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Finance & Accounting, Small Business Loans

Know the Rules of the Game: Coming Limitations and Curveballs to Short-Term Loans


Every year 12 million Americans turn to payday lending as a solution to their short-term financial woes. However, that number may begin to dwindle now that the federal government has inserted itself into the mix. Within the next few months, the Consumer Financial Protection Bureau is expected to release its first draft of federal regulations governing short-term payday loans.

Despite the fact that short-term payday loans tend to create an endless cycle of debt, many are worried the regulations will have a devastating impact on short-term lending’s $46 billion payday industry.

After the financial crisis of 2008, The Consumer Financial Protection Bureau (CFPB) was created by the Obama Administration to oversee consumer protection in the financial sector. Prior to the creation of the CFPB, the payday loan industry was regulated at the state level. The CFPB’s jurisdiction includes banks, credit unions, securities firms, payday lenders, mortgage servicing operations, foreclosure relief services, debt collectors, and other financial companies.

In 2013, the CFPB empowered consumers when it began accepting consumer complaints about payday loans. Some of the complaints included:

  • Unexpected fees on interest
  • Unauthorized or incorrect bank account charges
  • Payments not being credited to the loan
  • Problems contacting the lender
  • Receiving a loan that they did not apply for
  • Not receiving money after the loan had been applied for

On March 26, 2015 a hearing was held in Richmond, Virginia to address the proposed regulations. From 2013 to 2015 the CFPB analyzed the effects that personal short-term lending and longer credit terms had on consumers. The analysis included the demand of such loans and how they have impacted consumers.

Proposed Regulations

So what will the regulations mean for American consumers? According to the CFPB, the regulations are intended to prevent fraud and protect United States consumers. The proposed regulations will affect payday loans, car title loans, high interest loans, and short-term loans including any loans with a repayment period of 45 days or less. Richard Cordray, Director of the CFPB, stated that currently no attempt is made to determine whether the consumer will be able to afford the ensuing payments.

Under the new regulations, lenders will need to ensure that borrowers have the means to repay the loans. The new regulations will reduce the number of unaffordable loans that lenders can make each year. Some of the regulation specifics include:

  • Lenders will be required to assess a customer’s income, other financial obligations, and borrowing history to ensure that repayment is feasible.
  • Lenders will be prohibited from rolling over loans more than two times in a 12-month period, and this includes a 60-day cooling off period.
  • Lenders have to provide an affordable way for borrowers to get out of debt or repay current loans before approving second and third consecutive loans.
  • Lenders will be required to limit the number of loans per consumer.
  • For certain longer-term loans, lenders will have to put a ceiling on rates at 28 percent.

Short-Term Lending

Short-term lenders provide loans to people in need of fast cash. Unfortunately, the consumers that need these types of loans are willing to apply for loans based on their future earnings, such as their paychecks. This specific group of borrowers tend to be vulnerable, rolling over their loans an average of two to three times before being able to pay the debt off. And the numbers are shocking: the payday loan industry collects $8.7 billion in annual interest fees alone.

Borrowers are also paying ridiculously excessive interest rates. In some cases, borrowers pay as much as 400 percent in interest. Borrowers are also applying for additional payday loans to cover existing ones, which means they sometimes bounce back and forth between different lenders. It appears to be a double-edged sword, one side being the financial necessity and the other side the need for oversight.

Another issue at the forefront of payday lending is lack of knowledge. Many times, borrowers don’t understand the full cost associated with their loans; because they need funds quickly, they tend to skip the fine print and just sign their name on the dotted line.

While the proposed regulations will not ban high interest or short-term loans altogether, it will definitely change the payday and short-term lender loan processes. Some predict that short-term loan industry will collapse because of the stricter guidelines.

How will the proposed regulations affect consumers?

Although it may be months before the proposed regulations are put into effect, payday lenders are warning that the proposed regulations will force many payday companies to close, which will leave consumers with fewer short-term loan options.

Recently, consumers have turned away from traditional banking as a resource for short-term lending in part because it was easier to obtain a loan from a payday lender. In fact, according to a Wall Street Journal article, the majority of traditional banks are no longer providing short-term loans. However, that may change if the proposed regulations create an opening for the banks to re-enter the arena, albeit with stricter guidelines.

Since proposed legislation will impact consumers who normally would turn to payday loans for a short-term fix, here are a few things borrowers can do:

Borrow responsibly – Consumers should borrow when the funds are absolutely needed. Borrow an amount that can be repaid. This will be mandated by the new legislation.

Research other lenders – Research and shop around for other short-term lenders. Alternative online lenders such as Karrot offer 36 to 60-month repayment terms.

A 2013 study by the Pew Charitable Trusts asked payday borrowers what they would do if there were no payday loans; 81 percent of them stated that they would cut back on expenses such as food and clothing. The majority of them also stated that they would delay paying bills, borrow from family or friends, or sell possessions.

The study also indicated that because there are so many payday loan options available, consumers do not tend to shop around. The proposed legislation may put them in a position where they will have to comparison shop for small loans instead of looking for the quick fix.

Have you ever taken out a payday or short-term loan? Do you think the new regulations will help or hurt consumers? Sound off in the comment section below.