New Regulations Look To Curb Payday Lending

The Consumer Financial Protection Bureau, an independent regulatory body created under the administration of President Barack Obama, recently released a new set of rules aimed at curbing what it calls "debt traps" involved in payday lending. This form of lending at high interest rates has recently become more popular throughout the U.S., with many consumer and financial policy groups calling for greater restrictions on the industry. But while the new rule shows the CFPB taking perhaps its toughest stance yet on alternative lenders, it still faces the possibility of repeal or replacement under the new administration of President Donald Trump.

"A new CFPB rule looks to crack down on payday lending."

According to a press release  announcing the final rule Oct. 5, the CFPB will now require and enforce a restriction that lenders only approve borrowers for loans if they have proof that they can afford them and understand the terms. Calling them "strong, common sense protections," the rule is designed to regulate any loan for which all or most of the debt is repaid at once, including payday loans, auto title loans, deposit advances and any long-term loan with "balloon payments."

"The Bureau found that many people who take out these loans end up repeatedly paying expensive charges to roll over or refinance the same debt," the CFPB said in the press release. "The rule also curtails lenders' repeated attempts to debit payments from a borrower's bank account, a practice that racks up fees and can lead to account closure."

Background on payday lending

Payday loans are characterized by small sums of money loaned to people at interest rates much higher than for the most common types of debt, and are so-called because they are supposed to be repaid in full when the borrower receives his or her next paycheck. For example, a payday loan of $400 might require the borrower pay back $460 in two weeks via a post-dated check they submit when they receive the loan. In this example, the borrower would be paying an annual percentage interest rate of around 300 percent, significantly more interest than is charged on credit card debt, mortgages and most other conventional loan products. 

With such a high cost to these loans, many consumers avoid them and are thus unfamiliar with the practice. But the industry is effectively kept afloat with its generally lax lending requirements, according to the CFPB, and often markets its services to low-income borrowers who are usually misled by the terms of the loans. A 2012 report from the Pew Charitable Trusts estimated that around 12 million Americans take out short-term loans  like payday loans each year. Most of these borrowers do so because they lack access to conventional forms of credit and need cash in an emergency. Across the U.S. are more than 18,000 retail locations or websites offering payday loans or similar products. According to The New York Times, there are more payday loan stores in the U.S. than there are McDonald's restaurants.

Based on the new CFPB rules, this is expected to change soon. The New York Times noted these new regulations pose a significant threat to the alternative lending industry, and "could largely eliminate" the practice of payday lending. In fact, 15 states already have such tough restrictions on these services that payday lending is effectively illegal. Still, the industry continues to grow, dispensing approximately $46 billion per year in loans and raking in $7 billion from fees. It remains to be seen if these rules will even take effect as scheduled, pending legal arguments and challenges from the Trump administration, which has made its distaste for business regulations clear. In any event, it may signal changing attitudes toward alternative lending.