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Federal agency proposes rule to end payday loan debt traps

A rule to end payday debt traps by requiring lenders to take steps to make sure consumers have the ability to repay their loans is being proposed by a federal agency. It also would cut off repeated debit attempts that rack up fees.

The proposed protections would cover payday loans, auto title loans, deposit advance products, and some high-cost installment and open-end loans.

The Consumer Financial Protection Bureau 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 Richard Cordray, director of the bureau. “Too many borrowers seeking a short-term cash fix are saddled with loans they cannot afford and sink into long-term debt.”

The bureau has concerns that risky lender practices are pushing borrowers into debt traps. Among these concerns is that consumers are being set up to fail with loan payments that they’re unable to repay.

Faced with unaffordable payments, consumers must choose between defaulting, reborrowing, or skipping other financial obligations such as rent or basic living expenses including food and medical care. The bureau is concerned that these practices also lead to damage in other parts of consumers’ lives such as steep penalty fees, bank account closures, and vehicle seizures, Cordray said.

The U.S. Public Interest Research Group said the proposal is groundbreaking and has the potential to save consumers nationwide billions of dollars in unfair fees and interest.

However, it thinks changes are needed in the proposal.

“The rule will be most effective only if changes are made before it is finalized,” said National Consumer Program Advocate Mike Litt. “It is a good beginning, but there is still much work to be done to ensure this rule truly protects consumers from the legalized loan sharks who prey on our communities in many states.”

While the rule dramatically ratchets up protections for consumers where payday loans are allowed, 90 million Americans already live in states that effectively ban payday lending.

U.S. PIRG urges the bureau to issue a strong final rule that bolsters, and doesn’t undermine, those states’ protections, including by requiring an ability-to-repay assessment across the board and by declaring any violation of state usury and other consumer protection laws an unfair, deceptive, and abusive act or practice.”

Loans covered by the proposal include:

  • Payday and other short-term credit products: Payday loans are usually 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. Research by the bureau 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: These are loans that the lender charges a total, all-in annual percentage rate that exceeds 36 percent, including add-on charges. The lender 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 found that over one-third of loan sequences end in default, sometimes after the consumer has already refinanced or reborrowed at least once.

Proposal to end debt traps


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.

The bureau is asking for comments on the proposed rule by Sept. 14.

The agency is also launching an inquiry into other potentially high-risk loan products and practices that aren’t specifically covered by the proposed rule. It’s request for information is focused on:

  • Concerns about risky products not covered: The bureau is seeking information on high-cost, longer-term installment loans and open-end lines of credit where the lender doesn’t take a vehicle title as collateral or gain account access. It wants to know about the range and volume of the products, their pricing structures, and lenders’ practices for determining whether the loan will be granted.
  • Concerns about risky practices not covered:The bureau wants to know 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. The bureau is also interested in learning more about the sales and marketing practices of add-on products such as credit insurance.

Comments on the proposal are due by Oct. 14.

Copyright 2016, Rita R. Robison, Consumer Specialist

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