On June 2, 2016, the CFPB released its long-awaited proposed regulations for payday loans, vehicle title and certain high-cost installment loans.  Comments on the proposed rules must be received on or before September 14, 2016.

While most payday lenders would need to make significant changes to their products and practices under the proposed rules, the final rules could well be delayed though legal challenges in court.  The scope of the proposal is extraordinary, even requiring a new credit reporting system, that would need to be built, to facilitate the ability-to-repay requirements of the proposal.  The CFPB is relying on its authority under the Dodd-Frank UDAAP provisions to issue the rules, which is admittedly very broad, but even that might not be enough to support this ambitious proposal.

Nevertheless, because we cannot predict how courts would ultimately rule on the CFPB’s authority, it’s important to understand the proposed rules, prepare comments, and consider what business model changes might be needed.   This article therefore summarizes the key provisions of the proposal.

The Covered Loans

The proposal would impose requirements on three different types of loan, with the requirements varying depending on the loan type.  Both closed-end and open-end loans would be covered, again with varying requirements.

Covered Short-Term Loans.  These are either closed-end, single advance loans that require the consumer to repay substantially the entire amount of the loan within 45 days of consummation, or all other loans (open or closed-end) that require the consumer to repay substantially the entire advance within 45 days of the advance.

Covered Longer-Term Loans.  These are either closed-end, single advance loans where the consumer is not required to repay substantially the entire amount of the loan within 45 days of consummation, or other loans (open or closed-end) where the consumer is not required to repay substantially the entire amount of the loan within 45 days of an advance under the loan, where in either case the “total cost of credit” exceeds 36 percent per annum and either the lender obtains vehicle security or a “leveraged payment mechanism.”

“Total cost of credit” is broadly defined to include, among other things, all interest and other finance charges, certain credit insurance charges and charges for credit-related ancillary products or services, application fees, and participation fees.

“Leveraged payment mechanisms” would include the right to initiate a transfer of money through any means from a consumer’s “account” to repay the loan, other than a one-time electronic fund transfer initiated immediately after the consumer authorizes the transfer.  It would also include the contractual right to obtain payment directly from the consumer’s employer or other source of income, and any requirement that the consumer repay the loan through payroll deduction or deduction from another source of income.

Covered Longer-Term Balloon-Payment Loans.  These are covered longer-term loans that either require repayment in a single payment or through at least one payment that is more than twice as large as any other payment.  Note that even a single payment loan would fit under this “balloon” payment definition when the loan is otherwise a covered longer-term loan.

Excluded Loans

The definitions for covered loans are very broad, particularly for short-term loans, but the proposal would specifically exclude most purchase money security loans, real estate secured loans, credit cards, student loans, and non-recourse pawn loans.  “Overdraft services” subject to Regulation E would also be excluded, as would overdraft lines of credit subject to Regulation Z.

The Payment Notice

A requirement for lenders to deliver a payment notice to consumers in advance of each payment is somewhat buried near the end of the proposed rules.  Given its potential significance to the industry, it deserves mention before we address the various rules specific to each type of loan.

Under the proposal, a lender generally must provide a payment notice to the consumer before initiating any payment transfer from the consumer’s account.  The notice would need to be provided no earlier than seven and no later than three business days prior to initiating a payment transfer when the notice is provided in person or electronically, or mailed no earlier than ten or later than six business days before the transfer if the notice is sent by mail.  The CFPB has proposed a model form for this notice.

The timing requirements for delivery of the payment notices may present difficulties for very short term loans if the lender must rely on mailing of the notices, given that the notice cannot be mailed any later than six business days (not calendar days) before the payment transfer date.  See below for limitations on the use of electronic disclosures.

The payment notice requirement would not apply to the two longer-term loans that qualify for the conditional exceptions discussed below, to the first payment transfer after getting the consumer’s new payment consent following prior failed transfer attempts, or when initiating a one-time EFT within one business day after the lender obtains the consumer’s authorization for the EFT.

Electronic Delivery of Disclosures

The proposal provides for electronic delivery of disclosures, but the consumer must affirmatively consent to electronic disclosures.  The lender also must provide the consumer with the option to select email as the delivery method, separate and apart from any other methods such as text messaging.

The proposed rules also would allow consumer to revoke consent “for any reason and by any reasonable means of communication.”  It is unclear what the lender’s options would be if the consumer revokes consent, but it is possible that the lender would be required to mail all future disclosures.  Statements by the CFPB in the Federal Register publication of the rules, along with the relatively restrictive “affirmative consent” requirement, suggest that a lender could not condition the loan on the consumer’s consent to electronic disclosures.

The Short-Term Loan Rules

Ability to Repay

Both short-term loans and longer-term loans will be subject to an ability to repay (“ATR”) requirement, but there are differences in those requirements and in the exceptions to the requirements.

Unless the lender makes the loan under the exception provided in proposed Section 1041.7, the lender cannot make a covered short-term loan or increase the available credit without first making a “reasonable determination that the consumer will have the ability to repay the loan according to its terms.”  For lines of credit, this determination would need to be made every 180 days.

To make this determination, the lender must reasonably conclude that:

• The consumer’s residual income is sufficient to make all payments under the loan and to meet basic living expenses during the shorter of the term of the loan or the period ending 45 days after loan consummation;
• The consumer will be able to pay for major financial obligations when due, make any remaining payments on the loan, and meet basic living expenses for 30 days after having made the highest payment on the loan; and
• If the loan is subject to a “presumption of unaffordability,” additional requirements are satisfied.

Lenders would be required to obtain the consumer’s written statement regarding income and major expenses, obtain “verification evidence” of the consumer’s claims, and make a reasonable projection of the amount and timing of the consumer’s income and payments for major financial obligations.

Verification Evidence and the New Credit System

Income could be verified by obtaining a reliable record of income payments covering sufficient history to support the lender’s income projection.  Paystubs or deposit records might satisfy this requirement.

Verification of the consumer’s required payments for major financial obligations would present greater difficulties, and the CFPB’s approach to this requirement might involve their most ambitious proposal.  The CFPB recognized that many payday and other lenders do not reliably report their loans to the major credit bureaus.  They therefore are proposing to require lenders to obtain a consumer report from new “information systems” registered with the CFPB that would be formed to compile and share loan information and to which every lender would be required to provide information on their covered loans.

The proposal sets out the eligibility criteria for the information systems, including the ability to receive the necessary information from lenders and to report it to other lenders, and to perform “in a manner that facilitates compliance with” the regulations.  The CFPB would itself determine whether a proposed vendor satisfies all of the necessary conditions for registration and could suspend or revoke the registration of any entity that the CFPB determines no longer meets the conditions.

Cooling-Off Periods

The proposed rules would prohibit a lender from making a covered short-term loan while the consumer already has a covered short-term loan outstanding and for 30 days thereafter if that new loan would be the fourth loan in a “sequence.”  In general terms, “sequence” refers to a series of consecutive or concurrent covered short-term loans made while the consumer has such a loan outstanding and for 30 days thereafter.  The lender also could not make a covered short-term loan while the borrower has outstanding a loan made under the Section 1041.7 conditional exemption for certain short-term loans (see below) or for 30 days thereafter.

Because non-recourse pawn loans would not be covered loans, the CFPB was concerned that lenders might use those pawn lawns to bridge gaps between covered loans and thereby circumvent the loan sequence rules.  The proposal therefore would prevent a lender from including a pawn loan made by it or its affiliate when calculating the number of days between loans for purposes of the cooling-off periods.

Presumption of Unaffordability

When the consumer is presumed not to have the ability to repay the short-term loan, additional requirements would apply before the lender could make the loan.  Two of those presumptions tie to cooling-off periods, while the third would apply if there is evidence of repayment problems, the new loan would allow the consumer to skip a payment on the old loan, or the new loan would not provide sufficient proceeds to the borrower to allow payments due on the old loan within the next 30 days.  The presumption of unaffordability would apply:

• During the period in which the consumer has a covered short-term loan outstanding and for 30 days thereafter, with some exceptions.

• During the period in which the consumer has a covered longer-term balloon-payment loan outstanding and for 30 days thereafter, with no exceptions.

• If the consumer currently has a covered or non-covered loan outstanding that was made or is being serviced by the same lender or its affiliate and (a) the consumer has had recent payment difficulties with the outstanding loans, as defined in the proposal, (b) the period of time between the new loan and its first payment is longer than the period of time between the new loan and the next payment on the old loan, or (c) the new loan would not provide loan proceeds that substantially exceed payments due on the old loan within the next 30 days.

This presumption of unaffordability could be overcome only based on “reliable evidence” that the consumer will have sufficient improvement in financial capacity to be able to repay the new loan according to its terms.

The Section 1041.7 Conditional Exemption for Certain Short-Term Loans

Under proposed Section 1041.7, the ATR requirements, the prohibition on making loans that are presumed to be unaffordable, and the cooling-off rules would not apply if certain conditions are satisfied.  Those conditions include limits on the amount of the loan, depending on whether the loan is the first, second, or third such loan in the “loan sequence,” and limits on the number of outstanding and recent covered loans.  The new loan also could not be structured as open-end credit, the lender would be required to deliver specified disclosures, and the lender could not take an interest in the consumer’s motor vehicle.

The Longer-Term Loan Rules

As for shorter-term loans, unless specified exemptions apply, the lender could not make a covered longer-term loan or increase the available credit on the loan without first making a reasonable determination of ability to repay.  For lines of credit, this determination would need to be made every 180 days.   The requirements for a “reasonable determination” are similar to those for short-term loans, with some variations.

Also as with short-term loans, lenders would be required to obtain the consumer’s written statement regarding income and major expenses, obtain verification evidence of the consumer’s claims, and make a reasonable projection of the amount and timing of the consumer’s income and payments for major financial obligations.

Cooling-Off Period

The proposed rules for a cooling-off period when making longer-term loans are more limited than for short-term loans.  There is not, for example, a prohibition on making a fourth longer-term loan in a sequence of such loans.  However, if the lender or its affiliate made a covered short-term loan under the short-term loan conditional exemption of Section 1041.7, the lender then could not make a covered longer-term loan to the same borrower while that short-term loan is outstanding or for 30 days thereafter.

As with short-term loans, the days on which non-covered bridge loans made by the same lender or its affiliate are outstanding cannot be counted in determining whether 30 days have elapsed between covered loans.

Presumption of Unaffordability

For longer-term loans where the presumption of unaffordability applies, the lender would again be prohibited from making the new loan unless specified conditions are satisfied.  The presumption of unaffordability for longer-term loans would apply in these cases:

• During the period in which the consumer has a covered short-term loan or a covered longer-term balloon-payment loan outstanding and for 30 days thereafter, with a limited exception if the payments on the new loan are substantially smaller than the prior loan. Note that this exception based on loan payments does not apply to the presumption of unaffordability for covered short-term loans.

• If the consumer currently has a covered or non-covered loan outstanding that was made or is being serviced by the same lender or its affiliate if certain other conditions apply, similar to the rule for short-term loans.

This presumption of unaffordability could be overcome only based on “reliable evidence” that the consumer will have sufficient improvement in financial capacity to be able to repay the new loan according to its terms.

Conditional Exemptions for Certain Longer-Term Loans

The proposal provides for two conditional exemptions for certain loans from the ATR requirements, the cooling-off rule, the prohibition on making loans that are presumed to be unaffordable, and the payments notice rule.  Neither of these loans can be structured as open-end credit.

The first exception applies to loans of not more than six months.  The loan amount must be between $200 and $1,000, it must be repayable in two or more substantially equal monthly installments, it must be fully amortizing, and the total cost of credit cannot be more than the cost permissible for Federal credit unions to charge on special payday loans.  Additional rules relate to the borrower’s history, prepayment penalties may not be imposed, and limitations apply to the use of deposit account security, among other things.

The second exception applies to loans with terms of up to 24 months.  The key difference from the rule for loans of up to six months is that, instead of the total cost of credit being limited to the credit union rate, the “modified total cost of credit” could not exceed an annual rate of 36 percent.  The modified total cost of credit is similar to the total cost of credit except that a single origination fee can be excluded from the calculation.

Limitations on Failed Payment Attempts

Lenders generally would be prohibited from initiating a payment transfer from the consumer’s account after initiating two consecutive attempts to withdraw payment that failed due to a lack of sufficient funds in the account, unless the lender first obtains new and specific authorization from the consumer to make further payment withdrawals.  If the lender holds the consumer’s account that is being debited, a failed payment transfer also would include a transfer that resulted in the collection of less than the full amount for which the transfer was initiated due to insufficient funds.

All of the relevant terms in this prohibition are defined broadly with the obvious aim of ensuring that a lender cannot repeatedly attempt to charge the consumer’s account, by any means whatsoever, when such debits have already been unsuccessful.  The only way a lender could then initiate any future payment would be with the consumer’s express consent after the consumer is provided with specified disclosures. The effect of this rule would be to prevent all future attempts by the lender to initiate payment transfers without the consumer’s active involvement.

The lender’s request for a new authorization from the consumer must include specific payment transfer terms and certain other elements.  In most cases, payment transfer terms would include the specific date, amount, and payment channel of each additional payment transfer.

 Notice of Consumer Rights

After a lender initiates two consecutive failed payment transfers from the consumer’s account, the lender must provide the consumer with a consumer rights notice, for which the CFPB has proposed a model form.  The notice must be sent within three business days after the lender learns that the second attempt failed.

The lender cannot request the consumer’s authorization for an additional payment transfer following two failed attempts before the lender has provided the consumer rights notice to the consumer.  The CFPB contemplates that many lenders would provide the rights notice and request for payment authorization at the same time, but does not require that approach.

Conclusion

Despite the length of this article, there are a great many details that we have not attempted to address here.  Seemingly minor issues, such as the rules for delivery of electronic disclosures, require a careful analysis of the proposed rules and comments, as well as the CFPB’s statements in the Supplementary Information for the proposal.

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