The Consumer Financial Protection Bureau, or CFPB was created to ensure consumers receive fair treatment from financial companies, such as banks, credit card issuers and lenders. It implements and enforces federal consumer finance laws. But one law it hasn’t yet enacted is an Obama-era payday loan regulation aimed to protect consumers from debt accrued with payday loans.
The agency has not only not enacted the law but is planning to change the proposed regulation in a way that will significantly reduce intended protections for consumers.
Just What Are Payday Loans?
Payday loans differ from other types of lending. Payday loans are high-interest loans not offered by banks and credit unions. There’s a specific category of lender called a payday lender. Payday loans are almost exclusively made from payday lenders.
A basic summary of a payday loan is that it covers a gap between the immediate moment when the consumer needs cash and a short-term future date—usually a matter of weeks—when the consumer receives his or her next paycheck. Hence the name, payday loan.
In short, the borrower borrows money against money he or she expects to receive soon but pays a high-interest rate in exchange for getting cash immediately. Payday loan interest rates are often much higher than typical loan interest rates and can be as high as 400%.
Highlights of the Intended Regulation
The regulation intended by the Obama administration, which was scheduled to take effect in January 2018, aimed to stop what the CFPB called “payday debt traps.”
The new rule intended to ensure that lenders evaluated how likely the borrower was able to pay back the loan and therefore, avoid paying added interest if the initial pay-back date passed without the loan being settled—called the full-payment test. The oversight package contained a variety of criteria for determining the consumer’s ability to repay the loan, as well as specific requirements for lenders, including:
- The full-payment test
- A 30-day cooling-off period after three in a row and before another loan could be made
- Giving lenders principal payoff option that included capping loans that fail the full-payment test to $500, requiring one-third of the principal be paid off with an extension and disclosing this option to consumers
- Mandatory reporting
- Alternate options
The Full-Payment Test
One way the payday loan regulations set out to determine the borrower’s ability to repay the loan without having to borrow again in order to repay it was by establishing the full-payment test. Payday lenders would have to determine if the borrower would be able to repay the loan and also cover basic living expenses and other major financial obligations. The lender would have to verify the borrower’s income and other loan obligations by checking the consumer’s credit report.
One of the issues with payday loans is that borrowers can get caught in a cycle taking out another loan to pay off the original loan. The payday loan regulations established a 30-day cooling-off period after a borrower took out three loans one after another. This rule aimed to stop the debt trap caused by repeat loans.
Principal Payoff Option
The regulation set out options to let consumers take out loans of no more than $500 if they didn’t pass the full payment test. This option included restrictions to protect the consumer, including:
- Not allowing the lender to take a car title as collateral
- Not allowing the lender to loan to someone with an outstanding short-term loan
- Enabling a principal payoff option that restricted loan extensions to borrowers who could pay at least one-third of the principal with each extension
- Requiring lenders to disclose the principal payoff option
The regulation would have also required payday lenders to report loan information and update to the major credit reporting agencies.
The regulation also would have let lenders offer other longer-term loans that reduced risk to consumers and put restrictions on the lender. One option would have capped interest rates at 28%. The other would have enabled loans repayable in equal sums for a term of no more than two years and at an interest rate of no more than 36%. Lenders would have been restricted as to the number of these optional loans they could offer.
You can view the full proposed regulation in the CFPB’s “Payday, Vehicle Title, and Certain High-Cost Installment Loans” document.
What’s Changing Now
In February, the CFPB proposed eliminating the full-payment test. The bureau’s reason was that there isn’t enough evidence to show that payday loans are damaging enough to warrant the test.
NPR quoted one anonymous CFPB official who said that if the rule had been implemented, it would have excluded nearly two-thirds of potential borrowers from receiving this type of loan.
Getting rid of the full-payment test requirement basically guts the entire rule. Although other portions of the document would stay in place under the CFPB’s proposal, the CFPB says it intends to delay implementation until 2020.
How The Changes Will Affect Consumers
Consumer finance advocacy groups are unhappy about the CFPB’s decision. They believe it will harm borrowers by putting them at risk of the so-called debt trap that the regulation aimed to resolve.
The CFPB documented the risks of payday loans itself. In addition to high-interest payments, the debt spiral that comes from missed payments and extensions, there’s potential damage to the consumer’s credit report. By weakening the intended payday loan regulation, the CFPB enabled continued risk t consumer from the very predatory practices it outlined in 2016 and that the regulation was intended to stop.
Alternatives to Payday Loans
Payday loans have always been questionable and good alternatives exist, including personal loans and credit cards. Both offer lower interest rates than most payday loans. Find more alternative in “8 Smart Low-Interest Payday Loan Alternatives.”
Avoid Risk by Sticking to Traditional Lending
Now that the proposed payday loan regulations are being scrapped, you should seek out alternative sources of short-term financing, such as those mentioned above. Predatory lending creates financial victims, and you can avoid becoming one by turning to options.