After months of speculation, the Consumer Financial Protection Bureau (CFPB) released a final small-dollar loan rule on October 5. If the final rule takes effect, lenders will be required, among other things, to determine whether consumers have the ability to repay (ATR) their loans, prior to issuing certain short-term small dollar, payday, and auto title loans. The rule applies to all storefront and online small-dollar short-term lenders, regardless of state license or tribal affiliation. The CFPB did carve out an exception for lenders that make less than 2,500 short-term loans per year and derive no more than 10 percent of their revenue from such loans. This exception likely confers the most benefit on credit unions and community banks that occasionally make these loans to members in need. In addition, the CFPB has exempted NCUA authorized “payday alternative loans” and certain wage advance loans offered to employees by employers. The final rule comes in at 1,690 pages and is scheduled to take effect around July 2019. The rule will need to survive legislative challenges, trade association litigation, and a new CFPB Director to get there, but if the final rule does become law, then small dollar lenders should be prepared for a sea change in how their industry is regulated by the federal government.
1. Ability to repay
In its most basic form, the rule requires lenders to determine that consumers have the ability to repay the loans they are being offered, prior to extending those loans to consumers. The CFPB imposed a similar requirement on mortgage lenders through its 2013 mortgage rules and considers an ability-t0-repay determination a fundamental step in underwriting consumer loans. For loans that must be repaid in a lump sum with terms less than 45 days, lenders must determine that consumers have the ability to repay the full amount due, including principal, interest, and fees, and still have enough money to meet basic living expenses and financial obligations. For loans with longer repayment periods that include a balloon payment, lenders must determine a borrower’s ATR based on the month with the highest amount due on the loan. The CFPB classifies these loans as full-payment loans.
The final rule permits lenders to make consumer loans of up to $500 without determining the consumer has the ability to repay the full amount of the loan, as long as the borrower pays off the full amount due within 3 payments, and pays at least one-third of the original principal with each payment. For these loans below $500, lenders cannot take an auto title as collateral, cannot make these loans to consumers with outstanding short-term loans, cannot make three such loans in quick succession, and cannot extend such loans where borrowers have greater than six short-term loans over a rolling 12-month period. These loans are classified as principal-payoff loans.
2. Must use CFPB-registered credit reporting systems
In order to make credible and documented ATR determinations, lenders must use credit reporting systems registered by the Bureau to report and obtain consumers’ information. This requirement will allow the CFPB to monitor lender activity and verify that lenders are using recognized credit reporting systems to verify borrowers’ ATR and not making cursory determinations based on incomplete information. In addition, the registration requirement may allow small-dollar consumer borrowers to build credit portfolios by repaying their loans as scheduled. Lenders may make full-payment loans to consumers if no credit report is available for that consumer, but may not make a principal-payoff loan where no such information is available.
3. Written authorization to debit consumers’ accounts and withdrawal attempt limits
The CFPB perceived repeated failed withdrawal attempts as a major driver of insufficient fund and returned payment fees that could haunt consumers long after they had paid off the principal amount of their loans. To address the issue, the CFPB is requiring lenders to give consumers written notice before the first attempt to debit their account and give additional notice prior to attempting to withdraw funds at a different time or in a different amount. The rule also includes a restriction that prohibits lenders from attempting to debit money from a consumer’s account after two failed attempts. This portion of the rule applies not only to short-term lenders, but also to lenders that make small-dollar loans with repayment terms greater than 45 days if those loans have an APR above 36%.
4. Cordray’s last stand
CFPB watchers have long speculated that CFPB Director Richard Cordray was waiting to issue the final small-dollar rule prior to resigning his position to run for governor of Ohio. The day after the rule was announced, Director Cordray was scheduled to appear before an Ohio audience to give remarks entitled, The State of the CFPB and Moving Ahead. As of publication, there was no formal indication that Director Cordray was resigning his position. If this rule does mark the end of the road for Director Cordray at the CFPB, his time at the Bureau will be remembered as one of an astonishing, albeit controversial, amount of activity. While the CFPB has garnered many adversaries and advocates during his five year tenure, there is no denying that under Director Cordray the CFPB has changed the regulatory environment in which financial services providers operate. Through a flurry of rulemakings, enforcement actions, and examinations, the CFPB has changed the way that consumer financial services companies interact with their regulators and customers. Of equal importance, the CFPB has changed the culture at its sister federal and state regulators and for this reason, even after Director Cordray has departed, financial institutions should expect heightened scrutiny from other regulators with jurisdiction over this industry.
5. The road ahead
Whether Director Cordray resigns now or remains at the CFPB through the end of his term in July 2018, the fate of this rule may ultimately be decided by the next permanent director of the CFPB, who will be appointed by President Trump. Congress’s ability to overturn CFPB rules through the Congressional Review Act has been well documented and financial services providers and their trade associations will certainly pursue this route. If Congress fails to secure the votes to disapprove of the rule, then the industry will likely pursue legal challenges to the rule to keep this final rule from ever going into effect. Finally, since the effective date of the rule is beyond the expiration of Director Cordray’s term, there is certainly a possibility that the CFPB’s next director will take steps to delay, scale back, or eliminate the rule. The CFPB has a remarkable track record to date of seeing their proposed rules become law, but that track record may be in jeopardy once the Trump administration appoints a new director.