Payday rule helps protect consumers from debt traps

Monday, October 09, 2017

The Consumer Financial Protection Bureau (CFPB) has announced a groundbreaking rule that reins in short-term loans, which require consumers to repay all or most of the debt at once. The rule applies to payday loans, auto title loans, deposit advance products and longer-term “balloon-payment” loans. The payday rule will help protect consumers who find themselves trapped in a cycle of debt.

Here are key elements of the rule:

• Central to the rule is an “ability-to-repay” requirement. Before issuing a loan, lenders must determine that a borrower can afford to repay the short-term loan while also being able to afford basic living expenses (like rent and groceries), without having to re-borrow when the loan comes due. To meet the “full payment test,” lenders must verify a borrower’s income and financial obligations and estimate living expenses to decide if the borrower can actually repay.
• Lenders who allow consumers to repay a loan more slowly may skip the full payment test. Lenders who use what is known as the “principal payoff option” instead may allow borrowers to extend the loan two times, if  they require borrowers to pay off at least one-third of the principal loan balance. (This option is not available on auto title loans, if the borrower already has an outstanding payday loan or if they have already had six loans or been in debt for more than 90 days in a year. For more details on these exemptions click here.)
• The payday rule caps the number of short-term loans at three in a row. To help prevent debt traps, there must be a 30-day cooling off period before any new high-cost loans may be issued.
• The rule stops lenders from repeatedly deducting funds from borrowers’ bank accounts. For loans of more than 36% APR with automatic access to a borrower’s bank account, lenders are now limited to two attempts to automatically debit the account. After two tries a lender must get a borrower’s reauthorization to continue debiting. This is meant to prevent multiple, costly overdraft and other penalty fees.
• Before the first attempt by a lender to automatically debit money from a borrower’s account, the lender must provide written notice explaining when and how they plan to debit the money and the amount of the upcoming debit.

The main types of loans impacted by the rule are short-term payday loans, single payment auto title loans (with 45 days or less to pay them back) and longer-term “balloon payment” loans. Existing state laws may offer more stringent protections. 

The CFPB is studying longer-term high-cost loans with the intention of issuing further rules later.

The rule applies to loans made online and in-store, and is set to take effect mid-2019.

For more information, click here.