U.S. regulators have implemented new requirements for credit card companies and mortgage lenders. The emphasis is on high cost, short term “payday” loans, which will prevent lenders from issuing loans to borrowers who are unable to afford them. Although the principle is straightforward and logical, it is tough to put into practice, given the business structure of most payday loans companies.
The payday loan industry nets $46 billion annually. Currently, the Consumer Financial Protection Bureau (CPFB) is developing an initial set of national rules for the industry. The new “ability to repay” requirement will apply to all companies issuing payday loans, most of which are for $500 or less. There may also be a “vanilla” category for short-term loans, which is a set of guidelines for lenders to follow in order to ensure that they adhere to the “ability to pay” requirement.
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The primary way that states regulate payday lenders is by putting a cap on borrowers’ interest rates. The CFPB is not allowed to implement this cap. The Pew Charitable Trusts believes that the CFPB should limit borrower payments to five percent of lenders’ total monthly income. If borrowers request larger loans, they must be able to provide adequate proof before being issued the funds.
Many consumer advocacy groups are pushing for even tighter CFPB regulations. As most payday lenders make their money by charging high fees and issuing repeat “rollover” loans, they do not always fully consider the ability of borrowers to pay back their loans in a timely fashion. A major issue to consider is that payday loan businesses rely on having a certain percentage of their borrowers get caught in a viscous cycle of repeat rollovers.
There is a good chance that the new CFPB guidelines will force payday loan companies to adjust their business tactics, which will significantly shrink the payday lending market. If the guidelines are approved, they will favor the largest payday lenders, which are prepared to take the hit of these changes.