One of the most dangerous financial traps you can fall into involves short-term loans. For centuries, loan sharks have been willing to lend small amounts of money for short periods of time, charging usurious rates of interest in exchange for acting as a lender of last resort for borrowers who had no other options. Since the early 20th century, lenders charging interest rates of up to 500% per year attracted the attention of policymakers looking to prevent predatory lending practices, but that hasn't stopped the industry from continuing to evolve into what it looks like today.
In recent years, it looked as though short-term lenders were on their way out. The Consumer Financial Protection Bureau had drafted and proposed rules back in 2016 that would have put restrictions on payday lenders to prevent the endless cycle of loans that rack up fees and interest charges in such a destructive way. Yet now, the CFPB is taking steps to pull back that rule, citing what it sees as a better choice of allowing free-market competition to improve the state of affairs in the payday lending industry.
What the CFPB originally sought to do
The 2016 rules that the CFPB proposed [opens PDF] were intended to cover not only traditional payday loans but also similar lending practices, including auto title loans, deposit advance products, and other high-cost installment and open-end loans. The original proposal noted that payday loans typically have due dates within two weeks and carry annual percentage rates of 390% or higher. Auto title loans with similar provisions give borrowers only 30 days to repay and often have rates that work out to around 300% on an annualized basis. The need to keep coming back and borrowing when the original loan comes due ensures that borrowers pay fees multiple times.
As recently as October 2017, it looked as though the CFPB would move forward with its efforts to control payday loans. As former CFPB Director Richard Cordray said in the release announcing the final version of the rules, "The rule's common sense ability-to-repay protections prevent lenders from succeeding by setting up borrowers to fail."
Specifically, under the rules, payday lenders would have to do several things before making loans. They'd first have to determine whether borrowers were financially able to repay their loans without sacrificing basic living expenses or defaulting on other loans or financial obligations. The CFPB tried to encourage efforts to help borrowers get out of debt on a more gradual basis by providing some exceptions to the rule that would apply to loans with more favorable terms than the particularly problematic payday loans that prevail throughout the marketplace.
The CFPB rules would also put a limit on the number of attempts lenders could make to have payday loans automatically repaid using electronic funds transfers from checking accounts or prepaid debit cards. Lenders routinely make multiple attempts to tap those accounts, often draining them inappropriately and adding further difficulty when banks charge overdraft fees to their customers. Payday lenders would have to get new authorizations from borrowers to seek repayment on more than two separate occasions.
Steps to stop the payday loan rules
The CFPB's mission has changed dramatically over the past year, though, and the final CFPB rules on payday loans never took effect. As early as January 2018, CFPB officials warned that it would go through the administrative steps necessary to reconsider the payday loan rules.
More recently, CFPB Director Kathy Kraninger said the rules would actually be harmful to borrowers, and that pulling back the rules would be beneficial. The rescission notice on Feb. 6 specifically mentioned taking away the need to make underwriting determinations about the ability of borrowers to repay their loans. The bureau argued that doing so "would increase consumer access to credit."
In addition to taking out that provision of the rule, the CFPB also proposed delaying the effective date for the underwriting portion of the rules to November 2020. Kraninger did note that the changes wouldn't affect the rules governing multiple attempts to collect repayment, which would remain in line to become effective this August.
The best choice for borrowers
Many policymakers have argued that the big winner from these moves will be the payday loan companies, which will be able to keep extending credit under terms favorable to them. Yet regardless of whether the rules take effect, would-be borrowers are still in the best position to avoid the debt traps that result from payday loans by choosing not to take them. No matter how financially desperate one might be, the costs of payday loans are simply too great, and it's just too difficult to extricate yourself from the fees and other costs involved with such loans as they balloon your overall debt higher.
Payday lenders might thrive under laxer regulation, but you don't need to support them. Steer clear of payday loans and find more reputable, less expensive ways to meet your financial needs as you figure out long-term strategies to stay out of debt once and for all. Only that way will you be able to protect yourself and keep bad actors from taking advantage of your financial vulnerability.
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