In this general overview of the CFPB proposal, we explain:
- Why the CFPB created a framework for payday and other small loans
- The intentions behind the CFPB proposal
- Short-term loans
- Longer-term loans
Why create a framework for payday and other small loans?
The Consumer Finance Protection Bureau (CFPB) has developed a framework for the regulation of payday loans, auto loans and other small-dollar loans. Most pawn loans; credit card accounts; overdrafts; student loans; real estate secured transactions and all loans of longer than 45 days without a preferred payment position are excluded from the regulations in the CFPB proposal.
The main concern of the CFPB was that the repayments of smaller loans are often in the form of lump sums which can take a third or more of the borrower’s paycheck. Unable to afford their monthly living expenses, customers are then forced into repeat borrowing. As a result, the loan’s associated fees will be much higher than is advertised. The preferred repayment position of lenders (controlling the title of the borrower’s vehicle or having access to their deposit account) can also mean that lenders collect their loan repayment before the borrower can cover their other household bills.
The intentions behind the CFPB proposal
The CFPB has created a framework that offers consumer protection, but that is not so rigorous that it blocks borrowers’ access to credit. Loans will still be available, but the profits that lenders make will be restrained. The CFPB cannot limit the interest rate in the USA.
In general, the framework forbids lenders from issuing a new loan if there is an outstanding balance on a previous loan. Also, lenders would have to give borrowers notice before attempting to take money directly from their deposit account. If their first attempt is unsuccessful, they are only allowed to try to withdraw the cash from the account once more. To reflect the complexity of the lending market, the CFPB has divided these ‘covered’ loans into short- and long-term loans.
Short-term loans and ability to repay
The CFPB defines a short-term loan as one which lasts 45 days or less. The CFPB framework stipulates that lenders should check a customer’s borrowing history through commercially-available reporting systems which work in accordance with CFPB specifications. They should also verify their income and their major financial commitments.
The CFPB has created a framework that offers consumer protection, but that is not so rigorous that it blocks borrowers’ access to credit.
Their investigation should determine that the borrower would have enough money to cover all their living expenses (including housing, utilities, clothing, medical expenses, etc.) after the loan has been repaid.
The short-term alternative
This loan is limited to a maximum of $500, and the holding of vehicle titles is prohibited. There are also limitations about the frequency of loans. After 3 consecutive loans, there must be a mandatory period of 60 days when borrowing is not permitted. Over a 12-month period, the regulations state that there must be a 90-day maximum period of indebtedness and that the outstanding balance should taper down to zero after several consecutive loans.
A long-term loan is defined as one which lasts longer than 45 days. The annual percentage rate of APR (including interest, origination and all other fees) should be more than 36%, and the lender uses a preferred payment position.
Longer-term ability to repay
The lender should assess how affordable loan repayments would be using the same criteria as that for short-term loans such as verifying income, checking the customer’s borrowing history and ensuring they can meet the monthly financial commitments after repaying their loan installment.
If the borrower shows signs of financial distress, there should be more rigorous assessment for refinancing options. The proposal does not place restrictions on the loan’s size, cost or duration nor does it restrict how long a lender can have access to a deposit account or car title.
Longer-term NCUA-type loans
These loans would follow similar rules to the National Credit Union Administration Payday Alternative Loan Program. Loans would be available in amounts varying from $200 to $1,000 and would last a maximum of 6 months. Loans would have 28% interest and a $20-fee. The number of loans allowed would be limited to 2 in a period of 6 months.
The longer-term alternative
This type of loan would be restricted according to the salary of the borrower. Lenders would have to ensure that the monthly loan repayment was no more than 5% of the borrower’s gross monthly income. The duration of the loan would be a maximum of 6 months, and borrowers would be allowed a maximum of 2 loans over a 12-month period.