On October 5, 2017 the Consumer Financial Protection Bureau announced a new rule aimed to protect consumers against payday loan debt traps. The rule requires lenders to be upfront about whether or not the borrower will be able to repay and covers loans where borrowers repay all or most of the debt in one payment.
This includes payday loans, auto title loans, and deposit advance products which often come with APRs of several hundred percent. The problem with these types of products is that often borrowers pay to roll over or refinance the same debt. This results in a debt trap where the borrower continues to accrue fees and the amount owed can become an insurmountable problem for the borrower. According to the CFPB’s release, more than four out of five payday loans are re-borrowed within a month, usually right when the loan is due or shortly thereafter. This is the problem they are trying to solve.
What the CFPB has instituted are ability-to-repay protections which requires lenders to perform a full-payment test to determine whether the borrower will have the ability to repay the loan without rolling over the loan into a new one. In certain circumstances the full-payment test can be avoided if the lender offers a principal-payoff option where borrowers can repay over time.
There is also an exemption for what the CFPB deems less risky loan options which are loans made by a lender that makes 2,500 or fewer loans per year. These are commonly loans made by credit unions or community banks. Included in the new rules is also a debit attempt cutoff. Under this rule after two unsuccessful attempts to collect via a connected account the lender can’t debit the account again until getting permission from the borrower. The full details of what the CFPB has created is available on the CFPB’s website.
We wanted to get some industry reaction to the new rules so we reached out to several organizations who operate in the short term loan space. Their responses are below.
Sasha Orloff, CEO and Co-Founder of LendUp:
As a socially-responsible lender on a mission to improve credit access for underserved consumers, LendUp shares the CFPB’s goal of reforming the troubled payday lending market. Since our founding, we’ve been a strong advocate for eliminating the predatory practices that have defined the short-term lending market and are pleased that many of these reforms are included in the rule.
Overall, we’re encouraged by any attempts to eliminate business practices that enable lenders to win when customers fail.
At a time when more than half of Americans are unable to access traditional banking products, it is critical that we offer consumers as many safe credit options as possible. We will continue to advocate for reforms that put customers’ interests first.
Ken Rees, CEO of Elevate Credit:
We believe the CFPB got it exactly right with the rule. The rule will eliminate the most abusive aspects of non-prime loan products such as payday loans and title loans while ensuring that consumers will still be able to access responsible forms of credit.
Key benefits of the new rule (which Elevate already adheres to):
- The new rule helps eliminate the cycle of debt by severely limiting single-payment and balloon payment products which are notoriously difficult for consumers to repay without financial hardship.
- The rule gives consumers control over their bank accounts and reduces abusive bank charges from unexpected payment representments.
- The rule forces lenders to focus on thorough underwriting rather than aggressive collections to ensure repayment.
The rule will dramatically change the landscape of non-bank, non-prime lending in this country. In addition to reducing the number of payday lenders and title lenders, the requirements for advanced underwriting and reporting will push most of the mom-and-pop, primarily brick-and-mortar lenders out of existence. We believe that the growing need for non-prime consumer credit will be filled by more sophisticated technology-enabled online lenders. We also believe that the rule will create much needed regulatory clarity which will result in long-overdue innovation and investment in the space.
David Fisher, CEO of Enova (from their press release on the topic):
We are confident in our ability to successfully adapt to these new regulations. Our technology and experience provide us with a measurable advantage as we take the steps needed to ensure our U.S. consumer products comply with this new regulation. We’ve worked diligently to diversify our business, which has created significant growth in our installment and line of credit products, resulting in reduced exposure to this rule. We’ve seen very strong demand in our longer-term products offered by NetCredit, renewed growth in our U.K. business, success in building our small business and Brazil offerings, and good customer interest in Enova Decisions, our Analytics as a Service offering.
We are pretty happy with the rule as they made major changes to the ability to repay sections and of course this rule is only for payday which our members (except for a few states, where no other product is available) generally don’t offer.
The biggest problem with the rule is the very prescriptive nature for a product that is $500 or less. There is no room for any new products or innovation in this space.
There is nothing inherently wrong with a short term payday loan. I have no problem with a borrower paying $50 in interest on a one month $500 loan despite the astronomical APR such a product brings with it. APR is an irrelevant measure for very short term loans like this. Where I have a problem is the debt spiral such a product can create. The CFPB quotes that more than 80% of these loans are rolled over for another loan within the month. That is unacceptable.
For any industry to have long term sustainability transactions need to be win-win, a win for the company and a win for the customer. The reality is that for decades the payday loan industry has been operating on a win-lose proposition. Their product ends in a negative experience for most customers. That has to change and the new CFPB rules will go a long way towards creating that change.