The Consumer Financial Protection Bureau this week released new payday loan rules.
Consumer advocates say the rules will help low-income people and families trapped in endless cycles of debt.
The industry argues that payday loans provide an option for people facing unforeseen expenses or financial emergencies. The rules could cripple the industry, which raised around $ 3.6 billion in fee revenue in 2015, according to the CFPB.
Here is what you need to know about payday loans and the new regulations.
What Are Payday Loans?
Payday loans are generally between $ 200 and $ 1,000 and must be repaid when a borrower receives their next paycheck.
According to the Community Financial Services Association of America (CFSA), which represents payday lenders, borrowers incur an average fee of $ 15 for every $ 100 borrowed. This is the equivalent of an annual interest rate of over 391%.
Where do you find them?
A patchwork of state laws can limit access in certain areas or cap the amount people can borrow. Some states have banned them altogether, according to the National Conference of State Legislative Assemblies.
What is the controversy?
The CFPB maintains that most customers who take out payday loans cannot afford them.
About four in five payday loan clients re-borrow their loan within a month. A quarter ended up borrowing more than eight times, according to the CFPB. During this time, they accumulate new fees.
Watch groups have long called payday lending practices “predatory.”
Dennis Shaul, CEO of industry group CFSA, admits some clients are trapped by payday loans in a nefarious debt cycle – but it’s a small percentage, maybe 15%, he says.
He insists that the industry is not looking to prey on the financially vulnerable.
“We are achieving an average ROI of around 4%,” he told CNNMoney. “We are not making obscene profit off the backs of people.”
What are the new rules for?
1) Verification of borrowers: Lenders will need to verify a borrower’s income, living expenses, and major financial obligations (such as a mortgage or car payment). In most cases, that means pulling a credit report.
2) Special rules for loans under $ 500: Borrowers who take out smaller loans will not necessarily have to jump through all the hurdles. But these borrowers must pay off at least a third of their loan before they can take out another. Frequent borrowers and borrowers in debt may also be prevented from borrowing again.
3) Limits on the number of loans: If a borrower takes out three payday loans in “quick succession”, lenders must put them on hold for 30 days. Additionally, unless they can prove that they are able to pay it all off, borrowers cannot take out more than one payday loan at a time.
4) Prevention of penalty charges: Lenders cannot continue to try to withdraw payments on behalf of a borrower if they do not have sufficient funds. After two payment attempts, lenders will need to re-authorize a payment method with the borrower.
The new CFPB rules, which take effect in July 2019, will also apply to other types of loan products beyond traditional payday loans. They include auto title loans, deposit advance products, and longer term lump sum loans.
What does this mean for payday lenders?
Shaul says the industry wants to prevent the rules from coming into effect – perhaps by working directly with the CFPB, convincing Congress to intervene, or taking legal action.
If they can’t stop the rules from coming into effect, Shaul says he expects payday lenders to be hurt, but they will likely develop new products that comply with the rules.
Some payday lenders, however, may be forced to go out of business.
What does this mean for consumers?
While payday loans are no longer available in some areas, the CFPB says there are other options. These include some short term loans offered by some community banks or credit unions. Some employers also offer prepayment programs. Neither option would likely be affected by the new rules.
– CNNMoney’s Donna Borak contributed to this report.
CNNMoney (New York) First published October 7, 2017: 5:52 p.m. ET