Fact Sheet Summary

CFPB Fact Sheet: Payday Debt Traps (Payday, auto-title and similar credit)

 

Prepared by NASCUS Legislative and Regulatory Affairs Department
June 2016

The CFPB issued a proposed rule that would apply to certain short-term and longer-term credit products that are aimed at financially vulnerable customers.  The proposal describes “short-term” loans as those provided to “bridge a cash flow shortage between paychecks or receipt of other income.”  These loans are typically due within two weeks to a month after being made.  “Longer-term” loans are those typically repaid in multiple payments over a period of months or years.  The proposal would apply to all lenders that provide the type of loans described within the rule.

The proposal can be found here.  Comments are due to the Bureau by September 14, 2016.

Loans covered by the proposed rule include

  • Payday and other short-term credit products:
    • Generally due on the borrower’s next pay date (often within two weeks) and typically have an average annual percentage rate of around 390 percent or higher.
    • May include single payment auto title loans that require a borrower’s auto title for collateral, are usually due within 30 days and have a typical annual percentage rate of about 300 percent.
  • High-cost installment loans:
    • Loans for which the lender charges a total, all-in annual percentage rate that exceeds 36 percent (including add-on charges)
    • Lenders typically collect payment for these loans by accessing the consumer’s deposit account/paycheck or securing the loan by holding title to the consumer’s vehicle

“Debt Trap” Dangers

The proposed rule highlighted a number of the Bureau’s concerns about “risky” lender practices in the payday, auto-title and payday installment markets.  Specifically:

  • Repeat short-term borrowing: Occurs when a consumer pays new fees to extend the loan for a longer period of time or when a subsequent loan is taken soon after repayment.
  • Default: Failure to repay a loan. Default often subjects borrowers to aggressive and harmful debt collection efforts.
  • Auto Seizure: Auto title loan borrowers who cannot repay the initial loan (which typically last 30 days) must reborrow or risk losing their vehicle.
  • Penalty Fees: Attempts by online payday and payday installment lenders to debit a consumer’s checking account may add additional costs (such as overdraft fees) to payday loans. 
  • Account Closure: A consumer’s bank account may be closed by depository institutions for reasons such as having a negative balance for an extended period of time.

Full-Payment Test

Under the proposed full-payment test, before offering a loan, lenders would be required to determine if the consumer can afford to pay the full amount of each loan payment when due.  The full-payment test requires the following:

  • Lenders would be required to determine if the borrower will have enough income to afford the loan, meet the consumer’s major financial obligations and still pay basic living expenses.  Specifically, lenders would be required to verify the consumer’s income (after taxes) from employment and other sources and check the consumer’s credit report to verify the amount of outstanding debt.
    • For payday and single payment auto title loans – Lenders would be required to determine the borrower has sufficient income to pay the loan, meet major financial obligations and basic living expenses during the loan term and for 30 days after paying off the loan or the loan’s highest payment.
    • For high-cost installment loans – For installment loans with a balloon payment, lenders would be required to ensure a borrower can pay all of the payments when due (including the balloon payment), major financial obligations, and basic living expenses during the loan term and for 30 days after paying the loan’s highest payment. For installment loans without a balloon payment, lenders would be required to determine that a borrower can pay all of the installment payments, major financial obligations and basic living expenses during the loan’s term.
  • The proposal would limit the lenders ability to allow borrower’s to “reborrow” or refinance the same debt.
    • Payday and single-payment auto title limits:
      • Lenders would be restricted from offering a similar loan if a borrower seeks to roll over a loan or returns within 30 days after paying off a previous short-term debt. 
      • Lender could offer a similar short-term loan if a borrower demonstrated that their financial situation (during the term of the new loan) would be materially improved relative to what it was when the prior loan was made. 
      • Even where a borrower’s financial status justified a lender making a second or third loan, the loans would be capped at three consecutive loans which would have to be followed by a 30 day cooling off period.
    • High-cost installment loans:
      • For consumers struggling to make payments on a payday installment or auto title installment loan, lenders could not refinance the loan unless a borrower demonstrated their financial situation during the term of the new loan would be materially improved relative to what it was during the prior 30 days. 
      • Lender would be able to refinance debit if it would result in substantially smaller payments or would substantially lower the total cost of the consumer’s credit..

Principal Payoff Option for Short Term Loans

  • The proposal permits lenders to provide consumers with a short-term loan (up to $500), without completing the full payment test, as part of the principle payoff option.
  • This option would be restricted to lower-risk situations and would require the debt be repaid either in a single payment or with up to two extensions where the principle is paid down at each step.  The specific parameters include:
    • Restricted to lower-risk situations:
        • Consumers could borrow no more than $500 for an initial loan.
        • Lenders would be barred from taking auto title as collateral and structuring the loan as open-end credit.
        • Lenders would be barred from offering the option to consumers who have outstanding short-term or balloon payment loans or that have been in short-term loan debt more than 90 days in a rolling 12 month period.
      • Debt is paid off:
        • Lender could offer a borrower up to two extensions of the loan, only if the borrower pays off at least one-third of the principal with each extension.
      • Debt risk disclosed:
        • Lender required to provide notices before making a loan under the principal payoff option.

Reporting Requirements

  • The proposed rule would require lenders to use credit reporting systems to report and obtain information about loans made to consumers under the full-payment test or principal payoff option.

Less Risky Longer-Term Loan Option

  • Under the proposal, lenders are permitted to offer two longer-term loan options with more flexible underwriting if those options pose less risk and adhere to certain restrictions. 
    • Option #1 - Loans that generally meet the parameters of the NCUA’s “payday alternative loans” program where interest rates are capped at 28 percent and the application fee cannot exceed $20.
    • Option #2 – Loans that are payable in roughly equal payments with terms not to exceed two years, with an “all-in cost” of 36 percent or less (not including the origination fee) and with a projected default rate of 5% or less.  If the default rate exceeds 5% for a particular year, the lender would have to refund the origination fee for that year.

Penalty Fee Prevention

  • Written Notice Requirement:
    • The proposal would require lenders to give a consumer written notice before attempting to debit the consumer’s account to collect payment for loans covered by the proposal.
    • The notice would need to be delivered at least three days before a withdrawal attempt
    • The notice would need to alert consumers to the timing, amount and method of payment withdrawal
  • Debit Attempt Cutoff:
    • Lenders would be prohibited from debiting a consumer’s account after two consecutive unsuccessful attempts.
    • After the 2nd unsuccessful attempt, the lender would need to obtain a new debit authorization from the consumer.
    • An “unsuccessful attempt” would include a debit or withdrawal that is returned unpaid or declined due to insufficient funds in the borrower’s account.