Sweeping new rules proposed Thursday by the Consumer Financial Protection Bureau could upend the payday loan industry, which consumer advocates say often traps cash-strapped workers into a vicious cycle of borrowing.
If enacted, the rules generally will require lenders to verify that borrowers can afford the loans and cap the number of times people can take out successive loans. The rules also would go beyond payday loans to target other costly short-term loans, including some high-interest installment loans and car title loans.
Here’s a little more about the rules and how consumers would be affected:
Why is this happening?
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The Consumer Financial Protection Bureau says that because of the way the loans work now, borrowers who use them can often be overwhelmed by fees and trapped into a cycle of debt that forces them to skip important bills or make other difficult financial choices. For instance, the agency found that about 80 percent of payday loans are rolled over into a repeat loan, causing fees to pile up for borrowers. Roughly 45 percent of payday customers take out at least four loans in a row.
And each loan comes with steep fees. The Consumer Financial Protection Bureau found that payday borrowers pay a median $15 in fees for every $100 they borrow, amounting to an annual percentage rate of 391 percent on a median loan of $350. The rates on installment loans and auto title loans can be similarly high.
What would the rules do?
Payday lenders and certain companies offering short-term loans would essentially need to look into borrowers’ finances and make sure that they could realistically afford the loans. The only exceptions where lenders would not have to look into borrowers’ incomes or credit reports would be for loans under $500 or for loans with interest rates of less than 36 percent.
Still, even those loans would be subject to rules that put a cap on how often borrowers could roll over their debt into repeat payday loans. After the third loan, borrowers would need to enter a mandatory cooling-off period where they would not be able to take out another loan for at least 30 days.
For loans smaller than $500, which would not require the vigorous payment test, borrowers would be required to pay back part of their debt each time they rolled over the loan.
What types of loans are being targeted?
The rules would primarily target payday loans, high-cost short-term loans that borrowers take out with the expectation that they’ll repay the debt with their next paycheck.
Installment loans, which work differently from payday loans, would also be covered. These loans are usually paid back over time through a series of scheduled payments.
Auto-title loans that require borrowers to put their cars up as collateral would also be subject to the rules.
Don’t lenders already have to ask for income information?
No. Companies that issue payday loans and other short-term loans may ask for proof of income but are not required to prove a borrower’s ability to pay.
How else could the rules affect borrowers?
The Consumer Financial Protection Bureau is also trying to cut down on the overdraft fees borrowers face when they fall behind on payments. Under the new rules, lenders would need to notify borrowers at least three days before making an electronic withdrawal for payment. And after two failed attempts to collect payment, lenders would be blocked from debiting the accounts again unless the borrower said it was okay.
When would the rules go into effect?
The proposal needs to go through a comment period before a final version can be announced. It may be next year before the process is over.