Welcome to this meeting of our Consumer Advisory Board. It is a pleasure to be here in Little Rock today, and I look forward to our conversation. The feedback we receive from the members of this distinguished group invariably refines our thinking and our approach. It sheds new light on issues and helps us achieve better solutions for consumers. No doubt that will be true today.
Next month we will celebrate the fifth birthday of the Consumer Financial Protection Bureau. From the start, the Bureau has worked doggedly on behalf of consumers, on many fronts. In these remarks, I will describe three distinct aspects of the most recent work we are doing.
One key task has been to create new informational tools and resources that empower consumers to become savvier shoppers. We call this initiative, “Know Before You Owe,” and we have applied it to mortgages and student loans and prepaid financial products. Today, we are unveiling yet another “Know Before You Owe” initiative, this time for auto loans, with a shopping sheet, step-by-step guide, and additional online resources.
Another important goal has been to fashion new rules that protect consumers against the harms they may suffer from unfair, deceptive, or abusive practices. We have undertaken several years of research on the operations and effects of loans issued to consumers for quick cash. Based on what we have learned, we just issued our proposed new rule on payday, auto title, and certain other high-cost installment loans.
Finally, we look for ways to make it easier for everyone to implement our rules successfully and achieve compliance with the law. We recognize that doing so is good for consumers and for financial providers alike. One way we do that is through our eRegulations platform, an online tool we created that makes it easier to navigate, understand, and apply the regulations we are authorized to interpret, oversee, and enforce. So we will talk a bit about that as well.
Let me start with our “Know Before You Owe” auto initiative. These new resources include an auto loan shopping sheet, a step-by-step guide, and additional online information. We have developed these tools and are releasing them today to help consumers take control of the auto loan process. We want consumers to use them to get a clearer picture of how much their loan will cost. The shopping sheet helps consumers break down costs and make direct comparisons between loans. All of the resources are designed to help empower consumers and aid them in taking control of the financing process to get the best result that is right for their budget.
Auto loans are the third largest category of household debt for U.S. consumers, behind only mortgages and student loans. In this country, we now have almost 100 million auto loans worth just over $1 trillion. For those consumers who do not purchase a home, an auto loan may be the largest debt they ever have. Nine out of 10 households have at least one car or truck, most of which are financed: 86 percent of new purchases and 55 percent of used purchases.
The typical consumer takes out a 60-month loan, but the length of these loans and the amount of indebtedness have been increasing over time. On average, each vehicle is owned for about eight years, which means many consumers purchase several vehicles over a lifetime, and they may regularly repeat the budgeting and financing process. Sometimes, consumers are still paying off vehicles they are no longer driving. The financing process can take the form either of “direct” lending (where consumers go to a bank, credit union, or other lender to get their loan directly before going off to buy the vehicle) or of “indirect” lending (where consumers arrange financing through an automobile dealership at the same time they buy the vehicle). Indirect financing is used for most transactions.
Before developing the “Know Before You Owe” auto loan shopping sheet and other resources, the Bureau did some research. We looked at how consumers approach the auto finance decision, and the challenges they face in navigating that process. The findings of that research can be found in a report we are releasing today entitled, Consumer Voices on Automobile Financing. Perhaps not surprisingly, our research finds that even when consumers diligently research the auto purchase itself, they often do not fully explore the available financing options. According to data from the National Financial Capability Survey, only half of consumers report comparison shopping for an auto loan. This is much like what we had found in the housing and mortgage markets, where consumers spend a lot of time finding the right house, but often do not take the time to shop for the best mortgage. And that can be very costly.
The auto loan shopping sheet can help consumers shop more effectively. It breaks down the financing terms so they can make apples-to-apples comparisons from one loan to another. Anyone can download the shopping sheet from our website at consumerfinance.gov. We encourage people to print it out, take it with them, and use it when they are talking to lenders or to auto dealers who are arranging a loan for the consumer. Specifically, it helps consumers understand the total cost of the loan as well as the monthly payment. It is important for us to understand that when we lower the monthly payment by taking out a longer loan, we will end up paying more in interest. A longer loan also puts consumers at risk of having the loan last longer than the vehicle. For too many consumers, focusing only on the whether the monthly payments are affordable does not paint the entire picture. The total cost of the loan, the number of months of debt, the interest rate, and the additional charges also are important factors.
The shopping sheet makes clear what consumers can negotiate and what they cannot. Items that they can negotiate include the price of the vehicle, the down payment, the interest rate, the length of the loan, and the trade-in value of their current vehicle. Knowing what is negotiable allows consumers to negotiate with greater power and more clarity about the ultimate result.
The shopping sheet also helps consumers watch out for add-ons and costly financing features. Consumers should make their own assessment about the potential value of optional add-ons to their purchase or their loan, such as service contracts, extended warranties, specialty insurance, and credit insurance. They also should carefully check the paperwork to be sure all loan costs and other terms are the same as what they agreed to during the negotiations.
Our website also contains information, tips, and pitfalls to watch out for, as well as a step-by-step guide to help consumers all along the way, from budgeting to signing the final documents. In short, we simply want to help people know before they owe. Consumers should feel like they are in the driver’s seat when it comes to financing their car or truck.
While it is fresh in my mind, let me also talk about our field hearing last week in Kansas City, where we announced our proposed new rule aimed at ending debt traps caused by loans made to consumers seeking quick cash. Our rules would cover payday loans, auto title loans, and certain high-cost installment and open-end loans. After years of work, we determined that in such markets, where lenders can succeed by setting up borrowers to fail, something needs to change.
Our extensive research into millions of such loans has brought to light several key facts. Our research found that most payday borrowers reborrow within a month and more than half of all loans occur in sequences of 10 or more. With each new loan, the consumer pays more fees and interest on the same debt. The loan that was supposed to fill a short-term need becomes a long-term debt trap. It is much like getting into a taxi just to ride across town and finding yourself stuck in a ruinously expensive cross-country journey. We found similar rates of reborrowing for single-payment auto title loans and found that one in five sequences ends with the consumer losing her vehicle.
We also researched loans from several payday installment lenders and found that over one-third of loan sequences end in default. We further found that nearly one-third of auto title installment loan sequences end in default, and more than one-in-ten end with the borrower’s car having been seized by the lender.
Currently, about 16,000 payday loan stores operate in the 36 states where this type of lending takes place, joined by an expanding number of online outlets. Some of these lenders also make auto title loans, or payday installment loans, or both. What they have in common is that they offer quick cash on terms that make it very hard for consumers to pay off their loans on time, and they have devised ways to be profitable without determining whether consumers who take out these loans can actually afford them. In the case of payday and single-payment auto title loans, this business model depends critically on repeat borrowing. For payday installment and auto-title installment loans, the business model depends primarily on access to a borrower’s account or auto title, which provides the lender with the necessary leverage to extract payments even when the borrower cannot afford them.
As we took up the task of proposing reforms, we spent much time and effort learning about state and tribal regulatory regimes, including many discussions with state payday regulators, state attorneys general, and tribal leaders. Payday lenders already have to comply with federal laws on matters such as truth-in-lending and debt collection practices. Now we are proposing to add new federal protections against lending practices that harm consumers by trapping them in debt they cannot afford. These strong, common-sense protections would apply mainstream lending principles to such loans. Traditional lenders, such as community banks, credit unions, and many finance companies, make an effort to determine a borrower’s ability to repay before offering a loan with affordable payments. Both the lender and the borrower have a mutual stake in one another’s success. But today, the borrower’s ability to repay is often entirely absent from the transaction when it comes to payday and other similar loans.
Our proposed rule seeks to address these concerns by protecting consumers from such debt traps. Let me first describe how the proposal applies to short-term loans. For these loans, the lender generally would need to apply a “full-payment” test to determine that consumers have the ability to repay the loan without reborrowing. Specifically, lenders would need to verify the borrower’s income, borrowing history, and certain key obligations to decide whether the consumer will have enough money to cover their basic living expenses and other obligations and still pay off the loan when due without needing to reborrow in the next 30 days.
Lenders could also offer a loan with a “principal payoff option,” but only under specified conditions that are directly designed to ensure that consumers cannot get trapped in an extended cycle of debt. Under this option, lenders could extend a short-term loan of up to $500, but could offer no more than two extensions to the original loan, and then only if the consumer repays at least one-third of the principal with each extension. This proposal would afford somewhat more flexibility while expressly protecting borrowers from debt traps and providing them with a simpler way to pay off their debt. To further safeguard against extended indebtedness, lenders could not offer this option to any consumer who has been in debt over the preceding year on short-term loans lasting 90 days or more.
The proposed rule takes the same basic approach to longer-term loans that it covers. Here again, it would generally require lenders to apply the same full-payment test to determine whether borrowers can pay what they owe when it is due and still meet their basic living expenses and obligations. For payday and auto-title installment loans, either with or without a balloon payment, this means consumers have to be able to afford to repay the full amount when it is due, including any fees or finance charges.
Our proposed rule would permit lenders to offer certain longer-term loans without applying the full-payment test if their loans meet specific conditions designed to pose less risk to consumers and provide access to responsible credit. In particular, we are not intending to disrupt existing lending by community banks and credit unions that have found efficient and effective ways to make small-dollar loans to consumers that do not lead to debt traps or high rates of failure. Indeed, we want to encourage other lenders to follow their model.
Therefore, our proposal would not require lenders to apply the full-payment test for loans that generally meet the parameters of the kind of “payday alternative loans” (known as “PAL” loans) authorized by the National Credit Union Administration. For these loans, interest rates are capped at 28 percent and the application fee is no more than $20. The same is true of certain installment loans that we believe pose less risk to consumers. These loans would have to meet three main conditions. First, they must be for a term of no more than two years and be repaid in roughly equal payments. Second, the total cost cannot exceed an all-in percentage rate of 36 percent, plus a reasonable origination fee. Third, the projected annual default rate on all of these loans must not exceed 5 percent. The lender would have to refund all of the origination fees paid by all borrowers in any year where the annual default rate of 5 percent is exceeded. Lenders would also be limited as to how many such loans they could make to a consumer each year.
The Bureau is also proposing new requirements to address how lenders go about extracting payments from consumer accounts for the types of loans. Our research found that when these attempts failed because they were returned for insufficient funds, online payday and payday installment lenders often made repeated attempts to extract money electronically even though they were unlikely to succeed in doing so. When these attempts repeatedly fail, consumers risk incurring substantial fees. So these lenders would have to give borrowers advance notice before accessing their account to collect a payment. In addition, we propose what we call the “debit attempt cutoff.” After two straight unsuccessful attempts, the lender could not make further debits on the account without reaching out to the borrower to get a new and specific authorization.
Based on our review of the available evidence, we believe that under our proposal, the vast majority of borrowers would still be able to get the credit they need in an emergency. But now they would be shielded by an umbrella of stronger protections that would keep them from getting trapped in debt they cannot afford. We seek comment on this proposal from all stakeholders.
Finally, we want to share with everyone that we have recently added some further updates to our innovative eRegulations platform. As anyone who works with them knows, federal regulations can be difficult to navigate. Frequently readers cannot follow them carefully without having to connect information from different places, often separated by dozens or even hundreds of pages of dense text.
We found that many people were trying to understand our regulations by perusing paper editions or using several different online tools to piece together the relevant information. Even paid subscription services, which can be expensive, often do not succeed in making things very easy. So a few years ago we created a new tool, which we call eRegulations. This tool organizes the information in a user-friendly format that lets people search through our regulations, refer to the definitions as terms are being used, and view the official interpretation alongside the regulatory text. It has drawn rave reviews from industry groups and consumer groups alike, which is no small feat.
The only real complaints about this tool were that people wanted more of it. They wanted to see it cover more of our rules. So we are glad to announce that we have now added some important additional rules to the eRegulations tool on our website, which cover further aspects of the mortgage market and consumer lending more broadly. With these new additions, we now have on the eRegulations platform the rules implementing most of the major consumer financial laws we enforce, including the Truth in Lending Act, the Truth in Savings Act, the Electronic Fund Transfers Act, the Equal Credit Opportunity Act, the Home Mortgage Disclosure Act, the Consumer Leasing Act, and the Real Estate Settlement Procedures Act.
We continue to look for ways to improve and expand upon this tool and we encourage you to suggest ideas that will make it even more useful in the future.
I am told that Maya Angelou spent some of her childhood here in Arkansas, and she once said, “Nothing will work unless you do.” We take that advice to heart at the Consumer Bureau, and we have been applying ourselves to support and protect consumers over the past five years. Although we would like to see the financial crisis in the rearview mirror, we are keenly aware that much important work still lies ahead of us. And we will continue our earnest efforts to create a financial marketplace that works for American consumers, responsible providers, and the economy as a whole.
We have much to discuss today and I look forward to it very much. Thank you.
The Consumer Financial Protection Bureau 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 consumerfinance.gov.