On Thursday October 5, the Consumer Financial Protection Bureau (CFPB) issued a long-awaited final rule governing certain short-term loans and longer term loans involving balloon payments, better known as the payday lending rule. The rule is expected to dramatically impact the short-term loan industry, imposing numerous new restrictions on both short-term lenders (including “payday” lenders and auto title lenders), and lenders offering longer-term loans with large, final balloon payments.

Summary of the Rule

The final rule’s most significant new requirement on lenders is a mandatory upfront “full-payment test” on consumers. The test will require that lenders not only determine that a consumer can afford to repay the loan and fees, but can do so while still meeting basic living expenses and major financial obligations during the term of the loan and for 30 days after the loan’s highest required payment. This will require lenders to not only verify a borrower’s income, but also determine the borrower’s major financial obligations, and estimate the borrower’s basic living expenses.

Other major provisions of the final rule include:

  • The Principal Payoff Option: Lenders who issue loans under $500 and do not take car title as collateral may avoid the “full-payment test” if they structure the loan to allow the consumer to get out of debt more gradually. This option allows a lender to offer up to two additional loans (for a total of three) if the borrower pays off at least one-third of the original principal with each extension;
  • Cap on Successive Loans: Lenders may issue no more than three short-term loans (or covered longer-term loans with a balloon payment) to a borrower in quick succession, and must obey a 30-day “cooling-off period” after the third covered loan;
  • Reporting Systems: Lenders must use credit reporting systems to report and obtain information about loans made under the full-payment test or principal payoff option;
  • Limits and restrictions on withdrawal attempts: Covered lenders face new restrictions on debiting a borrower’s bank account;
  • Exemption aimed at community banks and credit unions: Lenders are exempt from the full payment test and principal payoff options if they make fewer than 2,500 covered short-term or balloon payment loans per year and derive less than 10% of their revenue from these loans.

Rule Effective Date

The rule becomes effective 21 months after publication in the Federal Register, which gives entities until the summer of 2019 to digest and implement its contents. There is one exception—the provisions concerning registered information systems take effect within 60 days of publication.

Impact on Industry and Consumers

The CFPB argues that the rule will help to prevent consumer “debt traps”—an inability to repay the principal and fees associated with a short-term loan, which may lead to repeated short-term borrowing, default, seizure of collateral (such as a car), and/or bank account closure.

The industry has a different take. During the protracted and highly contentious rulemaking process, opponents argued that the rule is overly burdensome on short-term lenders, could cause many lenders to go out of business or voluntarily exit the market, and will dry up the market for credit products used by millions of consumers. The CFPB and industry agree on the last point – the CFPB estimated that payday lending revenue will plummet by two-thirds under the new rule.

What is often lost in the rhetoric is the potentially devastating impact this rule could have on consumers. Recent reports estimate that over half of Americans live paycheck to paycheck, with nearly the same amount reporting an inability to come up with $400 for an emergency. While the payday industry is not perfect, it grew to record levels in response to this need. Significantly curtailing the industry, rather than proposing targeted reforms, could leave few options for the average American struggling to make ends meet. In the end, the real-world implications for consumers will be the true measure of the effectiveness of this rule.