The nation's top consumer financial watchdog on Thursday issued tough nationwide regulations on payday and other short-term loans, aiming to prevent lenders from taking advantage of cash-strapped Americans.
The long-awaited rules from the Consumer Financial Protection Bureau — the first broad federal regulations — would require lenders in most cases to assess whether a consumer can repay the loan.
"The CFPB's new rule puts a stop to the payday debt traps that have plagued communities across the country," said Richard Cordray, the bureau's director. "Too often, borrowers who need quick cash end up trapped in loans they can't afford. The rule's common sense ability-to-repay protections prevent lenders from succeeding by setting up borrowers to fail."
The bureau, established after the financial crisis, has been overseeing the $38.5-billion-a-year payday lending industry since 2012, the first such federal oversight.
The centerpiece of the new rules is a full-payment test that lenders would be required to conduct to make sure the borrower could afford to pay off the loan and still meet basic living expenses and major financial obligations.
The rules also limit the number of loans that could be made in quick succession to an individual borrower to three. There are no caps on interest rates.
Consumers would be allowed to take out a short-term loan of as much as $500 without a full repayment test if the loan is structured to let the borrower to get out of debt more gradually, such as allowing for payments to go directly to principal. Such loans could not be offered to borrowers with recent or outstanding loans due shortly or with balloon payments.
The rules are aimed at large scale payday and auto-title lenders. They would also apply to other short-term loans, but there is an exemption for community banks, credit unions and any other lenders that have not made such loans a big part of their business, bureau attorney Brian Shearer said.
Consumer advocates applauded the crackdown on payday lenders.
"Too many Americans end up sinking deep into a quicksand of debt when they take out expensive high-cost loans," said Suzanne Martindale, senior attorney for Consumers Union.
But a payday industry trade group said the new rules would harm consumers.
"Millions of American consumers use small-dollar loans to manage budget shortfalls or unexpected expenses," said Dennis Shaul, chief executive the Community Financial Services Assn. of America. "The CFPB's misguided rule will only serve to cut off their access to vital credit when they need it the most."
The rules would be a devasting financial blow to the industry. A 2015 study conducted for the industry trade group said somewhat tougher rules initially proposed by the consumer bureau would make many small payday loan stores unprofitable.
The bureau acknowledged Thursday that total loans could decline by about two-thirds. But because many consumers take out multiple loans, Shearer said consumers would be able to get the first loan 94% of the time under the new rules.
The rules won't go into effect until mid-2019 and are strongly opposed by most Republicans, who could scuttle them.
Cordray, a Democrat who was appointed by President Obama as the agency's first director, has continued an aggressive approach at odds with President Trump's deregulatory initiative.
Cordray's five-year term expires in July 2018, and there is speculation he could leave sooner to run for governor in his home state of Ohio. Trump would nominate a replacement who could move to rescind the rules before they ever go into effect.
The Republican-controlled Congress also could vote to repeal the rules before they take effect. One of Cordray's sharpest critics, Rep. Jeb Hensarling (R-Texas), said Thursday that the new regulations "must be rejected."
Payday and other short-term loans, such as those secured with an automobile's title, have been a fixture in lower-income and working-class communities for years. Their use surged during the Great Recession and its aftermath as struggling consumers looked for quick infusions of cash to pay bills.
Payday loans are allowed in California and 34 other states — the rest prohibit them.
An estimated 12 million Americans take out payday loans each year from websites and about 16,000 storefront locations. The loans typically are cash advances on a worker's paycheck for two to four weeks and carry a flat 15% fee or an interest rate that doesn't seem particularly high.
But costs can quickly add up if the loan isn't paid off, and the effective annual interest rate is actually 300% or more, the bureau said.
Payday borrowers in California were charged an average annual interest rate of 372% last year, according to the state's Department of Business Oversight. That led to $459 million in fees, with 75% of coming from people who took out seven or more loans, state officials said in a July report.
"Everyone who works hard for a paycheck deserves the chance to get ahead and basic protections," said California Atty. Gen. Xavier Becerra, who applauded the new federal regulations. "No one should be trapped in a rigged debt cycle."
California law limits payday loans to $300, minus a maximum fee of 15%, or $45. Although state law prevents consumers from rolling over a payday loan into another one, they could pay off a loan and then shortly thereafter take out another loan from the same lender. Or they could take out loans from multiple lenders. There are no state underwriting requirements.
After peaking at $4.2 billion in loans in 2015, payday lending declined last year in California by nearly 25% to $3.1 billion, according to the Department of Business Oversight. That was the lowest level since 2010. About half the 1.8 million people who took out payday loans last year had annual average incomes of $30,000 or less, the department said.
California also caps interest rates on consumer loans of less than $2,500 on a sliding scale that averages about 30%. There are no interest rate limits on loans above $2,500 and auto title lenders have exploited that, with nearly all auto title loans made for more than that amount.
Consumer advocates and public interest groups have criticized payday lenders as taking advantage of cash-strapped Americans. A 2015 consumer bureau analysis 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 size of the initial loan.
Last year, the bureau proposed rules that would limit the number of payday loans a consumer could take out each year, change how lenders collect payments and require them to more thoroughly review borrowers' finances to make sure they can afford to repay the money.
A fierce lobbying battle has taken place ever since as the consumer bureau worked to finalize the rules. Industry groups argued that the proposed rules would add onerous underwriting requirements that would prevent some people from obtaining the loans, which can be an important financial bridge.
3:40 p.m.: This article was updated with political and other reaction, the rules' expected effect on the industry and statistics about payday lending in California.
1:00 p.m.: This article was updated with additional details.
9:55 a.m.: This article was updated throughout with additional details and background.