Cheat Sheet: What to Expect from CFPB on Payday Lending

The payday loan business — loathed by some, misunderstood in others' eyes — stands on the verge of its biggest shake-up ever.

The Consumer Financial Protection Bureau is in the late stages of formulating the first nationwide rules for payday lending. The regulations will apply to all 20,000 or so payday stores across the country and many more online.

The industry has been preparing for tougher consumer protection rules since at least 2010, when Congress established the CFPB and gave it authority over payday stores.

Payday lenders are taking a pragmatic approach with their new overseers. Firms are migrating away from short-term loans tied to the borrower's pay cycle and toward longer installment loans, a move that could help mitigate the impact of the new regulations.

Meanwhile, the payday industry's biggest trade group hired Dennis Shaul, a longtime aide to former Democratic Rep. Barney Frank, in an effort to shape the CFPB rules. While Shaul maintains that many payday borrowers are helped by the loans, he also acknowledges that a certain percentage of customers are harmed, and says it's appropriate for CFPB to enact new protections for those borrowers.

"The question is: how do we detect them, and how do we protect them?" says Shaul, chief executive officer of the Community Financial Services Association of America.

What follows is a list of key questions and answers about the upcoming payday loan regulations.

Will CFPB establish a nationwide interest-rate cap?

No. At a CFPB hearing last week in Nashville, representatives of the payday industry voiced concern that the agency will cap annual interest rates at 36%.

That usury cap number has a long history in state law, it was adopted by Congress in 2007 legislation that restricts small-dollar loans to members of the military, and it was part of a 2008 campaign promise by then-candidate Barack Obama.

But despite the industry's hand-wringing, an interest rate cap is not going to happen. The Dodd-Frank Act bars CFPB from setting one.

How will the CFPB rules interact with state regulations?

The federal rules are likely to set a regulatory floor below which the states may not fall.

Today there is tremendous variation in state laws governing payday lending. Close to 20 states ban the loans entirely, and the rules in states that allow them vary considerably.

That patchwork will not go away. Observers expect the existing state-level bans to remain in place, while lenders in states that currently have few restrictions will be forced to adapt to the tougher federal rules.

It's possible that one or more of the states with laxer rules will challenge the CFPB's new regulations in court, arguing that the federal government is usurping state powers. But such a lawsuit seems unlikely, Shaul says.

Speaking about the CFPB, he adds, "I don't they're looking to engage in activity which would raise the ire of the states."

Will the rules include an ability-to-pay standard?

The CFPB isn't tipping its hand, but this issue is the top priority for consumer advocates.

They contend that most payday borrowers are unable to pay off their debt without rolling into a new loan, and the payday industry's profits depend on this cycle of repeat borrowing. So consumer advocates are calling for a requirement that all borrowers be evaluated to determine whether they can afford to pay off their loans without taking out new ones.

"Let's look at their accounts, and look at whether they have a positive flow over a period of time that will allow them to pay off the loan," says Paul Leonard, West Coast director at the Center for Responsible Lending.

An ability-to-pay standard could be structured in different ways.

The Pew Charitable Trusts wants a rule stating that customers can't borrow more than 5% of their gross paychecks unless the lender does enough underwriting to show the loan is affordable. New regulatory guidance that applies to banks doesn't include the 5% standard, but it does require strict underwriting, which has led banks to discontinue a small-dollar loan product that bore strong similarities to payday loans. Payday lenders are now trying to stave off that kind of restriction.

"I believe they made a mistake in forcing banks out," Shaul says. "They're not good restrictions. And in my judgment, they're not rationally drawn."

Will the rules crack down on lenders that insist on having access to their customers' bank accounts?

It's unclear, but this is another top priority for consumer advocates.

Under existing law, it's illegal for lenders to condition the approval of a loan application on the borrower agreeing to a particular method of repayment.

But payday lenders generally prefer the certainty that comes from having direct access to the customer's bank account.

In practice, it can be quite difficult for borrowers to take out payday loans without giving the lender electronic access to their checking accounts. Consumer advocates argue that some payday lenders have abused this access by tacking on confusing fees.

It appears that CFPB is sympathetic to that view. During last week's hearing in Nashville, Director Richard Cordray said the agency has found that "some lenders use the electronic payment system in ways that pose risks to consumers."

"These practices can hinder consumers from getting out of debt or can leave them unable to prioritize the payment of their various debts in ways that would leave them better off," he said.

Will payday lenders find loopholes in the CFPB rules?

It's far too early to say, but the payday loan industry has a history of outfoxing its regulators.

The aforementioned Military Lending Act of 2007 put a 36% annual interest rate cap on closed-end loans of up to $2,000 and terms of 91 days or less. Lenders countered by structuring their loans to members of the military as open-end credit, or by setting slightly longer loan terms.

Consumer advocates fear that the outcome will be the same this time, especially if the CFPB writes relatively specific, narrow rules.

Will the rules establish a level playing field?

No.  Small-dollar consumer credit comes in many forms, including payday, installment, auto title and bank and credit union loans. There's been a lot of talk about the need to establish uniform rules for small-dollar consumer credit, but that day seems as distant as ever.

Overdraft fees at banks, another product under study by CFPB, are also  functionally similar to payday loans. But there's been no indication that the bureau is planning to devise one umbrella set of rules that covers all forms of small-dollar credit.

How long will the CFPB's rulemaking process take?

It will last several months, if not a year or longer. Observers say the agency is likely to proceed in the following fashion: convening panels to assess the rules' potential impact on small business, proposing a rule, accepting public comment and then issuing a final rule.

It's possible that the bureau will add another step by proposing a preliminary rule before convening the small business panel.

Despite the constraints of the rulemaking process, Shaul, the payday industry's lobbyist, expects the bureau to move relatively fast.

"I think they are eager to get the rule out," he says. "I think they've been trying to get as much data as they can, with the object of doing something fairly quickly."