Thank you for joining us in Richmond for this field hearing. When I was originally appointed to serve as the Director of the Consumer Financial Protection Bureau, we decided to hold our first field hearing in Birmingham, Alabama on the topic of payday lending – the same subject we are addressing here today. That was in January of 2012. These issues generated intense interest then, and they continue to generate intense interest today. We have seen and heard and felt that same deep and passionate interest from a great many people in a wide range of settings all over the United States.
Over the past three years, we have engaged in intensive analysis of the short-term and longer-term credit markets for personal loans. We have considered the history of the demand for such loans and the conditions that create such demand. We have also focused carefully on how people are affected by the kinds of credit products that have evolved to meet this demand. As we first said in Alabama, and as we underscore again today, we believe that many people who live on the edge need access to credit that can help them manage their financial affairs. But we have also emphasized that the market for such credit products must be marked by responsible lending that helps rather than harms consumers. Extending credit to people in a way that sets them up to fail and ensnares considerable numbers of them in extended debt traps, is simply not responsible lending. It harms rather than helps consumers. It has deserved our close attention, and it now leads to a call for action.
So after much study and analysis, we are taking an important step toward ending the debt traps that are so pervasive in both the short-term and longer-term credit markets. Today we are outlining a proposal that would require lenders to take steps to make sure borrowers can repay their loans. The rules we are considering would cover payday, vehicle title, and certain high-cost installment loans. We have released an outline of the proposals we are considering, and we invite feedback on our approach. This is the first step in addressing much-needed change.
Before I discuss more specifics, it seems important that we first take a step back to get more perspective.
Consumer credit is a relatively modern phenomenon, which grew up with the rise of the money economy itself and developed initially as a means of enabling consumers to make a purchase. At one time, that purchase might have been dry goods from the community’s general store; today, it could be a home or an automobile. The advantage of consumer credit is that it lets people spread the cost of repayment over time. Until recently, a bedrock principle of all consumer lending was that before a loan was made, the lender would first assess the borrower’s capacity to repay the loan. In a healthy credit market, both the borrower and the lender succeed when the transaction succeeds – the borrower meets his or her need and the lender gets repaid.
What we have observed is that in the markets we are discussing today, many lenders make loans based not on the consumer’s ability to repay but on the lender’s ability to collect. The ability to collect is often fueled by modern technology that allows the lender to obtain electronic access to the consumer’s checking account or paycheck. A lender that acquires such access can then move to the head of the line and obtain payment as soon as money reaches the account or, in the case of payroll access, even before the money gets to the account. But collectability can also be achieved through less sophisticated means, such as by holding a postdated check or a vehicle title. Our research and analysis indicates that when loans are made on ability to collect, consumers are put at serious risk.
With payday loans, vehicle title loans, and many types of installment loans, the pattern is all too common. A consumer facing difficult financial circumstances is offered quick cash with no questions asked and in return agrees to provide access to a checking account or paycheck or vehicle title in order to get the loan. No attempt is made to determine whether the consumer will be able to afford the ensuing payments – only that the payments are likely to be collected. Indeed, in many of these markets the lender’s business model often depends on many consumers being unable to repay the loan and needing to borrow again and again while incurring repeated fees.
By providing the lender with an easy means of collection or, in the case of vehicle title loans, with power over the consumer’s means of getting about, the lender can trump the consumer’s own discretionary choices about budgeting and spending. At that point, the consumer is left unable to choose, for example, between repaying the loan and paying rent or covering food or medicine or other pressing needs. If the lender is able to exert a stranglehold over the consumer’s funds, the consumer may fall behind on her rent or utilities and fall deeper into debt. Often, the only alternative that these lenders present to consumers is to pay a new set of fees to roll the loan over and defer the day of reckoning. For many consumers, that choice repeats itself time after time, pushing the consumer further and further into a debt trap. Some consumers may attempt to climb out of the debt trap by taking out additional loans at the same time, which only compounds their financial difficulty.
In order to understand the nature and magnitude of the debt traps that can ensnare consumers, we need to gain a more complete understanding of the true costs of such loans to the borrower. Certainly these loans can seem quite costly on their face, with high annual percentage rates and especially where they lead to repeated rollovers with cascading fees. All of those costs are paid by the borrower to the lender over time.
But when we evaluate the further trajectory of these loans, we can begin to comprehend many additional costs that can end up being paid to parties other than the lender. Some consumers will not have enough money even to pay the fees to roll over the loan when it is due. In some instances, the lender may nonetheless succeed in collecting repayment by overdrawing the consumer’s deposit account. If so, the consumer will be charged at least one overdraft fee, and depending on the timing of other transactions the consumer might be charged repeated overdraft fees. This is not uncommon.
But even that is not the whole picture – other steps may add further costs along the way. In certain instances, when the lender goes to collect on the unpaid loan against the consumer’s deposit account, the bank or other depository institution may reject the transaction. When that happens, the consumer will incur “insufficient funds” fees. And when the lender’s collection efforts are thwarted in this way, it may respond by making repeated, unsuccessful attempts to withdraw the funds, leading to multiple charges. Some lenders even break up the total amount they are owed into smaller amounts and put them through the payment system in pieces that generate multiple fees to collect on what started out as a single unpaid loan.
After a period of time, some consumers will end up facing the closure of their accounts due either to the overdrafts or the piling up of fees or both. This exposes consumers to yet more fees as well as the costs (in time as well as money) of either having to establish another deposit account elsewhere or having to arrange for financial services outside the banking system altogether, which carries its own set of costs and risks. These scenarios also will have negative effects on consumers’ credit reports, causing further damage to their financial lives.
Of course, collection efforts do not end with attempts to debit the consumer’s bank account. Even though no attempt was ever made at the outset to determine whether the consumer could afford to repay, the consumer is still expected to do so. Consumers are thus exposed to standard – and, in some markets, non-standard – debt collection methods. These range from repeated telephone calls to worksite visits to debt collection lawsuits that can lead to wage garnishment. Debt collection efforts generate a further array of fees and charges, which can include the potential cost of having to defend against collection lawsuits. These encounters also exact a personal toll on consumers that disrupts their lives. The extent of that disruption can be hard to quantify, but consumers who experience it often find it to be quite substantial. And finally, another significant cost of a defaulted loan that turns into a court judgment is the blemish on the consumer’s credit report, which may result in blocking the consumer from accessing affordable credit for an even longer period into the future.
Each of these additional consequences can be significant, and together they may impose massive costs that go far beyond the amounts paid solely to the original lender. So the true costs, taken in the aggregate, of a lending model that rests on the ability to collect, rather than the ability to repay, must be kept in mind as we assess the effects on consumers, especially those who were already experiencing financial difficulties when they took out the loan in the first place.
We recognize that consumers have a legitimate need to access credit to meet their particular circumstances. But consumers need credit that helps them, not harms them. If the lender’s success depends on the borrower failing, market dynamics are not functioning properly. In these cases, the proper balance between lenders and borrowers is knocked off course and the “win-win” dynamic of healthy credit markets is no longer achieved. That is why we are holding this field hearing, so that we can begin to gain feedback on our approach to these issues.
Today we are outlining a framework that would put in place strong federal rules for both short-term and longer-term credit products. This framework is the product of extensive research, analysis, deliberation, and outreach. We recognize that it is challenging to determine the best way to address consumer harm in these markets while still leaving room for affordable credit. So we are releasing a preliminary outline of the proposals we are considering. We welcome feedback from small businesses and all other affected stakeholders, including consumers and providers alike. Our formal and deliberative process will lead to fundamental decisions about the proper direction of change in this important marketplace.
Our proposed framework would provide two different approaches: debt trap prevention and debt trap protection. Under the prevention requirements, lenders would have to take appropriate steps at the outset to determine that consumers will not fall into debt traps. Under the protection requirements, lenders would have to comply with various restrictions designed to ensure that the consumer can affordably extract themselves from the loan over time. Lenders could choose which set of requirements to follow. The proposals under consideration also would restrict lenders from accessing consumer deposit accounts in ways that cause consumers to lose control of their own finances and that tend to rack up high fees paid to financial institutions and other parties. We believe these measures could dramatically improve outcomes in these markets. Consumers would still be able to get the credit they need, but they could do so within a framework of strong consumer protections under federal and state law.
Under our proposed framework, we define the short-term credit market as loans for 45 days or less. These are typically payday loans or vehicle title loans, but one important feature of our rules is that they would apply to any lender issuing similar short-term loans. The rules thus would cover all firms that offer competing products in this segment of the market through any channel, including both storefront and online lenders.
Our proposals to address these short-term loans are based in part on extensive research we have done on the market for payday loans and deposit advance loans, our careful review of the many research studies that others have done on this and related markets, and our discussions with stakeholders on all sides. Based on our review of millions of transactions, we found in our own research that for about half of all initial payday loans, borrowers are not able to repay the loan without renewing it. More than one in five initial loans turns into a repeating series of seven or more loans. The amounts that people borrow in each successive loan in the series is usually the same or more as the initial amount borrowed, leaving many consumers mired in debt while lenders continue to receive their repeated fees.
Our proposals under consideration would seek to establish strong protections for these short-term loans so that consumers are able to borrow but are not set up to fail. Lenders would have two alternative ways to meet this requirement: either prevent debt traps at the outset or protect against debt traps throughout the lending process.
As Benjamin Franklin sensibly said, “An ounce of prevention is worth a pound of cure.” So the prevention requirements we are considering would help ensure, at the outset, that consumers can avoid debt traps. Specifically, the proposals under consideration would require the lender to make a reasonable determination that the consumer could repay the loan when it comes due without defaulting or re-borrowing. This requirement applies to the whole loan, including the principal, the interest, and the cost of any add-on products. Lenders would have to engage in basic underwriting by verifying the consumer’s income, major financial obligations, and borrowing history, and determining that the consumer can meet their obligations, cover basic living expenses, and cover payments on the loan.
If the consumer returns for an additional short-term loan before the consumer has had time to regain her financial footing, lenders would have to confirm that some change in circumstances has occurred that would make the new loan affordable even though the consumer has been unable to escape the debt. In cases where the consumer takes out three loans in close succession, there would be a mandatory 60-day cooling-off period after the third loan to give the consumer enough time to recuperate financially before borrowing again. This would prevent lenders from taking advantage of consumers caught in a financial rut by prohibiting long sequences of loans that trap consumers in debt.
While the prevention requirements would primarily apply at the moment when the borrower takes out the loan, the alternative protection requirements under consideration would apply throughout the life of the loan. We are considering two alternatives. Under the first alternative, lenders would have to decrease the principal amount for each subsequent loan so that after three loans the debt is paid off. At that point, a 60-day cooling-off period would kick in. Under the second alternative, when the borrower still cannot repay after two rollovers, the lender would have to offer the consumer an off ramp consisting of a no-cost extended payment plan. After that, a 60-day cooling-off period would apply. Under either approach, the lender could not lend more than $500 or take a security interest in a vehicle title, and the lender could not keep the consumer indebted on these loans for more than 90 days in a 12-month period.
These measures are being carefully considered to help consumers avoid spiraling into long-term debt. The financial incentives for the lenders would change significantly because loan rollovers could not continue indefinitely. In the end, the proposed framework under consideration for this segment of the market is designed to achieve one crucial objective: to allow for responsible lending while ensuring that short-term loans do not turn into long-term cycles of debt.
The second part of our proposal today covers certain longer-term, higher-cost loans. More specifically, the proposal under consideration would apply to credit products of more than 45 days where the lender has access to the consumer’s bank account or paycheck, or has a security interest in a vehicle, and where the all-in annual percentage rate is more than 36 percent. These types of installment and open-end loans cause us great concern. Not only are they high-cost credit, but the lender secures a special form of preferential control over the consumer’s ability to manage his or her own financial affairs, which as we have seen is dangerous and potentially disabling.
Once again, the proposed framework under consideration here would address the problem of debt traps by establishing strong requirements to help ensure that borrowers can afford to repay their loans. Just as with short-term loans, lenders would have a choice between two alternative ways to meet this requirement: prevent debt traps at the outset or protect against debt traps throughout the lending process.
As with short-term credit products, the debt trap prevention requirements would mean the lender must determine, before a consumer takes out the loan, that the consumer can repay the entire loan – including interest, principal, and the cost of add-on products – as it comes due. For each loan, the lender would have to verify the consumer’s income, major financial obligations, and borrowing history to determine whether the borrower could make all of the loan payments and still cover her major financial obligations and other basic living expenses.
If the borrower has difficulty repaying the loan, the lender would be barred from refinancing the old loan upon terms and conditions that the consumer was shown to be unable to satisfy in the first place. Instead, as with our framework for short-term loans, the lender would be required to document that the consumer’s financial circumstances have improved enough to take out yet another such loan upon the same terms and conditions.
Alternatively, lenders could adhere to the debt trap protection requirements. We are considering two approaches here. Under both approaches, lenders could extend loans with a minimum duration of 45 days and a maximum duration of six months. Under the first approach, lenders would generally be required to follow the same protections as loans that many credit unions offer under the National Credit Union Administration’s existing program for “payday alternative loans.” These loans protect consumers by charging no more than 28 percent interest and an application fee of no more than $20. Under the second approach, we are considering limiting monthly loan payments to no more than 5 percent of the consumer’s monthly income. This would shield the bulk of their income from being eaten up by repayments, while the six-month limit also prevents the payments from extending in perpetuity.
The proposed framework here is thus designed to protect consumers against high rates of default or re-borrowing that tend to aggravate their underlying financial problems while preserving their access to affordable credit. As we go along, we welcome further input on how we can best address the issues consumers face in these credit markets. We are focused on finding solutions that put an end to irresponsible lending practices too often based on the lender’s ability to collect rather than the consumer’s ability to repay.
We are also considering new consumer protections about when and how lenders are able to access consumer accounts. To mitigate the problems of racking up excessive overdraft and insufficient funds fees, we are weighing two measures: requiring lenders to notify borrowers before accessing their deposit accounts, and protecting consumers from repeated unsuccessful attempts to access their accounts.
The first provision would require lenders to give notice to consumers three business days before trying to withdraw funds from the account, including key information about the forthcoming attempt. The goal here is to protect consumers by giving them more information to help them plan how to manage their accounts and their overall finances. The notice provision would prevent nasty surprises when the consumer goes to see what money they have in their account. It would help them avoid unexpected problems such as a rent check that bounces because a payday or installment lender already got to their account first.
The second provision would require that if lenders make two consecutive unsuccessful attempts to collect money from consumers’ deposit accounts, they could not make any further attempts to collect from the account unless the consumer provided them with a new authorization. This would help avoid an unexpected cascade of debilitating overdraft or insufficient funds fees incurred by multiple collection attempts.
The goal behind these parts of our proposal is to block lenders from harming consumers by abusing their preferential access to the consumers’ accounts. Of course, lenders that are owed money are entitled to get paid back. But consumers should be able to maintain some meaningful control over their financial affairs, and they should not be subject to an array of fees and other costs that can be generated entirely at the whim of the lender.
The harms to consumers that we have observed in the short-term and longer-term credit markets for personal loans demand an appropriate policy response. As Virginia’s own Thomas Jefferson once said, “The care of human life and happiness, and not their destruction, is the first and only object of good government.” And that is why today we are issuing a call to action.
The proposed framework under discussion reflects rigorous thinking by our colleagues at the Consumer Bureau. In addition to our own extensive research, we have had many discussions with consumers, industry, other federal agencies, state and local regulators, academics, and other interested parties. Our outreach efforts have covered both depository and non-depository lenders that offer payday loans, deposit advance loans, vehicle title loans, installment loans, or other similar loans.
We are releasing this outline to kick off our efforts to solicit specific feedback from small entities that will be affected by this rulemaking. As we are getting this feedback, we will also continue to consult with consumers, industry, and others. We will then formally issue a proposed rule and provide opportunity for everyone to comment. We will move as quickly as we reasonably can, but we will be thoughtful and thorough as we continue this work, in accordance with our best lights about how to address these issues.
In the end, we intend for consumers to have a marketplace that works both for short-term and longer-term credit products. For lenders that sincerely intend to offer responsible options for consumers who need such credit to deal with emergency situations, we are making conscious efforts to keep those options available. For consumers who need more time to repay, there should continue to be opportunities available for affordable installment loans. But lenders that rely on piling up fees and profits from ensnaring people in long-term debt traps would have to change their business models. Consumers should be able to use these products without worrying that they will end up stuck in a deep hole with no way out. We urge you to join us in helping to achieve that goal. Thank you.
The Consumer Financial Protection Bureau (CFPB) is a 21st century agency that helps consumer finance markets work by making rules more effective, by consistently and fairly enforcing those rules, and by empowering consumers to take more control over their economic lives. For more information, visit www.consumerfinance.gov.