The Consumer Financial Protection Bureau (CFPB) recently announced its intention to implement a rule aimed at reducing the risk of short-term loans. Often called payday loans, this type of lending has created financial difficulties for some borrowers who haven’t been able to repay the loans in a timely fashion.
According to the official news release on the proposal, the CFPB’s new rule would require payday loan lenders to screen borrowers for their ability to repay the loans. The rule would also prevent lenders from repeatedly debiting borrower’s accounts in an attempt to collect.
The law would impact several types of loans including auto title loans, deposit advances, payday loans, and other types of installment loans. Before implementation of the law, the CFPB indicated that it would research other types of loans that might also fall under the rule’s guidelines.
The Popularity of Payday Loans
According to a report from The Pew Charitable Trust, millions of borrowers rely on payday loans each year. Numbers suggest around 12 million borrowers use payday loans each year, spending $7 billion in the process. Americans use payday loans for a variety of reasons, but the notable finding is that a single borrower will often take out multiple loans each year.
In their research, Pew found that borrowers were most often white and female and ranged in age from 24 to 44 years old. Other characteristics of the average borrower included a lack of a four-year college diploma, people earning less than $40,000 a year, and divorced or separated individuals.
Homeowners with incomes from $15,000 to $40,0000 were also more likely to use payday loans than homeowners with incomes from $40,000 to $100,000. The odds of using a payday loan were also higher for African Americans than other races.
Reducing Penalties Associated with Borrowing
One of the problems consumer advocates have seen with the payday loan industry has been the tendency for short-term loans to turn into large, long-term debts. Borrowers without the ability to cover payments have often ended up making payments for much longer than they intended.
The cost of a payday loan usually requires making a payment when the borrower gets paid that includes the original borrowed amount, as well as a flat fee based on the total amount borrowed. For example, the payday loan company might charge $10 for each $100 borrowed. A payday loan of $500 would require an additional fee paid of $50.
Several states around the country have implemented restrictions on payday loans and similar lending types. In response to the rules, some lenders have gotten creative with their lending methods. Some companies have established online payday loans to avoid the laws in specific states.
Examining the Newly Proposed Rules
The new rules would implement several guidelines to ensure only borrowers with an ability to pay would gain approval. One of the most notable rules would require lenders to check the credit of any borrower requesting $500 or more. The lender would need to decline any borrower without the ability to repay the loan within 30 days.
Another rule would restrict the number of loans a borrower could have at any one time. A lender wouldn’t be able to give money to a customer who already had a few other, active payday loans. The lender would also be restricted in the number of payment extensions the company could offer a borrower.
The rules would also require that lenders give borrowers written notice before debiting an account for payment. After two unsuccessful attempts to debit a borrower’s account, lenders would need to gain reauthorization from the borrower to initiate another debit.
Regulations and Fines from the CFPB
The newly proposed rules have been accompanied by efforts by the CFPB to fine payday lenders for practices seen as harmful to consumers. The Wall Street Journal recently reported that the CFPB levied a fine of more than $500,000 against Moneytree Inc., a payday lender based out of Seattle.
The CFPB alleged that the lender used deceptive advertising online to mislead customers about its collection practices. The CEO of the company stated the alleged practices were isolated within the company. The fine included $255,000 that would be paid to consumers and $250,000 for a civil penalty.
Payday loans aren’t the only types of borrowing on the CFPB’s radar. The federal bureau also plans to conduct research into other products like long-term installment loans with high-interest rates. The concern regarding high-cost loans is the issue of a borrower making payments for several months without seeing any significant progress in paying off the principal.