Will Installment Loans be Impacted like Payday Loans by the CFPB?
The Consumer Financial Protection Bureau, commonly known as the CFPB, has announced its proposed regulations for lenders who make small-dollar loans. Most of the media attention has been focused on payday loans, but the new regulations will also impact title loans and installment loans. Ever since the CFPB began evaluating ways to regulate payday loans, lenders have voiced objections to new rules that could force many lenders out of business. With the CFPB’s inclusion of installment loans, more lenders are going public with their objections, warning that if the CFPB paints payday loans and installment loans with the same brush, the impact will be devastating to their businesses.
Should the CFPB Treat Payday Loans and Installment Loans the Same?
Although some lenders offer both installment and payday loans, these products have some important differences and typically appeal to different markets. Installment loans typically have much lower annual percentage rates than payday loans, which makes sense because payday loans are intended to be repaid in 14 to 30 days while repayment terms on an installment loan can be six months or longer. State licensing requirements are often different for installment lenders and payday lenders. Even critics of payday loans acknowledge that installment loans are structured in a much safer manner.
The CFPB does appear to recognize that the products are different, and the proposed regulations are slightly less onerous for installment lenders. However, “less onerous” does not mean that the proposed regulations will not have a significant impact on installment lenders. According to the American Banker, the CFPB has estimated that the new regulations will reduce payday loan volume by up to 70 percent. There is no reason to assume that installment loans will not suffer a drastic reduction in volume as well, but the CFPB has been uncharacteristically silent about the effect that the new regulations will have on installment lenders.
Proposed CFPB Regulations Create Unmanageable Burden for Installment Lenders
To understand why the proposed regulations could limit the availability of installment loans, it might be helpful to examine what the CFPB is proposing. At the heart of the plan is a requirement for lenders to verify that a borrower has the means to make the payments and handle living expenses without the need to take out another loan within 30 days. This requirement applies to both payday and installment lenders. However, many borrowers have variable incomes and fluctuating living expenses, and few lenders have the staff necessary to conduct complex underwriting procedures.
The second requirement that poses potential problems for installment lenders pertains to the interest they are allowed to charge. The CFPB has provided two options. If the application fee does not exceed $20, the interest rate is to be capped at 28 percent. Alternatively, loans with equal payments that do not have terms that exceed 24 months can have an all-inclusive cap of 36 percent, excluding an origination fee that must be a “reasonable” amount. Most lenders feel that the first option would be too costly to make the loans financially viable. Under the second option, the loan would need to be at least $2,500 to justify the additional costs that the lender must absorb. Because most loans are made to high-risk borrowers, many lenders will be reluctant to loan that much money.
Early drafts of the CFPB proposed regulations included an option that made underwriting easier. Lenders could meet the requirements to verify that borrowers had the ability to repay their loans by ensuring that the loan payments did not exceed 5 percent of the borrower’s average monthly income. This option would have allowed lenders to remain in compliance while minimizing their underwriting costs. Unfortunately, the “5-percent solution” was eliminated from the final version of the CFPB regulations.
Does the CFPB Possess the Authority to Cap Interest Rates?
Some experts believe that the CFPB has exceeded its authority by regulating interest rates for installment loans. The Dodd-Frank Act specifically states that the CFPB does not have the authority to impose usury limits. This rule is found in Section 1027, subsection (o). Whether this apparent contradiction can withstand a legal challenge remains to be seen.
Will CFPB Regulations Deny Millions of Americans Access to Credit?
The Brookings Institution is a respected organization that conducts research on a wide range of policy issues. In an article posted on the Brookings website, Aaron Klein praised the CFPB’s proposed regulations. However, Klein also recognizes that there are millions of American consumers who have no financial safety net, live paycheck-to-paycheck and do not qualify for high-limit credit cards or bank loans. Despite this knowledge and his assertion that the number of loans made will decline significantly, Klein states that the number of people impacted will not be substantial.
Other analysts disagree. They argue that many borrowers will be unable to meet the underwriting requirements, particularly if they work in a seasonal business. Furthermore, if installment loans cease to be profitable, lenders will simply stop offering these loans. As a result, millions of consumers could be left without access to the credit they need.
The CFPB Regulations Are Controversial and Complex
Whenever the federal government attempts to regulate an industry, controversy is sure to arise. The regulations proposed by the CFPB are no exception. The issue is not a simple one, and both sides have presented valid concerns. If you would like to learn more about the CFPB and installment loans, you can find additional information at PersonalMoneyStore.com.