This rule covers loans that require consumers to repay all or most of the debt at once, including payday loans, auto title loans, deposit advance products, and longer-term loans with balloon payments. The bureau found that many people who take out these loans end up repeatedly paying expensive charges to roll over or refinance the same debt.
The rule also curtails lenders’ repeated attempts to debit payments from a borrower’s bank account, a practice that racks up fees and can lead to account closure.
“The CFPB’s new rule puts a stop to the payday debt traps that have plagued communities across the country,” CFPB Director Richard Cordray said. “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.”
Payday loans are typically for small-dollar amounts and are due in full by the borrower’s next paycheck, usually two or four weeks. They are expensive, with annual percentage rates of over 300 percent or even higher. As a condition of the loan, the borrower writes a post-dated check for the full balance, including fees, or allows the lender to electronically debit funds from their checking account. Single-payment auto title loans also have expensive charges and short terms usually of 30 days or less. Borrowers are required to put up their car or truck title for collateral for these loans. Some lenders also offer longer-term loans of more than 45 days where the borrower makes a series of smaller payments before the remaining balance comes due. These longer-term loans, or balloon-payment loans, often require access to the borrower’s bank account or auto title.
These types of loans are primarily marketed to consumers who are financially vulnerable and often cannot afford to pay back the full balance when it is due. Many borrowers end up repeatedly rolling over or refinancing their loans, each time racking up expensive new charges. More than four out of five payday loans are re-borrowed within a month, usually right when the loan is due or shortly thereafter. The cycle of taking on new debt to pay back old debt can turn a single, unaffordable loan into a long-term debt trap.
The CFPB rule aims to stop debt traps by putting in place ability-to-repay protections. These protections apply to loans that require consumers to repay all or most of the debt at once. Under the new rule, lenders must conduct a “full-payment test” to determine upfront that borrowers can afford to repay their loans without re-borrowing. For certain short-term loans, lenders can skip the full-payment test if they offer a “principal-payoff option” that allows borrowers to pay off the debt more gradually. The rule requires lenders to use credit reporting systems registered by the bureau to report and obtain information on certain loans covered by the proposal. The rule allows less risky loan options, including certain loans typically offered by community banks and credit unions, to forgo the full-payment test.
The new rule also includes a “debit attempt cutoff” for any short-term loan, balloon-payment loan, or longer-term loan with an annual percentage rate higher than 36 percent that includes authorization for the lender to access the borrower’s checking or prepaid account.