The volume of payday/short-term loans could be cut in half and many of the 16,000 payday lender stores in 35 states will be forced out of business if the Consumer Financial Protection Bureau’s final payday loan rule — which was announced Oct. 5 and could go into place in 2019 — is allowed to stand.

There are two major changes proposed under the new rules: The requirement for lending agencies to verify the individual’s ability to repay the loan in the specified time and still cover their household living expenses and a penalty-fee prevention measure that maxes a loan company to two straight unsuccessful attempts to draft a customer’s account.

The Background Information

For those who are unfamiliar with the workings of payday, auto title and balloon-payment loans; they are typically for small-dollar amounts and are due in full by the borrower’s next paycheck, usually two or four weeks. Already banned in 15 states, these loans are expensive, with annual percentage rates of over 300% or higher. As condition of the loan, the borrower writes a post-dated check for full balance, including fees, or allows the lender to electronically debit funds from their checking account.

For example, you write a check for, say, $115 to receive a $100 loan. Given a two-week loan term, which is fairly standard, the $15 finance charge works out to an APR of nearly 400%, and this assumes you pay back the loan on time.”

But a 2014 study by the CFPB found that the vast majority of payday loans are not paid back on time: More than 80% are rolled over or followed by another loan within two weeks. The study found that 15% percent of new loans “are followed by a loan sequence (rollover or re-loaning) at least 10 loans long.”

CFPB found many consumers are “being set up to fail with loan payments that they are unable to repay,” ultimately landing them in a debt trap.

Full-payment test

The CFPB rule aims to stop debt traps by putting in place strong ability-to repay protections for loans that require consumers to repay all or most of the debt at once. Under the new rule, lenders must conduct a “full-payment test” to determine upfront that borrowers can afford to repay their loans and still meet basic living expenses and major financial obligations both during the loan and for 3- days after the highest payment on the loan.

After the third covered short-term or longer-term balloon-payment loan in quick succession, lenders are required to respect a 30-day cooling-off period during which no news loans can be entered into

Principal-payoff option

A way around the ability-to repay protection, for both lenders and consumers, is a principal-payoff option. This option is available for short-term loans up to $500. Under this option, a consumer can either repay the loan in a single payment or the lender can offer a borrower up to two additional loans, but only if the borrower pays off at least one-third of the original principal with each extension.

The principal reduction feature is intended to steadily reduce consumers’ debt burden, allowing consumers to pay off the original loan in more manageable amounts as a way to avoid a debt trap. Under the rule, a lender cannot take an auto title as collateral on this type of loan.

While this option offers a better alternative for the typical short-term loan, CFPB was still concerned about the possibility of lenders getting in over their head under with a principal-payoff option, so the rule limits the number of these loans a consumer can enter into to “three such loans in quick succession.”

The principal-payment loans are also not available to individuals who have taken out six short-term loans or been in debt for more than 90 days on short-term loans during the previous 12 months.

Penalty-fee prevention

Repeated unsuccessful withdrawal attempts by lenders to collect payment from consumers’ accounts can pile on insufficient funds fees for consumers from their financial institutions and prompt late fees and returned payment fees from the lender. CFPB research found that over a period of 18 months, half of payday and payday-installment online borrowers have at least one debit attempt that overdrafts or fails. And these borrowers incur an average of $185 in bank penalty fees.

As the fees pile up and linger on, CFPB found 36% of accounts with a failed debit attempt from an online payday lender ended up being closed by the depository institution.

The new CFPB rule attempts to address these penalties in two ways. These rules apply to short-term loans, balloon-payment loans, and any loan with an annual percentage rate over 36% that includes authorization for the lender to access the borrower’s checking or prepaid account.

Written notice: Lenders have to give consumers written notice before the first attempt to debit the consumer’s account to collect payment for any loan covered by the rule. The notice must alert consumers to the timing, amount, and channel of payment transfer. If a subsequent payment transfer is for a different amount, at a different time or through a different payment channel than the consumer might have expected based upon past practice, the lender must give a notice specifically alerting the consumer to the change.

Debit attempt cutoff: After two straight unsuccessful attempts, the lender is prohibited from debiting the account again unless the lender gets a new and specific authorization from the borrower to again debit the account.

Will the new rule work?

Consumer organizations who have been railing against current short term lending laws are speaking favorably about the changes.

Ann Baddour, director of the Fair Financial Services Project at Texas Appleseed, a nonprofit advocacy and research group that pushed for increased regulation, said the rules ensure payday lenders don’t go after borrowers they know cannot pay off their loans.

“These rules are transformative because they are…. underpinned by basic tenets of fair and responsible lending, ” Baddour says.

U.S. Rep. Roger Williams, R-Texas, said in a statement the new rules are “punishing vulnerable Americans.” Williams, who serves as the vice chairman of the House Committee on Financial Services Subcommittee on Monetary Policy and Trade, said the rules takes away the “right to small-dollar emergency loans.”

“Washington bureaucrats will never experience the financial instability that many of our hardworking families do.

We must correct this system by rolling back the rule-making authority of this agency, whose decisions are guided by ‘scholars’ rather than industry and subject matter experts,” he says.

Congress could move to overturn the rule — but some say that’s unlikely.

According to lenders, the rules — which are scheduled to be fully implemented in the summer of 2019— will put them out of business, and according to some experts, they’re right.

“The documentation requirements would result in a significant increase in loan origination costs, which could make small loans uneconomic,” writes Jack Guttentag, professor emeritus of finance at the Wharton School of the University of Pennsylvania. “In addition, lenders would lose the most profitable part of their customer base.”

The rules as written would still work for the cautious borrower,’ writes Guttentag, who blogs under the name Mortgage Doctor. However, the new rules will knock those who borrow “heedlessly” out of the payday loan cycle, and those are the customers from whom payday loan companies make most of their money.

However Baddour says, the lenders protest too much.

“That says something when a lending business complains about a standard that merely requires assessing the borrower’s ability to repay, which should be a basic tenant of reasonable fair lending,” she says. “It definitely gives one pause.”

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