Lenders who offer payday loans and other small advances to cash-strapped consumers must first consider whether borrowers can afford to pay off debt under a long-awaited federal rule finalized on Thursday.
The rule, adopted by the Consumer Financial Protection Bureau, would also reduce repeated attempts by lenders to debit payments from borrowers’ bank accounts, a practice that results in rising fees and can trigger account closings.
“These protections provide the necessary reforms in a market where lenders have too often succeeded by defeating borrowers,” CFPB director Richard Cordray told reporters on a conference call.
The rule will take effect 21 months after it is posted in the Federal Register.
Following:The Fed Tackles Payday Loan Regulation
Representatives of the retail banking sector criticized the new requirements.
“It’s hard to believe that just days after the CFPB reported that more than four in ten Americans were struggling to pay their monthly bills – often because of unforeseen or emergency expenses – the Bureau would be driving Americans to pawn shops, offshore lenders, high cost installment lenders and runaway entities, ”said Richard Hunt, CEO of the Consumer Bankers Association.
Dennis Shaul, CEO of the Community Financial Services Association of America, said, “Millions of American consumers use small loans to manage budget deficits or unexpected expenses. The flawed rule of the CFPB will only serve to cut off their access to the vital credit they need the most. “
The CFPB, which proposed the new constraints in 2016 after four years of study, found that 62% of all payday loans go to consumers who repeatedly extend their repayments and ultimately owe more fees than they pay. they initially borrowed. Half of borrowers who received similar high-interest loans online were subsequently hit with an average of $ 185 in bank overdraft and insufficient fund fees, according to another CFPB analysis.
And more than 80% of auto title loans – in which consumers give their vehicles as collateral – are renewed or extended on the day they’re due because borrowers can’t afford to pay them off in full, the report found. agency.
Payday loans are typically up to $ 500 and are due in full by the borrower’s next paycheck. They carry annual interest rates of 300% or more.
“Faced with unaffordable payments, cash-strapped consumers must choose between defaulting, re-borrowing, or skipping other financial obligations like rent or basic living expenses,” Cordray said.
Many borrowers renew or refinance loans time and time again, each time leading to new and expensive charges. More than four of the five payday loans are re-borrowed within a month, and nearly one in four is re-borrowed nine or more times, according to the CFPB. The agency calls such episodes “payday debt traps.”
Under the new rule:
• Lenders should consider whether the borrower can afford to repay the loan within two weeks or one month, including fees and finance charges, while meeting basic living expenses and other obligations. financial. For longer-term lump sum loans, borrowers should be able to afford the cost of the month with the highest total payments due. In addition, the number of loans that can be granted in rapid succession is capped at three.
• Consumers can take out a short-term loan of up to $ 500 without passing this test if the loan allows for more gradual payments. However, this option cannot be offered to consumers who have repeatedly incurred payday debts or other short-term debts.
• After two unsuccessful attempts to access the borrower’s return account, the lender can no longer debit the account unless the borrower authorizes it. This gives consumers the opportunity to dispute unauthorized or erroneous debit attempts and cover unforeseen payments, says CFPB.
Restrictions are lifted for less risky short-term loans typically made by community banks or credit unions to existing customers who were members of them, and for certain loans authorized by the National Credit Union Administration.
Contributor: Kevin McCoy