The Internet-facilitated practice of extracting high profits from vulnerable consumers with virtually no oversight is the primary reason why the Consumer Finance Protection Bureau (CFPB) has proposed setting rules around payday, single-payment auto title, and online loan services. Enterprises that offer these quick-turnaround, often ultra-high interest rate loans are generally not banks and are therefore not subject to traditional banking laws. Consequently, the consumers who access their services, typically the most financially vulnerable members of the community, have almost no protection from the predatory practices that exact high fees or impose other economic burdens to gain the profits they are seeking. The CFPB intends to establish and enforce parameters on these lenders to ensure they are not intentionally preying on society’s lowest earning members.
The Proposed Rule Impacts “Small Dollar” Lenders
Banks make money from the interest accrued on the loans they make; the larger the loan amount, the more interest (profit) gained. Most banks set a bottom threshold loan amount, and will not fund loan requests for dollar amounts below that threshold. A “small dollar loan” is typically under $3,000, which is usually below the bank’s bottom loan value threshold. For borrowers who seek small dollar loans, the online, payday and auto title lenders are often their sole resource for quickly needed cash infusions.
Non-banks = Few Regulations
However, with almost no regulation or oversight from national or state authorities, these non-banked lenders have had a field day providing that quick money. For the borrowers, the cash is often needed to make critical rent, car, or other cost-of-living payments and many of them have challenged or no credit histories so they couldn’t qualify for a traditional loan, even if the banks were willing to extend it to them. Their option is to get the money from the as-yet unregulated small dollar loan sector, which applies extremely high interest rates on relatively low loan amounts. In Louisiana alone, consumers paid over $180 million in fees (not loan repayments) to payday lenders in 2011, plus an interest rate that averaged 780 percent.
Proposed Rules Cover Two Types of Loans
Overall, the proposed rules address the borrower’s ability to repay the loan; the lender’s opportunity to extend further credit to existing customers, and the lender’s access to the borrower’s accounts when the loan is in default. A new term for all lenders would be the requirement to use CFPB-registered credit reporting systems to establish borrower’s financial capacity to assume the loan.
Specifically, there are two types of loan that are at issue: 1. Loans with a term of 45 days or fewer; or 2. Loans with a term longer than 45 days, and
- that carry an annual interest rate of more than 36 percent, or
- are repaid from either:
- the borrower’s account or income directly, or
- are secured by the title to the borrower’s vehicle.
Establishing an “Ability to Pay” Standard
To date, these loans were made with no advance evaluation of the borrower’s capacity to repay. The lenders added escalated interest rates and extra fees on borrowers who were not able to make their payment, and sometimes, the loans were turned over for another period, again with higher interest rates and fees attached. Repeated attempts by the lender to gain payment from the borrower’s account also racked up fees, and sometimes caused the closure of the account altogether.
Before the Loan Agreement Closure
The new rules are proposing that lenders perform a “full payment test” before making the loan. This test would require prior verification of the borrower’s income, living expenses, major financial obligations, and ability to pay within the loan term and for the 30 days after paying it off. The new requirement would apply to payday, single payment auto title, and installment loans.
New and Extended Loans
To avoid a constantly revolving “debt trap,” payday and single-payment lenders would be prohibited from funding subsequent loans to paid-off customers within 30 days of the paid-off date without proof that the consumer’s financial situation had “materially improved‘ since the previous first or second loan periods. For third loans, the interim period between the pay-off of the past debt and issuance of the new loan would be 60 days.
For installment loans, refinancing an existing loan would be allowable when the borrower demonstrated “significantly improved financial conditions” or the lender refinanced with substantially smaller payments or reduced costs or fees.
Lender’s Collections Practices Targeted
When a borrower defaults on a loan, some lenders will make numerous attempts to collect the funds automatically from their bank accounts, often triggering the assessment of fees by both the lender and the bank. With no rules currently in place, the lender is not required to notify the borrower of its intent to pursue the account, and some borrowers have had their accounts closed as a consequence of the repeated collections attempts.
If passed, the new rule would require lenders to provide notice to the consumer that a collection attempt was forthcoming, and obtain renewed authorization for access to the account from the borrower after two failed attempts.
Opportunities to Opt Out
The proposed rules include provisions that, if met, would allow lenders to opt out of compliance with some of the conditions, including the “ability to repay” condition. Installment lenders, for example, could avoid that term by adhering to the National Credit Union Administration’s “payday alternative loans.”
Proposed Rules Open for Comment
Per the CFPB policies, the proposed rules are open to comments from interested parties. The comments period for these proposed rules closes September 14, 2016.