The Consumer Financial Protection Bureau (the Bureau or CFPB) released its Notice of Proposed Rulemaking that would regulate small-dollar lenders on the federal level and subject them to strict requirements that when finalized would require many lenders and their service providers to fundamentally alter their business models. The highly anticipated proposed rule spans over 1,300 pages, and this article provides answers to several frequently asked questions.
Director Richard Cordray says that the proposed rule is designed to end "payday debt traps," where "borrowers seeking a short-term cash fix are saddled with loans they cannot afford and sink into long-term debt." Comparing the payday and small-dollar lending to a taxi ride across town that ends up becoming a cross-country journey, he said that a system where "a lender can succeed when borrowers are set up to fail, it is a telltale sign of a malfunctioning market."
Whether the proposed rule will create a better-functioning marketplace is debatable, but one thing is certain: the proposed rule could upend the market and place a host of new regulations on an industry that will need to adapt quickly or disappear. The proposed rule would impose strict underwriting requirements on payday and title lenders that many believe would be difficult if not impossible to comply with and thus pose an existential threat to the traditional payday and auto title industries. The proposal would create three alternatives exempt from these requirements, however, which appear designed to push the market away from traditional loans and toward other products. The rule also requires lenders to maintain detailed records of loan determinations and exceptions and includes an anti-evasion clause to enforce compliance. Lenders will need to adapt, but the proposed rule provides an opportunity for the lenders to pioneer these new markets.
The new rule would go into effect 15 months after the final rule is published, which will likely occur toward the middle of 2017. The proposed rule is open for public comment until September 14, 2016.
In addition, the Bureau issued a Request for Information (RFI) and is seeking comment on (1) potential consumer protection concerns with loans that fall outside the scope of the proposed rule, but are designed to serve populations and needs similar to those covered by the proposal; and (2) business and sales practices concerning loans falling within the proposed rule's coverage that raise potential consumer protection concerns that are not addressed. The Bureau also anticipates issuing a future proposal to regulate debt collection practices for covered and non-covered loans, but is concerned at this stage that there may be certain practices (referred to as "enhanced collection practices") that are more prevalent for high-cost loans and that may be exacerbated by the finalization of the proposed rule.
Comments are due on the RFI by October 14, 2016.
Are commercial loans covered by the proposed rule?
The proposed rule applies only to consumer loans made primarily for "personal, family, or household purposes," and excludes loans made primarily for "business, commercial, or agricultural" purposes. The proposed rule prohibits lenders from evading the intent of the proposed rule. The CFPB will take into consideration the "actual substance" of the lender's action as well as "other relevant facts and circumstances" to determine if the lender's action was taken with the intent of evading the requirements of the proposed rule. Such evasive action can be knowing or reckless.
Business-purpose loans that would, if made to consumers, be considered a covered loan under the proposed rule must be made for actual business purposes.
Are there limits to a lender's creativity in how it structures loans and charges fees if they do not violate the letter of the proposed rule?
The Bureau acknowledges that it cannot anticipate every possible way in which lenders could evade the requirements of the proposed rule, but it does provide a short, non-exclusive list of actions that might be taken with such an intent. These include various fee structures as well as methods of changing the nature of a loan after consummation.
What types of loans are "covered loans" under the proposed rule?
The proposed rule provides two categories of covered loans. A "covered loan" means closed-end or open-end credit that is extended to a consumer primarily for personal, family, or household purposes that is not excluded by the rule. Specifically, covered loans are:
- short-term loans of 45 days or less, including payday loans, deposit advance products, vehicle title loans, installment loans, and open-end lines of credit; and
- longer-term loans greater than 45 days that have an all-in APR greater than 36%, and either are repaid directly from the consumer's account or direct access to the consumer's paycheck, or are secured by the consumer's vehicle. This category includes vehicle title loans, installment loans, and open-end products.
The proposed rule would cover loans made by banks, credit unions, and nonbanks regardless of whether the institution operates online or out of storefronts, and regardless of what state licenses the institution may hold.
What does the proposal require for short-term loans like payday loans and auto title loans?
The proposal would impose onerous and unprecedented underwriting requirements for short-term loans like payday and auto title loans. Lenders would be required to collect and consider records regarding the consumer's debts, income, housing expenses and determine the consumer's Ability-to-Repay (ATR) the full debt obligation prior to making the loan.
- Full-Payment Test:
- Lenders of short-term loans and installment loans with balloon payments would be required to conduct an ATR analysis for each consumer to determine if the consumer can make the full payment and would not have to re-borrow within 30 days, while still meeting basic living expenses.
- Lenders of covered installment loans without balloon payments would be required to determine that a borrower can afford all payments when they are due.
Does the proposal provide any alternatives for short-term loans that do not require an ATR analysis?
Yes. The proposal would include an alternative short-term option called the Principal Payoff Option where no ATR analysis is required, but must adhere to strict requirements, including:
- Loan amount cannot exceed $500.
- Consumer may not have outstanding covered loans.
- Consumer cannot have been in debt on a covered loan for more than 90 days in a rolling 12-month period.
- The lender may only renew or "roll over" the loan twice with the condition that the borrower pays one-third of the principal each time the loan is extended.
- Additionally, the consumer is not permitted to take out more than six of these covered loans in a 12 month period.
- The principal payoff option would also not be permitted for loans where a lender takes an auto title as collateral.
What does the proposal require for longer-term loans?
The proposed ATR requirements for covered longer-term loans closely track those for short-term loans with an added requirement that the lender reasonably account for the possibility of volatility in the consumer's income, obligations, or basic living expenses during the term of the loan.
Does the proposal provide any alternatives for longer-term loans that do not require an ATR analysis?
Yes. The proposal would include two alternative longer-term option where no ATR analysis is required, assuming the loan meets certain criteria:
- NCUA PAL Approach (no ATR analysis required):
- Lenders would be able to offer loans with terms that generally meet the parameters of the National Credit Union Administration's (NCUA) payday alternative loans (PAL) program, which caps the interest rate at 28% and the application fee at $20 or less, and does not include any prepayment fees.
- Portfolio Approach (All-In Cost of 36%) (no ATR analysis required):
- Lenders could also offer loans with an all-in cost of no more than 36% with no prepayment fees (excluding a reasonable origination fee), a term that does not exceed two years, and with payments that are roughly equal.
How does a lender determine a consumer's Ability-to-Repay?
For both types of covered loans under the proposed rule, the lender must conduct an ATR analysis, also known as a full-payment test. It will be considered an abusive and unfair practice for a lender to make a covered loan without reasonably determining the consumer's ATR.
To determine a consumer's ATR, the lender providing payday and single-payment auto title loans will need to verify a consumer's current net income, debt obligations (using a national consumer report), and housing expenses, and will have to forecast a reasonable amount for the consumer's basic living expenses, net income, debt obligations, and housing costs for the term of the loan, and, in some cases, for 30 days after. Providers of high-cost installment loans with balloon payments would also have to determine that a borrower can pay all of the installment payments when due.
Does the proposal exclude any specific financial products?
The proposed rule excludes several types of consumer credit from the scope of the proposal, including (1) loans extended solely to finance the purchase of a car or other consumer good securing the loan (purchase money security interest or PMSI); (2) home mortgages and other real estate secured loans; (3) credit cards; (4) student loans; (5) non-recourse pawn loans; and (6) overdraft services and lines of credit. The Bureau notes that excluding these types of loans does not mean that the Bureau is not interested in regulating abusive or deceptive practices in this area. Rather, the proposed rule is limited only to those types of loans that the Bureau has studied in depth today. The Bureau seeks comments regarding how and whether particular types of these excluded loans should be covered by the proposed rule.
Of particular note, there is no provision in the proposed rule that provides an exemption from certain underwriting requirements for banks. An earlier proposal included a potential exemption if monthly payments did not exceed 5% of the borrower's gross monthly income – a proposal banks were looking at as a business model.
Are there any restrictions on collecting payments from borrowers?
The proposed rule makes it an unfair and abusive practice to attempt to withdraw payment from a consumer's account without first providing notice at least three but not more than six business days in advance of a withdrawal attempt. Furthermore, a lender may not attempt to withdraw payment from a consumer's account after two consecutive payment attempts have failed, unless the lender obtains new and specific authorization from the consumer.
What restrictions exist for rolled-over or additional loans?
The mandatory cooling-off period requires the lender to deny offering a new loan to a borrower who seeks to roll over a loan or attempts to initiate a new loan within 30 days after paying off a previous short-term loan. Lenders can get around this restriction if the borrower demonstrates that his or her financial situation has materially improved since the prior loan was made.
Regardless of whether the borrower meets this requirement, loans would be capped at three successive rollovers or new loans followed by a mandatory 30-day cooling-off period. The original proposal created a 60-day cooling-off period, so the industry should be aware that the CFPB may go back to the longer period after receiving comments.
The ATR must be reanalyzed each time a consumer seeks to refinance or re-borrow. Certain borrower actions lead to a presumption that the borrower is not able to afford a new loan. First, if a borrower seeks a covered short-term loan within 30 days of a covered loan, then a consumer is likely not able to afford the new loan. Likewise, for longer-term loans, a presumption of unaffordability would apply if the consumer has shown or expressed difficulty in repaying other covered or non-covered loans made by the same lender. A lender can overcome the presumption of unaffordability if it can document a sufficient improvement in the consumer's financial capacity since the last loan.
The presumption of unaffordability would not apply if the consumer paid in full the prior covered short-term loan, and the consumer would not owe, in connection with the new loan, more than 50% of the amount that the consumer paid on the prior loan. Additionally, the presumption would not apply if the consumer is seeking to roll over the remaining balance on a covered short-term loan and would not owe more on the new loan than the consumer paid on the prior loan that is being rolled over, and the repayment period was at least as long as the period for the prior loan.
What are the additional disclosure requirements for lenders?
Numerous disclosure requirements exist that make clear to the consumer the terms and risks of the covered loans. Such disclosures include a tabular display of the consumer's borrowing limits for the loan and sequence of loans should the consumer roll over. The CFPB has provided model disclosure forms.
What are the new reporting requirements for lenders?
Under the proposed rule, lenders would be required to use CFPB-registered information systems to report and obtain credit information about covered loans. This requirements includes the duty to report basic loan information and updates to that information. The registered information systems will have to be created by companies that will provide this service once the rule is finalized. The CFPB will publish a list of registered systems.
Lenders must provide basic information about the loans and the borrower at the time of origination, updates during the life of the loan, and additional information when the loan period ceases. The lenders must also solicit and review a consumer report about the borrower from a registered information system before making the loans. The registered information systems themselves must meet certain eligibility requirements related primarily to their reporting capabilities and performance.
In addition to reporting requirements associated with registered information systems, lenders must establish and follow a compliance program and retain certain records, such as the initial loan agreement, documentation obtained for a covered loan, and calculations surrounding presumptions of unaffordability. As an enforcement mechanism for the reporting requirements listed, the proposed rule contains an anti-evasion clause.
What are the new recordkeeping requirements for lenders?
A lender will need to keep records of all information provided to credit reporting bureaus, as well as documentation of its ATR determination, a verification of borrowing history, the history of payment, and any presentments. The proposed retention period is 36 months after the last entry involving the covered loan.