If you’re reading this article, you’ve probably heard about the Consumer Financial Protection Bureau’s small dollar lending proposal. But if you’ve somehow missed the most controversial news item in the finance industry this year, here’s what you need to know:
- In June, the CFPB released a proposed rule intended to reform payday loans, single-payment vehicle title loans and other forms of short-term, high-cost, small dollar credit. Think loans in the range of hundreds of dollars, with annual percentage rates over 100%, due back in weeks—not months.
- Millions of Americans take out these loans every year and, according to the CFPB, fall into predatory “debt traps” when they are unable to repay the loans without engaging in further borrowing.
- In brief, the Bureau’s rigorous new rules would overhaul small dollar lending as we know it:
- Consumers would be limited to taking out no more 6 loans per year.
- Lenders would need to ensure borrowers could afford pay back these loans by conducting an extensive review of each borrower’s finances and living expenses.
There are plenty of additional details, as well as exceptions, contained in the CFPB’s 1300-page proposal. If you aren’t familiar with the rules to come, I encourage you to read all about them in advance of October 7th, when the CFPB will close the ongoing comment period.
For now, let’s take a look at five lingering questions you should consider before then:
Will small dollar loans become cost prohibitive?
Conducting a detailed analysis of an individual’s income, bank accounts, bills and other monthly expenses is no small feat. When it comes to loan amounts of less than $500, the time and overhead associated with such an analysis simply may not add up for many lenders. In other words, the CFPB’s new underwriting requirements will lower lenders’ profit margins, which could compel businesses to discontinue small dollar loan products or exit the market entirely.
Will borrowers turn elsewhere?
What happens if payday lenders go out of business? Consumers who rely on immediate access to small sums of money will have to find it elsewhere. Even if they do retain the option to walk into their local loan provider’s office, some borrowers may be put off by the arduous application process, or may not get approved. Instead, these borrowers may wind up borrowing from friends and family, asking for payday advances or finding alternative ways to obtain the cash they need.
Does the rule really benefit consumers?
The CFPB’s proposal is designed to protect borrowers who don’t have credit with a banking institution and lack assets they could use to secure low-interest loans. Sometimes referred to as “non-prime”, near-prime, or underbanked borrowers, members of this enormous consumer group—like most Americans—typically have less than $1000 in their savings accounts. When you have no money stowed away and nowhere else to turn, a small dollar loan represents a valuable lifeline of credit, even if you know you probably won’t be able to pay it back in 30 days.
By disallowing untenable loans at the outset, the CFPB’s new rules may have an unintended consequence: numerous Americans could lose access to money they use to keep the lights on. It’s a choice between defaulting on a loan and not having the ability to pay for a life-saving medical procedure or repairs in the aftermath of a car accident. It may not be a great choice, but it’s a reality for people all over the US.
Then there’s the subset of non-prime consumers who have unpredictable income but consistently pay back their debts: How will they adjust when they can only take out a maximum of 6 loans annually?
Which loan products are next?
As CFPB director Richard Cordray stated in his speech during the proposal announcement, the Bureau is “also launching a related inquiry into other situations that may harm consumers,” including “further questions about high-cost, longer-term installment loans and open-end lines of credit that lack vehicle security or an account access feature.” Non-depository, non-bank lenders—which the CFPB tends to consider together with payday lenders—are very much distinct entities but could soon face similar regulations.
Will Congress step in?
The CFPB is unique in that it is a wholly independent agency not accountable to the Executive or Legislative branches of government. However, months before the Bureau released its small dollar lending proposal, members of Congress introduced the Consumer Protection and Choice Act (H.R. 4018), which would delay the imminent rules until 2020 and negate the CFPB’s jurisdiction over the issue in any state with existing payday loan legislation. Suffice it to say that Congressional moves—as well actions taken by the incoming president—could fundamentally alter the CFPB as it exists today.
If you can take the rights steps to navigate the consumer finance landscape that exists today, you’ll be better equipped for the future. Whatever happens next, any lender would be wise to implement a robust compliance management system in preparation of what is sure to be an endless river of regulatory changes to come, rather than scrambling to do so after the fact.