What if a bar could not serve a customer a second drink until one hour after the first drink was consumed?  What if a donut shop could not sell a second serving unless they determined if the consumer would burn off all the calories by the end of the day? What if a tobacco store could not sell a second pack of cigarettes without first taking a lung x-ray? What if casino gamblers could not place successive bets until completing a session with a gambling addiction counselor?

The Consumer Financial Protection Bureau has announced that it will issue a complex set of regulations that are designed to prevent consumers from renewing high interest rate payday loans over and over again.  The impact on the payday lending industry should be devastating.

Today we are taking an important step toward ending the debt traps that plague millions of consumers across the country,” said CFPB Director Richard Cordray. “Too many short-term and longer-term loans are made based on a lender’s ability to collect and not on a borrower’s ability to repay. The proposals we are considering would require lenders to take steps to make sure consumers can pay back their loans. These common sense protections are aimed at ensuring that consumers have access to credit that helps, not harms them.

The CFPB proposals target consumers loans that must be paid back in full within 45 days.  Most payday and auto-title loans are due within two weeks, and CFPB research indicates that 4 out of 5 payday loans are rolled over within two weeks.  According to the bureau, what starts off as a short-term loan usually turns into a long-term “debt trap.”

Lenders making high interest rate payday loans would have to comply with one of the two following regulations:

  • Debt Trap Prevention:
    • Lenders would have to determine if borrowers could repay the loans at the outset.
    • Lenders would have to collect paycheck stubs and tax returns to determine the borrower’s income.
    • Lenders would have to document borrower’s major obligations, repayment history and credit profile.
    • A 60-day “cooling off” period between loans would be required.
    • To make 2nd and 3rd loans the lender would have to obtain additional documentation to verify if the consumer could repay the loan.
  • Debt Trap Protection:
    • Lenders would be limited as to how many loans they could extend to a consumer in a one year period.
    • Lenders could not keep consumers in debt on short-term loans for more than 90 days in a 12-month period.
    • Rollovers would be capped at two – three loans total – followed by a mandatory 60-day cooling-off period.
    • The second and third consecutive loans would be permitted only if the lender offers an affordable way out of debt.

The impact of these regulations on the payday lending industry would be immediate and substantial. The very notion of determining whether a payday borrower can repay the debt is absurd.  The proposed regulations are not designed to “regulate” the industry but to destroy it. When 80% of the industry’s customers renew their loans every two weeks can no longer receive more than 3 rollovers in a year, the impact on the industry will be significant.  The proposed CFPB regulations will weed out many lenders and certainly reduce industry profits in general.  When these reforms roll out sometime next year, the payday lending industry will cease to exist as we know it today.

Image courtesy of Flickr and Jason Comeley.