By Jacob Passy
The Consumer Financial Protection Bureau has proposed gutting a rule that aimed to regulate the payday loan industry.
The agency released two proposals Wednesday for rolling back the regulations on payday, vehicle title and other balloon-payment installment loans that were finalized in 2017 and were set to go into effect in August. The announcement comes over a year after the CFPB, which is now run by Trump appointee Kathy Kraninger, first said it would explore rolling back the rule.
Consumers can pay dearly for such loans. Payday loans generally refer to short-term loans, often of $500 or less, that are intended to be repaid in a single payment by a consumer’s next payday. The loans typically come with high fees — the average annual percentage rate equates to nearly 400%, according to the CFPB.
‘What you’re talking about is wiping out the heart and soul of the rule here.’
— Richard Cordray, former director of the Consumer Financial Protection Bureau
But a 2016 report from the Center for Responsible Lending found that payday interest rates in states can reach as high as 662%. Comparatively, the average APR for credit cards is 17.55%, according to CreditCards.com .
Opponents to the CFPB’s proposal argue that removing underwriting requirements would reduce the agency’s ability to protect consumers.
“What you’re talking about is wiping out the heart and soul of the rule here,” said Richard Cordray, the former director of the Consumer Financial Protection Bureau who oversaw the design and implementation of the existing rule.
The CFPB’s rule also applied to other short-term loans, including vehicle title loans. Those loans are structured similarly in that they come with high interest rates and must be repaid in full after a short period of time. The key difference with these loans is that they are backed by the title for a car, truck or motorcycle.
There are alternatives to payday loans for consumers in need
The payday lending industry is built on a common problem: Many Americans are living paycheck to paycheck, and don’t have enough money to make ends meet when emergencies arise.
Consumers should start by attempting to negotiate payments with creditors, landlords and utility companies to see if there’s any flexibility about when and how much they pay. Barring those options, here are some alternatives:
<STRONG>Credit union loans</STRONG>
Payday alternative loans (PALs) are available through federally-chartered credit unions as part of a program administered by the National Credit Union Administration . As of 2017, around 503 federal credit unions offered the loans .
The loans are similar to traditional payday loans in that they can range in size from $200 to $1,000 and are meant to be paid off over a short period of time between one and six months. However, the interest rate and fees are much lower — the maximum APR is 28%, and credit unions can charge an application fee of no more than $20.
Unlike payday loans, borrowers cannot take out more than three PALs in a six-month period, and rollovers aren’t allowed. Borrowers must also have been a member of the credit union for at least a month to qualify, and the loans do go through some underwriting.
“Because they’re a different model and are subject to regulation, credit-union alternatives have been to our knowledge more successful and safer alternatives,” said Suzanne Martindale, senior policy counsel for Consumer Reports.
While informal lending circles — groups of people who pool money to lend to each other in times of need — are not a new concept, some companies and nonprofits are formalizing this method of offering loans.
For instance, California-based nonprofit Mission Asset Fund helps facilitate the creation of lending circles: Consumers can apply online and join a group of people. Participants are required to take online financial education courses, decide on loan amounts together and sign documents stating what each person owes.
While consumers will need to contribute money upfront to participate in a lending circle — with Mission Asset Fund monthly payments range from $50 to $200 — the loans carry zero interest, but still count in building someone’s credit score.
<STRONG>Secured credit cards</STRONG>
Unlike a traditional credit card, secured credit cards require a deposit . However, these cards are designed for people looking to build — or repair — their credit, and therefore are available to a wide range of consumers. Discover /zigman2/quotes/208747867/composite DFS -3.96% , Citi /zigman2/quotes/207741460/composite C -2.54% and Capital One /zigman2/quotes/204480509/composite COF -0.73% are among the companies that offered these cards.
While submitting an application and receiving a card can take time, a secured credit card can be a major lifeline to people who struggle to pay for necessities between paychecks.
“Every credit card in America has a built-in payday loan with respect to the built-in grace period if you’re not carrying a balance from month to month,” said Christopher Peterson, a law professor at University of Utah and financial services director of the Consumer Federation of America. “In comparison to payday loans, they’re 10 times or 20 times cheaper.”
Though they have a bad image, pawn shops are generally a much better alternative to payday lenders. “Pawn shops are the best lender of last resort,” Peterson said. “It’s no fun to pawn something, but there are built-in consumer protections. The borrower can preplan their repayment strategy from the debt by choosing an item that they can live without.”
There’s less risk to consumers: If they don’t repay their loan, they simply lose the item rather than running high amounts of interest or losing their car like with payday or vehicle title loans.
‘If you don’t have that money today, it’s going to be even harder to come up with that money plus a hefty fee in two weeks. People are effectively in debt for a whole year as a result of taking out these loans.’
— Suzanne Martindale, senior policy counsel for Consumer Reports
The CFPB is rolling back key consumer protections
The first CFPB proposal on payday loans released earlier this week would rescind the provisions requiring lenders offering these products to underwrite the loans in order to ensure borrowers’ ability to repay them. “The bureau is preliminarily finding that rescinding this requirement would increase consumer access to credit,” the agency said in a press release.
The second proposal would delay when the rule’s provisions go into effect until November 2020.
If the CFPB’s plan goes into effect, regulations regarding how payday lenders collect payments will remain in place. The 2017 rule stipulated that lenders must provide written notice before attempting to withdraw funds from a consumer’s account to repay the loan.
Lenders are also barred from making a withdrawal attempt after two previous attempts have failed due to insufficient funds until they get customer consent for future withdrawals.
The Community Financial Services Association of America , a trade group that represents the payday lending industry, welcomed the CFPB’s proposals, though criticized the agency’s choice to leave portions of the existing regulation intact.
“We are disappointed that the CFPB has, thus far, elected to maintain certain provisions of its prior final rule, which also suffer from the lack of supporting evidence and were part of the same arbitrary and capricious decision-making of the previous director,” the organization’s CEO Dennis Shaul said in a public statement. “As such, we believe the 2017 final rule must be repealed in its entirety.” (The CFSAA did not return a request for comment.)
80% of people who use payday loans roll them over
These loans have attracted criticism in large part because lenders typically do little to no underwriting before providing the funds to consumers. A consumer can often show up to a payday lender’s storefront and write a check for the loan amount and interest, and the lender then holds onto this check and will exchange it for cash when the loan is due.
If the borrower cannot repay the loan in time, however, some consumers will opt to take out another payday loan to pay off the original one, rather than go into default. And so it becomes a punitive cycle of more high-interest loans piled on top of the original loan.
Indeed, a CFPB analysis found that more than 80% of payday loans were rolled over or followed by another loan within two weeks. A report from Pew Charitable Trusts found that 70% of payday borrowers were using their loans for recurring expenses such as rent.
Payday loans often make the problem worse
“If you don’t have that money today, it’s going to be even harder to come up with that money plus a hefty fee in two weeks,” Martindale said. “People are effectively in debt for a whole year as a result of taking out these loans.”
Eighteen states and the District of Columbia essentially prohibit high-cost payday lending by setting interest rate cap.
Consequently, the Obama administration and the CFPB under Cordray’s leadership wrote regulations requiring the payday lending industry to verify borrower’s income and credit before lending to them to ensure they could repay the loans in a timely fashion.
“That’s what being done now in the mortgage market and the credit-card market, and it made sense to apply that to payday loans,” Cordray said.
The CFPB is not the only agency regulating the payday lending industry. Eighteen states and the District of Columbia essentially prohibit high-cost payday lending by setting interest rate caps. In some states, including Connecticut, Massachusetts and West Virginia, payday lending has never been allowed.
Three states — Maine, Colorado and Oregon — only allow lower-cost payday lending. Elsewhere, high-cost payday lending is allowed.
Voters in some states, including South Dakota and Colorado, have approved restrictions or outright bans on payday lending at the ballot box. “Where it has gone to the ballot, the public generally supports restrictions on payday loans,” Cordray said.