Proposed CFPB Rule Seeks to End Debt Traps Caused by Payday Loans

The CFPB says that risky lender practices in the payday, auto title, and payday installment loan markets are setting consumers up to fail from the start

Proposed CFPB Rule Seeks to End Debt Traps Caused by Payday Loans
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June 8, 2016

The Consumer Financial Protection Bureau (CFPB) has proposed a new rule aimed at preventing consumers from getting stuck in debt traps caused by payday loans. The rule would require payday lenders to make certain that a potential borrower has the ability to repay a loan prior to lending any money.

The proposed rule would also cut off repeated debit attempts made by lenders seeking loan repayment that quickly rack up fees. The rule would apply to payday loans, auto title loans, deposit advance products, as well as certain high-cost installment and open-end loans.

According to the CFPB, risky lender practices in the payday, auto title, and payday installment markets are setting consumers up to fail from the start with loan payments they simply cannot repay. Faced with unaffordable payments, consumers must then choose between defaulting on their loan, borrowing even more money, or skipping other financial obligations like rent or basic living expenses like food and medical care just to ensure that a loan gets repaid.

The CFPB says that it is concerned that these practices also lead to collateral damage in other aspects of consumers' lives such as steep penalty fees, bank account closures, and vehicle seizures.

"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, common-sense lending standards, our proposal would prevent lenders from succeeding by setting up borrowers to fail."

Specifically, the CFPB's proposed rule includes the following protections:

Full-payment test: Lenders would be required to determine whether the borrower can afford the full amount of each payment when it's due and still meet basic living expenses and major financial obligations.

Principal payoff option for certain short-term loans: Under the proposal, consumers could borrow a short-term loan up to $500 without the full-payment test as part of the principal payoff option that is directly structured to keep consumers from being trapped in debt. Lenders would be barred from offering this option to consumers who have outstanding short-term or balloon-payment loans or have been in debt on short-term loans more than 90 days in a rolling 12-month period.

Less risky longer-term lending options: Lenders would be permitted to offer two longer-term loan options with more flexible underwriting, but only if they pose less risk by adhering to certain restrictions.

Debit attempt cutoff: Lenders would have to give written notice before attempting to debit a consumer's bank account to collect payment for any loan covered by the rule. After two straight unsuccessful attempts, the lender would be prohibited from debiting the account again unless the lender gets a new and specific authorization from the borrower.

In addition to the proposed rule, the CFPB has also launched an inquiry into other products and practices that may harm consumers facing cash shortfalls.

The CFPB is inviting the public to submit feedback on the proposed rule once it is published in the Federal Register. All comments must be submitted by September 14, 2016 and will be considered carefully by the Bureau before final regulations are issued.

A factsheet summarizing the proposed rule is available here.