The Bureau of Consumer Financial Protection (CFPB) recently issued final regulations regarding short- and long-term loans that have balloon payments (such as payday loans). Lenders will be required to reasonably determine that consumers have the ability to repay the loans. In addition, for those loans, as well as longer-term loans with an APR greater than 36 percent that are repaid directly from the consumer’s account, lenders will be prohibited from attempting to withdraw payment from a consumer’s account after two consecutive payment attempts have failed due to insufficient funds.

What loans are subject to the new regulation?

The regulation generally applies to a lender that extends credit by making “covered loans”. A “covered loan” is generally closed- or open-end credit extended to a consumer for personal, family, or household purposes, that satisfies one of the following: (1) the maturity date for the loan is within 45 days after the loan is made (“Covered Short-Term Loans”); (2) the consumer is required to repay the entire balance in a single payment more than 45 days after the loan is made or through at least one payment that is more than twice as large as any other payment (or, with respect to multiple advance loans that are structured such that paying the required minimum may not fully amortize the balance by a specified date or time, the amount of the final payment could be more than twice the amount of other minimum payments) (“Covered Longer-Term Balloon-Payment Loans”); or (3) the cost of credit exceeds 36% and the lender is authorized to withdraw payments from the consumer’s account.

Certain types of loans are excluded, including: (i) purchase money security interest loans (credit extended for the purpose of financing a consumer’s purchase of goods when secured by the goods purchased), (ii) home mortgages, (iii) credit cards, (iv) student loans, (v) overdraft services, (vi) wage advance programs, and (vii) certain no-cost advances.

Certain alternative loans are exempt if they satisfy the following requirements: (a) not open-end credit, (b) a term of not less than 1 month and not more than 6 months, (c) the principal is not less than $200 and not more than $1,000, (d) repayable in two or more payments, all of which are equal in amount and in equal intervals, and the loan amortizes completely during the term of the loan, and (e) no charges are imposed other than the rate and application fees permissible for Federal credit unions under applicable National Credit Union Administration regulations (12 CFR 701.21(c)(7)(iii)). The lender must also satisfy certain other diligence and documentation requirements.

Loans made by lenders who, on an annual basis, do not make more than 2,500 covered loans and not more than 10% of revenue derives from covered loans, are exempt.

How does a lender reasonably determine if a consumer will have the ability to repay?

For Covered Short-Term Loans and Covered Longer-Term Balloon-Payment Loans, the lender must reasonably determine that the consumer will have the ability to repay the loan according to the terms of the loan. The lender must determine that, based on estimates of the consumer’s basic living expenses and the calculation of the consumer’s debt-to-income ratio or consumer’s residual income, the consumer can pay all major financial obligations, make all payments under the loan, and meet basic living expenses during specified time periods.

Lenders must obtain certain certifications from the consumer and conduct certain other diligence in order to satisfy verification requirements. Lenders may not make a Covered Short-Term Loans or Covered Longer-Term Balloon-Payment Loans if, during the period in which the consumer has a Covered Short-Term Loan or Covered Longer-Term Balloon-Payment Loan outstanding and for 30 days thereafter, the new loan would be the fourth loan in a sequence of such loans.

A Covered Short-Term Loan that satisfies the following requirements is not subject to this requirement: the principal amount is not greater than $500 (or lesser specified amounts for additional loans of a sequence), (x) the loan amortizes completely during the term of the loan and the payment schedule provides for the lender allocating a consumer’s payments to the outstanding principal and interest and fees as they accrue only by applying a fixed periodic rate of interest to the outstanding balance of the unpaid loan principal during every scheduled repayment period for the term of the loan, (y) no vehicle security is taken for the loan, and (z) the loan is not open-end credit. The lender must also satisfy certain diligence and disclosure requirements. A lender may not make a Covered Short-Term Loan or a Covered Longer-Term Balloon Payment Loan during the period in which a consumer has an exempt Covered-Short Term Loans outstanding and for 30 days thereafter.

What payment transfers are prohibited?

For all covered loans, a lender may not attempt to withdraw payment from a consumer’s account after two consecutive payment attempts from that account have failed due to insufficient funds. This prohibition does not apply if the lender obtains the consumer’s new and specific authorization to make further withdrawals from the account or if the lender executes a single immediate payment transfer at the consumer’s request, in each case subject to the satisfaction of certain requirements set forth in the regulation.

If the lender is also the account-holder, an account-holding institution’s transfer of funds from a consumer’s account held at the same institution is not prohibited if it satisfies the following requirements: (A) the lender, pursuant to the terms of the loan agreement or account agreement, does not charge the consumer any fee, other than a late fee under the loan agreement, in the event that the lender initiates a transfer of funds from the consumer’s account in connection with the covered loan for an amount that the account lacks sufficient funds to cover; and (B) the lender, pursuant to the terms of the loan agreement or account agreement, does not close the consumer’s account in response to a negative balance that results from a transfer of funds initiated in connection with the covered loan.

Prior to making a withdrawal from a consumer’s account for a covered loan, the lender must provide notice to the consumer in form and content as required by the regulation.

Other requirements of lenders

For each Covered Short-Term Loan and Longer-Term Balloon-Payment Loan, the lender must provide certain information to registered information systems at or prior to the time the loan is made, any updates thereto, and at the time the loan ceases to be an outstanding loan.

A lender making covered loans must develop and follow written policies that are reasonably designed to ensure compliance with this regulation and be appropriate for the size and complexity of the lender and the nature and scope of lending activities.

A lender must retain evidence of compliance with the regulation for at least 36 months after the date on which a loan ceases to be an outstanding loan.

When does the regulation become effective?

The regulation will be effective 21 months after publication of the final rule in the Federal Register. The full version of the final regulation may be found here.

Rescission of OCC Guidance

In 2013, the Office of the Comptroller of the Currency (OCC) released “Guidance on Supervisory Concerns and Expectations Regarding Deposit Advance Products” (OCC Bulletin 2013-40). The deposit advance products at issue were the issuance of small-dollar, short-term loans or lines of credit that a national bank makes available to a customer whose deposit account reflects recurring direct deposits. The OCC outlined its expectations for national banks with respect to these products, which included an assessment of the customer’s ability to repay, cooling off periods after a loan was paid off prior to the making of another loan, and periodic reevaluation of customer’s eligibility. Purportedly in light of the release of the CFPB regulation, the OCC rescinded its guidance but did caution that the OCC may release guidance in the future. The OCC’s release may be found here.