New Payday-Loan Rules Won’t Stop Predatory Lenders

The proposed rules focus on determining ability to pay the loans back. But actually enforcing underwriting standards is more difficult than enforcing specific product safety rules.

Payday loan window in Henrico County VA Photo: Taber Andrew Bain

A borrower taking out a $500 loan could still pay over 300 percent in annual interest, despite new rules designed to crack down on predatory small-dollar lending out Thursday from the Consumer Financial Protection Bureau (CFPB).

The proposed consumer protections for payday loans, auto title loans, and high-cost installment loans focus on making the lenders document borrowers’ incomes and expenses to confirm that they have the ability to make their payments and still maintain basic living expenses. Payday lenders currently do minimal financial checks before issuing loans.

That could prevent deceptive practices. But actually enforcing underwriting standards is more difficult than enforcing specific product safety rules.

One more enforceable provision, limiting monthly payments on some loans to no more than 5 percent of a borrower’s paycheck, was considered by the CFPB but rejected.

Small-dollar loans have become massively popular in America, perhaps because an estimated 47 percent of Americans are in such precarious financial shape that they would have trouble coming up with $400 in an emergency, according to Federal Reserve data.

Payday lenders take advantage of this desperation to trap consumers in a cycle of debt, with products designed to roll over endlessly, ringing up additional interest and fees. Auto title loans use a borrower’s car as collateral, subjecting them to repossession if they default. Over 12 million Americans use payday loans and similar products each year.

“Too many borrowers seeking a short-term cash fix are saddled with loans they cannot afford,” CFPB Director Richard Cordray said in a statement. “Our proposal would prevent lenders from succeeding by setting up borrowers to fail.”

Under the Dodd-Frank financial reform law, CFPB is prohibited from simply capping interest rates. So officials there chose a strong ability-to-repay requirement as an alternative, which some experts believe neglects other issues with high-cost payday loans.

“The problem with payday loans is they’re dangerous simply because the lender gets direct access to a borrower’s checking account, and that’s going to continue,” said Nick Bourke, director of the small-dollar loans project at the Pew Charitable Trusts.

Bourke does not believe the underwriting process will turn out to be burdensome. “People will still be able to apply and get payday loans on the same day,” Bourke said. “The application process will take 15 to 20 minutes instead of five to 10.”

The market would also likely shift to longer-term installment loans, said Bourke, where the borrower pays a set amount of pre-determined payments. This shift has already begun in the industry. While installment loans are safer because of the set terms, they are also incredibly expensive.

Installment loans on the market in 26 states appear to comply with the new proposed rules, even on the underwriting. And yet, if you took out a $500 loan under those terms, you would pay $600 just in interest and fees, and potentially as much as $2,700, according to Bourke. “As long as the lender did the required documentation, that loan would continue.”

Almost all these non-bank installment loans have payments that exceed 5 percent of the average borrower’s paycheck. Pew’s Bourke wanted to see an alternative that included safety standards like the 5 percent rule, or a loan duration of no more than six months. Then, alternatives to payday lenders like credit unions might try to compete, with lower-cost products.

The rule does include options with more streamlined underwriting, with lower interest rates and prohibitions on cycles of debt. But Bourke contended competitors won’t jump into the market under those terms. “Payday lenders are willing to do endless paperwork for a $300 loan. Banks are not.”

In an email, CFPB spokesman Samuel Gifford said that the bureau considered a limit on monthly payments and loan duration, but determined they were too low to allow lenders to make enough viable loans. The bureau is soliciting comment on this approach in the proposed rule, so they could still revive this approach later.

CFPB has studied the small-dollar loan market for over three years, and released a framework for consideration last year. Thursday’s announcement is a more formal proposed rule-making.

Other protections are included in the rules: Borrowers can receive no more than three successive loans before a mandatory 30-day cooling-off period, theoretically stopping the debt trap.

Some consumer protection experts welcomed the CFPB action. Mike Calhoun of the Center for Responsible Lending told Politico the rule “could dramatically reduce unaffordable, debt-trap loans and encourage the availability of more responsible credit.”

But Bourke believes that high-cost installment loans do little more for the borrower, regardless of the underwriting. “This proposal focuses on the process of originating loans rather than making sure those loans are safe and cost less,” he said.

The public comment period for the rule will last until September 14.

Top photo: “Payday Loan Place Window Graphics” by Taber Andrew Bain using CC-BY-2.0

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