WASHINGTON (MNI) - The following is an excerpt from the Consumer Financial Protection Bureau's proposed rules for installment loans carrying annual interest rates of 36% or more, published Thursday. The deadline for comments is Oct. 14:
PROPOSAL TO END DEBT TRAPS
The CFPB is proposing a rule that would put an end to the risky practices in these markets that trap consumers in debt they cannot afford. The proposed ability-to-repay protections include a "full-payment" test that would require lenders to determine upfront that consumers can afford to repay their loans without reborrowing. The proposal includes a "principal payoff option" for certain short-term loans and two less risky longer-term lending options so that borrowers who may not meet the full-payment test can access credit without getting trapped in debt. Lenders would be required to use credit reporting systems to report and obtain information on certain loans covered by the proposal. The proposal would also limit repeated debit attempts that can rack up more fees and make it harder for consumers to get out of debt. These protections would be in addition to existing requirements under state or tribal law.
Full-Payment Test
Under the proposed full-payment test, lenders would be required to make an upfront determination of a consumer's ability to repay the loan. Before offering a loan, lenders would be required to check if the borrower can afford to pay the full amount of each payment owed when it's due, whether as a lump sum or an installment. The full-payment test includes the following:
Requirements for determining affordability: Lenders would have to determine whether the borrower will have enough income to afford the loan, meet the consumer's major financial obligations, and still pay basic living expenses, like food and utilities. Lenders would be required to verify the amount of income that a consumer receives, after taxes, from employment, government benefits, or other sources. In addition, lenders would be required to check a consumer's credit report to verify the amount of outstanding loans and required payments.
Payday and single payment auto title: For short-term loans, lenders would be required to determine that the borrower has sufficient income to pay the loans and to meet major financial obligations and basic living expenses during the term of the loan and for 30 days after paying off the loan or paying the loan's highest payment.
High-cost installment loans: For installment loans with a balloon payment, lenders would be required to ensure a borrower can pay all of the payments when due, including the balloon payment, as well as major financial obligations and basic living expenses during the term of the loan and for 30 days after paying the loan's highest payment. For installment loans without a balloon payment, lenders would be required to determine that a borrower can pay all of the installment payments when due, as well as major financial obligations and basic living expenses during the loan's term.
Requirements for justifying additional loans: The proposal would further protect against debt traps by making it difficult for lenders to push distressed borrowers into reborrowing or refinancing the same debt.
Payday and single-payment auto title: If a borrower seeks to roll over a loan or returns within 30 days after paying off a previous short-term debt, the lender would be restricted from offering a similar loan. Lenders could only offer a similar short-term loan if a borrower demonstrated that their financial situation during the term of the new loan would be materially improved relative to what it was since the prior loan was made. The same test would apply if the consumer sought a third loan. Even if a borrower's finances improved enough for a lender to justify making a second and third loan, loans would be capped at three in succession followed by a mandatory 30-day cooling off period.
High-cost installment loans: For consumers struggling to make payments under a payday installment or auto title installment loan, lenders could not refinance the loan into a loan with similar payments unless a borrower demonstrated that their financial situation during the term of the new loan would be materially improved relative to what it was during the prior 30 days. The lender could offer to refinance if that would result in substantially smaller payments or would substantially lower the total cost of the consumer's credit.
Principal Payoff Option for Certain Short-Term Loans
Under the proposal, consumers could take out a short-term loan up to $500 without the full payment test as part of the principal payoff option that is directly structured to keep consumers from being trapped in debt. This option would be restricted to lower-risk situations and would require the debt to be repaid either in a single payment or with up to two extensions where the principal is paid down at each step. The specific parameters of the principal payoff option include:
-Restricted to lower-risk situations: Under this option, consumers could borrow no more than $500 for an initial loan. Lenders would be barred from taking auto title as collateral and structuring the loan as open-end credit. Lenders would also be barred from offering the option to consumers who have outstanding short-term or balloon-payment loans or have been in debt on short-term loans more than 90 days in a rolling 12-month period.
-Debt is paid off: As part of the principal payoff option, the lender could offer a borrower up to two extensions of the loan, but only if the borrower pays off at least one-third of the principal with each extension. This proposed principal reduction feature is intended to steadily reduce consumers' debt burden, allowing consumers to pay off the original loan in more manageable amounts to avoid a debt trap.
-Debt risks are disclosed: The proposal would require a lender to provide notices before making a loan under the principal payoff option. These notices must use plain language to inform consumers about elements of the option. Reporting Requirements The proposal would require lenders to use credit reporting systems to report and obtain information about loans made under the full-payment test or the principal payoff option. These systems would be considered consumer reporting companies, subject to applicable federal laws, and registered with the CFPB. Lenders would be required to report basic loan information, and updates to that information.
Less Risky Longer-Term Loan Option
The proposal would also permit lenders to offer two longer-term loan options with more flexible underwriting, but only if they pose less risk by adhering to certain restrictions. The first option would be offering loans that generally meet the parameters of the National Credit Union Administration "payday alternative loans" program where interest rates are capped at 28 percent and the application fee is no more than $20. The other option would be offering loans that are payable in roughly equal payments with terms not to exceed two years and with an all-in cost of 36 percent or less, not including a reasonable origination fee, so long as the lender's projected default rate on these loans is 5 percent or less. The lender would have to refund the origination fees any year that the default rate exceeds 5 percent. Lenders would be limited as to how many of either type of loan they could make per consumer per year.
Penalty Fee Prevention
Repeated unsuccessful withdrawal attempts by lenders to collect payment from consumers' accounts can pile on insufficient fund fees for consumers from their financial institution and prompt returned payment fees from the lender. A CFPB study over an 18-month period found that half of online payday and payday installment borrowers racked up penalty fees. These consumers were charged $185 in bank penalties on average from debit failures or overdrafts. More than one-third of borrowers with a failed payment ultimately lost their account. The following protections would apply to all loans covered by the proposal:
-Written notice: Lenders would have to give consumers written notice before attempting to debit the consumer's account to collect payment for any loan covered by the proposed rule. This notice, which generally would be delivered at least three days before the withdrawal attempt, would alert consumers to the timing, amount, and channel of the forthcoming payment transfer. If the payment transfer would be for a different amount, at a different time, or through a different payment channel than the consumer might have expected based upon past practice, the notice would specifically alert the consumer to the change. The Bureau believes the proposed required notice would help to reduce harm that may occur from a debit attempt by alerting the consumers to the upcoming attempt in sufficient time for them to contact the lender or the consumer's bank if there are any mistakes. It would also allow them time to make arrangements to cover payments that are due.
-Debit attempt cutoff: After two straight unsuccessful attempts, the lender would be prohibited from debiting the account again unless the lender gets a new and specific authorization from the borrower to again debit the account.
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--MNI Washington Bureau; tel: +1 202-371-2121; email: denny.gulino@mni-news.com