The Consumer Financial Protection Bureau (CFPB) is considering rolling back payday and title loan regulations designed to protect consumers from dangerous debt traps. Considered part of America’s democratization of credit, payday and title loans are offered by a multi-billion-dollar industry that is growing at a rate that far exceeds the rest of the financial services industry.

Claiming that the studies it relied on in the original rule are now suddenly flawed, the Trump-era CFPB has chosen to favor lender profits over protections for low-end consumers.

Whatever happened to interest rate regulation?

The deregulation of interest rates that followed the US Supreme Court’s decision in Marquette National Bank of Minneapolis vs. First of Omaha Service Corp. has led us to an interesting place in history.

Middle-class and upper middle-class people can now get a 30-year fixed rate mortgage for between 3% and 4.5%, in contrast the working poor and working-class regularly take out loans carrying annual interest rates of 300%, 500%, 1100% or more. Never before in our credit-hungry history has there been a greater gap between the interest rates paid by well-heeled and low-end consumers.

What are the various high-cost loans and how do they work?

Post-Marquette, high-cost, small dollar, loans have proliferated in states that allow them. The loans are readily available with no credit check, and are easy to get but hard to pay back. These products include “payday loans” designed to get a cash-strapped consumer from today until payday, “title” loans secured by an unencumbered auto, and high-cost “installment” loans designed to get around state payday loan laws as well as the proposed CFPB regulation that is now being rescinded.

Payday loans, the original product in this portfolio, cost $15-20 for every $100 borrowed for up to two weeks, or 391-500% per annum. The loans don’t amortize. At the end of the 14 days or less, the borrower can pay back the loan plus the fee, or just keep rolling over the fee, leaving the principal untouched. Rollovers are frequent because it is hard for low-income people to come up with all that money at once, and because the demographic who uses these loans is always in need of more cash.

Installment loans are best illustrated through the facts of the B & B Investments v. King case, in which a customer borrowed $100, to be repaid in twenty-six bi-weekly installments of $40.16 each, plus a final installment of $55.34. The customer pays $1,099.71 to borrow $100. The annual percentage rate on this loan is 1,147%. The high-cost installment loan is the new darling of the short-term loan industry because it remains largely unregulated. These increasingly popular installment loans are not covered at all by the new CFPB regulations.

Then there is the 25% per month title loan, which is 300% per annum, secured by a car that is worth more than the loan. The lender looks to the car to recover its loan, not just the borrower’s future income.  Repossession is frequent and to make repossession more efficient, cars are often equipped with location and automatic turnoff devices. The new payday and title loan regulations, which are now being rescinded, would have made a huge difference in regulating title loans.

None of these loans are currently underwritten, meaning that lenders need not determine if borrowers can repay the loan principal when making the loans. Indeed the industry business model seems designed to make principal loans that consumers cannot repay, so that lenders can continue to extract lucrative rollover fees. In his paper, Loan Sharks, Interest-Rate Caps, and Deregulation, psychology professor Robert Mayer, draws some obvious parallels between high-cost lenders and traditional loan sharks:

“The real aim of loan sharks,” explained Avon Books’ How and Where to Borrow Money, “is to keep their customers eternally in debt so that interest (for the sharks) becomes almost an annuity.” A scholarly study on The Small-Loan Industry in Texas, published in 1960, noted that, while the loan shark always charges a high rate of interest, “he does more than this. He loans for… too short a period of time…making payments too high, and… encouraging renewals or refinancing.”

The CFPB’s creation and mission

The CFPB was created under the Dodd–Frank Wall Street Reform and Consumer Protection Act in 2010, in reaction to the financial crisis of 2007-08 and the subsequent great recession. After creation, the agency’s mission statement read:

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.

The new mission under Trump appointee Mick Mulvaney and his predecessor, Kathy Kraninger, reads like this:

The Consumer Financial Protection Bureau is a 21st century agency that helps consumer finance markets work by regularly identifying and addressing outdated, unnecessary, or unduly burdensome regulations, by making rules more effective, by consistently enforcing federal consumer financial law, and by empowering consumers to take more control over their economic lives.

Since its inception, the CFPB has regulated many financial products, including high-cost loans. The question now is whether the CFPB will continue to do so.

What did the rule now being rescinded do?

On November 17, 2017, the CFPB issued a final rule governing payday and title loans with short term or balloon-payment structures. The rule itself is quite complex but at its essence  it is an underwriting rule that- if enforced as planned- would have required lenders to determine if a borrower could pay back the principal of a loan without entering into a long-term debt trap.

Underwriting has long been considered the only way to lend responsibly and to avoid a debt-trap, which is why the new payday loan rule focuses on underwriting.  There are particular rules regarding how a lender determines ability to repay, and other rules as well, but at its essence the rule requires lenders to determine if the borrower can repay the principal of the loan. If not, the loan is an unfair and abusive practice and is illegal.

The Rollback

The CFPB had a long and arduous payday loan rulemaking process underway for some time, with both industry and consumer groups participating. At the end of the day, as indicated above, a rule was passed that would have required underwriting for payday and title loans but not installment loans. Despite this big installment loan loophole, even these half-measure regulations may never be enforced.

On February 6, 2019, the Trump-era CFPB announced its proposal to rescind the mandatory underwriting provisions of the new payday loan rule, or to at the very least to delay the compliance date for the mandatory underwriting provisions.  While the CFPB made it sound like it was only rescinding part of the new rule, the underwriting provisions are the essence of the rule.

As stated by the Pew Charitable Trust which has been engaged in thoughtful payday loan research for nearly a decade, the proposed plan to rescind the rule would:

leave millions of Americans at risk of becoming trapped in a cycle of debt. The rule…was based on years of extensive research and was designed to take a balanced approach by curbing harmful lending practices while keeping credit available to consumers. Today’s proposal would eliminate the rule’s ability-to-repay provision—the central consumer protection measure that curbs unaffordable loan terms… Eliminating these protections would be a grave error and would leave the 12 million Americans who use payday loans every year exposed to unaffordable payments at interest rates that average nearly 400 percent.

The heart of the reconsideration is the CFPB’s finding that only 33 percent of current payday and vehicle title borrowers would be able to satisfy the Rule’s ability-to-pay requirement when initially applying for a loan and that for each succeeding loan in a sequence only one-third of borrowers would satisfy the mandatory underwriting requirement, i.e., 11 percent of current borrowers for a second loan and 3.5 percent for a third loan.

This is a remarkable admission that as it stands now, only one third of borrowers can afford to pay back even their first loans. This leaves two-thirds or more of consumers in the debt trap.

In the rescission, the current CFPB chronicles a lengthy and embarrassing explanation of why the studies originally relied upon in drafting the proposed rule are not that great after all, creating a back and forth worthy of telenovela drama.

The Trump-era CFPB ultimately concluded that the mandatory underwriting provisions would reduce payday loan volume and lender revenue by approximately 92 to 93 percent relative to lending volumes in 2017 and reduce vehicle title volume and lender revenue by between 89 and 93 percent, resulting in payday lender reduction in revenue of between 71 and 76 percent.

Therein lies the real reason for the rescission. The current CFPB concluded that the mandatory underwriting provisions would restrict loans, impose substantial burdens on industry, and significantly constrain lenders’ offering of products.

Everyone involved in analyzing and writing the new underwriting rules knew that these rules would result in less lending and fewer loans for covered loans, namely traditional payday loans and title loans. This result was seen as better than letting consumers continue to borrow loans they could not repay.  The decision was made to keep consumers out of loans that they could not pay back, because these loans would likely cause more harm than good. That decision is now in question, given that limiting dangerous lending will limit lender profits. The CFPB has clearly chosen lender profits over borrow protections, allowing the debt trap to continue.

Professor Nathalie Martin of University of New Mexico School of Law research focuses on consumer law and bankruptcy, as well as elder law. Her recent research focuses on high-cost loans, such as payday, title, and installment loans, as well as the Mindfulness in Law movement. Her high-cost loan projects include several empirical studies funded by the National Conference of Bankruptcy Judges, including one that funded curbside interviews of payday loan customers and another that studied the credit habits of undocumented New Mexicans. Her works have been cited by the New Mexico Supreme Court, the California Supreme Court, and the United States Supreme Court.

Suggested citation: Nathalie Martin, Payday Loan Rule Rollback Consistent with CFPB’s New Anti-Regulation Pro Industry Mission, JURIST – Academic Commentary, Mar. 6, 2019, http://jurist.org/commentary/2019/03/martin-payday-loan-rule-rollback

This article was prepared for publication by Brianna Bell, a JURIST Staff Editor. Please direct any questions or comments to her at commentary@jurist.org