The Consumer Financial Protection Bureau on Tuesday issued a final rule on payday lending, rescinding Obama-era provisions that would have required lenders to ensure borrowers could repay their loans before issuing cash advances.
To help ensure borrowers were not getting sucked into so-called debt traps, the CFPB released a new, multi-part payday loan regulation in 2017 that, among other things, required payday lenders to check that borrowers could afford to pay back their loan on time by verifying information like incomes, rent and even student loan payments.
But the Trump administration blocked those rules from going into effect and called for a review. On Tuesday, the CFPB — under new leadership — released a finalized rule that doesn't require lenders to check that borrowers can afford to pay.
Doing so "ensures that consumers have access to credit and competition in states that have decided to allow their residents to use such products, subject to state law limitations," the agency said in a statement. Additionally, CFPB staff found there was "insufficient legal and evidentiary bases" in requiring lenders to verify consumers' ability to repay loans.
The CFPB did keep in place restrictions that bar payday lenders from repeatedly trying to directly withdraw payments from a person's bank account. Some payday lenders attempt to recover their money by taking what they're owed directly from borrowers' checking accounts, which borrowers grant access to as a condition of the loan. But unexpected withdrawals from the lender can rack up pricey overdraft fees and damage credit scores.
Consumer advocates say the CFPB's case for overturning the 2017 rule does not hold up to scrutiny and condemned the agency's decision to remove the underwriting mandates. "By eliminating the ability-to-repay protections, the CFPB is making a grave error that leaves the 12 million Americans who use payday loans every year exposed to unaffordable payments at annual interest rates that average nearly 400%," says Alex Horowitz, senior research officer with Pew Charitable Trusts' consumer finance project.
"Last October we learned that, in exchange for contributions to the Trump campaign, payday lenders were bragging about being able to 'pick up the phone and...get the president's attention' to fend off regulation," Sen. Sherrod Brown (D-Ohio) said in a statement Tuesday. "Today, the CFPB gave payday lenders exactly what they paid for by gutting a rule that would have protected American families from predatory loans that trap them in cycles of debt."
Why payday loans can be problematic
Tuesday's final rule by the CFPB comes at a time when Americans are increasingly looking for credit. One out of three Americans have lost income because of the coronavirus pandemic, according to the Financial Health Network's 2020 U.S. Financial Health Pulse, a survey of over 2,000 U.S. adults fielded between April 20 and May 7, 2020.
Among Americans who report losing income, 3% of survey respondents say they've had to borrow money using a payday loan, deposit advance or pawn shop loan.
Payday loans can be easy to get, but hard to pay off. In the 32 states that allow payday lending, borrowers can generally take out one of these loans by walking into a lender and providing just a valid ID, proof of income and a bank account. Unlike a mortgage or auto loan, there's typically no physical collateral needed.
Most lenders that offer payday loans require borrowers to pay a "finance charge" (service fees and interest) to get the loan, the balance of which is due two weeks later, typically on your next payday. Nationally, the average APR on a payday loan is about 400%. That's compared to personal loan rates that range from 10% to 28% on average, based on your credit. Or credit cards, which charged an average interest rate of roughly 15% interest as of February, according to the St. Louis Federal Reserve.
Lenders say the high rates are necessary because payday loans are risky to finance. And opponents of the Obama-era payday loan rule argue that the ability-to-pay provisions were too burdensome and costly. "The ability-to-repay provisions were simply unworkable and imposed burdens on consumers and lenders in the form of unreasonable levels of documentation not even required of mortgage lenders," D. Lynn DeVault, chairman of the Community Financial Services Association of America said Tuesday. The complex and costly regulations "would have effectively put lenders out of business altogether rather than protect consumers," she added.
However, borrowers often can't pay back these high-cost loans right away, so they get sucked into a cycle of borrowing and racking up finance charges. Research conducted by the Consumer Financial Protection Bureau during the Obama administration found that nearly 1 in 4 payday loans are reborrowed nine times or more. Plus, it takes borrowers roughly five months to pay off the loans and costs them an average of $520 in finance charges, Pew reports. That's on top of the amount of the original loan.
The payday loan landscape
The Obama-era rules were already starting to work, Horowitz says: "Lenders were beginning to make changes even before [the 2017 rules] formally took effect, safer credit was already starting to flow, and harmful practices were beginning to fade. Today's action puts all of that at risk."
Currently, 12 states — Arizona, Arkansas, Georgia, Maryland, Massachusetts, New Jersey, New York, North Carolina, New Mexico, Pennsylvania, Vermont and West Virginia — ban these types of loans entirely. Among those that allow payday lending, 16 states and the District of Columbia have implemented provisions capping interest rates at 36%, while other states have put other lending restrictions on payday loans. Currently, 32 states allow small dollar lending without major restrictions, according to the CFPB.
More states are working to add restrictions. Last month, Nebraskans for Responsible Lending coalition said they had collected enough signed petitions to get an initiative that would cap the annual interest rate on payday loans at 36% onto the state's November ballot.
In November, federal lawmakers introduced legislation through the Veterans and Consumers Fair Credit Act that would cap interest rates at 36% for all consumers nationwide. The bipartisan legislation — which is the latest attempt to curb payday loans at the federal level — was built off the framework of the 2006 Military Lending Act, which capped loans at 36% for active-duty service members. But despite both Democrat and Republican co-sponsors, the bill remains stalled.
"With the CFPB abandoning its role in protecting families, Congress must act now to extend to all families a national rate cap of 36% — which is broadly supported by Americans across the ideological spectrum," says Lauren Saunders, associate director of the National Consumer Law Center.