Federal regulators are launching a major crackdown on payday and other short-term, high-interest lenders by proposing tough new regulations to halt the cycle of debt that cripples some consumers.
The planned rules from the Consumer Financial Protection Bureau would require lenders to determine a borrower’s ability to repay and to limit how often a consumer can roll over existing loans into new ones.
The proposed regulations are designed to keep cash-strapped Americans from falling into what the agency describes as a predatory debt trap in which they must take out new loans to pay off the old ones — ultimately paying more in fees than the original amount they borrowed.
FOR THE RECORD:
Payday lenders: In the March 26 Business section, an article about proposed rules restricting payday lenders said that one provision would require lenders to determine borrowers’ ability to repay loans. The article also should have said the proposal provides an option that would let lenders instead offer more affordable repayment plans.
“Extending credit to people in a way that sets them up to fail and ensnares considerable numbers of them in extended debt traps, is simply not responsible lending," Richard Cordray, the bureau’s director, said at a public hearing on the issue Thursday in Richmond, Va.
“It harms rather than helps consumers. It has deserved our close attention, and it now leads to a call for action,” he said.
Corday announced the proposed regulations at the hearing as the agency began collecting input from the industry and consumer advocates. In the coming weeks, the bureau will convene a panel of small lenders to get their feedback and then formally propose regulations on which the public can comment.
President Obama also planned to tout the new regulations and other bureau initiatives during an appearance at an Alabama community college Thursday.
“The idea is pretty common sense: If you lend out money, you should first make sure that the borrower can afford to pay it back,” Obama said, according to excerpts of his prepared remarks released by the White House.
“As Americans, we believe there’s nothing wrong with making a profit,” he said. “But if you’re making that profit by trapping hard-working Americans in a vicious cycle of debt, then you need to find a new way of doing business.”
Payday and other short-term loans, such as those secured with an automobile’s title, long have been a fixture in working-class communities. Their use increased during the Great Recession and its aftermath as struggling consumers sought a quick influx of cash to pay bills.
About 2.5 million households use payday loans annually, according to a 2013 survey by the Federal Deposit Insurance Corp. Payday lenders collect about $8.7 billion in interest and fees a year, the bureau said.
The loans usually are cash advances on a worker’s paycheck. The loan typically is for two weeks and carries a flat 15% fee or an interest rate that doesn’t sound too high.
But if the loan is not paid off, the costs quickly add up.
Although some banks and credit unions have offered the loans, most are made from storefront lenders or websites that are part of what’s known as the shadow banking system.
The consumer bureau, created by the Dodd-Frank financial reform law, began the first federal oversight of payday lenders in 2012 amid strong criticism of the industry from fair lending and public interest groups.
A bureau analysis last year of 12 million payday loans found that 22% of borrowers renewed their loans at least six times, leading to total fees that amounted to more than the initial loans.
The payday loan industry has argued that the loans are an important financial bridge for some consumers and that regulations should not be too onerous.
“It’s apparent to me that literally hundreds of businesses would be so adversely affected by this that they would be put out of business,” said Dennis Shaul, chief executive of the Community Financial Services Assn., a payday lending industry trade group.
He said he was disappointed with proposed regulations and accused the bureau of being biased against payday loans.
“Often what I see here is the tendency to accept at face value the criticism of payday lending ... from our adversaries without determining if there is truth to them,” Shaul said.
Still, he said, the group would work with the bureau to try to develop rules that protect consumers but also ensure that short-term credit remains available.
Lauren Saunders, associate director of the National Consumer Law Center, said “ensuring that a loan is affordable is the cornerstone of fair and responsible lending.”
She said new regulations were needed but was concerned about potential loopholes that could allow “some unaffordable high-cost loans to stay on the market.”
The proposed regulations would require that lenders take steps to determine that a prospective customer can repay the loan when it is due, including principal, interest and any other fees, without requiring another loan.
Lenders would have to verify the consumer’s income, major financial obligations and borrowing history to determine whether the person would have enough money left to repay the loan after paying living expenses and other bills.
For short-term loans — ones that require repayment in 45 days or less — lenders would have to wait 60 days before offering a consumer a second loan, unless the lender can document that the borrower’s financial circumstances have improved enough to repay another loan.
After three straight short-term loans, lenders would be prohibited from making another loan to the consumer for 60 days. And a lender could not keep a consumer in debt for more than 90 days in a 12-month period.
For payday loans longer than 45 days, which typically have installment and sometimes balloon payments, the bureau would make the maximum duration six months and is considering two other types of limits.
The first would cap interest rates at 28% and application fees at $20.
The second would allow the lender to make loans as long as the amount a borrower must repay each month is no more than 5% of gross monthly income. Lenders would be limited to making two such loans to a consumer in a 12-month period.
Consumer advocates and payday loan industry officials have been expecting new regulations.
Advance America, Cash Advance Centers Inc., the nation’s largest nonbank provider of payday loans, said the consumer bureau “should establish clear and consistent guidelines and disclosures for all of the products and services consumers use and view as comparable.”
“Rules that treat short-term lenders, banks and other creditors the same will foster competition and allow for greater and more consistent protections that enable consumers — not regulators — to pick winners and losers in the marketplace,” the company said.
The company released results from a survey it commissioned that said 69% of respondents from households that have used payday loans agreed that “you should be able to decide how often you take out a payday loan and not be limited by government restrictions.”
About 47% of respondents from households that have never taken out a payday loan agreed with the statement, while 47% disagreed and 6% had no opinion.