraft fees from adding to the debt burdens of people struggling to pay back short-term lenders.

Cordray said the rule isn’t meant to limit safer loan options from community banks and credit union. The rule exempts lenders who make fewer than 2,500 qualifying short-term loans each year and derives less than 10 percent of its income from short-term loans. It also doesn’t apply to loans authorized as safe payday alternatives by the National Credit Union Administration, the chief federal credit union regulator. 

Cordray said the rule was based on five years of research, several field hearings and more than 1 million comments. He said the final version included specific requests from community banks, credit unions and other financial firms meant to safeguard safer short-term lending options.

Progressive nonprofits and consumer-rights groups praised the CFPB soon after its release.

“The CFPB rule limits payday lenders’ ability to put families into a vicious cycle of debt by adopting the common sense requirement that lenders consider a borrower’s ability to repay and by restricting the number of unaffordable back-to-back loans,” said Lauren Saunders, associate director of the National Consumer Law Center. “These protections are an important step forward and should mean fewer families will face financial devastation.”

Sen. Sherrod Brown (Ohio), ranking Democrat on the Senate Banking Committee, also lauded the rule.

“The Consumer Financial Protection Bureau’s rule will crack down on shady payday lenders that saddle borrowers with triple-digit interest rates and cost Ohioans over $500 million year in fees alone,” Brown said. “Payday lenders have exploited loophole after loophole to trap working people in debt, and this rule will help put an end to their abusive practices.”

Much of the financial services industry panned the rule soon after its release, arguing it would limit lending options for vulnerable consumers with few resources. 

“The CFPB whiffed at an opportunity to provide assistance to the millions of Americans experiencing financial hardship,” said Richard Hunt, president of the Consumer Bankers Association. He argued the rule “would drive Americans to pawnshops, offshore lenders, high-cost installment lenders and fly-by-night entities.”

Hunt said the CFPB should have worked with banks and regulators to bolster cheaper, safer short-term lending options such as deposit advances instead of cracking down on a wide swath of lenders.

The payday rule will likely be challenged in court, and Republican lawmakers are expected to attempt to repeal the rule though the Congressional Review Act. That law gives Congress the power to repeal administration regulations within 60 days of their finalization.

The rule is likely one of the last major CFPB regulations released under Cordray, whose term ends in July. Cordray, the former Democratic attorney general of Ohio, has been rumored to be considering a run for governor. Several financial services lobbyists have said they expect Cordray to resign from the CFPB to run for governor soon after the release of the payday rule.

Cordray has said he doesn’t plan to leave the CFPB early, and his limited by federal law from discussing or starting a campaign until he leaves the bureau.

Updated at 3:31 p.m.