On June 2, 2016, the CFPB proposed new ability-to-repay and payment processing requirements for short-term and certain longer-term consumer loans. Relying largely on the CFPB's authority to prohibit unfair or abusive practices, the proposal would generally require that lenders making payday, vehicle title, and certain high-rate installment loans either originate loans satisfying strict product characteristic limitations set by the rule or make an ability-to-repay determination based on verified income and other information.
To facilitate the ability-to-repay determination, the CFPB is also proposing to establish special "registered information systems" to which lenders would have to report information about these loans. In addition, servicers would have to obtain new payment authorizations from consumers after making two consecutive unsuccessful attempts at extracting payment from consumer accounts, and would be subject to new disclosure requirements related to payment processing.
The rule's basics are summarized below, and additional details will follow in a Mayer Brown Legal Update. Comments on the proposal are due on September 14, 2016. Once the CFPB considers those comments and issues a final rule, it anticipates providing a 15-month window after publication before lenders will be required to comply. Legal challenges brought against the agency in connection with the rulemaking could of course affect that timeline.
Ability to Repay and Alternatives
The CFPB's ability-to-repay requirements distinguish between short-term and longer-term loans. By "short-term loans," the CFPB is addressing loans commonly referred to as "payday" or "deposit advance" loans, but including any consumer loan that is repayable within 45 days. A lender of such a loan would be required to make a reasonable determination that the consumer can repay the loan according to its terms. The lender would have to consider and verify the amount and timing of the consumer's income and major financial obligations, and ensure that the consumer can make all payments under the loan as they become due while still being able to pay his/her basic living expenses. The proposal does not set specific requirements or guidelines for determining sufficient residual income.
The lender also would be required to review the consumer's borrowing history, using information from its records, the records of its affiliates, and a consumer report from a new "registered information system" if such a report is available. The consumer's borrowing history would determine whether any of several presumptions of the consumer's inability to repay would apply. If so, the proposal would further limit the lender's ability to originate the loan—or potentially prohibit the loan altogether. For instance, a consumer must generally wait at least 30 days after paying off a prior short-term loan before seeking another one, unless the loan meets a detailed set of requirements regarding a reduction in principal.
However, the rule proposes that certain short-term loans would be exempt from the ability-to-repay requirement. Specifically, lenders may make loans that are limited in amount, fully amortizing, not secured by the consumer's vehicle, and subject to renewal restrictions, without considering and verifying the consumer's ability to repay. In general, a lender would be able to make up to three such loans in a sequence, with the first being no larger than $500 and each subsequent renewal falling in principal amount by one-third of the amount of the initial loan. In any consecutive 12-month period, however, a consumer would not be permitted to have more than six covered short-term loans outstanding or have covered short-term loans outstanding for an aggregate period of more than 90 days.
The proposal also addresses certain longer-term installment loans with high rates and fees, that have either a "leveraged payment mechanism" (e.g., a recurring ACH or other preauthorized access to the consumer's deposits or income) or a non-purchase-money security interest in the consumer's vehicle. Specifically, for consumer loans that are repayable over a longer term than 45 days, with a total cost of credit (an "all-in APR") that exceeds 36%, and a leveraged payment mechanism or a non-purchase money security interest in the consumer's vehicle, the lender must determine the consumer's ability to repay as described above for short-term loans.
Similar to the short-term covered loans, the CFPB proposes certain longer-term loans that would be presumed to fail the ability-to-repay requirement. For instance, if a lender sought to make a covered longer-term loan, it would need to confirm (among other things) that at least 30 days had passed since the consumer paid off a prior short-term loan (or a covered longer-term balloon loan), unless every payment of the new loan would be substantially smaller than the largest required payment on the old loan. Otherwise the lender could only offer the longer-term loan if it could establish that the consumer's financial situation had significantly improved.
However, the proposal provides for two types of longer-term loans to which the general ability-to-repay requirement would not apply. The first of these loans is modeled after the National Credit Union Administration's (NCUA's) Payday Alternative Loan. The loan must be closed-end, between $200 and $1,000, not more than 6 months in duration, and require at least 2 regular periodic payments no less frequently than monthly. It also must be fully amortizing and carry a total cost of credit not in excess of the NCUA limit.
The second type of longer-term loan that would escape the general ability-to-repay requirement is somewhat more complicated. Similar to the first type, the loan would have to be payable in 2 or more regular, fully-amortizing payments due no less frequently than monthly. However, the loan may be up to 24 months in duration and bear a total cost of credit up to 36% plus a limited origination fee. To retain origination fees for these loans, the lender must maintain a portfolio default rate of not more than 5% per year (based on the dollar-volume of defaulted loans). If the lender's default rate exceeds 5%, the lender would have to refund all origination fees for consumers over the past year, including for those borrowers who did not default.
In its 2015 outline for this proposal, the CFPB described an NCUA-type product as one of two safe harbors from the general ability-to-repay requirement, but there are significant differences between the outline and the proposal with respect to the second safe harbor product. Most significantly, the outline's second safe-harbor product could have been no longer than 6 months in duration, had no portfolio default aspect, and permitted the payment on the loan to be as much as 5% of the consumer's income (without regard to the corresponding cost of credit expressed as an all-in APR). Following the publication of that 2015 outline, several banks indicated support for payday alternative loans under such a "5% of income" safe-harbor provision. These banks apparently believed that a 5-month, $500 loan product ultimately requiring $625 in payments could be made profitably with an assumed 6% default rate.
The proposed structure of the second safe-harbor product has similar economics to the specific $500 loan product the banks suggested might work if, and only if, a 5% default rate can be achieved. However, the amount of interest that a lender may charge on the proposed product varies based on loan amount, whereas the version of the product in the 2015 outline would have resulted in a cost of credit that varied based on the consumer's income. In addition, it remains to be seen whether banks or other payday alternative lenders will be willing to bear the risk of the refund provision. On the other hand, lenders may find more flexibility in the fact that the proposed product may be longer in duration (6 vs. 24 months) and may find originating a product that does not depend on verified income to be simpler upfront. It is possible that these factors may offset the revised cost structure and portfolio default rate requirement.
Exclusions
The CFPB proposal and its ability-to-repay requirement would not apply to: (i) loans in which a security interest is taken in purchased goods; (ii) residential mortgage loans; (iii) credit card accounts; (iv) student loans; (v) non-recourse pawn transactions; or (vi) overdraft services and lines of credit (including when offered with prepaid cards). However, the CFPB warns that it will not ignore unfair, deceptive, or abusive practices in connection with those products that it sees through its supervisory or enforcement activities. In addition, certain of those products—credit card accounts and most closed-end residential mortgage loans—are already subject to ability-to-repay requirements.
Originally published June 6, 2016
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