The Consumer Financial Protection Bureau took the first step this week toward ending debt traps by finalizing new consumer protections for loans where consumers are required repay all or most of the debt at once. These loans include shorter-term loans such as payday and auto title loans, and longer-term loans with balloon payments.
It requires lenders to determine upfront whether people can afford to repay their loans.
The bureau found that many people who take out these loans end up repeatedly paying expensive charges to roll over or refinance the same debt. The rule also stops lenders’ repeated attempts to take payments from a borrower’s bank account, a practice that racks up fees and can lead to account closure.
“The CFPB’s new rule puts a stop to the payday debt traps that have plagued communities across the country,” said Richard Cordray, director of the bureau. “Too often, borrowers who need quick cash end up trapped in loans they can’t afford. The rule’s commonsense ability-to-repay protections prevent lenders from succeeding by setting up borrowers to fail.”
Payday loans are usually for small amounts and are due by the borrower’s next paycheck, often two or four weeks. They’re expensive, with annual percentage rates of more than 300 percent or even higher. The borrower writes a post-dated check for the full balance, including fees, or allows the lender to electronically take funds from his or her checking account.
Single-payment auto title loans also have expensive charges and short terms of 30 days or less. Borrowers are required to put their car or truck title up for collateral. Some lenders also offer longer-term loans of more than 45 days where the borrower makes a series of smaller payments before the remaining balance comes due. These longer-term loans – called balloon-payment loans – often require access to the borrower’s bank account or auto title.
These loans are heavily marketed to financially vulnerable consumers who often can’t afford to pay back the full balance when it’s due, Cordray said. Faced with unaffordable payments, cash-strapped consumers need to choose between defaulting, re-borrowing, or skipping other financial obligations such as rent or basic living expenses including buying food or getting medical care.
Many borrowers end up rolling over or refinancing their loans again and again, each time racking up expensive new charges. More than four out of five payday loans are re-borrowed within a month, usually right when the loan is due or shortly thereafter. And nearly one-in-four initial payday loans are re-borrowed nine times or more, with the borrower paying far more in fees than they received. The bureau also found that most auto title loans are re-borrowed on their due date or shortly thereafter.
Ninety-one percent of written complaints to the bureau about these types of loans were related to unaffordability.
The cycle of taking on new debt to pay back old debt can turn a single, unaffordable loan into a long-term debt trap, he said. The aftereffects of a debt trap can be severe. Even when the loan is repeatedly re-borrowed, many borrowers wind up in default and getting chased by a debt collector or having their car or truck seized by their lender. Lenders’ repeated attempts to take payments from accounts can add large penalties, as overdue borrowers get hit with insufficient funds fees and may even have their bank account closed.
The bureau developed the payday rule over five years of research, outreach, and a review of more than one million comments.
The final rule doesn’t apply ability-to-repay protections to all of the longer-term loans that would have been covered under the proposal. The bureau is conducting further study to consider how the market for longer-term loans is evolving and the best ways to address concerns about existing and potential practices.
The rule takes effect 21 months after it’s published in the Federal Register, although the provisions that allow for registration of information systems take effect earlier.
U.S. PIRG commends the bureau for its five-year, data-driven approach to the problem and its decision to take the first step to rein in short-term, one payment loans, said Mike Litt, consumer advocate.
Litt points out that the bureau can’t set interest rate caps, but the states can. Fifteen states and Washington, D.C., ban high-cost lending through 36 percent interest rate caps.
Litt said U.S. PIRG will be working with those states to defend their laws and working with other states to join them. It will also work with the bureau on next steps to finish a rule for reining in longer-term, high-cost predatory loans.”
