The Consumer Financial Protection Bureau, commonly called the CFPB, is a federal agency that was created under the authority of the Dodd-Frank Act. The CFPB’s jurisdiction includes credit unions, debt collectors, banks, securities firms and even payday lenders. Since its inception, the CFPB has been especially critical of lenders offering credit products to subprime borrowers, and the agency’s pending regulations may eliminate installment loans for bad credit borrowers.
Why the CFPB Regulations Are Likely to Eliminate Installment Loans for Bad Credit Borrowers
An installment loan is simply a loan that is repaid over a period of months or years with each monthly payment being the same amount. Installment loans may be secured by tangible property that the lender may claim if the borrower defaults; mortgages and loans to purchase vehicles are examples of collateralized installment loans.
However, the CFPB regulations are primarily targeting unsecured installment loans for relatively small amounts. With an unsecured loan, the lender has little more than the borrower’s word that payments will be made on time and that the loan will be repaid in full. These are the types of installment loans for bad credit that may soon become unavailable.
Although the CFPB regulations for payday loans have received most of the attention in the media, the proposed rules will have a significant impact on installment loans. Highlights of the new regulations include:
• Requiring lenders to determine whether the borrower has the ability to repay the loan and still cover living expenses and other financial obligations
• Barring lenders from refinancing a loan that would have similar payments unless the borrower can demonstrate that the new loan would leave him in a better financial situation than what he was in during the previous 30 days
• Requiring lenders to report most installment loans to the credit bureaus
Of the provisions contained in the proposed regulations, lenders are most concerned over the requirement to evaluate the borrower’s ability to repay the loan. This step will increase the lender’s costs substantially, and the way that the regulations are worded, lenders are concerned that many of their current customers will not be able to pass the full-repayment test.
The regulations do offer alternatives to the test, but even the Credit Union National Association has officially stated that they fear the new regulations will prevent many credit unions from being able to offer installment loans. The alternatives can only be applied in two instances.
1. If the interest rate is 28 percent or less and the application fee does not exceed $20, the lender may skip the full-repayment test.
2. If the interest rate does not exceed 36 percent and the loan term is 24 months or less, lenders with a default rate of no more than 5 percent on these loans may skip the full-repayment test.
What Happens if Bad Credit Installment Loans Become Unavailable?
The looming demise of small-dollar installment loans is especially distressing as these loans are one of the safest types of loans for bad credit. Even the Illinois Attorney General, who has been an active advocate for tighter regulations on small-dollar loans in her state, has stated that installment loans are much better than payday loans.
However, installment loans for bad credit may not be available much longer. In an article appearing on AmericanBanker.com, Dennis Shaul estimates that 80 percent of the current small-to-medium-sized lenders could be forced out of the market. Consumers will be left scrambling to find other types of credit, but few options are readily available except for borrowers who present the least risk to lenders.
In a letter to the CFPB, CUNA and the Independent Community Bankers of America stated their concerns about what will happen if community banks and credit unions are “regulated out of this market.” The letter expresses concern that the options left to consumers will include unlicensed, unregulated predatory lenders. Other analysts have stated that illegal loan sharks will likely thrive or that potential borrowers may turn to petty crimes to meet their financial needs.
Some experts predict that a variety of other industries may profit if consumers with damaged credit can no longer have access to small-dollar loans. The consumers may be faced with an increased number of re-connect fees from utility companies, more NSF fees from their banks or late-payment fees from their landlords or mortgage companies.
The exact consequences of the CFPB regulations are yet to be seen. In all likelihood, it will be two to three years before accurate studies can be conducted to measure the true impact of the regulations. However, all predictions are that the new rules are going to reduce access to credit for those who already have few options.
Where to Learn More
The proposed CFPB regulations are lengthy and complex. If you would like to learn more about the impact of the new rules or about installment loans for bad credit, visit the Personal Money Store.