The CFPB has moved a step closer to issuing payday loan rules by releasing a press release, factsheet and outline of the proposals it is considering in preparation for convening a small business review panel required by the Small Business Regulatory Enforcement Fairness Act and Dodd-Frank. The CFPB’s proposals are sweeping in terms of the products they cover and the limitations they impose. In addition to payday loans, they cover auto title loans, deposit advance products, and certain “high cost” installment and open-end loans. In this blog post, we provide a detailed summary of the proposals. We will be sharing industry’s reaction to the proposals as well as our thoughts in additional blog posts.
When developing rules that may have a significant economic impact on a substantial number of small businesses, the CFPB is required by the Small Business Regulatory Enforcement Fairness Act to convene a panel to obtain input from a group of small business representatives selected by the CFPB in consultation with the Small Business Administration. The outline of the CFPB’s proposals, together with a list of questions on which the CFPB seeks input, will be sent to the representatives before they meet with the panel. Within 60 days of convening, the panel must issue a report that includes the input received from the representatives and the panel’s findings on the proposals’ potential economic impact on small business.
The contemplated proposals would cover (a) short-term credit products with contractual terms of 45 days or less, and (b) longer-term credit products with an “all-in APR” greater than 36 percent where the lender obtains either (i) access to repayment through a consumer’s account or paycheck, or (ii) a non-purchase money security interest in the consumer’s vehicle. Covered short-term credit products would include closed-end loans with a single payment, open-end credit lines where the credit plan terminates or is repayable in full within 45 days, and multi-payment loans where the loan is due in full within 45 days.
Account access triggering coverage for longer-term loans would include a post-dated check, an ACH authorization, a remotely created check (RCC) authorization, an authorization to debit a prepaid card account, a right of setoff or to sweep funds from a consumer’s account, and payroll deductions. A lender would be deemed to have account access if it obtains access before the first loan payment, contractually requires account access, or offers rate discounts or other incentives for account access. The “all-in APR” for longer-term credit products would include interest, fees and the cost of ancillary products such as credit insurance, memberships and other products sold with the credit. (The CFPB states in the outline that, as part of this rulemaking, it is not considering proposals to regulate certain loan categories, including bona-fide non-recourse pawn loans with a contractual term of 45 days or less where the lender takes possession of the collateral, credit card accounts, real estate-secured loans, and student loans. It does not indicate whether the proposal covers non-loan credit products, such as credit sale agreements.)
The contemplated proposals would give lenders alternative requirements to follow when making covered loans, which vary depending on whether the lender is making a short-term or longer-term loan. In its press release, the CFPB refers to these alternatives as “debt trap prevention requirements” and “debt trap protection requirements.” The “prevention” option essentially requires a reasonable, good faith determination that the consumer has adequate residual income to handle debt obligations over the period of a longer-term loan or 60 days beyond the maturity date of a short-term loans. The “protection” option requires income verification (but not assessment of major financial obligations or borrowings), coupled with compliance with specified structural limitations.
For covered short-term loans (and longer-term loans with a balloon payment more than twice the level of any prior installment), lenders would have to choose between:
Prevention option. A lender would have to determine the consumer’s ability to repay before making a short-term loan. For each loan, a lender would have to obtain and verify the consumer’s income, major financial obligations, and borrowing history (with the lender and its affiliates and with other lenders.) A lender would generally have to adhere to a 60-day cooling off period between loans (including a loan made by another lender). To make a second or third loan within the two-month window, a lender would need to have verified evidence of a change in the consumer’s circumstances indicating that the consumer has the ability to repay the new loan. After three sequential loans, no lender could make a new short-term loan to the consumer for 60 days. (For open-end credit lines that terminate within 45 days or are fully repayable within 45 days, the CFPB would require the lender, for purposes of determining the consumer’s ability to repay, to assume that a consumer fully utilizes the credit upon origination and makes only the minimum required payments until the end of the contract period, at which point the consumer is assumed to fully repay the loan by the payment date specified in the contract through a single payment in the amount of the remaining balance and any remaining finance charges. A similar requirement would apply to ability to repay determinations for covered longer-term loans structured as open-end loans with the additional requirement that if no termination date is specified, the lender must assume full payment by the end of six months from origination.)
Protection option. Alternatively, a lender could make a short-term loan without determining the consumer’s ability to repay if the loan (a) has an amount financed of $500 or less, (b) has a contractual term not longer than 45 days and no more than one finance charge for this period, (c) is not secured by the consumer’s vehicle, and (d) is structured to taper off the debt.
The CFPB is considering two tapering options. One option would require the lender to reduce the principal for three successive loans to create an amortizing sequence that would mitigate the risk of the borrower facing an unaffordable lump-sum payment when the third loan is due. The second option would require the lender, if the consumer is unable to repay the third loan, to provide a no-cost extension that allows the consumer to repay the third loan in at least four installments without additional interest or fees. The lender would also be prohibited from extending any additional credit to the consumer for 60 days.
Although a lender seeking to utilize the protection option would not be required to make an ability to repay determination, it would still need to apply various screening criteria, including verifying the consumer’s income and borrowing history and reporting the loan to all commercially available reporting systems. In addition, the consumer could not have any other outstanding covered loans with any lender, rollovers would be capped at two followed by a mandatory 60-day cooling-off period for additional loans of any kind from the lender or its affiliate, the loan could not result in the consumer’s receipt of more than six covered short-term loans from any lender in a rolling 12-month period, and after the loan term ends, the consumer cannot have been in debt for more than 90 days in the aggregate during a rolling 12-month period.
For covered longer-term loans, lenders would have to choose between:
Prevention option. Before making a fully amortizing covered longer-term loan, a lender would have to make essentially the same ability to repay determination that would be required for short-term loans, over the term of the longer-term loan. In addition, an ability to repay determination would be required for an extension of a covered longer-term loan, including refinances that result in a new covered longer-term loan. To extend the term of a covered longer-term loan or refinance a loan that results in a new covered longer-term loan (including the refinance of a loan from the same lender or its affiliate that is not a covered loan), if certain conditions exist that indicate the consumer was having difficulty repaying the pre-existing loan (such as a default on the existing loan), the lender would also need verified evidence that there had been a change in circumstances that indicates the consumer has the ability to repay the extended or new loan. Covered longer-term loans with balloon payments are treated the same as short-term loans.
Protection option. The CFPB is considering two alternative approaches for a lender to make a longer-term loan without determining the consumer’s ability to repay. Under either approach, the loan term must range from a minimum of 45 days to a maximum of six months and fully amortize with at least two payments.
- The first approach is based on the National Credit Union Administration’s program for payday alternative loans, with additional requirements imposed by the CFPB. The NCUA program would limit the loan’s terms to (a) a principal amount of not less than $200 and not more than $1,000, and (b) an annualized interest rate of not more than 28% and an application fee of not more than $20, reflecting the actual cost of processing the application. Under the NCUA’s screening requirements, the lender would have to use minimum underwriting standards and verify the consumer’s income. The CFPB would also require the lender to verify the consumer’s borrowing history and report use of the loan to all applicable commercially available reporting systems and would prohibit the lender from making the loan if the consumer has any other outstanding covered loan or the loan would result in the consumer having more than two such loans during a rolling six-month period. Under this alternative, a lender that holds a consumer’s deposit account would not be allowed to fully sweep the account to a negative balance, set off from the consumer’s account to collect on the loan in the event of delinquency, or close the account in the event of delinquency or default.
- The second approach limits each periodic payment to 5 percent of the consumer’s expected gross income over the payment period. No prepayment fee could be charged. The lender would also have to verify the consumer’s income and borrowing history and report use of the loan to all applicable commercially available reporting systems. In addition, the consumer must not have any other outstanding covered loans or have defaulted on a covered loan within the past 12 months and the loan cannot result in the consumer being in debt on more than two such loans within a rolling 12-month period.
Restrictions on collection practices. For all covered short-term and longer-term loans, lenders would be subject to the following restrictions:
- Advance notice of account access. A lender would be required to provide three business days advance notice before attempting to collect payment through any method accessing an account, including ACH entries, post-dated signature checks, RCCs, and payments run through the debit networks. The notice would have to include information such as the date of the payment request, payment channel, payment amount (broken down by principal, interest and fees), and remaining loan balance. Notice by email would generally be permitted.
- Limit on collection attempts. If two consecutive attempts to collect money from a consumer’s account made through any channel are returned for insufficient funds, the lender would not be allowed to make any further attempts to collect from the account unless the consumer provided a new authorization.