The Consumer Financial Protection Bureau on Thursday is proposing new regulations to protect consumers from predatory lending practices that the CFPB's top regulator calls "debt traps."
Americans are being "set up to fail" by payday and auto-title lenders, Richard Cordray, the director of the Consumer Financial Protection Bureau, tells NPR.
"The way these products are structured, it's very difficult to repay the loan, and therefore people end up borrowing again and again and paying far more in fees and interest than they borrowed in the first place," Cordray says.
Under the proposed rule, so-called "payday," "auto-title" and other short-term lenders would be required to determine that people they loan money to can make the payments and fees when they come due and still meet basic living expenses and major financial obligations.
With interest rates of 300 percent and higher, these lenders have fallen under greater scrutiny at both the state and federal level. In March of last year, President Obama said he supported tougher regulations for payday lenders who profit by charging borrowers super-high interest rates. "If you're making that profit by trapping hard-working Americans into a vicious cycle of debt, you've got to find a new business model," the president said.
Payday Loans: A Helping Hand Or Predatory Quicksand?
Let's say a low-wage worker's car breaks down. She has to get to work and take her kids to school. But she has bad credit, no credit cards and no way to pay for the car repair. A payday lender might in effect say, "No problem. I'll give you the money you need right now to get your car fixed, and you give me your bank account number, and when you get paid in two weeks I'll withdraw the money you owe me from your checking account."
The industry says these loans are needed to help working Americans through a cash squeeze and that the new regulations are unwarranted. "The CFPB's proposed rule presents a staggering blow to consumers as it will cut off access to credit for millions of Americans who use small-dollar loans to manage a budget shortfall or unexpected expense," says Dennis Shaul, CEO of the payday lending industry group, the Community Financial Services Association.
But regulators say the problem is that the terms are so onerous that many borrowers can't afford to pay the loans back and still have enough for their rent and other essentials. And so they end up taking out another loan, and then another loan after that, again and again for months or sometimes years, sinking deeper into a quagmire.
Cordray says consumers think they are getting into a one-time loan but they get "trapped" by this cycle. He says it is like "getting in a taxi just to drive across town and you find yourself in cross-country journey that can be ruinously expensive."
The CFPB studied the payday lending industry before crafting the proposed rule and found that four out of five of these single-payment loans are re-borrowed within a month. In the case of auto-title loans where borrowers put their cars up as collateral, one in five borrowers ends up having a car or truck seized by the lender for failure to repay.
Consumer Groups Applaud The Rule But Wary Of Loopholes
Watchdog groups for decades have been critical of payday lenders. "The lesson from the last 20 years since this industry started is that it's been remarkably effective at evading attempts at regulation and using a very high-powered lobbying machine to push for loopholes," says Mike Calhoun, the president of the Center for Responsible Lending.
Calhoun says he supports the proposed rule from the CFPB, but he's still concerned the industry will find a way to work around it.
AILSA CHANG, HOST:
A federal watchdog agency is cracking down on payday lenders and other costly forms of short-term credit. Payday loans can carry interest rates of 300 percent or more. And while they're typically marketed as a way to tide borrowers over 'til their next paycheck, many people wind up having to renew the loans again and again. The Consumer Financial Protection Bureau wants to stop all that with a proposed rule it's unveiling today. NPR's Scott Horsley reports.
SCOTT HORSLEY, BYLINE: Payday lending has mushroomed into big business. There are more payday storefronts in the U.S. than there are McDonald's restaurants. And last year, the industry collected more than three and a half billion dollars in fees. Richard Cordray, who directs the Consumer Financial Protection Bureau, worries payday lenders, car title lenders and other providers of short-term credit are too often profiting at their customers' expense.
RICHARD CORDRAY: Lenders are finding ways to succeed, even as they're setting up borrowers to fail.
HORSLEY: The watchdog agency's research found 4 out of 5 customers who take out a payday or car title loan soon have to take out another one. The refinancing fees quickly mount up. And 20 percent of car title borrowers wind up having their vehicles seized. Last month, Google announced it plans to stop taking ads for payday lenders. President Obama also promised to crack down when the government launched its rulemaking process last year.
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President BARACK OBAMA: If you're making that profit by trapping hard-working Americans into a vicious cycle of debt, you've got to find a new business model. You've got to find a new way of doing business.
HORSLEY: Consumer advocates have long argued that the payday way of doing business is a potential trap. Borrowers hand over a post-dated check or sign paperwork giving the lender direct access to their bank account. Payday lenders can then collect as soon as a borrower is paid, even if that leaves little money left over to pay their rest of the monthly bills. In fact, Mike Calhoun of the Center for Responsible Lending says that's how payday lenders prefer it.
MIKE CALHOUN: Their best customer is the one that they can collect from but who can't repay the loan and move on with their life, that has to refinance again.
HORSLEY: Their proposed rule is designed to curb that practice by requiring payday, car title and other lenders to check borrowers' income and expenses to make sure they can afford to repay a loan without falling deeper into debt. Cordray expects to finalize the rule in 90 days.
CORDRAY: We want these products to help consumers, not harm them.
HORSLEY: The rule would also restrict lenders from making repeated attempts to debit a borrower's bank account.
CORDRAY: They will just ping the account again and again. And you'll incur a fee for each one of those. And that can happen six, eight, ten times, racking up hundreds of dollars in fees.
HORSLEY: The payday industry complains the proposed rule goes too far. Dennis Shaul, who heads a trade group called the Community Financial Services Association, warns the rule could dry up access to credit for borrowers who badly need it.
DENNIS SHAUL: There are very few credit alternatives for the people who borrow from us. And eliminating one of their choices is not the way to go.
HORSLEY: Over the years, the payday industry has proven adept at lobbying policymakers to water-down regulation, and adjusting its products just enough to avoid oversight while maintaining hefty fees. Consumer advocate Calhoun says watchdogs will have to guard against that here.
CALHOUN: What this fight will come down to is can the payday lenders again pull one of their evasion moves so they continue preying on working families?
HORSLEY: The payday industry is already threatening a legal challenge to the proposed rule. And there is a bipartisan bill pending in Congress that would substitute a much weaker form of consumer protection. Scott Horsley, NPR News, Washington. Transcript provided by NPR, Copyright NPR.