The federal government announced Thursday new plans to crack down on payday loans and tighten protections for the low-income borrowers who rely on them.
Meant as a short-term way to get out of financial jam, the Consumer Financial Protection Bureau (CFPB) says payday loans can become "debt traps" that harm millions of people across the country.
The proposals being unveiled would apply to various small-dollar loans, including payday loans, vehicle title loans and deposit advance products. They would:
Require lenders to determine that a borrower can afford to repay the loan
Restrict lenders from attempting to collect payment from a borrower's bank account in ways that would rack up excessive fees
"Too many short-term and longer-term loans are made based on a lender's ability to collect and not on a borrower's ability to repay," said CFPB director Richard Cordray in a statement. "These common sense protections are aimed at ensuring that consumers have access to credit that helps, not harms them."
Based on its study of the marketplace, the bureau determined that it's often difficult for people who are living from paycheck to paycheck to accumulate enough money to pay off their payday loans (and other short-term loans) by the due date. When this happens, the borrower typically extends the loan or takes out a new one and pays additional fees.
Four out of five payday loans are rolled-over or renewed within two weeks, according to the CFPB's research, turning a short-term emergency loan into an ongoing cycle of debt.
Reaction already coming in
The Consumer Financial Protection Bureau will officially unveil its proposals and take public testimony at a hearing in Richmond, Va. Thursday afternoon, but various groups have already issued comments.
Dennis Shaul, CEO of The Community Financial Services Association of America (CFSA) said the industry "welcomes a national discussion" about payday lending. CFSA members are "prepared to entertain reforms to payday lending that are focused on customers' welfare and supported by data," Shaul said in a statement. He noted that "substantial regulation," including limits on loan amounts, fees and number of rollovers, already exists in the more than 30 states where these loans are offered
Consumer advocates, who have been pushing the CFPB to regulate small loans for several years now, are pleased that the process of proposing rules has finally started. But they don't like some of the initial proposals.
"The CFPB has set the scene to dramatically change the small loan market to make it work better for consumers and responsible lenders," Nick Bourke, director of the small-dollar loans project at The Pew Charitable Trusts, told NBC News.
But he believes the current proposals have a big "loophole" that would continue to allow loans with balloon payments. Very few people can afford such loans and still make ends meet, he said.
Lauren Saunders, associate director of the National Consumer Law Center, called the CFPB's proposal "strong," but said they would permit some "unaffordable high-cost loans" to stay on the market.
"The proposal would permit up to three back-to-back payday loans and up to six payday loans a year. Rollovers are a sign of inability to pay and the CFPB should not endorse back-to-back payday loans," Saunders said in a statement.
The Pew Charitable Trusts has done several in-depth studies of the payday loan market. Here are some key findings from this research:
Approximately 12-million Americans use payday loans each year. They spend an average of $520 in fees to repeatedly borrow $375 in credit.
Payday loans are sold as two-week products for unexpected expenses, but seven in 10 borrowers use them for regular bills. The average borrower ends up in debt for half the year.
Payday loans take up 36 percent of an average borrower's next paycheck, but most borrowers cannot afford more than five percent. This explains why most people have to re-borrow the loans in order to cover basic expenses.
Payday borrowers want reform: 81 percent of all borrowers want more time to repay the loans, and 72 percent favor more regulation.
The CFPB website has a factsheet that summarizes the proposals under consideration.