Payday loans are the perfect example of something that seems too good to be true. People short on cash seize on these loans to tide them over, but then become trapped in a cycle of repeat borrowing and escalating costs.
The Consumer Financial Protection Bureau has been watching payday lending practices, and it's now unveiled proposed rules aimed at putting a stop to some of the worst abuses.
"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 the bureau's director, Richard Cordray, in a prepared statement. "The proposals we are considering would require lenders to take steps to make sure consumers can pay back their loans."
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About 12 million Americans take out payday loans, or advances on coming paychecks, every year, according to a study by the Pew Charitable Trust. (Tweet this) But the interest rates are often high, and consumers wind up having to borrow again. The study found that the typical borrower takes out eight loans of $375 per year, and interest takes a $520 toll.
"With payday loans, vehicle title loans and many types of installment loans, the pattern is all too common," Cordray said in his statement. "In many of these markets the lender's business model often depends on many consumers being unable to repay the loan and needing to borrow again and again while incurring repeated fees."
The consumer bureau's research found that more than 80 percent of payday loans are rolled over. Half of all payday loans are in a lending sequence of 10 loans or more, and the size of the loan is more likely to increase in longer loan sequences. If borrowers can't keep up, they can face overdrafts and account closures, which can negatively affect their credit reports. Some may tip into bankruptcy.
The CFPB's potential payday loan proposal would require lenders to make sure a borrower has the ability to repay the loan before they extend credit, and to limit the number of times a loan can be rolled over. In theory, that would mean borrowers likely to get caught in cycles of repeat borrowing would not be able to take out that first loan. The proposal would also extend to other forms of credit in which lenders gain access to a borrower's paycheck or bank account to take repayment.
The Community Financial Services Association of America, which represents payday lenders, said it "welcomes a national discussion" on providing short-term credit, but argued that "payday loans represent an important source of credit for millions of Americans who live from paycheck to paycheck."
The association warned that new rules should be "grounded in rigorous research" and that rulemakers should consider the impact of new regulation on lenders that are small businesses.
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On the other side, some consumer groups said the bureau's proposals need to go further. Lauren Saunders of the National Consumer Law Center applauded much of the plan but said it contains more loopholes for lenders than it should.
"Lenders must be judged both on whether they evaluate affordability before making a loan and also on whether those loans default, roll over or are refinanced in significant numbers," she said in a prepared statement.
The bureau is holding a field hearing on payday lending in Virginia and plans to consult the Small Business Review panel before proceeding with rulemaking.