Consumer Financial Protection Bureau (CFPB) chief Richard Cordray presented several new rules for consideration on June 2 that would end the cycle of debt that many low-income consumers find themselves trapped in when they take out payday loans. Read Cordray’s comments to a Missouri audience below, followed by the CFPB press release.
Field Hearing on Small-Dollar Lending in Kansas City, Mo.
Thank you for joining us. We are here in Kansas City, known as “the Heart of America,” to discuss concerns about payday lending and other types of loans made to consumers facing an immediate need for cash. We have been here before, when we brought an enforcement action to shut down the Hydra Group. This predatory online-lending scheme maneuvered people into small-dollar loans and then stripped money out of their accounts without their consent. We froze their assets and put them out of business. We also held an earlier field hearing in St. Louis, on the other side of the “Show Me State.” There we learned about loans offered at rates as high as 1,950 percent annually, made to consumers who lacked the ability to repay, causing some people to roll over their loans again and again. Today we are here to show everyone concerned our proposed new rule on payday loans, auto title loans, and certain high-cost installment and open-end loans. In such markets, where lenders can succeed by setting up borrowers to fail, something needs to change.
From the beginning, payday lending has been an important priority for the Consumer Bureau. In the statute creating this new agency, Congress authorized us to exert supervisory authority from the outset over all financial companies in only three specified markets – and one of these is the market for payday loans. In addition, we have the authority to enforce the law against all payday lenders. We have deployed this authority in a number of cases, involving both storefront and online lenders, where our investigations have found violations of the law. And we have the authority to write new rules to clean up unfair, deceptive, or abusive practices that harm consumers. That is the purpose of our discussion today.
In January of 2012, just after I was appointed as the first Director of the Consumer Bureau, we held a field hearing in Birmingham, Ala., focused on payday lending. We have held others since on the same subject in Nashville, Tenn., and Richmond, Va. These issues have drawn interest from people of diverse backgrounds all over this country. In addition to these public events, we have sat and talked at length with many stakeholders, from consumer groups to lenders to academics. Perhaps most telling of all, we have held numerous sessions with a broad set of faith leaders. They have shared searing experiences of how payday loans affect the people they care for every day in their churches and synagogues and mosques. And they have described how these loans undermine financial life in their communities. In devising this proposed rule, we have been listening carefully, and we will continue to listen and learn from those who would be most affected by it. And we will take their comments into account as we go forward and work to finalize new reforms in this area.
***We have also looked at the history of small-dollar lending in this country. Some early examples were “salary lenders” who offered quick cash to consumers by essentially purchasing their next paycheck at discount rates that were very costly. These practices led to a crackdown and legal reforms designed to ensure that such loans would be made on more responsible terms. Many states, covering tens of millions of people, have maintained usury caps that effectively permit only small-dollar loans that are carefully underwritten. (The Consumer Bureau, by contrast, does not have authority under our statute to establish a usury limit for such loans and so our proposal would not do so.) More recently, other states created legal frameworks that opened the door to loosely underwritten, high-cost payday loans, auto title loans, and payday installment loans. These newer laws first arose when some check-cashing outlets began to hold a customer’s personal check for a period of time for a fee before cashing it, which spawned the payday loan business.
We have undertaken extensive research to understand how consumers experience these loans today. We have done so with the recognition that people who live from paycheck to paycheck sometimes need access to credit to deal with drops in income or spikes in expenses, as well as times when their income and expenses are misaligned. But at the same time, we have made clear our view that the credit products marketed to these consumers should help them, not hurt them. And our research has shown that too many of these loans trap borrowers in debt they cannot afford, instead of tiding them over in an emergency.
Specifically, we found that short-term loans with very high annualized interest rates offered over a short period – typically 390 percent or more for two-week single-payment loans – often result in consumers frequently rolling over these loans. Nearly four out of five of these loans are reborrowed within a month, usually when the loan is due or immediately after. Approximately one-in-four new loans results in a sequence of at least ten loans, one after the other, made in a desperate struggle to keep up with the payments due. Each time, the consumer pays more fees and interest on the same debt, turning a short-term loan into a long-term debt trap. It is much like getting into a taxi just to ride across town and finding yourself stuck in a ruinously expensive cross-country journey.
Indeed, the very economics of the payday lending business model depend on a substantial percentage of borrowers being unable to repay the loan and borrowing again and again at high interest rates, incurring repeated fees as they go along. More than half of all payday loans are made to borrowers in loan sequences of ten loans or more. For borrowers who are paid weekly or bi-weekly, one-fifth of these loans are in sequences of 20 loans or more.
We uncovered similar issues with single-payment auto title loans, where borrowers use the title to their car or truck as collateral for a loan. The borrower agrees to pay the full amount owed the lender in a lump sum plus interest and fees in a short time, usually in about 30 days, to get their title back. These are high-cost loans, with an annualized interest rate of about 300 percent. After analyzing over three million loan records, we found that these loans are single payment and short term in name only. Only 12 percent of new loans are repaid in full when due without having to reborrow. By contrast, more than 80 percent of auto title loans are rolled over or reborrowed on the day they are due because borrowers cannot afford to pay them off in a lump sum.
Moreover, one-in-five of these short-term auto title loan sequences ends up with the borrower having his or her car or truck seized by the lender because of a failure to repay the loan. When borrowers lose their personal vehicles, they may also lose mobility, which in much of the country can greatly imperil the foundations of their financial lives. For those who have to walk away from a loan without their car or truck, the collateral damage can be severe if they have relied on it to get to work or to conduct most of their daily affairs.
The rule we are proposing today also addresses certain longer-term installment loans and open-end lines of credit. Specifically, the proposal would cover loans for terms longer than 45 days when the lender either collects payment by accessing the consumer’s deposit account or paycheck or secures the loan by holding the consumer’s auto title as collateral. Of particular concern to us are payday installment loans. These are high-cost loans typically made by lenders that also offer standard payday loans, with the installment payments timed to fall on the consumer’s paydays and deploying these types of leverage to extract payments. Some have a balloon payment that has to be repaid after a number of interest-only payments. Our research into payday installment loans revealed that, at the end of the day, after accounting for some amount of refinancing activity, more than one-third of loan sequences end in default. Our study of auto title installment loans found similar figures, with loan sequences ending in default nearly one-third of the time. In addition, more than one-in-ten loan sequences ended with the borrower’s car or truck being seized by the lender.
***Currently, about 16,000 payday loan stores operate in the 36 states where this type of lending takes place, joined by an expanding number of online outlets. Some of these lenders also make auto title loans, or payday installment loans, or both. What they have in common is that they offer quick cash on terms that make it very hard for consumers to pay off their loans on time, and they have devised ways to be profitable without determining whether consumers who take out these loans can actually afford them. In the case of payday and single-payment auto title loans, this business model depends critically on repeat borrowing. For payday installment and auto-title installment loans, the business model depends primarily on access to a borrower’s account or auto title, which provides the lender with the necessary leverage to extract payments even when the borrower cannot afford them. Based on our research and what we hear around the country, we believe the harm done to consumers by these business models needs to be addressed.
As we took up the task of proposing reforms, we have spent much time and effort learning about state and tribal regulatory regimes, including many discussions with state payday regulators, state attorneys general, and tribal leaders. Payday lenders already have to comply with federal laws on matters such as truth-in-lending and debt collection practices. Today the Consumer Bureau is taking the next step, adding new federal protections against lending practices that harm consumers by trapping them in debt they cannot afford. These strong, common-sense protections would apply mainstream lending principles to payday, auto title, and certain other high-cost installment and open-end loans. Traditional lenders, such as community banks, credit unions, and many finance companies, make an effort to determine a borrower’s ability to repay before offering a loan with affordable payments. Both the lender and the borrower have a mutual stake in one another’s success. But today, the borrower’s ability to repay is often entirely absent from the transaction when it comes to payday and other similar loans.
Our proposed rule seeks to address these concerns by protecting consumers from such debt traps. Let me first describe how the proposal applies to short-term loans. For these loans, the lender generally would need to apply a “full-payment” test to determine that consumers have the ability to repay the loan without reborrowing. Lenders could also offer a loan with a “principal payoff option,” but only under specified conditions that are directly designed to ensure that consumers cannot get trapped in an extended cycle of debt.
To spell this out further, using the proposed full-payment test, lenders making short-term loans would be required to check upfront whether the borrower can afford to pay the full amount of the payment when it comes due, without needing to reborrow. Specifically, lenders would need to verify the borrower’s income, borrowing history, and certain key obligations. This would determine whether the consumer will have enough money to cover their basic living expenses and other obligations and still pay off the loan when due without needing to reborrow in the next thirty days. The proposal further protects against debt traps by making it difficult for lenders to press distressed borrowers into rolling over the same loan or reborrowing shortly after paying it off. And it would cap the number of single-payment loans that lenders can offer to a consumer in quick succession.
Under the “principal payoff option,” consumers could borrow a short-term loan up to $500 without passing the full-payment test, as long as the loan is directly structured to keep the consumer from getting trapped in debt. Under this option, if a consumer cannot pay off the original debt entirely or returns to borrow within 30 days, the lender could offer no more than two extensions to the original loan, and then only if the consumer repays at least one-third of the principal with each extension. This proposal would afford somewhat more flexibility while expressly protecting borrowers from debt traps and providing them with a simpler way to pay off their debt. To further safeguard against extended indebtedness, lenders could not offer this option to any consumer who has been in debt over the preceding year on short-term loans lasting 90 days or more.
Our proposal takes the same basic approach to the longer-term loans that it covers. Here again, our proposed rule would generally require lenders to apply the same full-payment test to determine whether borrowers can pay what they owe when it is due and still meet their basic living expenses and obligations. For payday and auto-title installment loans, either with or without a balloon payment, this means consumers have to be able to afford to repay the full amount when it is due, including any fees or finance charges.
Our proposed rule would permit lenders to offer certain longer-term loans without applying the full-payment test if their loans meet specific conditions designed to pose less risk to consumers and provide access to responsible credit. In particular, we are not intending to disrupt existing lending by community banks and credit unions that have found efficient and effective ways to make small-dollar loans to consumers that do not lead to debt traps or high rates of failure. Indeed, we want to encourage other lenders to follow their model.
Therefore, our proposal would not require lenders to apply the full-payment test for loans that generally meet the parameters of the kind of “payday alternative loans” (known as “PAL” loans) authorized by the National Credit Union Administration. For these loans, interest rates are capped at 28 percent and the application fee is no more than $20. This option would be available to all lenders on the same basis and not just to federal credit unions.
Our proposal also would not require the full-payment test for certain installment loans that we believe pose less risk to consumers. These loans would have to meet three main conditions. First, they must be for a term of no more than two years and be repaid in roughly equal payments. Second, the total cost cannot exceed an all-in percentage rate of 36 percent, plus a reasonable origination fee. Third, the projected annual default rate on all of these loans must not exceed 5 percent. The lender would have to refund all of the origination fees paid by all borrowers in any year where the annual default rate of 5 percent is exceeded. Lenders would also be limited as to how many such loans they could make to a consumer each year.
***The Bureau is also proposing new requirements to address how lenders go about extracting payments from consumer accounts for the types of loans covered by the proposal. From our research, we found that when these attempts failed because they were returned for insufficient funds, online payday and payday installment lenders often made repeated attempts to extract money electronically even though they were unlikely to succeed in doing so. When these attempts repeatedly fail, consumers risk incurring substantial fees, both for insufficient funds by their bank or credit union and for returned payments by the lender.
Some lenders even break up the total amount they are owed into smaller chunks and feed them through the system piecemeal, even though one payment will rarely succeed when another fails. This can lead to multiple penalty fees being assessed on what started out as a single payment, hiking costs for consumers while typically failing to collect any more money. Our research also found that many online payday borrowers lost their bank accounts after one or more failed attempts by a payday lender to extract a payment from the account.
For the loans covered by our proposal, lenders would have to give borrowers advance notice before accessing their account to collect a payment. This would give consumers a chance to question or dispute any unauthorized or erroneous payment attempts and to make arrangements for covering payments that are due. We believe this will reduce the risk of consumers being debited for payments they did not authorize or losing their accounts as a result of debits they did not authorize or anticipate.
In addition, we propose what we call the “debit attempt cutoff.” After two straight unsuccessful attempts, the lender could not make further debits on the account without reaching out to the borrower to get a new and specific authorization. This would keep consumers from being slammed by multiplying fees for returned payments and insufficient funds.
***Under all aspects of the proposal we are releasing today, we recognize that consumers may need to borrow money to meet unexpected drops in income or unexpected expenses. We recognize too that some lenders serving this market are committed to making loans that consumers can in fact afford to repay. We do not intend to disrupt the basic underwriting approaches taken by many banks, credit unions, and traditional finance companies, as well as some newer entrants, which offer installment loans in ways designed to assure that consumers can afford to repay them. We believe these lenders will have little difficulty adhering to our proposed rule. In fact, many elements of our full-payment test are based on information these lenders have shared about their approaches. But let me be clear: if a lender can succeed when borrowers are set up to fail, it is a telltale sign of a malfunctioning market. When the balance between lenders and borrowers is knocked askew, the “win-win” dynamic found in healthy credit markets disappears and puts consumers at great risk.
We believe the rule we are proposing would make a positive difference by prompting reforms in the markets for these products. Based on our review of the available evidence, we believe the vast majority of borrowers would still be able to get the credit they need in an emergency, either by passing the full-payment test or by utilizing one of the other options. But now they would be shielded by an umbrella of stronger protections that would keep them from getting trapped in debt they cannot afford.
***As we move forward with this rulemaking process, we are also launching a related inquiry into other situations that may harm consumers. Our Request for Information will help us learn more about a further range of products and practices that fall outside the scope of this proposal. This includes, for instance, further questions about high-cost, longer-term installment loans and open-end lines of credit that lack vehicle security or an account access feature. We will look into the business model for these loans and the underwriting practices of these lenders.
We also want to learn more about the extent to which these loans may keep borrowers on a debt treadmill by applying the payments to interest rather than paying down the principal. And we want to know whether these loans encourage loan churning or discourage early loan repayment. What we learn may affect future rulemaking, and it will clearly help guide our continuing efforts to supervise companies and take enforcement actions against unfair, deceptive, or abusive acts or practices.
Missouri’s own President Harry Truman notably said, “Every segment of our population, and every individual, has a right to expect from [our] government a fair deal.” Our proposed rule is designed to ensure more fairness with these financial products by making systemic changes to steer borrowers away from ruinous debt traps and restore to them a larger measure of control over their affairs. Ultimately, our objective is to allow for responsible lending while making sure that consumers do not fall into situations that undermine their financial lives.
This hearing and the notice-and-comment process are important steps. We greatly value the feedback we receive and we study it carefully. It invariably refines our thinking and our approach, and it makes our final rules better in the end. What we hear from you and from all stakeholders will help us decide how we can better protect financially vulnerable consumers. We ask you to share your thoughts and experiences to help us get there, and we appreciate your joining us today.
Rule Would Require Lenders to Determine Whether Consumers Have the Ability to Repay Payday, Auto Title, and Certain Other High-Cost Loans
WASHINGTON, D.C. — The Consumer Financial Protection Bureau (CFPB) today proposed a rule aimed at ending payday debt traps by requiring lenders to take steps to make sure consumers have the ability to repay their loans. The proposed rule would also cut off repeated debit attempts that rack up fees. These strong proposed protections would cover payday loans, auto title loans, deposit advance products, and certain high-cost installment and open-end loans. The CFPB is also launching an inquiry into other products and practices that may harm consumers facing cash shortfalls.
“The Consumer Bureau is proposing strong protections aimed at ending payday debt traps,” said CFPB Director Richard Cordray. “Too many borrowers seeking a short-term cash fix are saddled with loans they cannot afford and sink into long-term debt. It’s much like getting into a taxi just to ride across town and finding yourself stuck in a ruinously expensive cross-country journey. By putting in place mainstream, common-sense lending standards, our proposal would prevent lenders from succeeding by setting up borrowers to fail.”
The proposed rule would apply to certain short-term and longer-term credit products that are aimed at financially vulnerable consumers. The Bureau has serious concerns that risky lender practices in the payday, auto title, and payday installment markets are pushing borrowers into debt traps. Chief among these concerns is that consumers are being set up to fail with loan payments that they are unable to repay. Faced with unaffordable payments, consumers must choose between defaulting, reborrowing, or skipping other financial obligations like rent or basic living expenses like food and medical care. The CFPB is concerned that these practices also lead to collateral damage in other aspects of consumers’ lives such as steep penalty fees, bank account closures, and vehicle seizures. Loans covered by the proposal include:
- Payday and other short-term credit products: Payday loans are generally due on the borrower’s next payday, which most often is within two weeks, and typically have an annual percentage rate of around 390 percent or even higher. Single-payment auto title loans, which require borrowers to use their vehicle title for collateral, are usually due in 30 days with a typical annual percentage rate of about 300 percent. Most consumers end up rolling over these short-term loans when they come due or reborrowing within a short period of time. The consumer pays more fees and interest each time they reborrow, turning a short-term loan over time into a long-term debt trap. CFPB research shows that more than four-in-five single-payment loans are reborrowed within a month. One-in-five payday loan sequences end up in default and one-in-five single-payment auto title loan borrowers end up having their car or truck seized by the lender for failure to repay.
- High-cost installment loans: The proposal would cover loans for which the lender charges a total, all-in annual percentage rate that exceeds 36 percent, including add-on charges, and either collects payment by accessing the consumer’s account or paycheck or secures the loan by holding the title to the consumer’s vehicle as collateral. Some of the installment loans covered by the proposal have balloon, or lump-sum, payments required after a number of interest-only payments. The Bureau’s research, which looked at loans from several payday installment lenders, found that over one-third of loan sequences end in default, sometimes after the consumer has already refinanced or reborrowed at least once. The Bureau further found that nearly one-third of auto title installment loan sequences end in default, and 11 percent end with the borrower’s car being seized by the lender.
A summary of CFPB research on payday and installment loans is available at:http://files.consumerfinance.gov/f/documents/Payday_Loans_Highlights_From_CFPB_Research.pdf
Proposal to End Debt Traps
The CFPB is proposing a rule that would put an end to the risky practices in these markets that trap consumers in debt they cannot afford. The proposed ability-to-repay protections include a “full-payment” test that would require lenders to determine upfront that consumers can afford to repay their loans without reborrowing. The proposal includes a “principal payoff option” for certain short-term loans and two less risky longer-term lending options so that borrowers who may not meet the full-payment test can access credit without getting trapped in debt. Lenders would be required to use credit reporting systems to report and obtain information on certain loans covered by the proposal. The proposal would also limit repeated debit attempts that can rack up more fees and may make it harder for consumers to get out of debt.
Specifically, the proposal includes the following protections:
- Full-payment test: Under the proposed full-payment test, lenders would be required to determine whether the borrower can afford the full amount of each payment when it’s due and still meet basic living expenses and major financial obligations. For short-term loans and installment loans with a balloon payment, full payment means affording the total loan amount and all the fees and finance charges without having to reborrow within the next thirty days. For payday and auto title installment loans without a balloon payment, full payment means affording all of the payments when due. The proposal would further protect against debt traps by making it difficult for lenders to push distressed borrowers into reborrowing or refinancing the same debt. The proposal also would cap the number of short-term loans that can be made in quick succession.
- Principal payoff option for certain short-term loans: Under the proposal, consumers could borrow a short-term loan up to $500 without the full-payment test as part of the principal payoff option that is directly structured to keep consumers from being trapped in debt. Lenders would be barred from offering this option to consumers who have outstanding short-term or balloon-payment loans or have been in debt on short-term loans more than 90 days in a rolling 12-month period. Lenders would also be barred from taking an auto title as collateral. As part of the principal payoff option, a lender could offer a borrower up to two extensions of the loan, but only if the borrower pays off at least one-third of the principal with each extension.
- Less risky longer-term lending options: The proposal would also permit lenders to offer two longer-term loan options with more flexible underwriting, but only if they pose less risk by adhering to certain restrictions. The first option would be offering loans that generally meet the parameters of the National Credit Union Administration “payday alternative loans” program where interest rates are capped at 28 percent and the application fee is no more than $20. The other option would be offering loans that are payable in roughly equal payments with terms not to exceed two years and with an all-in cost of 36 percent or less, not including a reasonable origination fee, so long as the lender’s projected default rate on these loans is 5 percent or less. The lender would have to refund the origination fees any year that the default rate exceeds 5 percent. Lenders would be limited as to how many of either type of loan they could make per consumer per year.
- Debit attempt cutoff: Under the proposal, lenders would have to give consumers written notice before attempting to debit the consumer’s account to collect payment for any loan covered by the proposed rule. After two straight unsuccessful attempts, the lender would be prohibited from debiting the account again unless the lender gets a new and specific authorization from the borrower. Repeated unsuccessful withdrawal attempts by lenders to collect payment from consumers’ accounts pile on insufficient fund fees from the bank or credit union, and can result in returned payment fees from the lender. A CFPB study found that, over a period of 18 months, half of online borrowers had at least one debit attempt that overdrafted or failed, and more than one-third of borrowers with a failed payment lost their account.
This proposed rulemaking is the latest step in the CFPB’s efforts to reform the markets for these payday and installment loan products. The Bureau already exerts supervisory oversight of payday lenders and takes enforcement actions as appropriate to address violations of the law. With its action today, the Bureau continues to seek input from a wide range of stakeholders by inviting the public to submit written comments on the proposed rule once it is published in the Federal Register. Comments on the proposal are due on Sept. 14, 2016 and will be weighed carefully before final regulations are issued.
A factsheet summarizing the proposed rule is available at:http://files.consumerfinance.gov/f/documents/CFPB_Proposes_Rule_End_Payday_Debt_Traps.pdf
The CFPB’s proposal will be available at:http://files.consumerfinance.gov/f/documents/Rulemaking_Payday_Vehicle_Title_Certain_High-Cost_Installment_Loans.pdf
Inquiry into Emerging Risks
Today, the CFPB is also launching an inquiry into other potentially high-risk loan products and practices that are not specifically covered by the proposed rule. The Request for Information is focused on:
- Concerns about risky products not covered: The Bureau is seeking information about forms of non-covered loans such as high-cost, longer-duration installment loans and open-end lines of credit where the lender does not take a vehicle title as collateral or gain account access. The CFPB’s inquiry seeks information about the range and volume of installment and open-end credit products that are offered in this market, their pricing structures, and lenders’ practices with regard to underwriting. The Bureau is also interested in learning whether these loans keep borrowers in long-term debt with a structure where borrowers pay down little to no principal for an extraordinarily long period.
- Concerns about risky practices not covered: The Bureau seeks to learn more about practices that can impact borrowers’ ability to pay back their debt. This includes methods lenders may use to seize borrowers’ wages, funds, vehicles, or other forms of personal property in a way that could pose consumer protection concerns. The Bureau is also interested in learning more about the sales and marketing practices of credit insurance, debt suspension or debt cancellation agreements, and other add-on products. Other practices subject to the inquiry include loan churning, default interest rates, teaser rates, prepayment penalties, and late-payment penalties.
Comments on the Request for Information are due on Oct. 14, 2016.
The Request for Information will be available at:http://files.consumerfinance.gov/f/documents/RFI_Payday_Loans_Vehicle_Title_Loans_Installment_Loans_Open-End_Credit.pdf