New rules may keep consumers off payday loan hamster wheel

I had a hallelujah moment when I saw that the Consumer Financial Protection Bureau is proposing new rules that would require payday lenders to make sure borrowers have the means to repay their loans.

I know. You have to be thinking what I’ve thought for years. Isn’t it the responsible thing for lenders to determine that people can pay the money back?But because many people are still in a financial bind after paying off the loan, they end up taking out another loan. Repeat borrowing is good business for the lenders. The bureau found that more than 80 percent of payday loans are followed by another loan within 14 days.

Payday loans are relatively small and are supposed to be paid back in full relatively quickly, typically in a few weeks. The lending requirements are pretty skimpy — a bank account and income.

Borrowers can either give lenders post-dated personal checks or authorize an electronic funds withdrawal.

The typical customer spends five months on the payday hamster wheel and pays $520 in fees for an original loan of $375, according to findings from the Pew Charitable Trusts, which has been doing great research on the dangers of these types of loans.

Payday loans are big business — $7.4 billion annually, according to Pew. Each year, 12 million Americans take out these loans from storefront locations, websites, and a growing number of banks.

The bureau proposal pertains to other types of loans, too, including auto title loans. If a customer fails to repay a title loan, the lender can repossess the car. In a recent report, Pew said more than 2 million people use high-interest automobile title loans, generating $3 billion in revenue for lenders. The average title loan is $1,000. The average borrower spends an estimated $1,200 per year in fees.

The businesses that peddle these loans say they are providing a needed service. And even some payday clients I’ve talked to see it that way — or at least at first. The regrets come later.

“Most people aren’t looking for credit,” said Nick Bourke, director of the small-dollar loans project at Pew. “They are looking for a financial solution for a persistent financial problem.”

Under the bureau’s proposal, lenders would have to look at a person’s income and other financial obligations to determine ability to pay the interest, principal, and fees.

The agency is also considering imposing limits on how many loans a customer can take out in a year.

“For lenders that sincerely intend to offer responsible options for consumers who need such credit to deal with emergency situations, we are making conscious efforts to keep those options available,” said Richard Cordray, the bureau’s director. “But lenders that rely on piling up fees and profits from ensnaring people in long-term debt traps would have to change their business models.”

What the agency is proposing has the ingredients for good reform, according to Bourke and other consumer advocates such as Consumers Union and the Consumer Federation of America. But they are concerned about a loophole that lenders may exploit. The proposed rule includes a provision allowing a small number of balloon-payment loans that wouldn’t have the ability-to-repay requirement, Bourke points out.

“None of this is set in stone, but giving lenders the option to make three loans in a row without requiring a straightforward, common-sense ability-to-repay review should not be part of a final rule,” said Tom Feltner, director of financial services at the Consumer Federation of America.

Borrowing against a future paycheck or putting up the title to your car is an unwise choice that can cause a financial avalanche. Even with better protections, just don’t do it.