Mayday for Payday? High Cost Installment Loans
The Consumer Financial Protection Bureau (CFPB) today proposed rules (Payday, Vehicle Title, and Certain High-Cost Installment Loans) pursuant to its authority under 12 U.S.C. §§1022, 1024, 1031, and 1032 (Dodd-Frank) that will severely restrict what is generally referred to as the “payday lending” industry (Proposed Rules).
The Proposed Rules merit careful review by all financial services providers; in addition to true “payday lenders,” they create substantial risk for banks and other traditional financial institutions that offer short-term or high-interest loan products—and risk making such credit effectively unavailable in the marketplace. The rules also create a serious risk of secondary “assisting and facilitating” liability for all financial institutions that provide banking services (in particular, access to the ACH payments system) to lenders that the rules directly cover.
For the loans to which they apply, the Proposed Rules would
sharply curtail the now-widespread practice of making successive short-term loans;
generally require assessment of the borrower’s ability to repay; and
impose limitations on the use of preauthorized ACH transactions to secure repayment.
Violations of the Proposed Rules, if adopted as proposed, would constitute “abusive and unfair” practices under the CFPB’s broad unfair, deceptive, or abusive acts or practices (UDAAP) authority. This would make them enforceable not only by the CFPB, but by all state attorneys general and financial regulators, and may form the basis of private class action claims by contingent fee lawyers.
The deadline to submit comments on the Proposed Rules is September 14, 2016. The Proposed Rules would become effective 15 months after publication as final rules in the Federal Register. If the CFPB adheres to this timeline, the earliest the rules could take effect would be in early 2018.
Summary of the Proposed Rules
The Proposed Rules would apply to two types of products:
Consumer loans that have a term of 45 days or less, and vehicle title loans with a term of 30 days or less, would be subject to the Proposed Rules’ extensive and onerous conditions and requirements.
Consumer loans that (i) have a total “cost of credit” of 36% or more and are secured by a consumer’s vehicle title, (ii) incorporate some form of “leveraged payment mechanism” such as creditor-initiated transfers from a consumer’s paycheck, or (iii) have a balloon payment. For the purpose of determining whether a loan is covered, the “total cost of credit” is defined to include virtually all fees and charges, even many that would be excluded from the definition of “finance charge” (and hence from the standard APR calculation) under the Truth in Lending Act and Regulation Z. The proposed definition has some similarities to the “Military APR” calculation for the total cost of credit on short-term loans to active-duty service members under the Military Lending Act, but is even broader than that definition.
The Proposed Rules would exclude entirely many traditional forms of credit from their coverage. This would include lines of credit extended solely for the purchase of an item secured by the loan (e.g., automobile loans), home mortgages and home equity loans, credit cards, student loans, non-recourse loans (e.g., pawn loans), and overdraft services and lines of credit.
The Proposed Rules would impose so-called “debt trap” restrictions on covered loans, including an upfront ability-to-pay determination requirement, as well as restrictions on loan rollovers. Specifically, the Proposed Rules would require a covered lender to take measures prior to extending credit to assure that the prospective borrower has the means to repay the loan sought. These measures would include income verification, verification of debt obligations, forecasted reasonable living expenses, and a projection of both income and ability to pay. In many cases, if a consumer seeks a second covered short-term loan within 30 days of obtaining a prior covered loan, the lender would be required to presume that the customer lacks the ability to repay and therefore reconduct the required analysis. Depending on the circumstances, the rules create several consumer-focused exceptions to this presumption that could allow for subsequent loans. Notwithstanding those exceptions, however, the rules would impose a per se bar on making a fourth covered short-term loan after a consumer has already obtained three such loans within 30 days of each other.
In addition, the Proposed Rules would require covered lenders to give notice of upcoming due dates, and lenders would not be permitted to make more than two automated debt/collection attempts should a payment channel such as ACH fail due to insufficient funds.
Initial Takeaways and Implications
Whether these loan products will remain economically viable in light of the proposed new restrictions, especially the upfront due diligence requirements and the “debt trap” restrictions, is very much an open question. Certainly, the Proposed Rules would put at risk some of the principal forms of short-term consumer credit that currently are available to lower-income borrowers, and potentially could make such credit commercially nonviable for lenders—especially for smaller lenders that would lack the operational infrastructure and systems to comply with the many proposed conditions and restrictions.
However, traditional bank and similar lenders need to understand the specific risks that could be associated with providing ACH and other commercial banking services to lenders covered by the Proposed Rules. The CFPB may well consider these commercial banks to be “service providers” under CFPB guidance issued in 2012. As a result, banks and savings institutions may have a duty to assure that high-interest and short-term lenders using the bank’s services and facilities are in compliance with the rules or risk being considered to have “assisted and facilitated” a violation. This could be especially true should, for example, a third attempt be made to collect a payment through the ACH network because a bank’s operations system was unaware that it was withdrawing a “payday” payment. Hence, banking institutions may conclude that providing payments or other banking services to covered lenders is simply too risky a proposition.