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Understanding the consequences of the new CFPB short term lending rules

Jul 08, 2016 Philip Burgess

Early in June, the Consumer Financial Protection Bureau announced new proposals regarding short-term, high-interest loans, also known as "payday" loans. Now that some time has passed, it's worth surveying the scene to determine what impact these new rules are likely to have and how lenders can best respond.

The goal: Eliminating 'traps'

According to the CFPB, the primary purpose behind these new rules is to eliminate "short term debt traps," in the words of CFPB Director Richard Cordray.

"By putting in place mainstream, commonsense lending standards, our proposal would prevent lenders from succeeding by setting up borrowers to fail," Cordray asserted.

Ostensibly, the rules are intended to protect consumers from debt.

Going beyond paydays

However, it's important to note that while short-term, high-interest loans are the main focus of the CFPB's new rules and have certainly received the bulk of the attention, the agency's proposals actually extend well beyond this specific type of loan. In addition to short term loans, these regulations will affect certain types of auto title loans as well as high-cost installment loans.

This latter group is defined by the CFPB as "loans for which the lender charges a total, all-in annual percentage rate that exceeds 36 percent, including add-on charges, and either collects payment by accessing the consumer's account or paycheck or secures the loan by holding the title to the consumer's vehicle as collateral."

New rules

So what are the new rules?

"Lenders will ensure applicants are capable of repaying the loan amount."

The CFPB put forth four key protections. First and foremost, lenders will need to conduct a full-payment test for borrowers, ensuring that any applicant for a loan is actually capable of repaying the loan amount. Granting a short- or long-term loan to a borrower who cannot meet this requirement would therefore be in violation of the new CFPB rules.

The other rules require lenders to offer principal payoff options for select short-term loans; offer less risky long-term lending packages; and provide consumers with written notice before making any attempt to collect loan payments via debit.

Debating the merits

These proposed rules have received a mix response.

In its coverage, The New York Times described the proposal as "Short term Loans' Debt Spiral to Be Curtailed" - suggesting a rather high degree of approval. NPR adopted a similar tone in its headline, "New Rules to Ban Short term Lending 'Debt Traps.'" In that piece, Mike Clahoun, president of the consumer advocacy group the Center for Responsible Lending, stated that he supported the rules, although he feared that lenders would find and exploit loopholes negating their impact.

However, The Washington Post ran an op-ed by Tim Worstall of the Adam Smith Institute and Forbes, claiming "We can't get rid of short term loans just because we don't like them." Worstall went on to argue that the CFPB's proposed rules will severely undermine this lending industry, even though there is clearly a high level of demand for these types of loans and no apparent alternative solution for consumers in this market.

Next steps for lenders

Regardless of whichever interpretation you may subscribe to, lenders that offer these types of loans undoubtedly need to take steps to comply with the new regulations.

Obviously, the exact course of action will have to vary significantly from one lending institution to another. Yet one common theme for virtually every organization will be the need for a increased focus on Know Your Customer (KYC). Lenders need to invest in tools that will allow them to gain a clearer understanding of their potential customers' financial information in order to accurately gauge whether a given loan applicant can actually repay what's borrowed. With the right resources on-hand, lenders will be much better able to adapt to these new requirements.