In June of 2016, the Consumer Financial Protection Bureau (CFPB) proposed new rules designed to protect consumers who take out short-term loans. These regulations would put more restrictions on lenders before issuing short-term loans, helping fewer people fall into the debt trap.
The Danger of Short-Term Loans
The CFPB regulations would apply primarily to payday loans and car title loans, which are some of the most common short-term loans available. Here’s a quick breakdown on how each type of loan works:
- Payday Loans – A borrower gives the lender a check for a certain amount of money, along with a service fee. The lender then loans the borrower the money, minus that fee. When the next payday comes around, the lender cashes the borrower’s check.
- Title Loans – A borrower gives the lender their car title (also known as a pink slip, the origin of the term “pink slip loan”). The lender, after inspecting the vehicle, loans the borrower a certain amount of money, with a typical maximum being 50 percent of the car’s trade-in value. The borrower gets the title back after paying back the loan.
Both types of loans are known for being easy and fast to obtain. Borrowers just have to provide some of their basic information, and they can usually obtain a loan on the same day.
So, why did the CFPB feel the need to step in? While both types of loans seem fine on the surface, they tend to be on the expensive side, especially if the borrower fails to repay them within the original repayment period. When that happens, it’s far too easy to get stuck in a debt trap cycle.
The CFPB explained that the fees and interest on these types of loans, when adjusted to what you’d pay over a full year, can reach the equivalent of a 390-percent APR. The market for payday and title loans consists primarily of people who need a quick, convenient loan and don’t have the credit for something better. The combination of the high fees and the financial situations of those in need of these loans often leads to lengthy debt trap cycles.
The New Regulations
The CFPB’s first proposed regulation is that lenders must perform a full-payment test on borrowers. This test involves taking a look at the borrower’s income and expenses, to make sure that they will be able to make their payments on the loan along with their other living expenses.
Its next regulation makes it more difficult for lenders to refinance and reissue loans. Lenders can’t issue a similar loan or rollover a loan for a borrower that just paid off a short-term debt in the last 30 days.
Finally, the CFPB plans to require lenders to give borrowers at least three days’ written notice before they attempt to charge an account. The notice must include when the charge will occur and for what amount. This requirement was put in place because borrowers who don’t have the money to repay their short-term loans often get hit with overdraft fees when the lender tries to charge their account. This makes a difficult financial situation even worse.
Controversy Over the New Regulations
The CFPB’s regulations have attracted criticism from both sides of the argument. Some believe that the regulations aren’t strict enough, and that the government should set limits to the maximum amount of a short-term loan.
Others claim that the CFPB is twisting the information to fit its arguments against short-term lending (specifically when the organization equates payday and title loan fees with a 390-percent APR, as a finance fee for a short loan is very different from APR on a credit card or long-term loan), and that regulating the short-term lending process is only going to hurt borrowers. If borrowers are unable to obtain a short-term loan, what is their alternative? Borrowers often use short-term loans to pay for necessary, unexpected expenses, such as a vehicle breakdown. Without a short-term loan, a borrower may end up in an even more difficult situation.
While opinions are mixed regarding the CFPB’s new rules, many people see it as a positive change. For the most part, the rules aren’t going to prevent people from getting short-term loans, they’ve simply been put in place to make sure that borrowers only get loans that they can afford and aren’t trapped in a vicious cycle of debt that keeps growing.