A Dollarwise payday loan store is featured on Friday January 23, 2009 in Kent, Washington. (Ted S. Warren / AP)
The US agency responsible for protecting consumers from financial abuse on Thursday unveiled a proposal that would limit short-term borrowing known as “payday” loans, which can carry interest rates up to 390%.
The Consumer Financial Protection Bureau’s (CFPB) proposal requires lenders to determine whether certain borrowers can afford to take on debt. He also calls for restrictions on loan renewals.
Payday lenders typically cater to low-income borrowers who need cash in a pinch but cannot access funding from traditional banks. The name comes from the idea that a borrower would take out an emergency loan and pay it off with the next paycheck. Since loans are often unsecured, lenders take the risk of not being repaid and charge higher rates.
“Too many borrowers looking for a short-term cash flow solution are struggling with loans they cannot afford and are going into debt over the long term,” said CFPB director Richard Cordray, in a statement, calling the proposal “common” and “common sense”.
“It’s a bit like getting in a cab just to cross town and get stuck on a journey through the ruinous country.”
The industry has braced for further regulation of the CFPB since the Dodd-Frank Wall Street Reform Act of 2010 gave it authority in the payday lending market, and anticipation of new federal rules has already created political rifts on Capitol Hill.
Meanwhile, the Federal Bureau of Investigation and the Internal Revenue Service have cracked down on allegations of fraud and racketeering in the industry. Payday lenders are one of the targets of “Operation Chokepoint,” an FBI investigation into commercial relationships between banks and companies that may break the law.
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The CFPB proposal includes a “full payment” test for people borrowing up to $ 500 over a short period. According to one summary, lenders should determine if a borrower can afford each loan payment while still meeting basic living expenses.
This would prevent lenders from taking auto securities as collateral and make it difficult for them to “get troubled borrowers to re-borrow.” It would also cap the number of short-term loans made in rapid succession. At the same time, it would limit the number of times a lender could try to debit a borrower’s bank account for an unpaid payment, with the CFPB claiming that unsuccessful withdrawal attempts result in bank charges for borrowers.
The proposal presents two alternatives for longer term loans. One caps interest rates at 28% and administration fees at $ 20. The other is an installment loan with equal installments, with the total cost of the loan capped at 36%.
The agency said current practices trap borrowers in “debt traps” with accrued fees and interest, and encourage people to take out new loans to pay off old debts, which can leave them without a bank account or without a car.
Lenders say they are filling a critical void in the economy, allowing people living paycheck to paycheck to cover basic costs and those in need, who may have bad records. credit, to take out loans quickly.
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The fight over the proposal will last for months. The agency will assess comments on the proposal, due September 14, before releasing final regulations. It is also starting a review of “other potentially high-risk lending products and practices” such as open-ended credit.
Cordray was scheduled to discuss the proposal later Thursday at a hearing in Kansas City, Missouri. A coalition of pressure groups supporting the reforms have scheduled a rally in the city, while critics have already started to voice their concerns.
Politically, Republicans, who are widely critical of the office, say restricting short-term small dollar loans will prevent struggling consumers from accessing a legal financial lifeline in an emergency.
Democrats generally support reform, but are divided on how it should be carried out.
Massachusetts Senator Elizabeth Warren and other supporters of tighter financial regulation have lined up behind the CFPB.
Democratic National Committee chair Debbie Wasserman Schultz, meanwhile, promoted the approach used in her home state of Florida, which is seen as more permissive. She sponsored a bill with other members of the state House of Representatives to delay CFPB rules by two years and exempt states with laws similar to Florida.