Payday loans are small-dollar, short-term loans typically due by the borrower’s next paycheck, often in about two weeks. Generally, the interest rates are considerably higher than what consumers pay for personal loans or credit card advances, to name two alternatives. The Consumer Financial Protection Bureau (CFPB) just finalized new regulations for payday lenders designed to stop what it calls “debt traps” by requiring lenders to ensure that borrowers can repay the loan in a timely manner.
The proposed regulations have inspired both proponents and opponents to sound off on what they see as the pros and cons of the new rule. For background on the issue, see Beware of Payday Loans.
What The Regulations Require
The centerpiece of the new rule, set to take effect in 2019, is called the full repayment test. Essentially this test requires lenders to determine, before lending money that the borrower can repay the loan in a timely manner. The rule applies to short-term loans with terms of 45 days or less, plus certain longer-term loans that cost more than 36% per anum and those that allow the lender to withdraw the payment from the consumer's account. Ten types of loans are omitted from the rules, including mortgages, student loans and overdraft services.
The regulations also restrict payday lenders from withdrawing payments from a borrower’s bank account if two earlier attempts to get the loan repaid have failed (this limits banking fees) and limit the number of times the loans can be rolled over. The new CFPB rules apply to payday loans, auto title loans, deposit advance products and loans with balloon payments. There are exceptions for short-term loans under $500 that allow for smaller payments.
Those in favor of the new regulations include the CFPB, Democratic members of Congress and various consumer advocates. According to proponents, the new rules are a real positive for consumers. They see the following as pros.
- Requiring lenders to ensure that borrowers can repay loans protects them from a cycle of debt.
- While some lenders will be prohibited, consumers can still borrow from those that meet the new requirements.
- Voters generally prefer stricter guidelines for payday lenders.
- The new regulations will stop lenders from exploiting loopholes in the law.
- Limiting the number of times a loan can be rolled over limits the effective APR.
- Preventing multiple attempts to withdraw from bank accounts will stop excessive overdraft charges for consumers.
The payday lending industry, the Community Financial Services Association of America (CFSA), researchers at Pew Charitable Trusts, the banking industry and even some consumer advocates have pointed out what they see as the cons of these new rules.
- The proposal exceeds the authority given CFPB by Congress and will be subject to expensive lawsuits.
- The new rules still allow payday loans with interest rates of 300% or higher.
- Banks and credit unions will be discouraged or prevented from entering the market with lower-cost loans.
- Ultimately, the rules will inhibit consumer access to credit, driving them to far worse alternatives.
- Many payday lenders will be forced out of business, costing jobs and creating credit “deserts” in areas where payday lending currently thrives.
- Losing the ability to roll over loans will hurt consumers who need more time to pay off debt.
The Bottom Line
The subject of payday lending generates anger on all sides. Attempts to regulate the industry only seem to fan the flames. Payday lenders sees themselves as under attack while simply providing a needed service for what they regard as a reasonable fee. Consumer advocates view the industry as nothing less than loan sharks.
The CFPB believes requiring lenders to fully vet borrowers will help keep consumers out of an endless cycle of debt. The industry says the CFPB’s rules will force people facing a financial emergency to seek help under even worse terms than they receive from payday lenders. So far, the Trump administration, which has made rolling back business regulations a central theme, has not weighed in on the new CFPB rules. For more, see The Best Alternatives to Payday Loans.