In this blog post, we share our thoughts on how the CFPB’s contemplated proposals taking aim at payday (and other small-dollar, high-rate) loans (“Covered Loans”) will impact “short-term” Covered Loans and the flaws we see in the CFPB’s ability to repay analysis. (Our last blog post looked at the CFPB’s grounds for the proposals.)
Impact. The CFPB plans to provide two options for “short-term” Covered Loans with terms of 45 days or less. One option would require an ability to repay (ATR) analysis, while the second option, without an ATR evaluation, would limit the loan size to $500 and the duration of such Covered Loans to 90 days in the aggregate in any 12-month period. These restrictions on Covered Loans made under the non-ATR option make the option plainly inadequate.
Under the ATR option, creditors will be permitted to lend only in sharply circumscribed circumstances:
- The creditor must determine and verify the borrower’s income, major financial obligations (such as mortgage, rent and debt obligations) and borrowing history.
- The creditor must determine, reasonably and in good faith, that the borrower’s residual income will be sufficient to cover both the scheduled payment on the Covered Loan and essential living expenses extending 60 days beyond the Covered Loan’s maturity date.
- Except in extraordinary circumstances, the creditor would need to provide a 60-day cooling off period between two short-term Covered Loans that are based on ATR findings.
In our view, these requirements for short-term Covered Loans would virtually eliminate short-term Covered Loans. Apparently, the CFPB agrees. It acknowledges that the contemplated restrictions would lead to a “substantial reduction” in volume and a “substantial impact” on revenue, and it predicts that Lenders “may change the range of products they offer, may consolidate locations, or may cease operations entirely.” See Outline of Proposals under Consideration and Alternatives Considered (Mar. 26, 2015) (“Outline”), pp. 40-41. According to CFPB calculations based on loan data provided by large payday lenders, the restrictions in the contemplated rules for short-term. Covered Loans would produce: (1) a volume decline of 69% to 84% for lenders choosing the ATR option (without even considering the impact of Covered Loans failing the ATR evaluation), id., p. 43; and (2) a volume decline of 55% to 62% (with even greater revenue declines), for lenders using the alternative option. Id., p. 44. “The proposals under consideration could, therefore, lead to substantial consolidation in the short-term payday and vehicle title lending market.” Id., p. 45.
Ability to Repay Analysis. One serious flaw with the ATR option for short-term Covered Loans is that it requires the ATR evaluation to be based on the contractual maturity of the Covered Loan even though state laws and industry practices contemplate regular extensions of the maturity date, refinancings or repeat transactions. Instead of insisting on an ATR evaluation over an unrealistically short time horizon, the CFPB could mandate that creditors refinance short-term Covered Loans in a manner that provides borrowers with “an affordable way out of debt” (id., p. 3) over a reasonable period of time. For example, it could provide that each subsequent short-term Covered Loan in a sequence of short-term Covered Loans must be smaller than the immediately prior short-term Covered Loan by an amount equal to at least five or ten percent of the original short-term Covered Loan in the sequence. CFPB concerns that Covered Loans are sometimes promoted in a deceptive manner as short-term solutions to financial problems could be addressed directly through disclosure requirements rather than indirectly through overly rigid substantive limits.
This problem is particularly acute because many states do not permit longer-term Covered Loans, with terms exceeding 45 days. In states that authorize short-term, single-payment Covered Loans but prohibit longer-term Covered Loans, the CFPB proposals under consideration threaten to kill not only short-term Covered Loans but longer-term Covered Loans as well. As described by the CFPB, the contemplated rules do not address this problem.
The delays, costs and burdens of performing an ATR analysis on short-term, small-dollar loans also present problems. While the CFPB observes that the “ability-to-repay concept has been employed by Congress and federal regulators in other markets to protect consumers from unaffordable loans” (Outline, p. 3), the verification requirements on income, financial obligations and borrowing history for Covered Loans go well beyond the ability to repay (ATR) rules applicable to credit cards. And ATR requirements for residential mortgage loans are by no means comparable to ATR requirements for Covered Loans, even longer-term Covered Loans, since the dollar amounts and typical term to maturity for Covered Loans and residential mortgages differ radically.
Finally, a host of unanswered questions about the contemplated rules threatens to pose undue risks on lenders wishing to rely upon an ATR analysis:
- How can lenders address irregular sources of income and/or verify sources of income that are not fully on the books (e.g., tips or child care compensation)?
- How can lenders estimate borrower living expenses and/or address situations where borrowers claim they do not pay rent or have formal leases? Will reliance on third party data sources be permitted for information about reasonable living costs?
- Will Covered Loan defaults deemed to be excessive be used as evidence of ATR violations and, if so, what default levels are problematic? Unfortunately, we believe we know the answer to this question. According to the CFPB, “Extensive defaults or reborrowing may be an indication that the lender’s methodology for determining ability to repay is not reasonable.” Id., p. 14. To give the ATR standard any hope of being workable, the CFPB needs to provide lenders with some kind of safe harbor.
In our next blog post, we will look at the CFPB’s contemplated 36% “all-in” rate trigger and restrictions for “longer-term” Covered Loans.