In this blog post, we share our thoughts on the 36% “all-in” rate trigger and restrictions for loans considered to be “longer-term” under the CFPB’s contemplated proposals taking aim at payday (and other small-dollar, high-rate) loans (“Covered Loans”). (Our previous blog posts have looked at the CFPB’s grounds for the proposals, how the proposals will impact “short-term” Covered Loans and the flaws we see in the CFPB’s ability to repay analysis.)
36% “all-in” rate trigger. CFPB rules under consideration for “longer-term” Covered Loans, with terms exceeding 45 days, are limited to loans that: (1) have “all-in” annual percentage rates (APRs) exceeding 36%; and (2) either create a security interest in the consumer’s motor vehicle or authorize the lender to collect payments by accessing the consumer’s bank account or paycheck. See Press Release, “CFPB Considers Proposal to End Payday Debt Traps” (Mar. 26, 2015) (“Press Release”), p. 3. As with short-term Covered Loans, the CFPB contemplates that lenders will be allowed to make longer-term Covered Loans either using an ATR analysis or, at the lender’s option, without an ATR analysis but subject to elaborate restrictions.
The CFPB skates on very thin ice when it chooses to severely restrict longer-term Covered Loans based on “all-in” APRs exceeding 36% while it leaves lower-rate loans outside the coverage of its contemplated rules. Section 1027(o) of Dodd-Frank explicitly denies the CFPB authority to set usury limits, yet the contemplated proposal does just that. With the 36% rate trigger, the CFPB is effectively saying that specified longer-term loans are perfectly lawful if the all-in APR is 36% or less but unlawful at a higher rate.
There is one type of higher-rate loan the CFPB apparently intends to leave alone—unsecured “signature” loans payable more than 45 days after origination. While the CFPB seems to believe—incorrectly, in our view—that it can restrict interest rates when they are coupled with other loan features, there is no obvious way it could regulate signature loans without nakedly addressing rates in isolation. Conversely, eliminating the rate trigger on longer-term Covered Loans would seriously interfere with credit products for which there is virtually universal support, such as the unsecured installment loans offered through the Lending Club and Prosper online marketplaces.
Restrictions. As with short-term Covered Loans, the CFPB contemplates two options for longer-term Covered Loans. Press Release, pp. 3-4. Under the first option, the longer-term Covered Loan would need to pass an ATR analysis. Under the second option, the lender could make Covered Loans with terms from 45 days to six months (no maximum term applies to longer-term Covered Loans made under ATR authority) provided that debt service is limited to five percent of the borrower’s verified gross income and the lender does not make more than two such Covered Loans within any 12-month period. (We do not address a third option here, based on an NCUA program, since it does not appear at all viable to us.)
Once again, the contemplated CFPB limitations are severe. For Covered Loans made on the basis of an ATR evaluation, the issues discussed above would apply, although ATR issues are necessarily more severe for short-term Covered Loans than for longer-term Covered Loans. Only a small segment of longer-term Covered Loans will meet the five percent and six-month limitations contemplated by the CFPB. Indeed, for Covered Loans studied by the CFPB, only 18 percent had payment to income ratios below five percent and only nine percent had ratios below five percent and terms of six months or less. See Outline of Proposals under Consideration and Alternatives Considered (Mar. 26, 2015), p. 50.
The materials released by the CFPB do not explain its basis for selecting five percent and six-month thresholds for longer-term Covered Loans that do not utilize ATR authority. In the absence of any compelling explanation, a rule that threatens to eliminate over 90% of the market seems overly tough. If one were to accept the CFPB’s theory that it is entitled to regulate on the basis of interest rates—and we do not—should it not be more liberal when rates are at the low end of the regulated range rather than the upper reaches? If a lender can make a six-month loan at a triple-digit interest rate, we believe it should be able to make a one-year loan at a 37% rate.
In our next blog post, we will look at the CFPB’s contemplated rules for payment collection practices.