The CFPB’s Proposal for Regulating Payday Lending

The Consumer Financial Protection Bureau (CFPB) published a plan in March 2015 for regulating payday loans and similar types of high-cost, small-dollar credit. If the proposal becomes a federal rule, it would eliminate many harmful or deceptive practices and could make it easier for responsible lenders to offer safer, more affordable loans. However, the proposal contains some serious risks for consumers that the CFPB still needs to address, and whatever federal regulators do, officials in states where payday loan stores operate will continue to play an important role in ensuring a fair and transparent market.

Below are answers to some key questions and links to additional information about the proposal.

• Read Pew’s summary “Understanding the CFPB Proposal for Payday and Other Small Loans.”

Is the rule final?

No. What the CFPB published in early 2015 was a proposal, or framework, for future rule-making. It is not yet a rule that lenders need to follow. But it is important because it sets expectations for the types of loans that would be covered by a rule, including short-term loans and most high-cost loans lasting more than 45 days for which lenders have access to the borrower’s checking account or vehicle title. This category would cover payday, vehicle title, and some installment loans, including those from banks and credit unions. Additionally, the proposal offers a glimpse of the rules that lenders would have to follow after the CFPB finalizes the new regulation, which is likely to happen in 2016.

Why do we need a new rule? What’s the problem?

New rules are urgently needed. Unaffordable balloon payments, excessive interest rates, unreasonably long loan durations that drive up costs, and front-loaded fees make this market dangerous for borrowers and create an unfair competitive environment for responsible lenders. But aside from a few limited rules covering certain banks or those lending to military families, no federal regulation governs the overall market for small, high-cost credit products such as payday and auto title loans. The CFPB’s proposal lays the groundwork for such a regulation.

Watch Pew’s animated video for a short demonstration of the problem and how to fix it.

What would the CFPB’s proposal do?

The framework would organize the small-dollar loan market into five sections, according to loan durations (short-term, longer-term) and whether the lender has conducted an analysis of the borrower’s ability to repay based on income and expenses or has chosen to adhere to a set of “alternative” guidelines. Each section sets its own requirements, such as parameters for judging a borrower’s financial condition or limits on how recent, frequent, or large a loan can be.

Click on the table to expand.

Would the CFPB’s proposal help?

Overall, the proposal would transform the small-dollar loan market in positive ways, and it rightly emphasizes the need for affordable payments and safe loan structures. But it is very complex, which could make compliance and enforcement difficult. It also provides a number of exceptions that would allow harmful practices to flourish. The section with the greatest risks for consumers covers longer-term “ability-to-repay” loans (Section 3 in the table below), which would require lenders to evaluate borrowers’ financial condition but fails to protect against unreasonable durations or excessive costs.

Click on the table to expand.

Read the full brief.

Is this what borrowers want?

Borrowers overwhelmingly favor new regulations, according to nationally representative surveys by The Pew Charitable Trusts. Eight in 10 payday loan borrowers support requiring loans to be repayable in installments that consume only a small amount of every paycheck. Auto title loan borrowers also strongly support such reforms. Small, high-cost loans would continue to be widely available under the proposal.

What’s the bottom line?

The CFPB’s proposal seeks to fix the fundamental problem with the payday and auto title loan markets: unaffordable lump-sum payments that lead to extended reborrowing and long-term indebtedness. It would generally require reasonable installment payments and has the potential to steer the market toward safer loans while preserving access to credit. The proposal could lead to significantly better outcomes for American consumers—if the CFPB addresses certain risks by making a few key modifications and simplifications. In particular, the CFPB should prohibit unreasonable loan durations that drive up costs and harm financially fragile borrowers. The CFPB should also make it easier for lower-cost lenders, including banks and credit unions, to issue relatively safe loans (Sections 4 and 5 of the table above).

Recommendations

Make dangerous loans safer

• Limit loan duration or limit how long lenders may hold a preferred repayment position.

  Protect against unreasonable loan durations; constrain lenders’ unique and potentially harmful power to collect payment before other bills are paid by accessing borrowers’ bank accounts or repossessing their vehicles.

• Eliminate the short-term alternative loan, or, if it is kept, significantly increase requirements for offering it.

  Protect against deceptive or unaffordable loan structures.

• Require all fees to be pro rata refundable for loans that are refinanced or repaid early.

  Mitigate the risk of loan flipping and the resulting harm.

Make safe loans easier to provide

• Remove the two-loan limit on the longer-term alternative loans.

  Encourage customers to borrow only what they need and to prepay when possible.

• Make data reporting and verification for longer-term alternative loans easier.

  Encourage responsible lenders to offer safer, lower-cost products.

Pew’s small-dollar loans project is available to help policymakers, members of the media, and other stakeholders understand the CFPB’s proposal and how it relates to laws in particular states. To schedule a conversation with Pew’s team, please contact Sultana Ali at [email protected] or 202-540-6188.