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Payday loans face new challenge: Can borrowers afford them?
October 5, 2017
Lenders that offer payday loans and other small advances to cash-strapped consumers must first determine if the borrowers can afford to repay the debt under a long-awaited federal rule finalized Thursday.
The rule, adopted by the Consumer Financial Protection Bureau, also would curtail repeated attempts by the lenders to debit payments from borrowers’ bank accounts, a practice that racks up mounting fees and can trigger account closures.
“These protections bring needed reform to a market where lenders have too often succeeded by setting up borrowers to fail,” CFPB Director Richard Cordray told reporters on a conference call.
The rule will take effect 21 months after it’s published in the Federal Register.
Retail banking industry representatives criticized the new requirements.
“It is hard to believe just days after the CFPB reported more than four in ten Americans were struggling to pay monthly bills – often because of unexpected or emergency expenses – the Bureau would drive Americans to pawnshops, offshore lenders, high-cost installment lenders and fly-by-night 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-dollar loans to manage budget shortfalls or unexpected expenses. The CFPB’s misguided rule will only serve to cut off their access to vital credit when they need it 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 in fees than what they initially borrowed. Half the borrowers who received similar high-interest loans online later were hit with an average of $185 in bank penalties for overdraft and nonsufficient fund fees, another CFPB analysis found.
And more than 80% of auto title loans – in which consumers pledge their vehicles as collateral -- are rolled over or extended the day they’re due because borrowers can’t afford to pay them in full, the agency found.
Payday loans are typically for 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 repeatedly roll over or refinance the loans, incurring expensive new charges each time. More than four of five payday loans are re-borrowed within a month, and nearly one in four are re-borrowed nine times or more, CFPB says. The agency calls such episodes “payday debt traps.”
Under the new rule:
• Lenders must determine whether the borrower can afford to repay the loan within two weeks or a month, including fees and finance charges, and still meet basic living expenses and other financial obligations. For longer-term loans with balloon payments, borrowers must be able to afford the costs in the month with the highest total payments due. Also, the number of loans that can be made in quick succession is capped at three.
• Consumers may take out a short-term loan of up to $500 without passing this test if the loan allows for more gradual payments. Yet this option can’t be offered to consumers who have repeatedly incurred payday or other short-term loan debt.
• After two failed attempts to access the borrowers back account, the lender can’t debit the account again unless the borrower authorizes it. That provides consumers an opportunity to dispute unauthorized or erroneous debit attempts, and to cover unanticipated payments., CFPB says.
The restrictions are waived for less risky short-term loans typically made by community banks or credit unions to existing customers were members, and certain loans authorized by the National Credit Union Administration.