The real impact on the high-cost loan industry is restricting the ability to attempt to collect a loan using any type of pull transaction more than twice.
On October 5, the CFPB issued it long-anticipated Payday, Vehicle Title, and Certain High-Cost Lending Rule covering certain short-term loans. The final regulation, published more than 15 months after it was proposed in June 2016, differs substantially from the initial proposal. The Rule, interpretations and accompanying materials are almost 1,700 pages long. This is a summary of the highlights of the final Rule to help clients and other interested parties understand the scope of the Rule and how it could affect their lending business. Based on the substantial changes made to the final Rule, it is not anticipated that it will dramatically alter the current high-cost lending landscape. In addition, the Rule will not take effect for some time — 21 months after publication in the Federal Register — bringing into question whether it will survive in its present form.
What types of consumer loans are covered?
The Rule covers three types of loans:
Short-terms loans with a term of 45 days or less: closed-end loans where the consumer is required to pay the entire amount within 45 days of consummation; open-end loans where the consumer is required to pay the entire balance of any advance within 45 days.
Longer-term balloon payment loans: closed-end and open-end loans where the consumer is required to pay the entire balance or advance more than 45 days after consummation or receipt of any advance in at least one payment that is more than twice as large as any other payment. Also covered are longer-term balloon payment loans where there are multiple advances and paying the minimum payment may not fully amortize the outstanding balance by a specified date or time and the final payment could be more than twice the amount of any other minimum payments.
Longer-term loans: Loans that have annual percentage rates (APRs) of 36 percent or higher at consummation (for open-end plans as measured at consummation and the end of any billing cycle) and have a “leveraged payment mechanism,” an automated clearing house (ACH) payment plan, a check, or any other “pull” type of payment device. These types of loans are only subject to the Rule’s requirements limiting payment withdrawals and required disclosures and recordkeeping.
What are the requirements for covered loans?
If a loan is a short-term loan or a longer-term balloon payment loan, then the Rule deems it an unfair and abusive practice to make the loan without determining a consumer’s ability to repay the loan. This requires the lender to determine a consumer’s ability to make the loan’s payments while also meeting the consumer’s major financial obligations, which include basic living expenses, without needing to reborrow for 30 days. For an open-end plan, the lender is required to make this determination if a consumer seeks an advance more than 90 days after the lender’s last determination of their ability to repay.
How is ability to repay determined?
A lender has a number of options to determine ability to repay. While there are other ways to do this, the lender:
Is permitted to obtain a consumer’s statement of his or her net income and payment obligations.
Must verify a consumer’s payment obligations using a national consumer credit report.
Must project the consumer’s residual income or debt-to-income ratio during the calendar month with the highest payment(s) under the loan.
In addition, the lender must also ensure the consumer does not have a sequence of more than three covered short-term or balloon payment loans taken out within 30 days of each other. Once the three-loan sequence is met, there is a required 30-day cooling-off period before other covered loans can be made.
How does the principal step-down option work?
A lender can assist a consumer to pay down the principal balance of an outstanding short-term loan without meeting the ability-to-repay requirements so long as the lender does not take a security interest in a motor vehicle and:
The loan is not open-end credit.
The loan being repaid is less than $500, and the second and third covered loans made within 30 days of the prior loan reduce the principal by at least a third from the prior loan. The loan must amortize completely during the term of the loan.
The lender ensures the consumer does not have a sequence of more than three covered short-term or balloon payment loans taken out within 30 days of each other or six covered loans during any consecutive 12-month period. Once repaid, the 30-day cooling-off period begins.
Certain required disclosures are provided to the consumer. The first disclosure must be provided at the beginning of the first sequence of loans and must advise the consumer of the principal step-down requirement for subsequent loans. Another disclosure must be provided at the time of the third loan in the sequence and must advise the consumer that two similar loans have been taken out without a 30-day cooling-off period and that the third loan must be smaller in amount than the prior two loans and that a 30-day cooling-off period is required.
What are the restrictions on the use of ACH withdrawals?
The restrictions on the use of what are called “leveraged payment mechanisms,” ACH withdrawals, PIN and signature debit card withdrawals, remotely created checks, internal transfers, or any other type of “pull transactions” apply to all three types of covered loans — short-term loans, longer-term balloon loans and longer-term loans.
A lender is required to:
Provide a written notice before its first attempt to withdraw a payment and before subsequent attempts that deviate from the scheduled amounts or dates or involve a different payment mechanism.
When two consecutive withdrawal attempts have failed due to insufficient funds, a lender is not permitted to attempt another withdrawal from the same account unless the lender obtains a new specific authorization to make further withdrawals.
What is a registered information system?
Lenders subject to the ability-to-repay requirements and under the principal step-down option are required to furnish certain loan data to information systems registered with the CFPB and to pull a consumer report from the systems in the course of making covered short-term loans or longer-term balloon payment loans.
Reporting must be done at origination, updated if changes occur while the loan is outstanding, and when repaid or charged off.
Registered information systems must be able to receive the furnished information, generate a consumer report, have a federal consumer financial law compliance program, have an independent security assessment program done periodically, and be able to comply with the Rule.
What are the record retention requirements?
Lenders must develop and follow policies and procedures to comply with the Rule and retain evidence of compliance for 36 months.
What does the CFPB say about trying to evade the Rule?
The Rule has a simple statement that prohibits lenders from taking any action “with the intent of evading the requirements” of the Rule. The interpretation for this section discusses this issue in more depth and provides an example but, as did the initial proposal, raises serious questions about how lenders can operate in ways to avoid the Rule’s ability-to-repay requirements by structuring products that by their terms are outside of the Rule’s coverage.
While we will continue to review the extensive 1,700 pages of additional materials included in the Rule, which itself is only 57 pages long, the key takeaways are that the Rule focuses primarily on loans of less than 45 days, but the payment restrictions apply to any loan with a 36 percent or greater APR where a leveraged payment mechanism is used. So the real impact on the high-cost loan industry is restricting the ability to attempt to collect a loan using any type of pull transaction more than twice. This restriction may have profound implications for collecting such loans from consumers and may give rise to innovative “push” transactions, including those initiated by the consumer, such as automatic payments from a bank account.
While the high-cost lending industry has been moving away from the classic two-week “payday” loan for many years, the Rule will no doubt hasten its demise. The costs of underwriting such loans and the restrictions on rollovers will surely make these types of loans less profitable than those longer-term, installment loans that are prevalent in the marketplace today.
That being said, the ability-to-repay requirements have been substantially simplified, as evidenced by the ability to use stated income and expenses and rely on third parties to validate debts and other obligations. These changes from the initial proposal may help lenders continuing to make the traditional type of payday loan.
We will continue to review this extensive Rule and would be glad to assist clients and others in dealing with its implications for their lending programs.