Earlier in October, the Consumer Financial Protection Bureau (CFPB) set its sights on payday lenders with a new ruling for the short-term loan industry. Firms offering “payday loans” will now need to qualify their applicants in a similar way as traditional bank loans.
Lenders must administer a full-payment test. This requires them to verify whether a borrower can pay a lump sum within two weeks on a short-term loan or handle the largest monthly payment on a long-term loan. The full-payment test rule restricts the number of loans to a borrower to three within a short time period; it also restricts authorized lender access to a borrower’s bank account on short-term loans.
There are several exceptions to this rule. It does not apply on short-term loans below $500, so long as borrowers have the option for a gradual repayment term. If a lender’s short-term loan revenue does not exceed 10 percent of total revenue, then it can administer a short-term loan without adhering to the full-payment test rule.
The new policy takes effect in July 2019, giving payday lenders some time to adjust to stricter guidelines for their services. One of the cited aims of the CFPB was to “stop payday debt traps.”
Why is this important?
Low-income Americans often have limited choices when it comes to obtaining loan products, and payday lenders fill that void by offering short-term, easy-to-acquire loans to those low-income borrowers. So, what’s the problem with that?
Payday loans often carry high interest rates, a short, aggressive repayment term, and unforgiving fees. Many consider a payday loan as “predatory,” meaning it is meant to make money for the lender, not actually help the borrower. Oftentimes, a successful “predatory” loan results in a debt trap for the consumer, leaving them with harmful fees and mounting debt payments under their belts.
While some payday loan borrowers pay off their debt, a majority, 80 percent, of payday loans will be rolled within a month of disbursement, meaning they are re-borrowed, oftentimes coming with an expensive fee to do so.
Are payday loans gone?
With these new regulations in place, some industry experts estimate a 55-80 percent drop in payday loan volume. It remains to be seen whether payday lenders will close up shop or try to find a way to comply with the new laws to remain in business.
The CFPB expects other lenders to fill the gap with responsible lending under their payday alternative loans program (PAL). Credit unions and small community banks offer these PAL small consumer loans ($200 to $1000) with strict limits on the APR (28 percent) and the APR plus fees (36 percent annualized).
The best way to avoid trouble from payday loans is avoidance altogether. It’s important to establish an emergency fund as soon as possible if you don’t already have one. On top of that, there are various reputable lenders who do not try banking on fees. If they do not accept a credit application, then it may be a good idea to forgo the idea of getting a loan if possible.
Author: Andrew Rombach
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