Feds to Issue Tougher Rules for Payday Loans

CFPB Seeks to Eliminate "Debt Traps" of Risky, Short Term Loans

Tall pole signs advertising payday loan and pawn store
CFPB to Better Regulate Payday Loan Market. David Woo / Getty Images

So-called “payday” loans are easy to get. Far too easy, says a federal government agency that wants to limit the risky loans that often leave consumers facing interest rates as high as 390%.

What Are ‘Payday’ Loans and Why are They Bad?

Payday loans are short-term, personal loans that take their name from the idea that the borrower will repay it with their next paycheck. Lenders who offer payday loans typically cater to low-income people who need cash in a hurry, but are unable to qualify for traditional loans from mainstream banks or savings and loans.

Since payday loans require no collateral on the borrower’s part, the lenders assume the risk of not being paid back and thus charge far higher interest rates as high as 390%.

Typically, proof of current employment or income from a monthly benefit, like Social Security, is all that is required – if anything -- to “qualify” for a payday loan.

Due to their ultra-high interest rates and short payoff times, payday loans often leave borrowers facing payments they cannot afford. These borrowers are forced to either borrow even more money (“reborrowing”) or skip paying other financial obligations like rent, or basic living expenses like food and medical care. As a result, they risk damages such as steep penalty fees, bank account closures, wrecked credit ratings, and vehicle repossessions.

[ Government Warns of Online Payday Loan Dangers ]

Payday lenders, however, argue that they provide a way for people living paycheck to paycheck to cover their basic costs of living and give people with bad credit a way to borrow money.

How the Government Plans to Help

On June 2, 2016, the Consumer Financial Protection Bureau (CFPB), the agency charged with protecting consumers from all sorts of abusive financial practices, announced plans to issue a federal regulation that would at least clip the wings of payday lenders.

“Too many borrowers seeking a short-term cash fix are saddled with loans they cannot afford and sink into long-term debt,” said CFPB Director Richard Cordray, who called getting a payday loan as being “like getting into a taxi just to ride across town and finding yourself stuck in a ruinously expensive cross-country journey.”

In fact, the CFPB says payday lenders prosper by “setting borrowers up to fail.”

“The Bureau has serious concerns that risky lender practices in the payday, auto title, and payday installment markets are pushing borrowers into debt traps,” stated the CFPB.

The CFPB, which had sought it for several years, was finally given the power to regulate the payday lending market by provisions in the 2010 Dodd-Frank Wall Street reform law.

According to the CFPB’s press release, its federal regulation would eliminate payday loan “traps” by:

  • Imposing a “full payment” test requiring payday lenders to determine whether people borrowing more than $500 can afford the full amount of each payment when it’s due and still meet basic living expenses and major financial obligations.
  • Requiring payday lenders to offer two lower interest rate options for longer-term loans. One plan would offer a maximum interest rate of 28% with a $20 application fee. The other option would allow the borrower to make equal monthly installment payments, but cap the total cost of the loan at 36% of the amount borrowed.
  • Prohibiting payday lenders from accepting auto titles as collateral for loans.
  • Make it harder for lenders to “push distressed borrowers into reborrowing,” by capping the number of short term loans they can make to the same borrower over a short period of time.
  • Limit the number of times payday lenders can try to charge borrowers’ bank accounts for missed payments. According to the CFPB, failed attempts to withdraw money rack up additional bank fees for borrowers.

Before issuing the regulation, the CFPB tracked all payday borrowers for 10 months. Shockingly, the CFPB found that more than 80% of the loans were either rolled over or reborrowed within 30 days of being made, causing the borrowers to incur additional fees with every renewal.

In addition, the CFPB found that one-in-five payday loans ends up in default and that one-in-five payday borrowers who put up an auto title as collateral end up having their car or truck seized by the lender for failure to repay the loan.