The Consumer Financial Protection Bureau (CFPB) has finalized a rule requiring lenders to determine whether a borrower has the means to repay the loan.
Currently, payday loan borrowers can secure a loan without financial documentation; usually in the amount of $200 to $500. Since the loans are due in two weeks, borrowers often take out another loan to repay the first one.
The CFPB aims to put a stop to this by preventing borrowers from ending up with a series of loans (each with steep fees) to refinance the same debt.
The new rule not only covers payday loans, but similar products like auto title loans, deposit advance products, and longer-term loans with balloon payments.
Small dollar lenders will also face new restriction on their ability to make repeated attempts to debit payments from a borrower’s bank account, resulting in mounting fees and even account closure.
'Trapped in loans'
“Too often, borrowers who need quick cash end up trapped in loans they can’t afford," said CFPB Director Richard Cordray. "The rule’s common sense ability-to-repay protections prevent lenders from succeeding by setting up borrowers to fail.”
The Community Financial Services Association of America (CFSA), the trade group representing payday lenders, said the CFPB is out of touch and ignoring the wishes of consumers.
“This federal small-dollar lending rule is a tremendous blow to the more than one million Americans who spoke out against it during last year’s comment period," said Dennis Shaul, the group's CEO. "Millions of American consumers use small-dollar loans to manage budget shortfalls or unexpected expenses.
Praise from consumer advocates, however, is nearly universal. Michael Calhoun, president of the Center for Responsible Lending, says the new rule is a step toward preventing financial harm to families, who often turn to payday loans because they are struggling to make ends meet.
"Today's rule release was years in the making, and it wouldn't have been possible without the tireless effort of community and faith leaders, consumer and civil rights advocates, and countless people across the country who organized and worked hard to make their voices heard.
Payday loans normally carry what might seem modest -- $15 to $30 on a loan of around $100. But because the loan amount is small, and only for a two week period, the annual interest rate is extremely high, usually 400 percent or more.
Before making a loan, small dollar lenders will now be required to determine whether the borrower can pay back the loan when it is due two weeks later. For longer-term loans with a balloon payment, full payment is defined as being able to afford the payments in the month with the highest total payments on the loan.
Low-cost installment loans
Nick Bourke, director of The Pew Charitable Trusts’ consumer finance project, says the new rule opens the door to lower-cost installment loans from banks and credit unions. But regulators, he says, still have work to do.
“Bank and credit union regulators must now create the clear guidelines these lenders need in order to make small installment loans safely and profitably," Bourke said. "If they do, millions of consumers can save billions of dollars by gaining access to lower-cost credit."
Despite the celebration among consumer groups, there is some concern that the Payday Lending Rule may be short-lived.
A coalition of consumer groups, called Stop the Debt Trap, warned that some in Congress may attempt to repeal the rule. The group says it will fund an advertising campaign to mobilize consumers to oppose any Congressional roll-back.