The U.S. Consumer Financial Protection Bureau and the Payday Lending Industry

April 22, 2015

Since January 2012, the U.S. Consumer Financial Protection Bureau (CFPB) has been closely studying the market for payday loans and related products.  It has issued a white paper on payday loans and deposit advance products, and its Office of Research has released a "data point" relating to how frequently payday loan customers take out series of subsequent loans.  And earlier this spring, the CFPB released an outline of proposals under consideration for regulation of the industry generally pursuant to its authority under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), signaling an effort to reform the types of loan products that may be offered to consumers.  In this Alert, we discuss the CFPB’s efforts on payday lending to date.

I.   2013 White Paper on Payday Loans and Deposit Advance Products

In April 2013, the CFPB issued a white paper on Payday Loans and Deposit Advance Products (White Paper) that summarized its initial data findings and concerns about the industry.  Although the majority of the White Paper is devoted to a detailed description of the markets for payday loans and deposit advance products, the CFPB also provided an overview of its concerns, which included the following:

• Sustained use of payday loans and deposit advance products.  The CFPB gave its view that such products posed dangers to consumers when used over the long term:  "a pattern of [consumers’] repeatedly rolling over or consistently re-borrowing [is] resulting in the consumer incurring a high level of accumulated fees."[1]  The CFPB believed that many consumers were unable to repay their loans in full on time and still meet their other expenses, which led to continued re-borrowing and significant associated debt expense.  The CFPB stated that two-thirds of the payday borrowers in its data sample had seven or more loans in a year, with most of the transactions conducted by these borrowers occurring within two weeks of a previous loan being paid back.
• A view that consumers may not understand the costs, benefits, and risks associated with payday lending and deposit advances.  The CFPB noted that consumers may not appreciate the substantial probability of being indebted for longer than anticipated.
• A belief that lenders have failed to assess consumers’ needs for such products or their ability to repay.  The CFPB indicated its view that lenders rely on their relative priority position in the repayment hierarchy to extend credit without regard to whether particular consumers can ultimately afford the loan.

In the White Paper’s conclusion, the CFPB stated that "the potential consumer harm and the data gathered to date are persuasive that further attention is warranted to protect consumers."[2] Furthermore, the CFPB expressed a desire "to continue its inquiry into small dollar lending products to better understand the factors contributing to the sustained use of these products" and to assess "the effectiveness of limitations in curbing sustained use."[3]

Following the issuance of the White Paper, the CFPB released its rulemaking agenda for 2014, which listed pre-rulemaking for payday lending and deposit advance products as slated to begin in March 2014.  The CFPB stated that it was considering what rules would be appropriate for addressing the sustained use of short-term, high-cost credit products, including additional disclosures and regulations to address unfair, deceptive or abusive acts or practices (UDAAP).  

II.   CFPB Office of Research Data Point on Payday Lending Loan Sequences 

In March 2014, the CFPB’s Office of Research released a data point focusing on "loan sequences," which it defined as an initial payday loan plus the series of subsequent loans that are renewed within 14 days of repayment of a prior loan.[4]  The study used data obtained from a number of storefront payday lenders and included over twelve million loans in thirty states covering twelve-month windows in 2011 and 2012.  The Office of Research stated that, according to its review of the data:

• Over 80% of payday loans are rolled over or followed by another loan within 14 days (i.e., renewed).  Same-day renewals are less frequent in states with mandated cooling-off periods, but 14-day renewal rates in states with cooling-off periods are nearly identical to states without these limitations.
• While many loan sequences end quickly, 15% of new loans are followed by a loan sequence at least 10 loans long.  
• Half of all loans are in a sequence at least 10 loans long. 
• Few borrowers amortize, or have reductions in principal amounts, between the first and last loan of a loan sequence.  For more than 80% of the loan sequences that last for more than one loan, the last loan is the same size as or larger than the first loan in the sequence.  Loan size is more likely to go up in longer loan sequences, and principal increases are associated with higher default rates.
• Monthly borrowers were disproportionately likely to stay in debt for 11 months or longer.  Among new borrowers (i.e., those who did not have a payday loan at the beginning the year covered by the data), 22% of those borrowers who were paid monthly averaged at least one loan per pay period following their initial loan.   
• Most borrowing involved multiple renewals following an initial loan, rather than multiple distinct borrowing episodes separated by more than 14 days.  Roughly half of new borrowers (48%) had one loan sequence during the year.  Of borrowers who neither renewed nor defaulted during the year, 60% took out only one loan.

III.   CFPB’s 2015 Proposals on Payday Lending Regulation

            A little over a year later, on March 26, 2015, the CFPB announced that it is considering proposing regulations on payday loans, deposit advance products, vehicle title loans, high-cost installment loans and certain open-end loans pursuant to its authority under Sections 1031 and 1032 of the Dodd-Frank Act.  These sections allow the CFPB to issue rules:

• to identify and prevent UDAAP in connection with any consumer financial product or service,[5] and
• to require disclosure of the costs, benefits and risks associated with any consumer financial product or service.[6]   

As a part of its pre-rulemaking process, the CFPB published an Outline of Proposals Under Consideration and Alternatives Considered for the Small Business Advisory Review Panel for Potential Rulemakings for Payday, Vehicle Title, and Similar Loans (Outline of Proposals). 

Under Section 1100G of the Dodd-Frank Act, the CFPB is required to convene a Small Business Review Panel consisting of representatives from the CFPB, the Small Business Administration (SBA) and the Office of Management and Budget’s Office of Information and Regulatory Affairs when working on a rule that could have significant economic effects on small businesses.[7] 

The CFPB coordinates with the SBA to select between fifteen and twenty small businesses to provide feedback on the regulatory proposals including anticipated compliance requirements and potential costs of the proposed rules.  Within sixty days of the panel’s meeting, it will complete a report including any significant alternatives aimed at minimizing adverse economic effects, which will be published by the CFPB along with a proposed rule as the next step in the rulemaking process.

The proposed regulations under consideration would (i) require lenders to take action to ensure that consumers can repay their loans, (ii) restrict lenders from collecting payment from consumers in ways that tend to create fees deemed excessive by the CFPB, and (iii) require lenders offering covered products to create and maintain policies and procedures related to record-keeping and ensuring compliance with the regulations.  These proposed regulations, which are intended to create a "federal floor for consumer protection for covered loans,"[8] are discussed in further detail below.

            A.   Avoiding Long-Term Debt

Under the approaches being considered, the CFPB would seek to ensure that consumers can promptly repay two separate types of credit products: (i) short-term loans that consumers are required to pay back in full within 45 days (Short-Term Loans), which would include most payday loans, deposit advance products and some open-end lines of credit and vehicle title loans, and (ii) "high-cost, longer-term" credit products of more than 45 days where the lender can access repayment from the borrower’s depository account, or hold a security interest in a vehicle, and the all-inclusive annual percentage rate is more than 36 percent (High-Cost, Long-Term Credit Loans), which would include some high-cost installment loans, longer-term vehicle title loans and similar open-end products.  

For both Short-Term Loans and High-Cost, Long-Term Credit Loans, the CFPB has proposed two regulatory alternatives: either (i) conduct an ability-to-repay determination or (ii) comply with a set of screening and structural requirements.  Under the CFPB’s approach, lenders will be required to satisfy one of the alternatives prior to offering the loan.  The CFPB believes that providing lenders with the opportunity to comply with a set of screening and structural requirements will reduce the costs of compliance for lenders and provide an alternative arrangement for small lenders that may have difficulties conducting ability-to-repay determinations.

Under this approach, the proposals would not cover the following products:

• non-recourse pawn loans of 45 days or less in which the lender takes possession of the collateral;
• credit cards;
• secured real estate loans; and
• student loans.

                        1.      Short-Term Loans

Under the CFPB’s approach, lenders offering Short-Term Loans would be required to either (i) conduct an ability-to-repay determination prior to offering the loan or (ii) adhere to certain screening and structural requirements designed to prevent the sustained use of Short-Term Loans.  These options are outlined in further detail below.

                                            i.            Ability-to-Repay Requirements

• Prior to issuing the loan, lenders would be required to verify the potential borrower’s income, major financial obligations and borrowing history to determine prior to issuing the loan that the consumer could repay the loan (including interest, principal and any fees for add-on products) without re-borrowing or defaulting after satisfying major financial obligations and living expenses.
• The proposal would create a rebuttable presumption that borrowers lack the ability to repay additional Short-Term Loans taken out within 60 days of a prior Short-Term Loan.  To rebut the presumption and make a second or third loan within the 60-day window, the lender would have to verify a change in circumstances that would indicate the borrower’s financial circumstances have improved to make the loan without re-borrowing.  The potential borrower could not have any other Short-Term Loans with any lender. 
• Further, following three consecutive loans, all lenders would be prohibited from offering a Short-Term Loan to the borrower for a minimum of 60 days.

                                          ii.            Screening and Structural Requirements

• The lender would be required to verify the potential borrower’s income, borrowing history and report the use of the loan to all applicable commercially available reporting systems.
• Short-Term Loans could not exceed $500, last longer than 45 days, have more than one finance charge or require a security interest in the consumer’s vehicle as collateral for the loan.
• The potential borrower could not have any other Short-Term Loans with any lender.  Further, the potential borrower could not be more than 90 days in debt on Short-Term Loans in a 12-month period.
• The potential borrower could not take out more than three Short-Term Loans in a sequence and any third loan in a sequence would be required to be followed by a cooling-off period of 60 days.
• The loan would be required to be structured to allow the borrower to taper off of Short-Term Loans.  The CFPB would allow two potential options:  either (i) the lender would be required to reduce the principal over the course of the three-loan sequence to make the loan resemble an amortizing loan, or (ii) the lender would be required to provide a no-cost "off-ramp" if the borrower is unable to repay after the third loan, to allow the borrower to repay the third loan over four additional installments without further fees.

                                        iii.            Alternatives Considered

The CFPB stated that it had considered, but rejected, the following approaches due to the burdens imposed on small lenders and the potential for flexible determinations to provide a more meaningful assessment of ability-to-repay:

• prohibiting lenders from making Short-Term Loans below a specific level of residual income; and
• prohibiting lenders from making Short-Term Loans if the lender has portfolio default and re-borrowing rates above a specified level. 

The CFPB also rejected an approach that would only impose limitations on loan sequences without requiring lenders to make an ability-to-repay determination, believing that this approach failed to provide adequate protections for potential borrowers.

                        2.      High-Cost, Long-Term Credit Loans

Similar to the proposed regime for Short-Term Loans, lenders offering High-Cost, Long-Term Credit Loans would be required to either (i) conduct an ability-to-repay determination prior to offering the loan or (ii) adhere to certain screening and structural requirements designed to prevent the sustained use of High-Cost, Long-Term Credit Loans.  The CFPB has noted that it is considering treating long-term loans with balloon payments in the manner outlined above for Short-Term Loans. 

                                            i.            Ability-to-Repay Requirements

• Prior to issuing the loan, lenders would be required to verify the potential borrower’s income, major financial obligations and borrowing history to determine prior to issuing the loan that the consumer can repay the loan (including interest, principal and any fees for add-on products) without re-borrowing or defaulting after satisfying major financial obligations and living expenses.
• Each time that the borrower seeks to refinance or re-borrow, the lender would be required to determine that the borrower was able to repay the loan without re-borrowing or defaulting after satisfying major financial obligations and living expenses.
• If the borrower has been delinquent on a payment, the lender would be prohibited from refinancing into another loan with similar terms without verifying a change in circumstances that would indicate the borrower’s financial circumstances had improved to make the loan repayable without re-borrowing.

                                          ii.            Screening and Structural Requirements

The CFPB is considering two approaches for the screening and structural requirements.  Under either alternative, the lender must verify the potential borrower’s income, borrowing history and report the use of the loan to all applicable commercially available reporting systems.  Further, the length of the loan must be between 45 days and six months.

• National Credit Union Administration Alternative
  

  (a)    The loan principal must be between $200 and $1,000, and fully amortize over no fewer than two payments.

  (b)   The lender cannot charge an interest rate higher than 28 percent and an application fee, reflecting the actual costs, of more than $20.

  (c)    The potential borrower must have no other covered loans outstanding,  and the loan must result in the potential borrower having no more than two loans during a rolling six-month period.

• Payment-to-Income Alternative
  

  (a)    The loan must be a closed-end loan payable in at least two substantially equal payments.

  (b)   The borrower must have no other covered loans outstanding, and the monthly payment on the loan must be no more than 5 percent of the borrower’s expected gross monthly income.

  (c)    The lender cannot charge fees for prepayment of the loan.

  (d)   The borrower must not have defaulted on any High-Cost, Long-Term Credit Loans in the last 12 months or have any other High-Cost, Long-Term Credit Loans outstanding.  Further, the loan must not result in borrower taking out more than two High-Cost, Long-Term Credit Loans in a rolling 12-month period.

                                        iii.            Alternatives Considered

Similar to Short-Term Loans, the CFPB considered, but rejected, approaches prohibiting lenders from making loans based on borrowers’ residual income levels and portfolio default and re-borrowing rates due to the burdens imposed on small lenders and the potential, in its view, for flexible determinations to provide a more meaningful assessment of ability-to-repay.

            B.   Payment Collection Practices

The CFPB stated that it was also considering requiring lenders to provide written notice to borrowers before accessing deposit accounts.  Prior to accessing a borrower’s checking, savings or prepaid account, lenders would be required to provide borrowers with three business days’ advance written notice detailing key information about the upcoming payment collection attempt including an exact break-down of the payment amount and date of collection attempt, payment channel, contact information for the lender and loan balance remaining.  The CFPB stated that it was considering allowing lenders to provide notice either through the mail or electronically to reduce the compliance costs associated with the proposed regulations.

The CFPB is also considering proposing regulations to limit repeated attempts to collect payment to reduce the possibility of excessive fees being charged to the borrower.  If a lender makes two consecutive unsuccessful attempts to collect from a borrower’s account, the lender would be prohibited from making any further attempts until the consumer provides a new authorization.  This is designed to limit the fees borrowers are charged in the event of unsuccessful attempts on their checking, savings or prepaid accounts.

            C.   Compliance and Record-Keeping

Finally, the CFPB stated that it was considering regulations to require lenders (i) to institute and maintain policies and procedures to reasonably designed to ensure compliance with the proposals outlined above and (ii) to retain records related to Short-Term Loans and High-Cost, Long-Term Credit Loans for 36 months after the last action on the applicable loan.  The record-keeping procedures would also include annual reports detailing defaults, re-borrowing and loans made under each alternative discussed above.

            D.   Effects on Payday Lenders

Based on simulations, the CFPB believes that, due to the greater costs of determining the ability of borrowers to repay a loan, it is likely that lenders making Short-Term Loans will primarily make use of the structural and screening requirements, which would have substantial impacts on revenue, with lenders that specialize in payday lending being the most severely affected.  Further, the CFPB finds that the proposals could lead to lenders diversifying their product offerings, and substantial consolidation in the short-term payday lending market, particularly in those markets where diversification is very difficult. 

The CFPB is still seeking insight into the effect that the regulations would have on lenders of High-Cost, Long-Term Credit Loans, but finds that the costs of using the screening and structural requirements would likely reduce operational costs associated with determining a borrower’s ability to repay a loan.

IV.   Conclusion

As noted above, the CFPB has published the Outline of Proposals in preparation for a panel that will gather feedback from small lenders on the effects of the proposed regulations under consideration.  Upon completion of the panel, the CFPB may be expected to issue proposed regulations, on which the public will be invited to submit comments prior to the issuance of the final regulations. 

Given the CFPB’s interest in the payday lending industry and the stringency of the proposed approaches discussed above, it is likely that the CFPB’s proposed regulations will subject lenders to increased regulatory compliance costs and reduce their ability to offer many current products.  This in turn will raise questions about the extent of the CFPB’s legal authority under the UDAAP provisions of Dodd-Frank, as well as the likely market effects of restrictions on current lending practices for borrowers who are not likely to become mainstream banking customers.  

[1]   Consumer Financial Protection Bureau, Payday Loans and Deposit Advance Products: A White Paper of Initial Data Findings, at 4 (Apr. 24, 2013).

[2]   Id. at 45.

[3]   Id. at 44.

[4]   Office of Financial Research, Consumer Financial Protection Bureau, CFPB Data Point:  Payday Lending (March 2014).

[5]   12 U.S.C. § 5531(b).

[6]   Id. § 5532(a).

[7]   5 U.S.C. § 603(d).

[8]  Consumer Financial Protection Bureau, Small Business Advisory Review Panel for Potential Rulemaking for Payday, Vehicle Title, and Similar Loans: Outline of Proposals Under Consideration and Alternatives Considered, at 4 (Mar. 26, 2015).