On October 5, 2017 the Consumer Financial Protection Bureau (“CFPB”) finalized its Rules relating to short-term consumer loans. https://www.consumerfinance.gov/policy-compliance/rulemaking/final-rules/payday-vehicle-title-and-certain-high-cost-installment-loans/. The Rule will become effective 21 months after it is released in the Federal Register.
As noted in a report by the Wall Street Journal, the scope of the Rule was significantly reduced from the initial notice of proposed rulemaking issued on June 2, 2016. As predicted, the significant restrictions contained in the Rule are targeted only to loans of 45 days or less (although the CFPB notes that it is still finalizing rule making for certain high-cost installment loans) and balloon payment loans. The Rule focuses on two primary restrictions and a new disclosure obligation:
- For short term loans (less than or equal to 45 days) and loans that have longer terms, an interest rate greater than 36% and balloon payment(s), a lender must engage in an analysis of the borrower’s ability to repay (“ATR”) the loan. Not only must the lender obtain this information from the consumer, the lender must then “verify” this information using third-party sources. If a lender fails to do so, it will be treated as an unfair and abusive practice proscribed by the Dodd-Frank Act. The Rule has excluded loans with certain consumer protections from the ATR obligations. Under the exemption, the lender may make up to 3 short-term loans provided:
- The initial loan is of no more than $500;
- The second loan has a principal amount at least 1/3 smaller than the first;
- The third loan has a principal amount at least 2/3 smaller than the first;
- The loan amortizes completely during the term and payments will be allocated to principal and a fixed interest rate;
- The loan is a closed-end loan;
- The lender cannot use the alternative method to make a covered short term loan if the consumer has either: (i) obtained more than 6 covered loans during the preceding 12 months, or (ii) had outstanding short-term loan debt for more than 90 days during the preceding 12 months;
- A vehicle secured loan cannot qualify under this alternative approach; and
- The lender cannot make an alternative covered short-term loan and then make a covered short-term loan until 30 days have passed since the first loan was outstanding.
- For these short-term loans (the two categories above) and any longer-term loans with an interest rate greater than 36% that are repaid directly from a consumer’s bank account (a “leveraged payment mechanism” that gives the lender a right to withdraw payments directly from a consumer’s account), the Rule declares an attempt to withdraw funds more than twice as an unfair and abusive practice proscribed by the Dodd-Frank Act. To continue attempts to withdraw the funds, the lender must obtain a new consent from the consumer. Two failures of a payment to process are deemed a revocation of the consumer’s authorization to the transfers.
- In a move that will change how many lenders process payments, new disclosures are required before a lender attempts to debit a consumer’s account for payment on the loan.
Ability to Repay: The biggest change for small-loan lenders will be the implementation of ATR obligations that now requires lenders to confirm a consumers: (i) income, (ii) existing debt obligations, (iii) housing costs, (iv) living expenses, and (v) residual income or debt-to-income ratios. This verification must include the use of third party sources to confirm information provided by the consumer.
Prohibition on Refinancing: A lender may not make a short-term loan to a consumer that has already taken out three short-term loans (or balloon payment loans) within 30 days of each other, for 30 days after the third loan is outstanding. I.e., a consumer must wait a period of 30 days before obtaining a new loan.
Notices Regarding Payment Processing: A lender must provide at least 6 days’ notice (by mail) or 3 days’ notice (electronically or in person) prior to initiating the first payment transfer using an electronic payment method or a check. Model forms have been issued for the payment notices. If an “unusual payment” because of timing or amount will be processed, the lender must provide at least 10 days’ notice (by mail) or seven days’ notice (electronically) or three days’ notice (in person).
Exemptions: Importantly, the following categories of loans are exempt from the Rule:
- Loans to finance the purchase of vehicles or consumer goods that secure the loan;
- Home mortgages and home loans where the lender takes a security interest in the home;
- Credit cards;
- Student loans;
- Non-recourse pawn loans;
- Overdraft and overdraft lines of credit;
- Wage advance programs;
- No-cost advances;
- NCUA Payday Alternative Loans (“PALs”) or similar; and
- Accommodation loans.
What This Means
The Rule will significantly affect the payday and short-term title loan industry, dramatically changing the burden on lenders (and consumers) seeking access to short-term sources of financing. Many have speculated that Congress may attempt to overrule the Rulemaking under the Congressional Review Act (“CRA”). Only time will tell whether this will dramatically shift the nature of small-dollar, short-term lending. Many expect that this will push lenders out of traditional, fee-based, non-recourse payday lending into long-term vehicle secured or asset secured lending. The CFPB’s comments sprinkled throughout the Rule regarding their intent to ultimately take on this space may be the “fair warning” that an immediate transition from payday may take lenders out of the current Rule and into a similar regime once the CFPB has time to finalize additional rulemaking. The significant reduction in the coverage of the Rule may play into attempts by industry groups to challenge the rulemaking process since the initial CFPB research identified much broader “concerns” in multiple product categories, while the Rule only focuses on a subset of the lenders identified as causing consumer harm.