A subscribing borrower a $ 500 loan could still pay more than 300% annual interest, despite new rules designed to crack down on predatory small dollar lending on Thursday from the Consumer Financial Protection Bureau (CFPB).
The consumer protections proposed for payday loans, auto title loans and high-cost installment loans aim to require lenders to document borrowers’ income and expenses to confirm they have the ability to pay their bills. payments while maintaining their basic expenses. Payday lenders currently perform minimal financial checks before issuing loans.
This could prevent deceptive practices. But in fact, enforcing underwriting standards is more difficult than enforcing specific product safety rules.
Another enforceable provision, limiting monthly payments on certain loans to no more than 5% of a borrower’s salary, was considered by the CFPB but rejected.
Small loans have become very popular in America, perhaps because about 47% of Americans are in such a precarious financial situation that they would struggle to find $ 400 in an emergency, according to data from the Reserve federal.
Payday lenders take advantage of this desperation to trap consumers in a cycle of debt, with products designed to endlessly renew themselves, incurring additional interest and fees. Auto title loans use a borrower’s car as collateral, which subjects them to repossession in the event of default. Over 12 million Americans use payday loans and similar products each year.
“Too many borrowers looking for a short-term cash flow solution are struggling with loans they cannot afford,” CFPB director Richard Cordray said in a statement. “Our proposal would prevent lenders from succeeding by failing borrowers.”
Under the Dodd-Frank Financial Reform Act, the CFPB is prohibited from simply capping interest rates. As an alternative, officials chose a strong repayment capacity requirement, which some experts say overlooks other issues with high-cost payday loans.
“The problem with payday loans is that they are dangerous just because the lender has direct access to a borrower’s checking account, and that will continue,” said Nick Bourke, loan project manager. dollar for dollar at the Pew Charitable Trusts.
Bourke doesn’t think the underwriting process will prove cumbersome. “People will still be able to apply for 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, Bourke said, where the borrower pays a fixed amount of predetermined payments. This change has already started in the industry. While installment loans are more secure due to the terms, they are also incredibly expensive.
Installment loans on the market in 26 states appear to comply with the proposed new rules, even when it comes to underwriting. And yet, if you took out a $ 500 loan under those terms, you would pay $ 600 just in interest and fees, and potentially up to $ 2,700, according to Bourke. “As long as the lender provided the required documents, this loan would continue.”
Almost all of these non-bank installment loans have payments that exceed 5 percent of the average borrower’s salary. Pew’s Bourke wanted to see an alternative that included security standards like the 5 percent rule, or a loan term of no more than six months. Then, alternatives to payday lenders like credit unions might try to compete with less expensive products.
The rule includes options with more streamlined underwriting, with lower interest rates and bans on debt cycles. But Bourke argued that competitors would not enter the market under these conditions. “Payday lenders are willing to do endless paperwork for a $ 300 loan. Banks are not.
In an email, CFPB spokesperson Samuel Gifford said the office had considered a limit on monthly payments and the length of the loan, but determined they were too low to allow lenders to provide sufficient viable loans. The office is seeking comments on this approach in the proposed rule, so that they can revive this approach again later.
The CFPB has studied the small loan market for more than three years and released a framework for review last year. Thursday’s announcement is a more formal settlement proposal.
Other protections are included in the rules: borrowers cannot receive more than three successive loans before a mandatory 30-day cooling off period, theoretically stopping the debt trap.
Some consumer protection experts have praised the CFPB’s action. Mike Calhoun of the Center for Responsible Lending said Politics the rule “could dramatically reduce unaffordable and debt-trapped 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 granting loans rather than ensuring that these loans are secure and less expensive,” he said.
The public comment period on the rule will last until September 14.