After much anticipation, the Consumer Financial Protection Bureau (“CFPB”) has released its proposed small-dollar lending rule. Spanning 1,334 pages in length, the proposal marks the first time the CFPB has exercised its authority to issue regulations prohibiting unfair, deceptive, or abusive acts or practices (“UDAAP”). Until now, the CFPB has elected to define UDAAP through its enforcement actions. And despite the proposal’s length, it does not appear that it fully covers the waters of consumer credit in the CFPB’s sights. Accompanying the proposed rule is a Request for Information (“RFI”) asking additional questions about certain other high-cost, longer-term installment loans and open-end lines of credit, raising the possibility of additional rulemakings in the future.
Comments on the proposed small-dollar rule are due September 14, 2016, and responses to the RFI are due October 14, 2016.
Overview of the Proposed Rule:
The proposal generally would cover two categories of loans. First, it generally would cover loans with a term of 45 days or less. Second, it generally would cover loans with a term greater than 45 days, provided that they (1) have an all-in annual percentage rate (“APR”) greater than 36 percent; and (2) either are repaid directly from the consumer’s account or income or are secured by the consumer’s vehicle. These characteristics are common among payday and vehicle title loans.
For both categories of covered loans, the proposal would deem it an “abusive” and “unfair” practice for a lender to make the loan without reasonably determining that the consumer has the ability to repay the loan. Before making a covered loan, a lender would have to reasonably determine that the consumer has the ability to repay the loan. There would also be certain restrictions on making covered loans when a consumer has or recently had certain outstanding loans. Attempting to withdraw payment for a covered loan from a borrower’s bank account after two consecutive failed attempts to do so would also be an unfair and abusive practice, absent a new, specific authorization from the borrower. The proposal would provide lenders with options to make covered loans without satisfying the ability-to-repay requirements, if those loans meet certain conditions.
The rule would not impose interest rate limitations on covered loans, as the CFPB lacks the authority to set such limits.
When Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010, it gave the CFPB supervisory and enforcement authority over all payday loan companies as well as other covered persons, including lenders making other types of small-dollar loans. One of CFPB Director Richard Cordray’s first actions after his recess appointment (which we wrote about here) was to hold a field hearing on payday lending. In April 2013, the CFPB published its Payday Loans and Deposit Advance Products: A White Paper of Initial Data Findings, followed by its CFPB Data Point: Payday Lending in April 2014. In anticipation of the current proposed rule, the CFPB released a preliminary outline of the proposal in March 2015, which we previously wrote about here.
The CFPB has already exercised its enforcement authority over various payday lenders, entering into consent orders with Cash America, Ace Cash Express, Hydra Financial, and others. Now, for the first time, the CFPB is exercising its authority to promulgate rules governing unfair, deceptive or abusive acts or practices within this industry.
Details of the Proposed Rule:
Sharpen your pencils and get your reading glasses ready: the proposed rule is almost 18,000 words, more than the three times the length of the Constitution. It accordingly has many nuances, including exemptions, exceptions, exceptions to exemptions, and seeming disconnects and circularities. In addition to providing feedback to the CFPB during the public comment period, lenders will need to carefully parse the final version to sufficiently update their policies and procedures. Key details of the proposal are noted here:
While most buzz has focused on the proposal’s impact to payday loans, the proposed rule would apply to various types of both short-term and long-term credit. “Short-term credit” generally includes single-advance, closed-end loans with terms of 45 days or less. “Long-term credit” generally includes loans for which the term is longer than 45 days and both of the following conditions are met: 1) the total cost of credit for the loan is greater than 36 percent per annum; and 2) the lender or service provider obtains either a “leveraged payment mechanism” or vehicle security at the beginning of the loan. A leveraged payment mechanism would include a lender or service provider’s right to 1) initiate a money transfer from a consumer’s account, 2) obtain payment directly from the consumer’s employer or other source of income, or 3) require the consumer to repay the loan through a payroll deduction.
All lenders, including banks and credit unions, would be subject to the rule; the rule’s application is not limited to non-depository lenders. A broad range of products would be covered, including, but not limited to, payday loans, auto title loans, deposit advance products, and certain installment loans. The rule does exclude certain types of products:
- Certain purchase money security interest loans;
- Real estate secured credit;
- Credit cards;
- Student loans;
- Non-recourse pawn loans; and
- Overdraft services and lines of credit.
Short-Term Credit Ability to Repay:
The rule generally requires lenders to perform a “full-payment” test to reasonably determine whether an applicant has the ability to repay a short-term loan without reborrowing.
This test, like the CFPB’s ability-to-repay (“ATR”) rule for mortgages under Regulation Z, would require lenders to make a reasonable determination that the borrower’s “residual income” will be sufficient to repay the loan and meet basic living expenses for the borrower and the borrower’s dependents during the shorter of the term of the loan or the period 45 days ending after consummation of the loan.
The definitions here are somewhat confusing. “Residual income” is the borrower’s “net income” after payment of other “major financial obligations,” such as mortgages or rent for housing and child support. “Net income” is the “total amount that a consumer receives after the payer deducts amounts for taxes, other obligations, and voluntary contributions.” “Payer” is undefined—it is unclear whether it refers to the consumer, the consumer’s employer, or some other entity.
In addition to determining ability to repay within the shorter of the life of the short-term loan or 45 days, the lender must reasonably conclude that the borrower will be able to repay the loan, make any payments due on “major financial obligations,” and meet basic living expenses for 30 days after making the highest payment due on the loan. While the rule permits some reliance upon a borrower’s representations, lenders must verify the applicant’s income (after taxes), borrowing history (by obtaining the consumer’s credit report), and payments for “major financial obligations.”
The rule limits short-term loan extensions and renewals and encourages various cooling-off periods before borrowers may obtain new covered loans. While renewed loans and loans to serial borrowers are presumed to be unaffordable, some of these presumptions may be overcome by reliable evidence of changed circumstances.
As an alternative to performing the full-payment test, lenders could, in certain situations, make a loan using the “principal payoff option.” This option would permit lenders to make loans up to $500 without performing the full-payment test so long as the loan is directly structured to keep the consumer from getting trapped in debt. If the borrower cannot pay off the original loan or returns to reborrow within 30 days, the lender could offer no more than two extensions on the original loan and only if the consumer repays at least one-third of the principal at the time of each extension. Lenders could not, however, offer this option to a borrower who has been in debt on short-term loans lasting 90 days or more during the preceding year.
Long-Term Credit Ability to Repay:
For long-term credit, lenders would generally also be required to reasonably determine that the borrower can repay the loan within its terms. The requirements for long-term credit repayment determination and verification appear to be somewhat different than the rules for short-term credit—the CFPB has provided a second, presumably non-redundant set of requirements for long-term credit.
For long-term credit, lenders would have to determine that the borrower’s residual income will permit the borrower to repay the loan and meet basic living expenses. This determination would need to be made within 180 days before any advance under a line of credit. If the loan involves a balloon payment, the consumer will need to be able to make payments under the loan, meet basic living expenses, and pay major financial obligations within 30 days of the balloon payment. Presumably, these balloon payments and other expenses will need to be paid from “net income,” which the CFPB re-defines for long-term credit, but the proposed rule does not actually state this.
As with short-term credit, lenders must verify the factual basis for their ability to repay determination for long-term credit. While the verification rules for long-term appear to be largely identical to short-term credit, lenders will nevertheless need to separately review and implement these long-term credit verification rules because the CFPB has not provided a consolidated set of standards.
Lenders would be able to choose to offer two alternative products for long-term credit under two conditional exemptions. The first alternative would be to offer loans that meet the parameters of the National Credit Union Administration (“NCUA”)’s “payday alternative loan” program (i.e., interest rate is capped at 28 percent and the application fee is limited to $20). The second alternative would be to offer loans that meet three conditions:
- The loan term is two years or less with roughly equal payments;
- The total “all in” cost of the loan is 36 percent or less, excluding a reasonable origination fee; and
- The projected annual default rate on all such loans would not exceed 5 percent.
A lender utilizing the second alternative would be required to refund all origination fees paid during any year in which the lender’s annual default rate exceeds 5 percent. The lender would also be limited in how many loans it could make each year using the second alternative.
Access to Bank Accounts:
The proposed rule limits deferred presentment transactions, which payday lenders often use as a collection mechanism. The CFPB wants to limit this practice, especially with regard to repeated re-presentments, because “the success rate on these subsequent attempts is relatively low, and the cost to consumers may be correspondingly high.”
The proposal covers lender-initiated “payment transfers,” which includes many methods of presentment: electronic fund transfers (“EFTs”), paper checks, remotely created checks, payment orders, and intra-institution fund transfers. Lenders may not initiate payment transfers from a borrower’s account after two consecutive payment transfer attempts have failed due to insufficient funds in the consumer’s account. Each failed payment transfer—whether through the same channel or through different channels (e.g., signature check then EFT)—would count towards this limit.
Lenders may obtain re-authorization from a borrower for additional transfer attempts. The authorization must be signed or agreed to by the borrower in writing or electronically, or by phone if the lender records the call and sends a written memorialization to the borrower before initiating the re-authorized transfer. The authorization must specifically provide when the transfer will be made, what amount will be transferred, and how it will be transferred. A lender may re-present a re-authorized transfer only once if the first presentment fails. Certain additional disclosures must be provided if the lender will only collect late fees or returned fees with the re-authorized transfer.
The proposed rule also requires disclosures regarding payment transfer attempts, both before any transfers are attempted and after the second transfer fails. The pre-transfer requirement does not apply to conditionally exempt longer-term loans.
All of these disclosures must be in writing, unless the borrower agrees to accept them electronically. Consent to electronic notice can be revoked at any time.
For written pre-transfer disclosures, the disclosures must be provided 6-10 business days prior to initiating the transfer. Shorter time frames (3-7 business days) apply to electronic notices or in-person notices. This lead-time itself may significantly impact lenders, since the timeframe will be extended by re-noticing a second transfer after the first fails.
The CFPB has provided a model form for these pre-transfer disclosures, which must include a considerable amount of information, such as transfer date and amount, loan and payment account identification, payment channel, APR, check number, payment breakdown, and lender name and contact information. For payments that have irregular timing or amounts, additional disclosures are required.
In addition, a consumer rights notice must be provided after two consecutive failed payment transfers within three business days of the second failed attempt. The proposed rule includes a model disclosure for this form as well.
The recordkeeping requirements of the rule may not be controversial—indeed, given the increased regulatory scrutiny that lenders will be facing, lenders would be well-advised to document their compliance efforts voluntarily.
The CFPB’s rule calls for information system networks to be established so that lenders will be able to determine whether outstanding loans to borrowers from other lenders exist and whether those outstanding loans prevent further extension of credit to an applicant. Lenders will be required to update the information provided to these systems with regard to each loan both at origination and at pay-off or charge-off. These systems will be complex and expensive to design and implement; these costs will likely be passed along to lenders and then to consumers.
Lenders will need to keep internal records as well, including the loan agreement, ability-to-repay information and documentation, payment and collection history, and all other documents needed to demonstrate compliance with this new rule. This documentation should be retained for 36 months after the loans are paid off or charged off.
Potential Impact on Industry:
Just as the CFPB’s qualified mortgage rules have changed that market, the payday lending and title loan markets will be considerably different if this rule goes into effect as proposed.
In particular, implementing the “full-payment” test will likely be one of the biggest challenges for lenders who make loans covered by the proposed rule. While most lenders already consider borrowers’ ability to repay to some degree, the proposal’s specific provisions for how lenders would be required to do so going forward will present extra hurdles in the underwriting process. The specific and detailed underwriting requirements in the proposal are common in mortgage lending, but to date have not been seen in the small-dollar space, where lenders are under pressure to quickly provide loan decisions to borrowers who have an immediate need for cash. Additionally, income for borrowers in the small-dollar lending industry is often inconsistent and unpredictable—which often contributes to the borrower’s need for a loan in the first place—making it even more complicated to determine at the time of the loan whether a borrower will have the ability to pay off a loan in full.
Smaller-scale covered lenders may be unable to absorb the additional cost of complying with the strict underwriting standards of the proposal and stop offering covered loans. Lenders who continue to offer products covered by the rule would ultimately need to update their credit applications, adverse action notices, loan agreements, underwriting procedures, information technology (“IT”) controls, and employee training. On the other hand, any lenders who are prepared to comply with the rule, as well as those that potentially fall within any exemptions or safe harbors may have a competitive advantage.
An impact on borrowers may be that those who are rejected by covered lenders will turn to less-regulated lenders who operate online and offshore, or be unable to find the small-dollar credit options they prefer.
Request for Information:
The CFPB’s RFI asks additional questions about high-cost, longer-term installment loans and open-end lines of credit without vehicle security or account access features. The CFPB is particularly focused on the business models and underwriting used for such loans. Consumer protection concerns include the risk that these loans may keep borrowers in long-term debt with a structure where borrowers pay down little to no principal for a long period. The RFI also seeks information about other practices that hurt a borrower’s ability to pay back debt, including, but not limited to, attempts to seize borrowers’ wages, funds, vehicles, or other personal property. Finally, the RFI also requests information about the sale and marketing of certain add-on products such as credit insurance, debt suspension, and debt cancellation agreements. Submissions under the RFI are due October 14, 2016.
The CFPB will accept comments on the proposed rule until September 14, 2016 and responses to the RFI until October 14, 2016. All consumer lenders, even if they do not view themselves as payday lenders or title loan lenders, should review this rule and their loan products to determine if their products are covered. Companies that offer products covered by the proposed rule should consider filing comments. Even if a lender’s products are not covered by the proposed rule, the lender should consider responding to the RFI to ensure the CFPB receives robust feedback from industry stakeholders. The CFPB will likely take into account the information it receives in responses to its RFI when it drafts future rulemaking.