For decades, the payday lending industry has made significant profits by using predatory practices to strip billions of dollars of wealth from the pockets of hard-working Americans. According to the Consumer Financial Protection Bureau’s (CFPB) own figures, the typical payday borrower makes less than $30,000, and half of all borrowers take out 10 or more loans each year, with 80% renewing within 14 days of an outstanding older loan. The fees and interest racked up by these cycles of repeat borrowing are very lucrative for lenders, but extremely costly to consumers, with the average payday borrower paying $895 for a $375 loan.
While some states have enacted laws to curb the most abusive lending practices, many others have not been so lucky, and even in states with strong legislation (like Ohio), lenders have managed to exploit loopholes to get around the most impactful regulations. All Americans deserve to be protected from predatory lending practices, which is why strong rules at the federal level are so important.
Over the past five years, the Bureau has conducted research, talked with various stakeholders and developed rules that attempt to protect all consumers, but also promote and facilitate access to safe and affordable small-dollar credit. These efforts culminated in the highly anticipated release of proposed rules for comment at the beginning of June.
The main focus of these proposed rules is to ensure that the payday lending industry only makes loans to individuals who can afford to repay them—something that is a standard practice with any mainstream credit product or lender. As previously mentioned, payday lenders make money by keeping borrowers stuck in a cycle of debt where consumers typically end up paying many times more than the original principal amount of the loan. To address this fundamental problem, the proposed rule takes the following major steps:
• Require that lenders assess the ability to repay of potential borrowers before making a loan, and provide guidance on how to do so;
• Create three exceptions to the ability-to-repay standard for loan products that meet certain safeguards in terms of price, length, structure and other factors
• Establish limits on how lenders can seek repayment by capping the number of times funds can be automatically withdrawn from a borrower’s bank account, and by requiring notice of the intent to withdraw;
• Require “cooling off” periods between loans so borrowers are not continually stuck in a cycle of debt;
• Mandate that lenders report borrowing activity to lending databases, so borrowers do not end up with multiple loans at the same time;
CFED believes there is much to like about this comprehensive and carefully crafted proposal, but it is in need of improvement in several key areas. The CFPB should take steps to eliminate dangerous loopholes in the proposed rule that payday lenders could exploit. It should also strive to streamline the rule and improve its overall simplicity. Looking at the big picture, the current rules are overly complex, which ultimately benefits unscrupulous lenders. Overly complex rules make it harder for consumers to understand their rights, for regulators to supervise lenders and for legitimate lenders to offer responsible products.
Below are CFED’s six core recommendations to eliminate loopholes, improve simplicity and build on the solid foundation established by the CFPB’s proposed rule. Ability-to-Repay (ATR) Should be Required Across the Board. Fortunately, determining whether a loan is affordable before offering one undergirds much of the rule, but unfortunately, the proposal includes ways to circumvent the standard. In order for the rule to be as strong as possible, all loans should be subject to ATR, and any exception should be removed.
Default Rates of 10% or Higher Should Trigger Heightened Regulatory Scrutiny. The rule allows lender default rates to be compared with other similarly situated lenders to gauge whether lenders are adhering to the ATR standard and to ensure that lending practices are reasonable. The comparison with other lenders should be replaced with a universal default rate of 10% that will subject any lender to heightened Bureau scrutiny if exceeded. Other lenders may have poor underwriting standards, making them weak points of comparison. A non-comparative approach removes this distortion.
The “Cooling Off” Period Should be Lengthened from 30 Days to 60 Days. As proposed, the rule requires a 30-day cooling-off period between loans, which is half the length the Bureau recommended last year. For the sake of consumer safety, the 60-day cooling off period should be restored. Even one debt can strain a household budget over multiple expense cycles, and a longer cooling off period diminishes the potential impact of debt to safer levels.
Establish Strong Limits on Bank Account Withdrawals and Notice Requirements. To stop lenders from having unfettered access to a borrower’s account, the CFPB has limited automatic payment collection efforts by lenders to two withdrawals; further attempts require additional permission. Moreover, lenders must also notify a borrower of their intent to withdraw funds before accessing an account. These are highly welcome additions to the rule that should not be eroded for the final rule.
Longer-Term Loan Lengths Should Be Limited. The absence of limits on the length of a loan’s terms should be changed. As the industry increasingly moves toward longer-term installment products, the room for abuse created by excessive loan durations should be curbed by introducing limits on length.
Explore Safer Alternatives. The Bureau should invest in and encourage the creation of products that are less predatory than traditional small-dollar loans. They can do this through their research capacity and by developing pilot programs for potentially promising alternatives.
These top-line recommendations, if adopted, would help to truly end the debt trap and promote access to safe and affordable small-dollar credit alternatives for all Americans.
Additional recommendations and further details are offered in our full comment letter, which is available upon request by contacting Anju Chopra, Senior Policy Manager, at email@example.com.