The Consumer Financial Protection Bureau's new rules for payday loans and car title loans have drawn the predictable cries of outrage from lenders, particularly small storefront operators who say the restrictions will put them out of business. And it's an understandable complaint — after spending five years researching the market for high-cost credit, the bureau has fired a shot right at the heart of these lenders' business model.
But the outrage here isn't what the regulators are doing. It's the way these lenders have profited from the financial troubles of their customers. As the bureau's research shows, payday lenders rely on consumers who can't afford the loans they take out. With no way to repay their original loans other than to obtain further ones, most of these customers wind up paying more in fees than they originally borrowed.
That's the definition of predatory lending, and the bureau's rules precisely target just this problem. They don't prohibit lenders from offering the sort of financial lifeline they claim to provide — one-time help for cash-strapped, credit-challenged people facing unexpected expenses, such as a large bill for medical care or car repairs. Instead, they stop lenders from racking up fees by making multiple loans in quick succession to people who couldn't really afford them in the first place.
The question now is whether lawmakers will try to reverse the bureau and maintain a financial pipeline that's popular with millions of lower-income Americans precisely because it's the one most readily available to them, either online or from the storefront lenders clustered in urban areas. It's a huge pipeline too — the industry made $6.7 billion in loans to 2.5 million U.S. households in 2015, the bureau estimated.
Defenders of these costly loans say they're the only option available to people living paycheck to paycheck. The problem is that the typical borrower can't handle the terms of a payday loan, which require the entire amount to be repaid in about two weeks, plus fees.
What these borrowers really need is a conventional installment loan that they can pay back over time. This option is emerging in states that either ban payday loans or encourage small-dollar loans to borrowers with uncertain credit, as California does.
The bureau found that 90% of the fees payday lenders collect in a year come from customers who borrowed seven times or more, and 75% come from those with 10 or more loans. These people are not being helped out of a bind; they're being put in a debt trap.
The bureau's rules are expected to slash the number of payday and auto title loans issued, which to critics is an attack on low-income Americans' access to credit. A more accurate description is that the rules are an attack on unaffordable credit.
Starting in 21 months, the rules will require both payday and auto title lenders (who offer short-term loans that use the borrower's car or truck as collateral) to do the sort of thing banks and credit unions already do: Before extending a loan, they'll have to determine whether the borrower can repay it. These lenders haven't bothered with that sort of underwriting because it's costly, relying instead on high fees (typically, $15 per $100 borrowed, or the equivalent of an interest rate of at least 300% a year) to cover the high rate of default. The bureau found that in 2011-'12, nearly half of the money lent by storefront payday outlets went uncollected — hence the need for blockbuster revenue from fees.
The new rules will allow payday lenders (but not those issuing auto title loans) to skip the ability-to-repay determination if, and only if, they limit the loan to $500 or the maximum allowed under state law, whichever is lower. To discourage these borrowers from taking out loans they can't readily repay, the rule limits them to two more loans of diminishing size over the subsequent 90 days. If they haven't paid off their debt within 90 days, they'll have to go at least a month before obtaining a new loan.
Some consumer advocates argue that there should be no exceptions, and that the rule isn't tight enough to stop payday lenders from digging borrowers into deeper financial trouble. But the bureau is right to let these companies try to build a lending business that isn't predicated on collecting multiple fees for what amounts to a single loan.
Payday and auto-title lending companies have said they will fight the rule in court, and their allies in Congress are soon expected to try to pass a resolution rejecting it. Lawmakers shouldn't be fooled by the industry's argument that payday and auto title loans are a crucial source of credit for low-income Americans. As advocates for low-income consumers have argued to regulators for years, the issue here isn't access to credit. It's protection from predatory lending.