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Proposed Rule

Payday, Vehicle Title, and Certain High-Cost Installment Loans

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Start Preamble Start Printed Page 47864

AGENCY:

Bureau of Consumer Financial Protection.

ACTION:

Proposed rule with request for public comment.

SUMMARY:

The Bureau of Consumer Financial Protection (Bureau or CFPB) is proposing to establish 12 CFR 1041, which would contain regulations creating consumer protections for certain consumer credit products. The proposed regulations would cover payday, vehicle title, and certain high-cost installment loans.

DATES:

Comments must be received on or before October 7, 2016.

ADDRESSES:

You may submit comments, identified by Docket No. CFPB-2016-0025 or RIN 3170-AA40, by any of the following methods:

  • Email: FederalRegisterComments@cfpb.gov. Include Docket No. CFPB-2016-0025 or RIN 3170-AA40 in the subject line of the email.
  • Electronic: http://www.regulations.gov. Follow the instructions for submitting comments.
  • Mail: Monica Jackson, Office of the Executive Secretary, Consumer Financial Protection Bureau, 1700 G Street NW., Washington, DC 20552.
  • Hand Delivery/Courier: Monica Jackson, Office of the Executive Secretary, Consumer Financial Protection Bureau, 1275 First Street NE., Washington, DC 20002.

Instructions: All submissions should include the agency name and docket number or Regulatory Information Number (RIN) for this rulemaking. Because paper mail in the Washington, DC area and at the Bureau is subject to delay, commenters are encouraged to submit comments electronically. In general, all comments received will be posted without change to http://www.regulations.gov. In addition, comments will be available for public inspection and copying at 1275 First Street NE., Washington, DC 20002, on official business days between the hours of 10 a.m. and 5 p.m. eastern time. You can make an appointment to inspect the documents by telephoning (202) 435-7275.

All comments, including attachments and other supporting materials, will become part of the public record and subject to public disclosure. Sensitive personal information, such as account numbers or Social Security numbers, should not be included. Comments will not be edited to remove any identifying or contact information.

Start Further Info

FOR FURTHER INFORMATION CONTACT:

Eleanor Blume, Sarita Frattaroli, Casey Jennings, Sandeep Vaheesan, Steve Wrone, Counsels; Daniel C. Brown, Mark Morelli, Michael G. Silver, Laura B. Stack, Senior Counsels, Office of Regulations, at 202-435-7700.

End Further Info End Preamble Start Supplemental Information

SUPPLEMENTARY INFORMATION:

I. Summary of the Proposed Rule

The Bureau is issuing this notice to propose consumer protections for payday loans, vehicle title loans, and certain high-cost installment loans (collectively “covered loans”). Covered loans are typically used by consumers who are living paycheck to paycheck, have little to no access to other credit products, and seek funds to meet recurring or one-time expenses. The Bureau has conducted extensive research on these products, in addition to several years of outreach and review of the available literature. The Bureau is proposing to issue regulations primarily pursuant to authority under section 1031 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) to identify and prevent unfair, deceptive, and abusive acts and practices.[1] The Bureau is also using authorities under section 1022 of the Dodd-Frank Act to prescribe rules and make exemptions from such rules as is necessary or appropriate to carry out the purposes and objectives of the consumer Federal consumer financial laws,[2] section 1024 of the Dodd-Frank Act to facilitate supervision of certain non-bank financial service providers,[3] and section 1032 of the Dodd-Frank Act to require disclosures to convey the costs, benefits, and risks of particular consumer financial products or services.[4]

The Bureau is concerned that lenders that make covered loans have developed business models that deviate substantially from the practices in other credit markets by failing to assess consumers' ability to repay their loans and by engaging in harmful practices in the course of seeking to withdraw payments from consumers' accounts. The Bureau believes that there may be a high likelihood of consumer harm in connection with these covered loans because many consumers struggle to repay their loans. In particular, many consumers who take out covered loans appear to lack the ability to repay them and face one of three options when an unaffordable loan payment is due: take out additional covered loans, default on the covered loan, or make the payment on the covered loan and fail to meet other major financial obligations or basic living expenses. Many lenders may seek to obtain repayment of covered loans directly from consumers' accounts. The Bureau is concerned that consumers may be subject to multiple fees and other harms when lenders make repeated unsuccessful attempts to withdraw funds from consumers' accounts.

A. Scope of the Proposed Rule

The Bureau's proposal would apply to two types of covered loans. First, it would apply to short-term loans that have terms of 45 days or less, including typical 14-day and 30-day payday loans, as well as short-term vehicle title loans that are usually made for 30-day terms. Second, the proposal would apply to longer-term loans with terms of more than 45 days that have (1) a total cost of credit that exceeds 36 percent; and (2) either a lien or other security interest in the consumer's vehicle or a form of “leveraged payment mechanism” that gives the lender a right to initiate transfers from the consumer's account or to obtain payment through a payroll deduction or other direct access to the consumer's paycheck. Included among covered longer-term loans is a subcategory loans with a balloon payment, which require the consumer to pay all of the principal in a single payment or make at least one payment that is more than twice as large as any other payment.

The Bureau is proposing to exclude several types of consumer credit from the scope of the proposal, including: (1) Loans extended solely to finance the purchase of a car or other consumer good in which the good secures the loan; (2) home mortgages and other loans secured by real property or a dwelling if recorded or perfected; (3) credit cards; (4) student loans; (5) non-recourse pawn loans; and (6) overdraft services and lines of credit.

B. Proposed Ability-to-Repay Requirements and Alternative Requirements for Covered Short-Term Loans

The proposed rule would identify it as an abusive and unfair practice for a lender to make a covered short-term loan without reasonably determining that the consumer will have the ability Start Printed Page 47865to repay the loan.[5] The proposed rule would prescribe requirements to prevent the practice. A lender, before making a covered short-term loan, would have to make a reasonable determination that the consumer would be able to make the payments on the loan and be able to meet the consumer's other major financial obligations and basic living expenses without needing to reborrow over the ensuing 30 days. Specifically, a lender would have to:

  • Verify the consumer's net income;
  • verify the consumer's debt obligations using a national consumer report and a consumer report from a “registered information system” as described below;
  • verify the consumer's housing costs or use a reliable method of estimating a consumer's housing expense based on the housing expenses of similarly situated consumers;
  • forecast a reasonable amount of basic living expenses for the consumer—expenditures (other than debt obligations and housing costs) necessary for a consumer to maintain the consumer's health, welfare, and ability to produce income;
  • project the consumer's net income, debt obligations, and housing costs for a period of time based on the term of the loan; and
  • determine the consumer's ability to repay the loan based on the lender's projections of the consumer's income, debt obligations, and housing costs and forecast of basic living expenses for the consumer.

A lender would also have to make, under certain circumstances, additional assumptions or presumptions when evaluating a consumer's ability to repay a covered short-term loan. The proposal would specify certain assumptions for determining the consumer's ability to repay a line of credit that is a covered short-term loan. In addition, if a consumer seeks a covered short-term loan within 30 days of a covered short-term loan or a covered longer-term loan with a balloon payment, a lender generally would be required to presume that the consumer is not able to afford the new loan. A lender would be able to overcome the presumption of unaffordability for a new covered short-term loan only if it could document a sufficient improvement in the consumer's financial capacity. Furthermore, a lender would be prohibited from making a covered short-term loan to a consumer who has already taken out three covered short-term loans within 30 days of each other.

A lender would also be allowed to make a covered short-term loan, without making an ability-to-repay determination, so long as the loan satisfies certain prescribed terms and the lender confirms that the consumer met specified borrowing history conditions and provides required disclosures to the consumer. Among other conditions, a lender would be allowed to make up to three covered short-term loans in short succession, provided that the first loan has a principal amount no larger than $500, the second loan has a principal amount at least one-third smaller than the principal amount on the first loan, and the third loan has a principal amount at least two-thirds smaller than the principal amount on the first loan. In addition, a lender would not be allowed to make a covered short-term loan under the alternative requirements if it would result in the consumer having more than six covered short-term loans during a consecutive 12-month period or being in debt for more than 90 days on covered short-term loans during a consecutive 12-month period. A lender would not be permitted to take vehicle security in connection with these loans.

C. Proposed Ability-to-Repay Requirements and Alternative Requirements for Covered Longer-Term Loans

The proposed rule would identify it as an abusive and unfair practice for a lender to make a covered longer-term loan without reasonably determining that the consumer will have the ability to repay the loan. The proposed rule would prescribe requirements to prevent the practice. A lender, before making a covered longer-term loan, would have to make a reasonable determination that the consumer has the ability to make all required payments as scheduled. The proposed ability-to-repay requirements for covered longer-term loans closely track the proposed requirements for covered short-term loans with an added requirement that the lender, in assessing the consumer's ability to repay a longer term loan, reasonably account for the possibility of volatility in the consumer's income, obligations, or basic living expenses during the term of the loan.

A lender would also have to make, under certain circumstances, additional assumptions or presumptions when evaluating a consumer's ability to repay a covered longer-term loan. The proposal would specify certain assumptions for determining the consumer's ability to repay a line of credit that is a covered longer-term loan. In addition, if a consumer seeks a covered longer-term loan within 30 days of a covered short-term loan or a covered longer-term balloon-payment loan, the lender would, under certain circumstances, be required to presume that the consumer is not able to afford a new loan. A presumption of unaffordability also generally would apply if the consumer has shown or expressed difficulty in repaying other outstanding covered or non-covered loans made by the same lender or its affiliate. A lender would be able to overcome the presumption of unaffordability for a new covered longer-term loan only if it could document a sufficient improvement in the consumer's financial capacity.

A lender would also be permitted to make a covered longer-term loan without having to satisfy the ability-to-repay requirements by making loans under a conditional exemption modeled on the National Credit Union Administration's (NCUA) Payday Alternative Loan (PAL) program. Among other conditions, a covered longer-term loan under this exemption would be required to have a principal amount of not less than $200 and not more than $1,000, fully amortizing payments, and a term of at least 46 days but not longer than six months. In addition, loans made under this exemption could not have an interest rate more that is more than the interest rate that is permitted for Federal credit unions to charge under the PAL regulations and an application fee of more than $20.

A lender would also be permitted to make a covered longer-term loan, without having to satisfy the ability-to-repay requirements, so long as the covered longer-term loan meets certain structural conditions. Among other conditions, a covered longer-term loan under this exemption would be required to have fully amortizing payments and a term of at least 46 days but not longer than 24 months. In addition, to qualify for this conditional exemption, a loan must carry a modified total cost of credit of less than or equal to an annual rate of 36 percent, from which the lender could exclude a single origination fee that is no more than $50 or that is reasonably proportionate to the lender's costs of underwriting. The projected annual default rate on all loans made pursuant to this conditional exemption must not exceed 5 percent. The lender would have to refund all of the origination fees paid by all borrowers in Start Printed Page 47866any year in which the annual default rate of 5 percent is exceeded.

D. Proposed Payments Practices Rules

The proposed rule would identify it as an abusive and unfair practice for a lender to attempt to withdraw payment from a consumer's account in connection with a covered loan after the lender's second consecutive attempt to withdraw payment from the account has failed due to a lack of sufficient funds, unless the lender obtains from the consumer a new and specific authorization to make further withdrawals from the account. This prohibition on further withdrawal attempts would apply whether the two failed attempts are initiated through a single payment channel or different channels, such as the automated clearinghouse system and the check network. The proposed rule would require that lenders provide notice to consumers when the prohibition has been triggered and follow certain procedures in obtaining new authorizations.

In addition to the requirements related to the prohibition on further payment withdrawal attempts, a lender would be required to provide a written notice at least three business days before each attempt to withdraw payment for a covered loan from a consumer's checking, savings, or prepaid account. The notice would contain key information about the upcoming payment attempt, and, if applicable, alert the consumer to unusual payment attempts. A lender would be permitted to provide electronic notices so long as the consumer consents to electronic communications.

E. Additional Requirements

The Bureau is proposing to require lenders to furnish to registered information systems basic information for most covered loans at origination, any updates to that information over the life of the loan, and certain information when the loan ceases to be outstanding. The registered information systems would have to meet certain eligibility criteria prescribed in the proposed rule. The Bureau is proposing a sequential process that it believes would ensure that information systems would be registered and lenders ready to furnish at the time the furnishing obligation in the proposed rule would take effect. For most covered loans, registered information systems would provide a reasonably comprehensive record of a consumer's recent and current borrowing. Before making most covered loans, a lender would be required to obtain and review a consumer report from a registered information system.

A lender would be required to establish and follow a compliance program and retain certain records. A lender would be required to develop and follow written policies and procedures that are reasonably designed to ensure compliance with the requirements in this proposal. Furthermore, a lender would be required to retain the loan agreement and documentation obtained for a covered loan, and electronic records in tabular format regarding origination calculations and determinations for a covered loan, for a consumer who qualifies for an exception to or overcomes a presumption of unaffordability for a covered loan, and regarding loan type and terms. The proposed rule also would include an anti-evasion clause.

F. Effective Date

The Bureau is proposing that, in general, the final rule would become effective 15 months after publication of the final rule in the Federal Register. The Bureau is proposing that certain provisions necessary to implement the consumer reporting components of the proposal would become effective 60 days after publication of the final rule in the Federal Register to facilitate an orderly implementation process.

II. Background

A. Introduction

For most consumers, credit provides a means of purchasing goods or services and spreading the cost of repayment over time. This is true of the three largest consumer credit markets: The market for mortgages ($9.99 trillion in outstanding balances), for student loans ($1.3 trillion), and for auto loans ($1 trillion). This is also one way in which certain types of open-end credit—including home equity loans ($0.14 trillion) and lines of credit ($0.51 trillion)—and at least some credit cards and revolving credit ($0.9 trillion)—can be used.[6]

Consumers living paycheck to paycheck and with little to no savings have also used credit as a means of coping with shortfalls. These shortfalls can arise from mismatched timing between income and expenses, misaligned cash flows, income volatility, unexpected expenses or income shocks, or expenses that simply exceed income.[7] Whatever the cause of the shortfall, consumers in these situations sometimes seek what may broadly be termed a “liquidity loan.” [8] There are a variety of loans and products that consumers use for these purposes including credit cards, deposit account overdraft, pawn loans, payday loans, vehicle title loans, and installment loans.

Credit cards and deposit account overdraft services are each already subject to specific Federal consumer protection regulations and requirements. The Bureau generally considers these markets to be outside the scope of this rulemaking as discussed further below. The Bureau is also separately engaged in research and evaluation of potential rulemaking actions on deposit account overdraft.[9] Start Printed Page 47867Another liquidity option—pawn—generally involves non-recourse loans made against the value of whatever item a consumer chooses to give the lender in return for the funds.[10] The consumer has the option to either repay the loan or permit the pawnbroker to retain and sell the pawned property at the end of the loan term, relieving the borrower from any additional financial obligation. This feature distinguishes pawn loans from most other types of liquidity loans. The Bureau is proposing to exclude non-recourse possessory pawn loans, as described in proposed § 1041.3(e)(5), from the scope of this rulemaking.

This rulemaking is focused on two general categories of liquidity loan products: Short-term loans and certain higher-cost longer-term loans. The largest category of short-term loans are “payday loans,” which are generally required to be repaid in a lump-sum single-payment on receipt of the borrower's next income payment, and short-term vehicle title loans, which are also almost always due in a lump-sum single-payment, typically within 30 days after the loan is made. The second general category consists of certain higher-cost longer-term loans. It includes both what are often referred to as “payday installment loans”—that is, loans that are repaid in multiple installments with each installment typically due on the borrower's payday or regularly-scheduled income payment and with the lender generally having the ability to automatically collect payments from an account into which the income payment is deposited—and vehicle title installment loans. In addition, the latter category includes higher cost, longer-term loans in which the principal is not amortized but is scheduled to be paid off in a large lump sum payment after a series of smaller, often interest-only, payments. Some of these loans are available at storefront locations, others are available on the internet, and some loans are available through multiple delivery channels. This rulemaking is not limited to closed-end loans but includes open-end lines of credit as well.[11] It also includes short-term products and some more traditional installment loans made by some depository institutions and by traditional finance companies.

As described in more detail in part III, the Bureau has been studying these markets for liquidity loans for over four years, gaining insights from a variety of sources. During this time the Bureau has conducted supervisory examinations of a number of payday lenders and enforcement investigations of a number of different types of liquidity lenders, which have given the Bureau insights into the business models and practices of such lenders. Through these processes, and through market monitoring activities, the Bureau also has obtained extensive loan-level data that the Bureau has studied to better understand risks to consumers.[12] The Bureau has published four reports based upon these data, and, concurrently with the issuance of this Notice of Proposed Rulemaking, the Bureau is releasing a fifth report.[13] The Bureau has also carefully reviewed the published literature with respect to small-dollar liquidity loans and a number of outside researchers have presented their research at seminars for Bureau staff. In addition, over the course of the past four years the Bureau has engaged in extensive outreach with a variety of stakeholders in both formal and informal settings, including several Bureau field hearings across the country specifically focused on the subject of small-dollar lending, meetings with the Bureau's standing advisory groups, meetings with State and Federal regulators, meetings with consumer advocates, religious groups, and industry trade associations, consultations with Indian tribes, and through a Small Business Review Panel process as described further below.

This Background section provides a brief description of the major components of the markets for both short-term loans and certain higher-cost longer-term loans, describing the product parameters, industry size and structure, lending practices, and business models of each component. It then goes on to describe recent State and Federal regulatory activity in connection with these product markets. Market Concerns—Short-Term Loans and Market Concerns—Longer-Term Loans below, provide a more detailed description of consumer experiences with short-term loans and certain higher-cost longer-term loans, describing research about which consumers use the products, why they Start Printed Page 47868use the products, and the outcomes they experience as a result of the product structures and industry practices.

B. Single-payment and Other Short-Term Loans

At around the beginning of the twentieth century, concern arose with respect to companies that were responding to liquidity needs by offering to “purchase” a consumer's paycheck in advance of it being paid. These companies charged fees that, if calculated as an annualized interest rate, were as high as 400 percent.[14] To address these concerns, between 1914 and 1943, 34 States enacted a form of the Uniform Small Loan Law, which was a model law developed by the Russell Sage Foundation. That law provided for lender licensing and permitted interest rates of between 2 and 4 percent per month, or 24 to 48 percent per year. Those rates were substantially higher than pre-existing usury limits (which generally capped interest rates at between 6 and 8 percent per year) but were viewed by proponents as “equitable to both borrower and lender.” [15]

New forms of short-term small-dollar lending appeared in several States in the 1990s,[16] starting with check cashing outlets that would hold a customer's personal check for a period of time for a fee before cashing it (“check holding” or “deferred presentment”).[17] Several market factors had converged around the same time. Consumers were using credit cards more frequently for short-term liquidity lending needs, a trend that continues today.[18] Storefront finance companies, described below in part II.C that had provided small loans changed their focus to larger, collateralized products, including vehicle financing and real estate secured loans. At the same time there was substantial consolidation in the storefront installment lending industry. Depository institutions similarly moved away from short-term small-dollar loans.

Around the same time, a number of State legislatures amended their usury laws to allow lending by a broader group of both depository and non-depository lenders by increasing maximum allowable State interest rates or eliminating State usury laws, while other States created usury carve-outs or special rules for short-term loans.[19] The confluence of these trends has led to the development of markets offering what are commonly referred to as payday loans (also known as cash advance loans, deferred deposit, and deferred presentment loans depending on lender and State law terminology), and short-term vehicle title loans that are much shorter in duration than vehicle-secured loans that have traditionally been offered by storefront installment lenders and depository institutions. Although payday loans initially were distributed through storefront retail outlets, they are now also widely available on the internet. Vehicle title loans are typically offered exclusively at storefront retail outlets.

These markets as they have evolved over the last two decades are not strictly segmented. There is substantial overlap between market products and the borrowers who use them. For example, in a 2013 survey, almost 18 percent of U.S. households that had used a payday loan in the prior year had also used a vehicle title loan.[20] There is also an established trend away from “monoline” or single-product lending companies. Thus, for example, a number of large payday lenders also offer vehicle title and installment loans.[21] The following discussion nonetheless provides a description of major product types.

Storefront Payday Loans

The market that has received the greatest attention among policy makers, advocates, and researchers is the market for single-payment payday loans. These payday loans are short-term small-dollar loans generally repayable in a single payment due when the consumer is scheduled to receive a paycheck or other inflow of income (e.g., government benefits).[22] For most borrowers, the loan is due in a single payment on their payday, although State laws with minimum loan terms—seven days for example—or lender practices may affect the loan duration in individual cases. The Bureau refers to these short-term payday loans available at retail locations as “storefront payday loans,” but the requirements for borrowers taking online payday loans are generally similar, as described below. There are now 36 States that either have created a carve-out from their general usury cap for payday loans or have no usury caps on consumer loans.[23] The remaining 14 Start Printed Page 47869States and the District of Columbia either ban payday loans or have fee or interest rate caps that payday lenders apparently find too low to sustain their business models. As discussed further below, several of these States previously had authorized payday lending but subsequently changed their laws.

Product definition and regulatory environment. As noted above, payday loans are typically repayable in a single payment on the borrower's next payday. In order to help ensure repayment, in the storefront environment the lender generally holds the borrower's personal check made out to the lender—usually post-dated to the loan due date in the amount of the loan's principal and fees—or the borrower's authorization to electronically debit the funds from her checking account, commonly known as an automated clearing house (ACH) transaction.[24] Payment methods are described in more detail below in part II.D.

Payday loan sizes vary depending on State law limits, individual lender credit models, and borrower demand. Many States set a limit on payday loan size; $500 is a common loan limit although the limits range from $300 to $1,000.[25] In 2013, the Bureau reported that the median loan amount for storefront payday loans was $350, based on supervisory data.[26] This finding is broadly consistent with other studies using data from one or more lenders as well as with self-reported information in surveys of payday borrowers [27] and State regulatory reports.[28]

The fee for a payday loan is generally structured as a percentage or dollar amount per $100 borrowed, rather than a periodic interest rate based on the amount of time the loan is outstanding. Many State laws set a maximum amount for these fees, with 15 percent ($15 per $100 borrowed) being the most common limit.[29] The median storefront payday loan fee is $15 per $100; thus for a $350 loan, the borrower must repay $52.50 in finance charges together with the $350 borrowed for a total repayment amount of $402.50.[30] The annual percentage rate (APR) on a 14-day loan with these terms is 391 percent.[31] For payday borrowers who receive monthly income and thus receive a 30-day or monthly payday loan—many of whom are Social Security recipients[32] —a $15 per $100 charge on a $350 loan for a term of 30 days equates to an APR of about 180 percent. The Bureau has found the median loan term for a storefront payday loan to be 14 days, with an average term of 18.3 days. The longer average loan duration is due to State laws that require minimum loan terms that may extend beyond the borrower's next pay date.[33] Fees and loan amounts are higher for online loans, described in more detail below.

On the loan's due date, the terms of the loan obligate the borrower to repay the loan in full. Although the States that created exceptions to their usury limits for payday lending generally did so on the theory these were short-term loans to which the usual usury rules did not easily apply, in 19 of the States that authorize payday lending the lender is permitted to roll over the loan when it comes due. A rollover occurs when, instead of repaying the loan in full at maturity, the consumer pays only the fees due and the lender agrees to extend the due date.[34] By rolling over, the loan repayment of the principal is extended for another period of time, usually equivalent to the original loan term, in Start Printed Page 47870return for the consumer's agreement to pay a new set of fees calculated in the same manner as the initial fees (e.g., 15 percent of the loan principal). The rollover fee is not applied to reduce the loan principal or amortize the loan. As an example, if the consumer borrows $300 with a fee of $45 (calculated as $15 per $100 borrowed), the consumer will owe $345 on the due date, typically 14 days later. On the due date, if the consumer cannot afford to repay the entire $345 due or is otherwise offered the option to roll over the loan, she will pay the lender $45 for another 14 days. On the 28th day, the consumer will owe the original $345 and if she pays the loan in full then, will have paid a total of $390 for the loan.

In some States in which rollovers are permitted they are subject to certain limitations such as a cap on the number of rollovers or requirements that the borrower amortize—repay part of the original loan amount—on the rollover. Other States have no restrictions on rollovers. Specially, seventeen of the States that authorize single-payment payday lending prohibit lenders from rolling over loans and twelve more States impose some rollover limitations.[35] However, in most States where rollovers are prohibited or limited, there is no restriction on the lender immediately making a new loan to the consumer (with new fees) after the consumer has repaid the prior loan. New loans made the same day or “back-to-back” loans effectively replicate a rollover because the borrower remains in debt to the lender on the borrower's next payday.[36] A handful of States have implemented a cooling-off period before a lender may make a new loan. The most common cooling-off period is one day, although some States have longer periods following a specified number of rollovers or back-to-back loans.[37]

Twenty States require payday lenders to offer extended repayment plans to borrowers who encounter difficulty in repaying payday loans.[38] Some States' laws are very general and simply provide that a payday lender may allow additional time for repayment of a loan. Other laws provide more detail about the plans including: When lenders must offer repayment plans; how borrowers may elect to participate in repayment plans; the number and timing of payments; the length of plans; permitted fees for plans; requirements for credit counseling; requirements to report plan payments to a statewide database; cooling-off or “lock-out” periods for new loans after completion of plans; and the consequences of plan defaults. The effects of these various restrictions are discussed further below in Market Concerns—Short-Term Loans.

Industry size and structure. There are various estimates as to the number of consumers who use payday loans on an annual basis. One survey found that 2.4 million households (2 percent of U.S. households) used payday loans in 2013.[39] In another survey, 4.2 percent of households reported taking out a payday loan.[40] These surveys referred to payday loans generally, and did not specify whether they were referring to loans made online or at storefront locations. One report estimated the number of individual borrowers, rather than households, was higher at approximately 12 million and included both storefront and online loans.[41] See Market Concerns—Short-term Loans for additional information on borrower characteristics.

There are several ways to gauge the size of the storefront payday loan industry. Typically, the industry has been measured by counting the total dollar value of each loan made during the course of a year, counting each rollover, back-to-back loan or other reborrowing as a new loan that is added to the total. By this metric, one analyst estimated that from 2009 to 2014, storefront payday lending generated approximately $30 billion in new loans per years and that by 2015 the volume had declined to $23.6 billion,[42] although these numbers may include products other than single-payment loans. Alternatively, the industry can be measured by calculating the dollar amount of loan balances outstanding. Given the amount of payday loan reborrowing, which results in the same funds of the lender being used to Start Printed Page 47871finance multiple loan originations, the dollar amount of loan balances outstanding may provide a more nuanced sense of the industry's scale. Using this metric, the Bureau estimates that in 2012, storefront payday lenders held approximately $2 billion in outstanding single-payment loans.[43] In 2015, industry revenue (fees paid on storefront payday loans) was an estimated $3.6 billion, representing 15 percent of loan originations.[44]

About ten large firms account for half of all payday storefront locations.[45] Several of these firms are publicly traded companies offering a diversified range of products that also include installment and pawn loans.[46] Other large payday lenders are privately held,[47] and the remaining payday loan stores are owned by smaller regional or local entities. The Bureau estimates there are about 2,400 storefront payday lenders that are small entities as defined by the Small Business Administration (SBA).[48]

There were an estimated 15,766 payday loan stores in 2014 within the 36 States in which storefront payday lending occurs.[49] By way of comparison, there were 14,350 McDonald's fast food outlets in the United States in 2014.[50]

The average number of payday loan stores in a county with a payday loan store is 6.32.[51] The Bureau has analyzed payday loan store locations in States which maintain lists of licensed lenders and found that half of all stores are less than one-third of a mile from another store, and three-quarters are less than a mile from the nearest store.[52] Even the 95th percentile of distances between neighboring stores is only 4.3 miles. Stores tend to be closer together in counties within metropolitan statistical areas (MSA).[53] In non-MSA counties the 75th percentile of distance to the nearest store is still less than one mile, but the 95th percentile is 22.9 miles.

Research and the Bureau's own market outreach indicate that payday loan stores tend to be relatively small with, on average, three full-time equivalent employees.[54] An analysis of loan data from 29 States found that the average store made 3,541 advances in a year.[55] Given rollover and reborrowing rates, a report estimated that the average store served fewer than 500 customers per year.[56]

Marketing, underwriting, and collections practices. Payday loans tend to be marketed as a short-term bridge to cover emergency expenses. For example, one lender suggests that, for consumers who have insufficient funds on hand to meet such an expense or to avoid a penalty fee, late fee, or utility shut-off, a payday loan can “come in handy” and “help tide you over until your next payday.” [57] Some lenders offer new borrowers their initial loans at no fee (“first loan free”) to encourage consumers to try a payday loan.[58] Stores are typically located in high-traffic commuting corridors and near shopping areas where consumers obtain groceries and other staples.[59]

The evidence of price competition among payday lenders is mixed. In their financial reports, publicly traded payday lenders have reported their key competitive factors to be non-price related. For instance, they cite location, customer service, and convenience as some of the primary factors on which payday lenders compete with one another, as well as with other financial service providers.[60] Academic studies have found that, in States with rate caps, loans are almost always made at Start Printed Page 47872the maximum rate permitted.[61] Another study likewise found that in States with rate caps, firms lent at the maximum permitted rate, but that lenders operating in multiple States with varying rate caps raise their fees to those caps rather than charging consistent fees company-wide. The study additionally found that in States with no rate caps, different lenders operating in those States charged different rates. The study reviewed four lenders that operate in Texas [62] and observed differences in the cost to borrow $300 per two-week pay period: Two lenders charged $61 in fees, one charged $67, and another charged $91, indicating some level of price variation between lenders (ranging from about $20 to $32 per $100 borrowed).[63]

The application process for a payday loan is relatively simple. For a storefront payday loan, a borrower must generally provide some verification of income (typically a pay stub) and evidence of a personal deposit account.[64] Although a few States impose limited requirements that lenders consider a borrower's ability to repay,[65] storefront payday lenders generally do not consider a borrower's other financial obligations or require collateral (other than the check or electronic debit authorization) for the loan. Most storefront payday lenders do not consider traditional credit reports or credit scores when determining loan eligibility, nor do they report any information about payday loan borrowing history to the nationwide consumer reporting agencies, TransUnion, Equifax, and Experian.[66] From market outreach activities and confidential information gathered in the course of statutory functions, the Bureau is aware that a number of storefront payday lenders obtain data from one or more specialty consumer reporting agencies to check for previous payday loan defaults, identify recent inquiries that suggest an intention to not repay the loan, and perform other due diligence such as identity and deposit account verification. Some storefront payday lenders use analytical models and scoring that attempt to predict likelihood of default. Through market outreach and confidential information gathered in the course of statutory functions, the Bureau is aware that many storefront payday lenders limit their underwriting to first-time borrowers or those returning after an absence.

From market outreach, the Bureau is aware that the specialty consumer reporting agencies contractually require any lender that obtains data to also report data to them, although compliance may vary. Reporting usually occurs on a real-time or same-day basis. Separately, 14 States require lenders to check statewide databases before making each loan in order to ensure that their loans comply with various State restrictions.[67] These States likewise require lenders to report certain lending activity to the database, generally on a real-time or same-day basis. As discussed in more detail above, these State restrictions may include prohibitions on consumers having more than one payday loan at a time, cooling-off periods, or restrictions on the number of loans consumers may take out per year.

Although a consumer is generally required when obtaining a loan to provide a post-dated check or authorization for an electronic debit of the consumer's account which could be presented to the consumer's bank, consumers are in practice strongly encouraged and in some cases required by lenders to return to the store when the loan is due to “redeem” the check.[68] Some lenders give borrowers appointment cards with a date and time to encourage them to return with cash. For example, one major storefront payday lender explained that after loan origination “the customer then makes an appointment to return on a specified due date, typically his or her next payday, to repay the cash advance . . . . Payment is usually made in person, in cash at the center where the cash advance was initiated . . . .” [69]

The Bureau is aware, from confidential information gathered in the course of statutory functions and from market outreach, that lenders routinely make reminder calls to borrowers a few days before loan due dates to encourage borrowers to return to the store. One large lender reported this practice in a public filing.[70] Another major payday lender with a predominantly storefront loan portfolio reported that in 2014, over 90 percent of its payday and installment loans were repaid or renewed in cash; [71] this provides an opportunity for store personnel to solicit borrowers to roll over or reborrow while they visit the store to discuss their loans or make loan payments. The Bureau is aware, from confidential information gathered in the course of statutory functions, that one or more storefront payday lenders have operating policies that specifically state that cash is preferred because only half of their Start Printed Page 47873customers' checks would clear if deposited on the loan due dates. One storefront payday lender even requires its borrowers to return to the store to repay. Its Web site states: “All payday loans must be repaid with either cash or money order. Upon payment, we will return your original check to you.” [72]

Encouraging or requiring borrowers to return to the store on the due date provides lenders an opportunity to offer borrowers the option to roll over the loan or, where rollovers are prohibited by State law, to reborrow following repayment or after the expiration of any cooling-off period. Most storefront lenders examined by the Bureau employ monetary incentives that reward employees and store managers for loan volumes. Since as discussed below, a majority of loans result from rollovers of existing loans or reborrowing shortly after loans have been repaid, rollovers and reborrowing contribute substantially to employees' compensation. From confidential information gathered in the course of statutory functions, the Bureau is aware that rollover and reborrowing offers are made when consumers log into their accounts online, during “courtesy calls” made to remind borrowers of upcoming due dates, and when borrowers repay in person at storefront locations. In addition, some lenders train their employees to offer rollovers during courtesy calls even when borrowers responded that they had lost their jobs or suffered pay reductions.

Store personnel often encourage borrowers to roll over their loans or to reborrow, even when consumers have demonstrated an inability to repay their existing loans. In an enforcement action, the Bureau found that one lender maintained training materials that actively directed employees to encourage reborrowing by struggling borrowers. It further found that if a borrower did not repay or pay to roll over the loan on time, store personnel would initiate collections. Store personnel or collectors would then offer the option to take out a new loan to pay off their existing loan, or refinance or extend the loan as a source of relief from the potentially negative outcomes (e.g., lawsuits, continued collections). This “cycle of debt” was depicted graphically as part of “The Loan Process” in the company's new hire training manual.[73]

In addition, though some States require lenders to offer extended repayment plans and some trade associations have designated provision of such plans as a best practice, individual lenders may often be reluctant to offer them. In Colorado, for instance, some payday lenders reported prior to a regulatory change in 2010 that they had implemented practices to restrict borrowers from obtaining the number of loans needed to be eligible for State-mandated extended payment plans under the previous regime or banned borrowers on plans from taking new loans.[74] The Bureau is also aware, from confidential information gathered in the course of statutory functions, that one or more lenders used training manuals that instructed employees not to mention these plans until after employees first offered rollovers, and then only if borrowers specifically asked about the plans. Indeed, details on implementation of the repayment plans that have been designated by two national trade associations for storefront payday lenders as best practices are unclear, and in some cases place a number of limitations on exactly how and when a borrower must request assistance to qualify for these “off-ramps.” For instance, one trade association claiming to represent more than half of all payday loan stores states that as a condition of membership, members must offer an “extended payment plan” but that borrowers must request the plan at least one day prior to the date on which the loan is due, generally in person at the store where the loan was made or otherwise by the same method used to originate the loan.[75] It also states that borrowers must request an extended payment plan at least one day prior to the date on which the loan is due and must return to the store where the loan was made to do so or request the plan by using the same method used to originate the loan.[76] Another trade association claiming over 1,300 members, including both payday lenders and firms that offer non-credit products such as check cashing and money transmission, states that members will provide the option of extended payment plans in the absence of State-mandated plans to customers unable to repay but details of the plans are not available on its Web site.[77]

From confidential information gathered in the course of statutory functions and market outreach, the Bureau is aware that if a borrower fails to return to the store when a loan is due, the lender may attempt to contact the consumer and urge the consumer to make a cash payment before depositing the post-dated check that the consumer had provided at origination or electronically debiting the account. The Bureau is aware, from confidential information gathered in the course of its statutory functions and market outreach, that lenders may take various other actions to try to ensure that a payment will clear before presenting a check or ACH. These efforts may range from storefront lenders calling the borrower's bank to ask if a check of a particular size would clear the account or through the use of software offered by a number of vendors that attempts to model likelihood of repayment (“predictive ACH”).[78] If these attempts are unsuccessful, store personnel at either the storefront level or at a centralized Start Printed Page 47874location will then generally engage in collection activity.

Collection activity may involve further in-house attempts to collect from the borrower's bank account.[79] If the first attempt fails, the lender may make subsequent attempts at presentment by splitting payments into smaller amounts in hopes of increasing the likelihood of obtaining at least some funds, a practice for which the Bureau recently took enforcement action against a small-dollar lender.[80] Or, the lender may attempt to present the payment multiple times, a practice that the Bureau has noted in supervisory examinations.[81]

Eventually, the lender may attempt other means of collection. The Bureau is aware of in-house collections activities, either by storefront employees or by employees at a centralized collections division, including calls, letters, and visits to consumers and their workplaces,[82] as well as the selling of debt to third-party collectors.[83] The Bureau observed in its consumer complaint data that from November 2013 through December 2015 approximately 24,000 debt collection complaints had payday loan as the underlying debt. More than 10 percent of the complaints the Bureau has received about debt collection stem from payday loans.[84]

Some payday lenders sue borrowers who fail to repay their loans. A study of small claims court cases filed in Utah from 2005 to 2010 found that 38 percent of cases were attributable to payday loans.[85] A recent news report found that the majority of non-traffic civil cases filed in 14 Utah small claims courts are payday loan collection lawsuits and in one justice court the percentage was as high as 98.8 percent.[86] In 2013, the Bureau entered into a Consent Order with a large national payday and installment lender based, in part, on the filing of flawed court documents in about 14,000 debt collection lawsuits.[87]

Business model. As previously noted, the storefront payday industry has built a distribution model that involves a large number of small retail outlets, each serving a relatively small number of consumers. That implies that the overhead cost on a per consumer basis is relatively high.

Additionally, the loss rates on storefront payday loans—the percentage or amounts of loans that are charged off by the lender as uncollectible—are relatively high. Loss rates on payday loans often are reported on a per-loan basis but, given the frequency of rollovers and renewals, that metric understates the amount of principal lost to borrower defaults. For example, if a lender makes a $100 loan that is rolled over nine times, at which point the consumer defaults, the per-loan default rate would be 10 percent whereas the lender would have in fact lost 100 percent of the amount loaned. In this example, the lender would still have received substantial revenue, as the lender would have collected fees for each rollover prior to default. The Bureau estimates that during the 2011-2012 timeframe, charge-offs (i.e., uncollectible loans defaulted on and never repaid) equaled nearly one-half of the average amount of outstanding loans during the year. In other words, for every $1.00 loaned, only $.50 in principal was eventually repaid.[88] One academic study found loss rates to be even higher.[89]

To sustain these significant costs, the payday lending business model is dependent upon a large volume of reborrowing—that is, rollovers, back-to-back loans, and reborrowing within a short period of paying off a previous loan—by those borrowers who do not default on their first loan. The Bureau's research found that over the course of a year, 90 percent of all loan fees comes from consumers who borrowed seven or more times and 75 percent comes from consumers who borrowed ten or more times.[90] Similarly, when the Bureau identified a cohort of borrowers and tracked them over ten months, the Bureau found that more than two-thirds of all loans were in sequences of at least seven loans, and that over half of all loans were in sequences of ten or more loans.[91] The Bureau defines a sequence as an initial loan plus one or more subsequent loans renewed within a period of time after repayment of the prior loan; a sequence thus captures not only rollovers and back-to-back loans but also re-borrowing that occurs within a short period of time after repayment of a prior loan either at the point at which a State-mandated cooling-off period ends or at the point at which the consumer, having repaid the prior loan, runs out of money.[92]

Other studies are broadly consistent. For example, a 2013 report based on Start Printed Page 47875lender data from Florida, Kentucky, Oklahoma, and South Carolina found that 85 percent of loans were made to borrowers with seven or more loans per year, and 62 percent of loans were made to borrowers with 12 or more loans per year.[93] These four States have restrictions on payday loans such as cooling-off periods and limits on rollovers that are enforced by State-regulated databases, as well as voluntary extended repayment plans.[94] An updated report on Florida payday loan usage derived from the State database noted this trend has continued with 83 percent of payday loans in 2015 made to borrowers with seven or more loans and 57 percent of payday loans that same year made to borrowers with 12 or more loans.[95] Other reports have found that over 80 percent of total payday loans and loan volume is due to repeat borrowing within thirty days of a prior loan.[96] One trade association has acknowledged that “[i]n any large, mature payday loan portfolio, loans to repeat borrowers generally constitute between 70 and 90 percent of the portfolio, and for some lenders, even more.” [97]

Market Concerns—Short-Term Loans below discusses the impact of these outcomes for consumers who are unable to repay and either default or reborrow.

Recent regulatory and related industry developments. A number of Federal and State regulatory developments have occurred over the last 15 years as concerns about the effects of payday lending have spread. Regulators have found that the industry has tended to shift to new models and products in response.

Since 2000, it has been clear from commentary added to Regulation Z, that payday loans constitute “credit” under the Truth in Lending Act (TILA) and that cost of credit disclosures are required to be provided in payday loan transactions, regardless of how State law characterizes payday loan fees.[98]

In 2006, Congress enacted the Military Lending Act (MLA) to address concerns that servicemembers and their families were becoming over-indebted in high-cost forms of credit.[99] The MLA, as implemented by the Department of Defense's regulation, imposes two broad classes of requirements applicable to a creditor. First, the creditor may not impose a military annual percentage rate [100] (MAPR) greater than 36 percent in connection with an extension of consumer credit to a covered borrower. Second, when extending consumer credit, the creditor must satisfy certain other terms and conditions, such as providing certain information, both orally and in a form the borrower can keep, before or at the time the borrower becomes obligated on the transaction or establishes the account, refraining from requiring the borrower to submit to arbitration in the case of a dispute involving the consumer credit, and refraining from charging a penalty fee if the borrower prepays all or part of the consumer credit. In 2007, the Department of Defense issued its initial regulation under the MLA, limiting the Act's application to closed-end loans with a term of 91 days or less in which the amount financed did not exceed $2,000; closed-end vehicle title loans with a term of 181 days or less; and closed-end tax refund anticipation loans.[101] However, the Department found that evasions developed in the market as “the extremely narrow definition of `consumer credit' in the [then-existing rule] permits a creditor to structure its credit products in order to reduce or avoid altogether the obligations of the MLA.” [102]

As a result, effective October 2015 the Department of Defense expanded its definition of covered credit to include open-end credit and longer-term loans so that the MLA protections generally apply to all credit subject to the requirements of Regulation Z of the Truth in Lending Act, other than certain products excluded by statute.[103] In general, creditors must comply with the new regulations for extensions of credit after October 3, 2016; for credit card accounts, creditors are required to comply with the new rule starting October 3, 2017.[104]

At the State level, the last States to enact legislation authorizing payday lending, Alaska and Michigan, did so in 2005.[105] At least eight States that previously had authorized payday loans have taken steps to restrict or eliminate payday lending. In 2001, North Carolina became the first State that had previously permitted payday loans to adopt an effective ban by allowing the authorizing statute to expire. In 2004, Georgia also enacted a law banning payday lending.

In 2008, the Ohio legislature adopted the Short Term Lender Act with a 28 percent APR cap, including all fees and charges, for short-term loans and repealed the existing Check-Cashing Lender Law that authorized higher rates and fees.[106] In a referendum later that year, Ohioans voted against reinstating the Check-Cashing Lender Law, leaving the 28 percent APR cap and the Short Term Lending Act in effect.[107] After the vote, some payday lenders began offering vehicle title loans. Other lenders continued to offer payday loans utilizing Ohio's Credit Service Organization Act [108] and the Mortgage Loan Act; [109] the latter practice was upheld by the State Supreme Court in 2014.[110]

In 2010, Colorado's legislature banned short-term single-payment balloon loans in favor of longer-term, six-month loans. Colorado's regulatory framework is described in more detail in the discussion of payday installment lending below.

As of July 1, 2010, Arizona effectively prohibited payday lending after the authorizing statute expired and a statewide referendum that would have continued to permit payday lending failed to pass.[111] However, small-dollar Start Printed Page 47876lending activity continues in the State. The State financial regulator issued an alert in 2013, in response to complaints about online unlicensed lending, advising consumers and lenders that payday and consumer loans of $1,000 or less are generally subject to a rate of 36 percent per annum and loans in violation of those rates are void.[112] In addition, vehicle title loans continue to be made in Arizona as secondary motor vehicle finance transactions.[113] The number of licensed vehicle title lenders has increased by about 300 percent since the payday lending law expired and now exceeds the number of payday lenders that were licensed prior to the ban.[114]

In 2009, Virginia amended its payday lending law. It extended the minimum loan term to the length of two income periods, added a 45-day cooling-off period after substantial time in debt (the fifth loan in a 180-day period) and a 90-day cooling-off period after completing an extended payment plan, and implemented a database to enforce limits on loan amounts and frequency. The payday law applies to closed-end loans. Virginia has no interest rate regulations or licensure requirements for open-end credit.[115] After the amendments, a number of lenders that were previously licensed as payday lenders in Virginia and that offer closed-end payday loans in other States now operate in Virginia by offering open-end credit without a State license.[116]

Washington and Delaware have restricted repeat borrowing by imposing limits on the number of payday loans consumers may obtain. In 2009, Washington made several changes to its payday lending law. These changes, effective January 1, 2010, include a cap of eight loans per borrower from all lenders in a rolling 12-month period where there had been no previous limit on the number of total loans, an extended repayment plan for any loan, and a database to which that lenders are required to report all payday loans.[117] In 2013, Delaware, a State with no fee restrictions for payday loans, implemented a cap of five payday loans, including rollovers, in any 12-month period.[118] Delaware defines payday loans as loans due within 60 days for amounts up to $1,000. Some Delaware lenders have shifted from payday loans to longer-term installment loans with interest-only payments followed by a final balloon payment of the principal and an interest fee payment—sometimes called a “flexpay” loan.[119]

At least 35 Texas municipalities have adopted local ordinances setting business regulations on payday lending (and vehicle title lending).[120] Some of the ordinances, such as those in Dallas, El Paso, Houston, and San Antonio, include requirements such as limits on loan amounts (no more than 20 percent of the borrower's gross annual income for payday loans), limits on the number of rollovers, required amortization of the principal loan amount for repeat loans—usually in 25 percent increments, record retention for at least three years, and a registration requirement.[121] On a statewide basis, there are no Texas laws specifically governing payday lenders or payday loan terms; credit access businesses that act as loan arrangers or broker payday loans (and vehicle title loans) are regulated and subject to licensing, reporting, and requirements to provide consumers with disclosures about repayment and reborrowing rates.[122]

Online Payday and Hybrid Payday Loans

With the growth of the internet, a significant online payday lending industry has developed. Some storefront lenders use the internet as an additional method of originating payday loans in the States in which they are licensed to do business. In addition, there are now a number of lenders offering payday, and what are referred to as “hybrid” payday loans, exclusively through the internet. Hybrid payday loans are structured so that rollovers occur automatically unless the consumer takes affirmative action to pay off the loan, thus effectively creating a series of interest-only payments followed by a final balloon payment of the principal amount and an additional fee.[123] Hybrid loans with automatic rollovers would fall within the category of “covered longer-term loans” under the proposed rule as discussed more fully below.

Industry size, structure, and products. The online payday market size is difficult to measure for a number of reasons. First, many online lenders offer a variety of products including single-Start Printed Page 47877payment loans (what the Bureau refers to as payday loans), longer-term installment loans, and hybrid loans; this poses challenges in sizing the portion of these firms' business that is attributable to payday and hybrid loans. Second, many online payday lenders are not publicly traded, resulting in little available financial information about this market segment. Third, many other online payday lenders claim exemption from State lending laws and licensing requirements, stating they are located and operated from other jurisdictions.[124] Consequently, these lenders report less information publicly, whether individually or in aggregate compilations, than lenders holding traditional State licenses. Finally, storefront payday lenders who are also using the online channel generally do not separately report their online originations. Bureau staff's reviews of the largest storefront lenders' Web sites indicate an increased focus in recent years on online loan origination.

With these caveats, a frequently cited industry analyst has estimated that by 2012 online payday loans had grown to generate nearly an equivalent amount of fee revenue as storefront payday loans on roughly 62 percent of the origination volume, about $19 billion, but originations had then declined somewhat to roughly $15.9 billion during 2015.[125] This trend appears consistent with storefront payday loans, as discussed above, and is likely related at least in part to increasing lender migration from short-term into longer-term products. Online payday loan fee revenue has been estimated for 2015 at $3.1 billion, or 19 percent of origination volume.[126] However, these estimates may be both over- and under-inclusive; they may not differentiate precisely between online lenders' short-term and longer-term loans, and they may not account for the online lending activities by storefront payday lenders.

Whatever its precise size, the online industry can broadly be divided into two segments: online lenders licensed in the State in which the borrower resides and lenders that are not licensed in the borrower's State of residence.

The first segment consists largely of storefront lenders with an online channel to complement their storefronts as a means of originating loans, as well as a few online-only payday lenders who lend only to borrowers in States where they have obtained State lending licenses. Because this segment of online lenders is State-licensed, State administrative payday lending reports include this data but generally do not differentiate loans originated online from those originated in storefronts. Accordingly, this portion of the market is included in the market estimates summarized above, and the lenders consider themselves to be subject to, or generally follow, the relevant State laws discussed above.

The second segment consists of lenders that claim exemption from State lending laws. Some of these lenders claim exemption because their loans are made from a physical location outside of the borrower's State of residence, including from an off-shore location outside of the United States. Other lenders claim exemption because they are lending from tribal lands, with such lenders claiming that they are regulated by the sovereign laws of federally recognized Indian tribes.[127] These lenders claim immunity from suit to enforce State or Federal consumer protection laws on the basis of their sovereign status.[128] A frequently cited source of data on this segment of the market is a series of reports using data from a specialty consumer reporting agency serving certain online lenders, most of whom are unlicensed.[129] These data are not representative of the entire online industry, but nonetheless cover a large enough sample (2.5 million borrowers over a period of four years) to be significant. These reports indicate the following concerning this market segment:

  • Although the mean and median loan size among the payday borrowers in this data set are only slightly higher than the information reported above for storefront payday loans,[130] the online payday lenders charge higher rates than storefront lenders. As noted above, most of the online lenders reporting this data claim exemption from State laws and do not comply with State rate caps. The median loan fee in this data set is $23.53 per $100 borrowed, compared to $15 per $100 borrowed for storefront payday loans. The mean fee amount is even higher at $26.60 per $100 borrowed.[131] Another study based on a similar dataset from three online payday lenders is generally consistent, putting the range of online payday loan fees at between $18 and $25 per $100 borrowed.[132]
  • More than half of the payday loans made by these online lenders are hybrid payday loans. As described above, a hybrid loan involves automatic rollovers with payment of the loan fee until a final balloon payment of the principal and fee.[133] For the hybrid payday loans, the most frequently reported payment amount is 30 percent of principal, implying a finance charge during each pay period of $30 for each $100 borrowed.[134]
  • Unlike storefront payday loan borrowers who generally return to the same store to reborrow, the credit reporting data may suggest that online borrowers tend to move from lender to Start Printed Page 47878lender. As discussed further below, however, it is difficult to evaluate whether some of this apparent effect is due to online lenders simply not consistently reporting lending activity.[135]

Marketing, underwriting, and collection practices. To acquire customers, online lenders have relied heavily on direct marketing and lead generators. Online lead generators purchase web advertising, usually in the form of banner advertisements or paid search results (the advertisements that appear at the top of an internet search on Google, Bing, or other search engines). When a consumer clicks through on a banner or search advertisement, she is usually prompted to complete a brief form with personal information that will be used to determine the loans for which she may qualify. If a lead generator is involved, the consumer's information becomes a lead that is in turn sold directly to a lender, to a reseller, or to a “lender network” that operates as an auction in which the lead is sold to the highest bidder. A consumer's personal information may be offered to multiple lenders and other vendors as a result of submitting a single form, raising significant privacy and other concerns.[136] In a survey of online payday borrowers, 39 percent reported that their personal or financial information was sold to a third party without their knowledge.[137]

From the Bureau's market outreach activities, it is aware that large payday and small-dollar installment lenders using lead generators for high quality, “first look” or high-bid leads have paid an average cost per new account of between $150 and $200. Indeed, the cost to a lender simply to purchase such leads can be $100 or more.[138] Customer acquisition costs reflect lead purchase prices. One online lender reported its customer acquisition costs to be $297, while in 2015 another spent 25 percent of its total marketing expenditures on customer acquisition, including lead purchases.[139]

Online lenders view fraud (i.e., consumers who mispresent their identity) as a significant risk and also express concerns about “bad faith” borrowing (i.e., consumers with verified identities who borrow without the intent to repay).[140] Consequently, online payday and hybrid lenders attempt to verify the borrower's identity and the existence of a bank account in good standing. Several specialty consumer reporting agencies have evolved primarily to serve the online payday lending market. The Bureau is aware from market outreach that these lenders also generally report loan closure information on a real-time or daily basis to the specialty consumer reporting agencies. In addition, some online lenders report to the Bureau they use nationwide credit report information to evaluate both credit and potential fraud risk associated with first-time borrowers, including recent bankruptcy filings. However, there is evidence that online lenders do not consistently utilize credit report data for every loan, and instead typically check and report data only for new borrowers or those returning after an extended absence from the lender's records.[141]

Typically, proceeds from online payday loans are disbursed electronically to the consumer's bank account. The consumer authorizes the lender to debit her account as payments are due. If the consumer does not agree to authorize electronic debits, lenders generally will not disburse electronically, but instead will require the consumer to wait for a paper loan proceeds check to arrive in the mail.[142] Lenders may also charge higher interest rates or fees to consumers who do not commit to electronic debits.[143]

Unlike storefront lenders that seek to bring consumers back to the stores to make payments, online lenders collect via electronic debits. Online payday lenders, like their storefront counterparts, use various models and software, described above, to predict when an electronic debit is most likely to succeed in withdrawing funds from a borrower's bank account. As discussed further below, the Bureau has observed lenders seeking to collect multiple payments on the same day. Lenders may be dividing the payment amount in half and presenting two debits at once, presumably to reduce the risk of a larger payment being returned for nonsufficient funds. Indeed, the Bureau found that about one-third of presentments by online payday lenders occur on the same day as another request by the same lender. The Bureau also found that split presentments almost always result in either payment of all presentments or return of all presentments (in which event the consumer will likely incur multiple nonsufficient funds (NSF) fees from the bank). The Bureau's study indicates that when an online payday lender's first attempt to obtain a payment from the consumer's account is unsuccessful, it will make a second attempt 75 percent Start Printed Page 47879of the time and if that attempt fails the lender will make a third attempt 66 percent of the time.[144] As discussed further at part II.D, the success rate on these subsequent attempts is relatively low, and the cost to consumers may be correspondingly high.[145]

There is limited information on the extent to which online payday lenders that are unable to collect payments through electronic debits resort to other collection tactics.[146] The available evidence indicates, however, that online lenders sustain higher credit losses and risk of fraud than storefront lenders. One lender with publicly available financial information that originated both storefront and online single-payment loans reported in 2014, a 49 percent and 71 percent charge-off rate, respectively, for these loans.[147] Online lenders generally classify as “fraud” both consumers who misrepresented their identity in order to obtain a loan and consumers whose identity is verified but default on the first payment due, which is viewed as reflecting the intent not to repay.

Business model. While online lenders tend to have fewer costs relating to operation of physical facilities than do storefront lenders, as discussed above, they face high costs relating to lead acquisition, loan origination screening to verify applicant identity, and potentially larger losses due to fraud than their storefront competitors.

Accordingly, it is not surprising that online lenders—like their storefront counterparts—are dependent upon repeated reborrowing. Indeed, even at a cost of $25 or $30 per $100 borrowed, a typical single online payday loan would generate fee revenue of under $100, which is not sufficient to cover the typical origination costs discussed above. Consequently, as discussed above, hybrid loans that roll over automatically in the absence of affirmative action by the consumer account for a substantial percentage of online payday business. These products effectively build a number of rollovers into the loan. For example, the Bureau has observed online payday lenders whose loan documents suggest that they are offering a single-payment loan but whose business model is to collect only the finance charges due, roll over the principal, and require consumers to take affirmative steps to notify the lender if consumers want to repay their loans in full rather than allowing them to roll over. The Bureau recently initiated an action against an online lender alleging that it engaged in deceptive practices in connection with such products.[148] In a recent survey conducted of online payday borrowers, 31 percent reported that they had experienced loans with automatic renewals.[149]

As discussed above, a number of online payday lenders claim exemption from State laws and the limitations established under those laws. As reported by a specialty consumer reporting agency with data from that market, more than half of the payday loans for which information is furnished to it are hybrid payday loans with the most common fee being $30 per $100 borrowed, twice the median amount for storefront payday loans.[150]

Similar to associations representing storefront lenders as discussed above, a national trade association representing online lenders includes loan repayment plans as one of its best practices, but does not provide many details in its public material.[151] A trade association that represents tribal online lenders has adopted a set of best practices but they do not address repayment plans.[152]

Single-Payment Vehicle Title Loans

Vehicle title loans—also known as “automobile equity loans”—are another form of liquidity lending permitted in certain States. In a title loan transaction, the borrower must provide identification and usually the title to the vehicle as evidence that the borrower owns the vehicle “free and clear.” [153] Unlike payday loans, there is generally no requirement that the borrower have a bank account, and some lenders do not require a copy of a paystub or other evidence of income.[154] Rather than holding a check or ACH authorization for repayment as with a payday loan, the lender generally retains the vehicle title or some other form of security interest that provides it with the right to repossess the vehicle, which may then be sold, with the proceeds used for repayment.[155]

The lender retains the vehicle title or some other form of security interest during the duration of the loan, while the borrower retains physical possession of the vehicle. In some States the lender files a lien with State officials to record and perfect its interest in the vehicle or the lender may charge a fee for non-filing insurance. In a few States, a clear vehicle title is not required and vehicle title loans may be made as secondary liens against the title or against the Start Printed Page 47880borrower's automobile registration.[156] In Georgia, vehicle title loans are made under the State's pawnbroker statute that specifically permits borrowers to pawn vehicle certificates of title.[157] Almost all vehicle title lending is conducted at storefront locations, although some title lending does occur online.[158]

Product definition and regulatory environment. There are two types of vehicle title loans: Single-payment loans and installment loans. Of the 25 States that permit some form of vehicle title lending, seven States permit only single-payment title loans, 13 States allow the loans to be structured as single-payment or installment loans, and five permit only title installment loans.[159] (Installment title loans are discussed in more detail below.) All but three of the States that permit some form of title lending (Arizona, Georgia, and New Hampshire) also permit payday lending.

Single-payment vehicle title loans are typically due in 30-days and operate much like payday loans: The consumer is charged a fixed price per $100 borrowed and when the loan is due the consumer is obligated to repay the full amount of the loan plus the fee but is typically given the opportunity to roll over or reborrow.[160] The Bureau recently studied anonymized data from vehicle title lenders, consisting of nearly 3.5 million loans made to over 400,000 borrowers in 20 States. For single-payment vehicle title loans with a typical duration of 30 days, the median loan amount is $694 with a median APR of 317 percent, and the average loan amount is $959 and the average APR is 291 percent.[161] Two other studies contain similar findings.[162] Vehicle title loans are therefore for larger amounts than typical payday loans but carry similar APRs for similar terms.

Some States that authorize vehicle title loans limit the rates lenders may charge to a percentage or dollar amount per one hundred dollars borrowed, similar to some State payday lending pricing structures. A common fee limit is 25 percent of the loan amount per month, but roughly half of the authorizing States have no restrictions on rates or fees.[163] Some, but not all, States limit the maximum amount that may be borrowed to a fixed dollar amount, a percentage of the borrower's monthly income (50 percent of the borrower's gross monthly income in Illinois), or a percentage of the vehicle's value.[164] Some States limit the initial loan term to one month, but several States authorize rollovers, including automatic rollovers arranged at the time of the original loan.[165] Unlike payday loan regulation, few States require cooling-off periods between loans or optional extended repayment plans for borrowers who cannot repay vehicle title loans.[166] State vehicle title regulations sometimes address default, repossession and related fees; any cure periods prior to and after repossession, whether the lender must refund any surplus after the repossession and sale or disposition of the vehicle, and whether the borrower is liable for any deficiency remaining after sale or disposition.[167] Some States have imposed limited requirements that lenders consider a borrower's ability to repay. For example, both Utah and South Carolina require lenders to consider borrower ability to repay, but this may be accomplished through a Start Printed Page 47881borrower affirming that she has provided accurate financial information and has the ability to repay.[168] Nevada requires lenders to consider borrower ability to repay and obtain borrower affirmation of their ability to repay.[169] Missouri requires that lenders consider borrower financial ability to reasonably repay the loan under the loan's contract, but does not specify how lenders may satisfy this requirement.[170]

Industry size and structure. Information about the vehicle title market is more limited than with respect to the payday industry because there are currently no publicly traded vehicle title loan companies, most payday lending companies that offer vehicle title loans are not publicly traded, and less information is generally available from State regulators and other sources.[171] One national survey conducted in June 2013 found that 1.1 million households reported obtaining a vehicle title loan over the preceding 12 months.[172] Another study extrapolating from State regulatory reports estimates that about two million Americans use vehicle title loans annually.[173] In 2014, vehicle title loan originations were estimated at $2.4 billion with revenue estimates of $3 to $5.6 billion.[174] These estimates may not include the full extent of vehicle title loan expansion by payday lenders.

There are approximately 8,000 title loan storefront locations in the United States, about half of which also offer payday loans.[175] Three privately held firms dominate the vehicle title lending market and together account for about 3,200 stores in about 20 States.[176] These lenders are concentrated in the southeastern and southwestern regions of the country.[177] In addition to the large title lenders, smaller vehicle title lenders are estimated to have about 800 storefront locations,[178] and as noted above several companies offer both title loans and payday loans.[179] The Bureau understands that for some firms for which the core business had been payday loans, the volume of vehicle title loan originations now exceeds payday loan originations.

State loan data also show vehicle title loans are growing rapidly. The number of borrowers in Illinois taking vehicle title loans increased 78 percent from 2009 to 2013, the most current year for which data are available.[180] The number of title loans taken out in California increased 178 percent between 2011 and 2014.[181] In Virginia, between 2011 and 2014, the number of motor vehicle title loans made increased by 21 percent while the number of individual consumers taking title loans increased by 25 percent.[182] In addition to the growth in loans made under Virginia's vehicle title law, a series of reports notes that some Virginia title lenders are offering “consumer finance” installment loans without the corresponding consumer protections of the vehicle title lending law and, accounting for about “a quarter of the money loaned in Virginia using automobile titles as collateral.” [183] In Tennessee, the number of licensed vehicle title (title pledge) locations at year-end has been measured yearly since 2006. The number of locations peaked in 2014 at 1,071, 52 percent higher than the 2006 levels. In 2015, the number of locations declined to 965. However, in each year since 2013, the State regulator has reported more licensed locations than existed prior to the State's title lending regulation, the Tennessee Title Pledge Act.[184]

Vehicle title loan storefront locations serve a relatively small number of customers. One study estimates that the average vehicle title loan store made 227 loans per year, not including rollovers.[185] Another study using data from four States and public filings from the largest vehicle title lender estimated that the average vehicle title loan store serves about 300 unique borrowers per year—or slightly more than one unique borrower per business day.[186] The same report estimated that the largest vehicle title lender had 4.2 employees per store.[187] But, as mentioned, a number of large payday firms offer both products from the same storefront and may use the same employees to do so. In addition, small vehicle title lenders are Start Printed Page 47882likely to have fewer employees per location than do larger title lenders.

Marketing, underwriting, and collections practices. Vehicle title loans are marketed to appeal to borrowers with impaired credit who seek immediate funds. The largest vehicle title lender described title loans as a “way for consumers to meet their liquidity needs” and described their customers as those who “often . . . have a sudden and unexpected need for cash due to common financial challenges.” [188] Advertisements for vehicle title loans suggest that title loans can be used “to cover unforeseen costs this month . . . .[if] utilities are a little higher than you expected,” if consumers are “in a bind,” for a “short term cash flow” problem, or for “fast cash to deal with an unexpected expense.” [189] Vehicle title lenders advertise quick loan approval “in as little as 15 minutes.” [190] Some lenders offer promotional discounts for the initial loan and bonuses for referrals,[191] for example, a $100 prepaid card for referring friends for vehicle title loans.[192]

The underwriting policies and practices that vehicle title lenders use vary and may depend on such factors as State law requirements and individual lender practices. As noted above, some vehicle title lenders do not require borrowers to provide information about their income and instead rely on the vehicle title and the underlying collateral that may be repossessed and sold in the event the borrower defaults—a practice known as asset-based lending.[193] The largest vehicle title lender stated in 2011 that its underwriting decisions were based entirely on the wholesale value of the vehicle.[194] Other title lenders' Web sites state that proof of income is required,[195] although it is unclear whether employment information is verified or used for underwriting, whether it is used for collections and communication purposes upon default, or for both purposes. The Bureau is aware, from confidential information gathered in the course of its statutory functions, that one or more vehicle title lenders regularly exceed their maximum loan amount guidelines and instruct employees to consider a vehicle's sentimental or use value to the borrower when assessing the amount of funds they will lend.

One large title lender stated that it competes on factors such as location, customer service, and convenience, and also highlights its pricing as a competitive factor.[196] An academic study found evidence of price competition in the vehicle title market, citing the abundance of price-related advertising and evidence that in States with rate caps, such as Tennessee, approximately half of the lenders charged the maximum rate allowed by law, with the other half charging lower rates.[197] However, another report found that like payday lenders, title lenders compete primarily on location, speed, and customer service, gaining customers by increasing the number of locations rather than decreasing their prices.[198]

Loan amounts are typically for less than half the wholesale value of the consumer's vehicle. Low loan-to-value ratios reduce lenders' risk. A survey of title lenders in New Mexico found that the lenders typically lend between 25 and 40 percent of a vehicle's wholesale value.[199] At one large title lender, the weighted average loan-to-value ratio was found to be 26 percent of Black Book retail value.[200] The same lender has two principal operating divisions; one division requires that vehicles have a minimum appraised value greater than $500, but the lender will lend against vehicles with a lower appraised value through another brand.[201]

When a borrower defaults on a vehicle title loan, the lender may repossess the vehicle. The Bureau believes, based on market outreach, that the decision whether to repossess a vehicle will depend on factors such as the amount due, the age and resale value of the vehicle, the costs to locate and repossess the vehicle, and State law requirements to refund any surplus amount remaining after the sale proceeds have been applied to the remaining loan balance.[202] Available information indicates that lenders are unlikely to repossess vehicles they do not expect to sell. The largest vehicle title lender sold 83 percent of the vehicles it repossessed but did not report overall repossession rates.[203] In 2012, its firm-wide gross charge-offs equaled 30 percent of its average outstanding title loan balances.[204] The Bureau is aware of vehicle title lenders engaging in illegal debt collection activities in order to collect amounts claimed to be due under title loan agreements. These practices include altering caller ID information on outgoing calls to borrowers to make it appear that calls were from other businesses, falsely threatening to refer borrowers for criminal investigation or prosecution, and unlawful disclosures of debt information to borrowers' employers, friends, and family.[205] In addition, approximately 20 percent of consumer complaints handled by the Bureau about vehicle title loans Start Printed Page 47883involved consumers reporting concerns about repossession issues.[206]

Some vehicle title lenders have installed electronic devices on the vehicles, known as starter interrupt devices, automated collection technology, or more colloquially as “kill switches,” that can be programmed to transmit audible sounds in the vehicle before or at the payment due date. The devices may also be programmed to prevent the vehicle from starting when the borrower is in default on the loan, although they may allow a one-time re-start upon the borrower's call to obtain a code.[207] One of the starter interrupt providers states that “[a]ssuming proper installation, the device will not shut off the vehicle while driving.”[208] Due to concerns about consumer harm, one State financial regulator prohibited the devices as an unfair collection practice in all consumer financial transactions,[209] and a State attorney general issued a consumer alert about the use of starter interrupt devices specific to vehicle title loans.[210] The alert also noted that some title lenders require consumers to provide an extra key to their vehicles. In an attempt to avoid illegal repossessions, Wisconsin's vehicle title law prohibits lenders from requiring borrowers to provide the lender with an extra key to the vehicle.[211] The Bureau has received several complaints about starter interrupt devices.

Business model. As noted above, short-term vehicle title lenders appear to have overhead costs relatively similar to those of storefront payday lenders. Vehicle title lenders' loss rates and reliance on reborrowing activity appear to be even greater than that of storefront payday lenders.

Based on data analyzed by the Bureau, the default rate on single-payment vehicle title loans is six percent and the sequence-level default rate is 33 percent, compared with a 20 percent sequence-level default rate for storefront payday loans. One-in-five single-payment vehicle title loan borrowers has their vehicle repossessed by the lender.[212]

Similarly, the rate of vehicle title reborrowing appears high. In the Bureau's data analysis, more than half, 56 percent, of single-payment vehicle title loan sequences stretched for at least four loans; over a third, 36 percent, were seven or more loans; and 23 percent of loan sequences consisted of ten or more loans. While other sources on vehicle title lending are more limited than for payday lending, the Tennessee Department of Financial Institutions publishes a biennial report on vehicle title lending. Like the single-payment vehicle title loans the Bureau has analyzed, the vehicle title loans in Tennessee are 30-day single-payment loans. The most recent report shows similar patterns to those the Bureau found in its research, with a substantial number of consumers rolling over their loans multiple times. According to the report, of the total number of loan agreements made in 2014, about 15 percent were paid in full after 30 days without rolling over. Of those loans that are rolled over, about 65 percent were at least in their fourth rollover, about 44 percent were at least in their seventh rollover, and about 29 percent were at least in their tenth, up to a maximum of 22 rollovers.[213]

The impact of these outcomes for consumers who are unable to repay and either default or reborrow is discussed in Market Concerns—Short-Term Loans.

Bank Deposit Advance Products and Other Short-Term Lending

As noted above, within the banking system, consumers with liquidity needs rely primarily on credit cards and overdraft services. Some institutions have experimented with short-term payday-like products or partnering with payday lenders, but such experiments have had mixed results and in several cases have prompted prudential regulators to take action discouraging certain types of activity.

In 2000, the Office of the Comptroller of the Currency (OCC) issued an advisory letter alerting national banks that the OCC had significant safety and soundness, compliance, and consumer protection concerns with banks entering into contractual arrangements with vendors seeking to avoid certain State lending and consumer protection laws. The OCC noted it had learned of nonbank vendors approaching federally chartered banks urging them to enter into agreements to fund payday and title loans. The OCC also expressed concern about unlimited renewals (what the Bureau refers to as reborrowing), and multiple renewals without principal reduction.[214] The agency subsequently took enforcement actions against two national banks for activities relating to payday lending partnerships.[215]

The Federal Deposit Insurance Corporation (FDIC) has also expressed concerns with similar agreements between payday lenders and the depositories under its purview. In 2003, the FDIC issued Guidelines for Payday Lending applicable to State-chartered FDIC-insured banks and savings associations; the guidelines were revised in 2005 and most recently in 2015. The guidelines focus on third-party relationships between the chartered institutions and other parties, and specifically address rollover limitations. They also indicate that banks should ensure borrowers exhibit both a willingness and ability to repay when rolling over a loan. Among other things, the guidelines indicate that institutions should: (1) ensure that payday loans are not provided to customers who had payday loans outstanding at any lender for a total of three months during the previous 12 months; (2) establish appropriate cooling-off periods between loans; and (3) provide that no more than one payday loan is outstanding with the bank at a time to any one borrower.[216] In 2007, the FDIC issued guidelines encouraging banks to offer affordable small-dollar loan alternatives with APRs of 36 percent or less, reasonable and limited fees, amortizing payments, underwriting focused on a borrower's ability to repay but allowing flexible Start Printed Page 47884documentation, and to avoid excessive renewals.[217]

The NCUA has taken some steps to encourage federally chartered credit unions to offer “payday alternative loans,” which generally have a longer term than traditional payday products. This program is discussed in more detail in part II.C.

As the payday lending industry grew, a handful of banks decided to offer their deposit customers a similar product termed a deposit advance product (DAP). While one bank started offering deposit advances in the mid-1990s, the product began to spread more rapidly in the late 2000s and early 2010s. DAP could be structured a number of ways but generally involved a line of credit offered by depository institutions as a feature of an existing consumer deposit account with repayment automatically deducted from the consumer's next qualifying deposit. Deposit advance products were available to consumers who received recurring electronic deposits if they had an account in good standing and, for some banks, several months of account tenure, such as six months. When an advance was requested, funds were deposited into the consumer's account. Advances were automatically repaid when the next qualifying electronic deposit, whether recurring or one-time, was made to the consumer's account rather than on a fixed repayment date. If an outstanding advance was not fully repaid by an incoming electronic deposit within about 35 days, the consumer's account was debited for the amount due and could result in a negative balance on the account.

The Bureau estimates that at the product's peak from mid-2013 to mid-2014, banks originated roughly $6.5 billion of advances, which represents about 22 percent of the volume of storefront payday loans issued in 2013. The Bureau estimates that at least 1.5 million unique borrowers took out one or more DAP loans during that same time period.[218]

DAP fees, like payday loan fees, did not vary with the amount of time that the advance was outstanding but rather were set as dollars per amount advanced. A typical fee was $2 per $20 borrowed, the equivalent of $10 per $100. Research undertaken by the Bureau using a supervisory dataset found that the median duration for a DAP advance was 12 days, yielding an effective APR of 304 percent.[219]

The Bureau further found that while the average draw on a DAP was $180, users typically took more than one draw before the advance was repaid. The multiple draws resulted in a median average daily DAP balance of $343, which is similar to the size of a typical payday loan. With the typical DAP fee of $2 per $20 advanced, the fees for $343 in advances equate to about $34.30. The median DAP user was indebted for 112 days over the course of a year and took advances in seven months. Fourteen percent of borrowers took advances totaling over $9,000 over the course of the year; these borrowers had a median number of days in debt of 254.[220]

In 2010, the Office of Thrift Supervision (OTS) issued a supervisory directive ordering one bank to terminate its DAP program, which the bank offered in connection with prepaid accounts, after determining the bank engaged in unfair or deceptive acts or practices and violated the OTS' Advertising Regulation.[221] Consequently, in 2011, pursuant to a cease and desist order, the bank agreed to remunerate its DAP consumers nearly $5 million and pay a civil monetary penalty of $400,000.[222]

In November 2013, the FDIC and OCC issued final supervisory guidance on DAP.[223] This guidance stated that banks offering DAP should adjust their programs in a number of ways, including applying more scrutiny in underwriting DAP loans and discouraging repetitive borrowing. Specifically, the OCC and FDIC stated that banks should ensure that the customer relationship is of sufficient duration to provide the bank with adequate information regarding the customer's recurring deposits and expenses, and that the agencies would consider sufficient duration to be no less than six months. In addition, the guidance said that banks should conduct a more stringent financial capacity assessment of a consumer's ability to repay the DAP advance according to its terms without repeated reborrowing, while meeting typical recurring and other necessary expenses as well as outstanding debt obligations. In particular, the guidance stated that banks should analyze a consumer's account for recurring inflows and outflows at the end, at least, of each of the preceding six months before determining the appropriateness of a DAP advance. Additionally, the guidance noted that in order to avoid reborrowing, a cooling-off period of at least one monthly statement cycle after the repayment of a DAP advance should be completed before another advance could be extended. Finally, the guidance stated that banks should not increase DAP limits automatically and without a fully underwritten reassessment of a consumer's ability to repay, and banks should reevaluate a consumer's eligibility and capacity for DAP at least every six months.[224]

Following the issuance of the FDIC and OCC guidance, banks supervised by the FDIC and OCC ceased offering DAP. Of two DAP-issuing banks supervised by the Board of Governors of the Federal Reserve System (Federal Reserve Board) and therefore not subject to either the FDIC or OCC guidance, one eliminated its DAP program while another continues to offer a modified version of DAP to its existing DAP borrowers.[225] Today, with the exception of some short-term lending within the NCUA's Payday Alternative Loan program, described below in part II.C, relatively Start Printed Page 47885few banks or credit unions offer large-scale formal loan programs of this type.

C. Longer-Term, High-Cost Loans

As discussed above, beginning in the 1990s, a number of States created carve-outs from their usury laws to permit single-payment payday loans at annualized rates of between 300 percent and 400 percent. Although this lending initially focused primarily on loans lasting for a single income cycle, lenders have introduced newer, longer forms of liquidity loans over time. These longer loan forms include the “hybrid payday loans” discussed above, which are high-cost loans where the consumer is automatically scheduled to make a number of interest or fee only payments followed by a balloon payment of the entire amount of the principal and any remaining fees. They also include “payday installment loans,” described in more detail below. In addition, as discussed above, a number of States have authorized longer term vehicle title loans that extend beyond 30 days. Some longer-term, high cost installment loans likely were developed in response to the Department of Defense's 2007 rules implementing the Military Lending Act. As discussed above in part II.B, those rules applied to payday loans of 91 days or less (with an amount financed of $2,000 or less) and to vehicle title loans of 180 days of less. The Department of Defense recently expanded the scope of the rules due to its belief that creditors were structuring products to avoid the MLA's application.[226]

Payday Installment Loans

Product definition and regulatory environment. The term “payday installment loan” refers to a high-cost loan repaid in multiple installments, with each installment typically due at the consumer's payday and with the lender generally having the ability to collect the payment from the consumer's bank account as money is deposited or directly from the consumer's paycheck.[227]

Two States, Colorado and Illinois, have authorized payday installment loans. A number of other States have adopted usury laws that payday lenders use to offer payday installment loans in addition to more traditional payday loans. For example, a recent report found that eight States have no rate or fee limits for closed-end loans of $500 and that 11 States have no rate or fee limits for closed-end loans of $2,000.[228] The same report noted that for open-end credit, 14 States do not limit rates for a $500 advance and 16 States do limit them for a $2,000 advance.[229] Another recent study of the Web sites of five payday lenders, that operate both online and at storefront locations, found that these five lenders offered payday installment loans in at least 17 States.[230]

In addition, as discussed above, a substantial segment of the online payday industry operates outside of the constraints of State law, and this segment, too, has migrated towards payday installment loans. For example, a study commissioned by a trade association for online lenders surveyed seven lenders and concluded that, while single-payment loans are still a significant portion of these lenders' volume, they are on the decline while installment loans are growing. Several of the lenders represented in the report had either eliminated single-payment products or were migrating to installment products while still offering single-payment loans.[231]

There is less public information available about payday installment loans than about single-payment payday loans. Publicly traded payday lenders that make both single-payment and installment loans often report all loans in aggregate and do not report separately on their installment loan products or do not separate their domestic installment loan products from their international installment loan product lines, making sizing the market difficult. However, one analyst suggests that the continuing trend is for installment loans to take market share—both volume and revenue—away from single-payment payday loans.[232]

More specifically, data on payday installment lending is available, however, from the two States that expressly authorize it. Through 2010 amendments to its payday loan law, Colorado no longer permits short-term single-payment payday loans. Instead, in order to charge fees in excess of the 36 percent APR cap for most other consumer loans, the minimum loan term must be six months.[233] The maximum payday loan amount remains capped at $500, and lenders are permitted to take a series of post-dated checks or payment authorizations to cover each payment under the loan, providing lenders with the same access to borrower's accounts as a single-payment payday loan. The average payday installment loan amount borrowed in Colorado in 2014 was $392 and the average contractual loan term was 189 days. The average APR on these payday installment loans was 190 percent, which reflects the fact that at the same time that Colorado mandated minimum six-month terms it also imposed a new set of pricing restrictions on these loans.[234] Borrowers may prepay without a penalty and receive a pro-rata refund of all fees paid. According to loan data from Colorado, the average actual loan term was 94 days, resulting in an effective APR of 121 percent.[235]

In Illinois, lenders have been permitted to make payday installment loans since 2011 for terms of 112 to 180 days and amounts up to the lesser of $1,000 or 22.5 percent of gross monthly income.[236] A consumer may take out two loans concurrently (single-payment payday, payday installment, or a combination thereof) so long as the total amount borrowed does not exceed the cap. The maximum permitted charge on Illinois payday installment loans is $15.50 per $100 on the initial principal Start Printed Page 47886balance and on the balance scheduled to be outstanding at each installment period. For 2013, the average payday installment loan amount was $634 to be repaid in 163 days along with total fees of $645. The average APR on Illinois payday installment loans was 228 percent.[237]

In Illinois, payday installment loans have grown rapidly. In 2013, the volume of payday installment loans made was 113 percent of the 2011 volume. From 2010 to 2013, however, the volume of single-payment payday loans decreased by 21 percent.[238]

Beyond the data from these two States, several studies shed additional light on payday installment lending. A research paper based on a dataset from several payday installment lenders, consisting of over 1.02 million loans made between January 2012 and September 2013, provides some information on payday installment loans.[239] It contains data from both storefront installment loans (55 percent) and online installment loans (45 percent). It found that the median loan amount borrowed was $900 for six months (181 days) with 12 bi-weekly installment payments coinciding with paydays. The median APR on these loans was 295 percent. Online borrowers had higher median gross incomes than storefront borrowers ($39,000 compared to $31,000). When the researchers included additional loans they described as being made under “alternative business models, such as loans extended under tribal jurisdiction,” the median loan amount borrowed was $800 for 187 days due in 12 installments at a higher median APR of 319 percent.[240]

Similarly, a report using data from a specialty consumer reporting agency that included data primarily from online payday lenders that claim exemption from State lending laws examined the pricing and structure of their installment loans.[241] From 2010 to 2014, loans that may be described as payday installment loans generally accounted for one-third of all loans in the sample; however, this fluctuated by quarter between approximately 10 and 50 percent.[242] The payday installment loans had a median APR of 335 percent, across all payment structures. The most common payday installment loan in the sample had 12 bi-weekly payments; a median size of $500 and a median APR of 348 percent.

A third study commissioned by an online lender trade association surveyed a number of online lenders. The survey found that the average payday installment loan was for $667 with an average term of five months. The average fees for these loans were $690. The survey did not provide any APRs but the Bureau estimates that the average APR for a loan with these terms (and bi-weekly payments, the most common payment frequency seen) is about 373 percent.[243]

In a few States, such as Virginia discussed above in part II.B, and Kansas,[244] lenders offer loans structured as open-end payday installment loans. The Bureau believes based on market outreach, that lenders utilize open-end credit structures where they view State licensing or lending provisions as more favorable for open-end products. Some open-end products are for similar loan amounts as single-payment payday loans, cash advances are restricted to set increments such as $50 and must be requested in person, by calling the lender, or visiting the lender's Web site, and payments under the open-end line of credit are due on the borrower's scheduled paydays.

Marketing and underwriting practices. The Bureau believes based on market outreach, that some lenders use similar underwriting practices for both single-payment and payday installment loans (borrower identification, and information about income and a bank account) so long as they have access to the borrower's bank account for repayment. Some payday installment lenders, particularly but not exclusively online lenders, may use underwriting technology that pulls data from nationwide consumer reporting agencies and commercial or proprietary credit scoring models based on alternative data to assess fraud and credit risk.[245] In 2014, net charge-offs at two of the large licensed online installment lenders were over 50 percent of average balances.[246]

The Bureau likewise believes that the customer acquisition costs for online payday installment loans are likely similar to the costs to acquire a customer for an online single-payment payday loan. For example, one large licensed online payday installment lender reported that its 2014 customer acquisition cost per new loan was $297.[247] Another large online lender with both single-payment and payday installment loans reported that its marketing expense is 15.8 percent of revenue in 2014.[248]

Business model. In many respects, payday installment loans are similar to single-payment payday loans. However, one obvious difference is that the loan agreements provide for repayment in installments, rather than single-payment loans that may be rolled over or hybrid loans that automatically rollover, described above in part II.B above.

Regulatory reports from Colorado and Illinois provide evidence of repeat borrowing on payday installment loans. In Colorado, in 2012, two years after the State's amendments to its payday lending law, 36.7 percent of new loans were taken out on the same day that a previous loan was paid off, an increase from the prior year; for larger loans, nearly 50 percent were taken out on the same day that a previous loan was Start Printed Page 47887repaid.[249] Further, despite a statutorily-required minimum loan term of six months, on average, consumers took out 2.9 loans from the same lender during 2012 (by prepaying before the end of the loan term and then reborrowing).[250] Colorado's regulatory reports demonstrate that in 2013, the number of loan defaults on payday installment loans, calculated as a percent of the total number of borrowers, was 38 percent but increased in 2014 to 44 percent.[251]

One feature of Illinois' database is that it tracks applications declined due to ineligibility. In 2013, of those payday installment loan applications declined, 54 percent were declined because the applicants would have exceeded the permissible six months of consecutive days in debt and 29 percent were declined as they would have violated the prohibition on more than two concurrently open loans.[252]

In a study of high-cost unsecured installment loans, the Bureau has found that 37 percent of these loans are refinanced. For a subset of loans made at storefront locations, 94 percent of refinances involved cash out (meaning the consumer received cash from the loan refinance); for a subset of loans made online, nearly 100 percent of refinanced loans involved cash out. At the loan level, for unsecured installment loans in general, 24 percent resulted in default; for those made at storefront locations, 17 percent defaulted, compared to a 41 percent default rate for online loans.[253]

A report based on data from several payday installment lenders was generally consistent. It found that nearly 34 percent of these payday installment loans ended in charge-off. Charge-offs were more common for loans in the sample that had been made online (42 percent) compared to those made at storefront locations (27 percent).[254]

Installment Vehicle Title Loans

Product definition and regulatory environment. Installment vehicle title loans are vehicle title loans that are contracted to be repaid in multiple installments rather than in a single payment. Operationally, they are similar to single-payment vehicle title loans that are rolled over and discussed above in part II.B. As discussed in that section, about half of the States authorizing vehicle title loans permit the loans to be repaid in installments rather than, or in addition to, a single lump sum.[255]

As with single-payment vehicle title loans, the State laws applicable to installment vehicle title loans vary. Illinois requires vehicle title loans to be repaid in equal installments, limits the maximum loan amount to the lesser of $4,000 or 50 percent of the borrower's monthly income, has a 15-day cooling-off period except for refinances (defined as extensions or renewals) but does not limit fees. A refinance may be made only when the original principal of the loan is reduced by at least 20 percent.[256] Texas limits the loan term for CSO-arranged title loans to 180 days but does not cap fees.[257] Virginia has both a minimum loan term (120 days) and a maximum loan term (12 months) and caps fees at between 15 to 22 percent of the loan amount per month.[258] It also prohibits rollovers. Wisconsin limits the original loan term to six months but does not limit fees other than default charges, which are limited to 2.75 percent per month; it caps the maximum loan amount at $25,000.[259] Rollovers are not permitted on Wisconsin installment loans.

Some States do not specify loan terms for vehicle title loans, thereby authorizing both single-payment and installment title loans. These States include Arizona, New Mexico, and Utah. Arizona limits fees to between 10 and 17 percent per month depending on the loan amount; fees do not vary by loan duration.[260] New Mexico and Utah do not limit fees for vehicle title loans, regardless of the loan term.[261] Delaware has no limit on fees but limits the term to 180 days, including rollovers, likewise authorizing either 30-day loans or installment loans.[262]

State regulator data from two States track loan amounts, APRs, and loan terms for installment vehicle title loans. Illinois reported that in 2013, the average installment vehicle title loan amount was over $950 to be repaid in 442.7 days along with total fees of $2,316.43, and the average APR was 201 percent.[263] Virginia data show similar results. In 2014, the average amount borrowed on vehicle title loans was $1,048. The average APR was 222 percent and the average loan term was 345 days.[264] For a $1,048 loan, a Virginia title lender could charge interest of about $216.64 per month, or $2,491.36 for 345 days.[265] The average installment vehicle title loan amounts borrowed are similar to the amounts borrowed in single-payment title loan transactions; the average APRs are generally lower due to the longer loan term, described above in part II.B.

The Bureau obtained anonymized multi-year data from seven lenders offering either or both vehicle title and payday installment loans. The vehicle title installment loan data are from 2010 through 2013; the payday installment data are from 2007 through 2014. The Bureau reported that the average vehicle title installment loan amount was $1,098 and the median loan amount was $710; the average was 14 percent higher, and the median was two percent higher, than for single-payment vehicle title loans. The average APR was 250 percent and the median 259 percent compared to 291 percent and 317 percent for single-payment vehicle title loans.

Industry size and structure. The three largest vehicle title lenders, as defined by store count and described above in part II.B, make both single-payment and installment vehicle title loans, depending on the requirements and authority of State laws. As discussed above, there are no publicly traded vehicle title lenders (though some of the publicly-traded payday lenders also make vehicle title loans) and the one formerly public company did not distinguish its single-payment title loans from its installment title loans in its financial reports. Consequently, estimates of vehicle title loan market size include both single-payment and Start Printed Page 47888installment vehicle title loans, including the estimates provided above in part II.B, above.

Marketing and underwriting practices. In most respects, installment vehicle title loans are similar to single-payment vehicle title loans in marketing, borrower demographics, underwriting, and collections. For example, the Bureau is aware from market outreach and market monitoring activities that some installment vehicle title lenders require proof of income as part of the application process for installment vehicle title loans,[266] while others do not. Some installment vehicle title loans are set up to include repayment by ACH from the borrower's account, a practice common to payday installment loans. The Bureau has reviewed some installment vehicle title lenders' loan agreements that provide for delinquency fees if a payment is late.

Business model. Installment vehicle title loans generally perform in a manner similar to single-payment vehicle title loans. One study has analyzed data on repeat borrowing in installment vehicle title loans. The study found that in Q4 2014 in Texas, over 20 percent of installment vehicle title loans were refinanced in the same quarter the loan was made, and that during 2014 as a whole, the dollar volume of vehicle title loans refinanced almost equaled the volume of these loans originated.[267] More recent Texas regulator data indicates similar findings. Of the installment vehicle title loans originated in 2015, 39 percent were subsequently refinanced in the same year, and of all refinances of installment vehicle title loans in 2015, regardless of year of origination, 17 percent were refinanced five or more times.[268]

The Bureau has also analyzed installment vehicle lending data. The Bureau found that 20 percent of vehicle title installment loans were refinanced, with about 96 percent of refinances involving cash out. The median cash-out amount was $450, about 35 percent of the new loan's principal. At the loan level, 22 percent of installment vehicle title loans resulted in default and 8 percent in repossession; at the loan sequence level, 31 percent resulted in default and 11 percent in repossession.[269]

Other Nonbank Installment Loans

Product definition and regulatory environment. Before the advent of single-payment payday loans or online lending, and before widespread availability of credit cards, liquidity loans—also known as “personal loans” or “personal installment loans”—were offered by storefront nonbank installment lenders, often referred to as “finance companies.” “Personal loans” are typically unsecured loans used for any variety of purposes and distinguished from loans where the lender generally requires the funds be used for the specific intended purpose, such as automobile purchase loans, student loans, and mortgage loans. As discussed below, these finance companies, and their newer online counterparts (that offer similar loan products but place more reliance on automated processes and innovative underwriting), have a different business model than payday installment lenders and vehicle title installment lenders. Nonetheless, some loans offered by these installment lenders fall within the proposal's definition of “covered longer-term loan,” as they are made at interest rates that exceed 36 percent or include fees that result in a total cost of credit that exceeds 36 percent, and include repayment by access to the borrower's account or include a non-purchase money security interest in a consumer's vehicle. Additional information regarding the market for these finance company loans and their online counterparts is described below.

According to a report from a consulting firm using data derived from a nationwide consumer reporting agency, in 2015, finance companies originated 8.2 million personal loans (unsecured installment loans) totaling $37.6 billion in originations, of which approximately 6.8 million loans worth $24.3 billion were made to nonprime consumers (categorized as near prime, subprime, and deep subprime, with VantageScores of 660 and below), with an average loan size of about $3,593.[270] As of the end of 2015 there were 7.1 million outstanding loans worth $29.2 billion to nonprime consumers. These nonprime consumers accounted for 71 percent of outstanding accounts and 59 percent of outstanding balances, with an average balance outstanding of about $4,113. Subprime and deep subprime consumers, those with scores between 300 and 600 represented 41 percent of the borrowers and 28 percent of outstanding balances with an average balance of approximately $3,380.[271]

APRs at storefront locations in States that do not cap rates on installment loans can be 50 to 90 percent for subprime and deep subprime borrowers; APRs in States with rate caps are about 36 percent APR for near prime and subprime borrowers.[272] A survey of finance companies conducted in conjunction with a national trade association reported that 80 percent of loans were for $2,000 or less and 85 percent of loans had durations of 24 months or less (60 percent of loans had durations of one year or less).[273] No average loan amount was stated. Almost half of the loans had APRs between 49 and 99 percent; 9 percent of loans of $501 or less had APRs between 100 and 199 percent, but there was substantial rate variation among States.[274] Although APR calculations under Regulation Z include origination fees, lenders generally are not required to include within the finance charge application fees, document preparation fees, and add-on services such as optional credit insurance and guaranteed automobile Start Printed Page 47889protection.[275] A wider range and number of such up-front fees and add-on products and services appear to be charged by the storefront lenders than by their newer online counterparts.

Finance companies generally hold State lending licenses in each State in which they lend money and are subject to each State's usury caps. Finance companies operate primarily from storefront locations, but some of them now offer complete online loan platforms.[276]

Industry size and structure. There are an estimated 8,000 to 10,000 storefront finance company locations in the United States [277] —about half to two-thirds the number of payday loan stores—with approximately seven million loans to nonprime borrowers outstanding at any given point in time.[278] Three publicly traded companies account for about 40 percent of these storefront locations.[279] Of these, one makes the majority of its loans to consumers with FICO Scores above 600, and another makes a majority of loans to consumers who have either FICO Scores below 600 or no credit scores due to an absence of credit experience. Another considers its customer base to include borrowers with FICO Scores as low as 500.[280] Among the three publicly traded finance companies in this market, one will make installment loans starting at about $500 and another at $1,500, as well as larger installment loans as high as $15,000 to $25,000.[281]

Given the range of loan sizes of personal loans made by finance companies, and the range of credit scores of some finance company borrowers, it is likely that some of these loans are used to address liquidity shortfalls while others are used either to finance new purchases or to consolidate and pay off other debt.

Marketing and underwriting practices. Customer acquisition methods are generally similar for finance companies and online installment lenders. Finance companies rely on direct mail marketing and online advertising including banner advertisements, search engine optimization, and purchasing online leads to drive traffic to stores. Where allowed by State law, some finance companies mail “live” or “convenience checks” that, when endorsed and cashed or deposited, commit the consumer to repay the loan at the terms stated in the accompanying loan disclosures.[282] Promotional offers include 0 percent interest loans for borrowers who prepare and file their tax returns at the lender's office or refer friends [283] and free credit scores and gift cards.[284]

Finance companies suggest that loans may be used for bill consolidation, home repairs or improvements, or unexpected expenses such as medical bills and automobile repairs.[285] Like their storefront counterparts, online installment lenders also offer promotions such as offers of lower rates on installment loans after a history of successful loan repayments.[286]

Finance companies secure some of their loans with vehicle titles or with a legal security interest in borrowers' vehicles, although the Bureau believes based on market outreach that these loans are generally underwritten based on an assessment of the consumer's income and expenses and are not based primarily on the value of the vehicle in which the interest is provided as collateral. The portfolio of finance company loans collateralized by security interests in vehicles varies by lender and some do not separately report this data from overall portfolio metrics that include direct larger loans, automobile purchase loans, real estate loans, and retail sales finance loans.[287] The Bureau's market outreach with finance companies and their trade associations indicates that at most, 20 to 25 percent of finance company loans—though a higher percentage of receivables—involved a non-purchase money security interest in a vehicle.

Finance companies typically engage in underwriting that includes a monthly net income and expense budget, a review of the consumer's credit report, Start Printed Page 47890and an assessment of monthly cash flow.[288] One trade association representing traditional finance companies has described the underwriting process used by these lenders as evaluating the borrower's “stability, ability, and willingness” to repay the loan.[289] In addition to the typical underwriting described above, one finance company has publicized that it is now utilizing alternative sources of consumer data to assess creditworthiness, including the borrower's history of utility payments and returned checks, as well as nontraditional data (such as the type of personal device used when applying for the loan).[290] Many finance companies report loan payment history to one or more of the nationwide consumer reporting agencies,[291] and the Bureau believes from market outreach that these lenders generally furnish on a monthly basis.

From market monitoring activities, the Bureau is aware that there is an emerging group of online installment lenders entering the market with products that in some ways resemble the types of loans made by finance companies rather than payday installment loans. Some of these online installment lenders engage in sophisticated underwriting that involves substantial use of analytics and technology. These lenders utilize systems to verify application information including identity, bank account, and contact information focused on identifying fraud and borrowers intending to not repay. These lenders also review nationwide credit report information as well as data sources that provide payment and other information from wireless, cable, and utility company payments. The Bureau is aware that some online installment lenders obtain authorization to view borrowers' bank and credit card accounts to validate their reported income, assess income stability, and identify major recurring expenses.

Business model. Although traditional finance companies share a similar storefront distribution channel with storefront payday and vehicle title lenders, other aspects of their business model differs markedly. The publicly traded finance companies are concentrated in Midwestern and Southern States, with a particularly large number of storefronts in Texas.[292] A number of finance companies are located in rural areas.[293] One of the publicly traded finance companies states it competes on price and product offerings while another states it emphasizes customer relationships, customer service, and reputation.[294] Similarly, while the emerging online installment lenders share a similar distribution approach with online payday lenders, online hybrid payday installment lenders, and online payday installment lenders, their business models, particularly underwriting, are substantially different.

One of the indicators that underscores this contrast is default rates. In contrast to the high double digit charge-off rates discussed for some industry segments discussed above, reporting to a national consumer reporting agency indicates that during each quarter of 2015, between 2.9 and 3.4 percent of finance company loan balances were charged off. However, these figures include loans made to prime and superprime consumers that would likely not be covered loans under the total cost of credit threshold in proposed § 1041.2(a)(18).[295] In recent years, net charge-off rates at two publicly traded finance companies have ranged from 12 to 15 percent of average balances.[296]

Reborrowing in this market is relatively common, but finance companies refinance many existing loans before the loan maturity date, in contrast to the payday lending practice of rolling over debt on the loan's due date. The three publicly traded finance companies refinance 50 to 70 percent of all of their installment loans before the loan's due date.[297] At least one finance company states it will not “encourage” refinancing if the proceeds from the refinance (cash-out) are less than 10 percent of the refinanced loan amount.[298] In the installment context, refinancing refers to the lender extinguishing the existing loan and may include providing additional funds to the borrower, having the effect of allowing the borrower to skip a payment or reducing the total cost of credit relative to the outstanding loan.[299] The emerging online installment lenders also offer to refinance loans and some notify borrowers of their refinance options with email notifications and notices when they log in to their accounts.[300] Finance companies notify borrowers of refinance options by mail, telephone, text messages, on written payment receipts, and in stores.[301] State laws and company policies vary with respect to whether various loan Start Printed Page 47891origination and add-on fees must be refunded upon refinancing and prepayment and, if so, the refund methodology used.

Personal Lending by Banks and Credit Unions

Although as discussed above depository institutions over the last several decades have increasingly emphasized credit cards and overdraft services to meet customers short-term credit needs, they remain a major source of installment loans. According to an industry report, in 2015 banks and credit unions originated 3.8 million unsecured installment loans totaling $22.3 billion to nonprime consumers (defined as near prime, subprime, and deep subprime consumers with VantageScores below 660), with an average loan size of approximately $5,867.[302] As of the end of 2015, there were approximately 6.1 million outstanding bank and credit union unsecured installment loans to these nonprime consumers, with $41.5 billion in outstanding loan balances.[303] Approximately 29 percent of the number of outstanding bank loans (representing 21 percent of outstanding balances) and 49 percent of the credit union loans (representing 35 percent of balances) were to these nonprime consumers.[304]

National banks, most State-chartered banks, and State credit unions are permitted under existing Federal law to charge interest on loans at the highest rate allowed by the laws of the State in which the lender is located (lender's home State).[305] The bank or State-chartered credit union may then charge the interest rate of its home State on loans it makes to borrowers in other States without needing to comply with the usury limits of the States in which it makes the loans (borrower's home State). Federal credit unions must not charge more than 18 percent interest rate, with an exception for payday alternative loans described below.[306] The laws applicable to Federal credit unions are discussed below.

The Bureau believes that the vast majority of the personal loans made by banks and credit unions have a total cost of credit of 36 percent or less, and thus would not be covered loans under the Bureau's proposal. However, through market outreach the Bureau is also aware that many community banks make small personal loans to existing customers who face liquidity shortfalls, at least on an ad hoc basis at relatively low interest rates but some with an origination fee that would bring the total cost of credit to more than 36 percent. These products are generally offered to existing customers as an accommodation and are not mass marketed.

Two bank trade associations recently surveyed their members about their personal loan programs.[307] Although the surveys were small and may not have been representative, both found that banks continue to make personal loans. One survey generated 93 responses with banks ranging in size from $37 million in assets to $48.6 billion, with a heavy concentration of community banks (all bank survey).[308] The second survey was limited to community banks (community bank survey) and generated 132 responses.[309] The surveys, though asking different questions and not necessarily nationally representative, found:

  • Loan size and duration. In the community bank survey, 74 percent of the respondents reported that they make loans under $1,000 for durations longer than 45 days, with an average loan amount of $872. No average loan term was reported. Ninety-five percent reported making personal loans larger than $1,000, with an average loan size of under $4,000. In the all bank survey, 73 percent reported making loans of $5,000 or less for a term of less than one year, either as an accommodation for existing customers or as an established lending program. Slightly more than half of the respondents reported making more than 50 such loans in 2014.
  • Cost. In the community bank survey the average of the “typical interest rate” reported by the respondents was 12.1 percent for smaller dollar loans and the average maximum rate for such loans was 16.7 percent. Average interest rates for loans greater than $1,000 were about 250 basis points lower. At the same time, two-thirds of the banks reported that they also charge loan fees for the smaller loans and 70 percent do so for the larger loans over $1,000, with fees almost equally divided between application fees and origination fees. For the smaller loans, the median fee when set as a fixed dollar amount was $50 and the average fee $61.44 and when set as a percentage of the loan the average was 3 percent; average fees for loans above $1,000 were slightly higher and average percentage rates slightly lower. The all bank survey did not obtain data at this granular level but 53 percent of the respondents reported that the total cost of credit on at least some loans was above 36 percent.

The community bank survey provided some information about the lending practices of banks that offer small-dollar loans.

  • Underwriting. While the Bureau's outreach indicates that these loans are often thought of by the banks as “relationship loans” underwritten based on the bank's knowledge of the customer, in the community bank survey 93 percent reported that they also verified major financial obligations and debt and 78 percent reported that they verified income.

The two bank trade association surveys also provided information relative to repeat use and losses.

  • Rollovers. In the community bank survey 52 percent of respondents reported that they do not permit Start Printed Page 47892rollovers and 26 percent reported that they allow only a single rollover. Repayment methods vary and include manual payments as well as automated payments. Financial institutions that make loans to account holders retain the contractual right to set off payments due from existing accounts in the event of nonpayment.
  • Charge-offs. Both bank surveys reported low charge-off rates: in the community bank survey the average net charge-off rate for loans under $1,000 was 1 percent and for larger loans was less than 1 percent (.86 percent). In the all bank survey, 34 percent reported no charge-offs and 61 percent reported charge-offs of 3 percent or less.

There is little data available on the demographic characteristics of borrowers who take liquidity loans from banks. The Bureau's market monitoring indicates that a number of banks offering these loans are located in small towns and rural areas. Further, market outreach with bank trade associations indicates that it is not uncommon for borrowers to be in non-traditional employment and have seasonal or variable income.

As noted above, Federal credit unions may not charge more than 18 percent interest. However, as described below, they are authorized to make some small-dollar loans at rates up to 28 percent interest plus an applicable fee.

Through market monitoring and outreach, the Bureau is aware that a significant number of credit unions, both Federal and State chartered, offer liquidity loans to their members, at least on an accommodation basis. As with banks, these are small programs and may not be widely advertised. The credit unions generally engage in some sort of underwriting for these loans, including verifying borrower income and its sufficiency to cover loan payments, reviewing past borrowing history with the institution, and verifying major financial obligations. Many credit unions report these loans to a consumer reporting agency. On a hypothetical $500, 6-month loan, many credit unions would charge a 36 percent or less total cost of credit.

Some Federal credit unions offer small-dollar loans aimed at consumers with payday loan debt to pay off these loans at interest rates of 18 percent or less with application fees of $50 or less.[310] Other Federal credit unions (and State credit unions) offer installment vehicle title loans with APRs below 36 percent.[311] The total cost of credit, when application fees are included, may range from approximately 36 to 70 percent on a small loan of about $500, depending on the loan term.

Federal credit unions are also authorized to offer “payday alternative loans.” In 2010, the NCUA adopted an exception to the interest rate limit under the Federal Credit Union Act that permitted Federal credit unions to make payday alternative loans at an interest rate of up to 28 percent plus an application fee, “that reflects the actual costs associated with processing the application” up to $20.[312] PALs may be made in amounts of $200 to $1,000 to borrowers who have been members of the credit union for at least one month. PAL terms range from one to six months, may not be rolled over, and borrowers are limited one PAL at a time and no more than three PALs from the same credit union in a rolling six-month period. PALs must fully amortize and the credit union must establish underwriting guidelines such as verifying employment by requiring at least two pay stubs.[313]

In 2015, over 700 Federal credit unions (nearly 20 percent of all Federal credit unions) offered PALs, with originations at $123.3 million, representing a 7.2 percent increase from 2014.[314] In 2014, the average PAL amount was about $678 and carried a median interest rate of 25 percent.[315] The NCUA estimated that, based on the median PAL interest rate and loan size for 2013, the APR calculated by including all fees (total cost of credit) for a 30-day PAL was approximately 63 percent.[316] However, the Bureau believes based on market outreach that the average PAL term is about 100 days, resulting in a total cost of credit of approximately 43 percent.[317] Based on NCUA calculations, during 2014, annualized PAL charge-offs net of recoveries, as a percent of average PAL balances outstanding, were 7.5 percent.[318]

D. Initiating Payment from Consumers' Accounts

As discussed above, payday and payday installment lenders nearly universally obtain at origination one or more authorizations to initiate withdrawal of payment from the consumer's account. There are a variety of payment options or channels that they use to accomplish this goal, and lenders frequently obtain authorizations for multiple types. Different payment channels are subject to different laws and, in some cases, private network rules, leaving lenders with broad control over the parameters of how a particular payment will be pulled from a consumer's account, including the date, amount, and payment method.

Obtaining Payment Authorization

A variety of payment methods enable lenders to use a previously-obtained authorization to initiate a withdrawal from a consumer's account without further action from the consumer. These methods include paper signature checks, remotely created checks (RCCs) and remotely created payment orders (RCPOs),[319] and electronic payments like ACH [320] and debit and prepaid card Start Printed Page 47893transactions. Payday and payday installment lenders—both online and in storefronts—typically obtain a post-dated check or electronic payment authorization from consumers for repayments of loans.[321] For storefront payday loans, lenders typically obtain a post-dated check (or, where payday installment products are authorized, a series of postdated checks) that they can use to initiate a check or ACH transaction from a consumer's account.[322] For an online loan, a consumer often provides bank account information to receive the loan funds, and the lender often uses that bank account information to obtain payment from the consumer.[323] This account information can be used to initiate an ACH payment from a consumer's account. Typically, online lenders require consumers to authorize payments from their account as part of their agreement to receive the loan proceeds electronically.[324] Some traditional installment lenders also obtain an electronic payment authorization from their customers.

Payday and payday installment lenders often take authorization for multiple payment methods, such as taking a post-dated check along with the consumer's debit card information.[325] Consumers usually provide the payment authorization as part of the loan origination process.[326]

For storefront payday loans, providing a post-dated check is typically a requirement to obtain a loan. Under the Electronic Fund Transfer Act (EFTA) lenders cannot condition credit on obtaining an authorization from the consumer for “preauthorized” (recurring) electronic fund transfers,[327] but in practice online payday and payday installment lenders are able to obtain such authorizations from consumers for almost all loans. The EFTA provision concerning compulsory use does not apply to paper checks and one-time electronic fund transfers. Moreover, even for loans subject to the EFTA compulsory use provision, lenders use various methods to obtain electronic authorizations. For example, although some payday and payday installment lenders provide consumers with alternative methods to repay loans, these options may be burdensome and may significantly change the terms of the loan. For example, one lender increases its APR by an additional 61 percent or 260 percent, depending on the length of the loan, if a consumer elects a cash-only payment option for its installment loan product, resulting in a total APR of 462 percent (210 day loan) to 780 percent (140 day loan).[328] Other lenders change the origination process if consumers do not immediately provide account access. For example, some online payday lenders require prospective customers to contact them by phone if they do not want to provide a payment authorization and wish to pay by money order or check at a later time. Other lenders delay the disbursement of the loan proceeds if the consumer does not immediately provide a payment authorization.[329]

Banks and credit unions have additional payment channel options when they lend to consumers who have a deposit account at the same institution. As a condition of certain types of loans, many financial institutions require consumers to have a deposit account at that same institution.[330] The loan contract often authorizes the financial institution to pull payment directly from the consumer's account. Since these payments can be processed through an internal transfer within the bank or credit union, these institutions do not typically use external payment channels Start Printed Page 47894to complete an internal payment transfer.

Exercising Payment Authorizations

For different types of loans that would be covered under the proposed rule, lenders use their authorizations to collect payment differently. As discussed above, most storefront lenders encourage or require consumers to return to their stores to pay in cash, roll over, or otherwise renew their loans. The lender often will deposit a post-dated check or initiate an electronic fund transfer only where the lender considers the consumer to be in “default” under the contract or where the consumer has not responded to the lender's communications.[331] Bureau examiners have cited one or more payday lenders for threatening to initiate payments from consumer accounts that were contrary to the agreement, and that the lenders did not intend to initiate.[332]

In contrast, online lenders typically use the authorization to collect all payments, not just those initiated after there has been some indication of distress from the consumer. Moreover, as discussed above, online lenders offering “hybrid” payday loan products structure them so that the lender is authorized to collect a series of interest-only payments—the functional equivalent of paying finance charges to roll over the loan—before full payment or amortizing payments are due.[333] The Bureau also is aware that some online lenders, although structuring their product as nominally a two-week loan, automatically roll over the loan every two weeks unless the consumer takes affirmative action to make full payment.[334] The payments processed in such cases are for the cost of the rollover rather than the full balance due.

As a result of these distinctions, storefront and online lenders have different success rates in exercising such payment authorizations. Some large storefront lenders report that they initiate payment attempts in less than 10 percent of cases, and that 60 to 80 percent of those attempts are returned for non-sufficient funds.[335] Bureau analysis of ACH payments by online payday and payday installment lenders, which typically collect all payments by initiating a transfer from consumers' accounts, indicates that for any given payment only about 6 percent fail on the first try. However, over an eighteen-month observation period, 50% of online borrowers were found to experience at least one payment attempt that failed or caused an overdraft and over-third of the borrowers experienced more than one such incident.

Lenders typically charge fees for these returned payments, sometimes charging both a returned payment fee and a late fee.[336] These fees are in addition to fees, such as NSF fees, that may be charged by the financial institution that holds the consumer's account.

The Bureau found that if an electronic payment attempt failed, online lenders try again three-quarters of the time. However, after an initial failure the lender's likelihood of failure jumps to 70 percent for the second attempt and 73 percent for the third. Of those that succeed, roughly a third result in an overdraft.

Both storefront and online lenders also frequently change the ways in which they attempt to exercise authorizations after one attempt has failed. For example, many typically make additional attempts to collect initial payment due.[337] Some lenders attempt to collect the entire payment amount once or twice within a few weeks of the initial failure. The Bureau, however, is aware of online and storefront lenders that use more aggressive and unpredictable payment collection practices, including breaking payments into multiple smaller payments and attempting to collect payment multiple times in one day or over a short period of time.[338] The cost to lenders to repeatedly attempt payment depends on their contracts with payment processors and commercial banks, but is generally nominal; the Bureau estimates the cost is in a range of 5 to 15 cents for an ACH transaction.[339] These practices are discussed in more detail in Market Concerns—Payments.

As noted above, banks and credit unions that lend to their account holders can use their internal system to transfer funds from the consumer accounts and do not need to utilize the payment networks. Deposit advance products and their payment structures are discussed further in part II B. The Bureau believes that many small dollar loans with depository institutions are paid through internal transfers.

Due to the fact that lenders obtain authorizations to use multiple payment Start Printed Page 47895channels and benefit from flexibility in the underlying payment systems, lenders generally enjoy broad discretion over the parameters of how a particular payment will be pulled from a consumer's account, including the date, amount, and payment method. For example, although a check specifies a date, lenders may not present the check on that date. Under UCC Section 4-401, merchants can present checks for payment even if the check specifies a later date.[340] Lenders sometimes attempt to collect payment on a different date from the one stated on a check or original authorization. They may shift the attempt date in order to maximize the likelihood that funds will be in the account; some use their own models to determine when to collect, while others use predictive payment products provided by third parties that estimate when funds are most likely to be in the account.[341]

Moreover, the checks provided by consumers during origination often are not processed as checks. Rather than sending these payments through the check clearing network, lenders often process these payments through the ACH network. They are able to use the consumer account number and routing number on a check to initiate an ACH transaction. When lenders use the ACH network in a first attempt to collect payment, the lender has used the check as a source document and the payment is considered an electronic fund transfer under EFTA and Regulation E,[342] which generally provide additional consumer protections—such as error resolution rights—beyond those applicable to checks. However, if a transaction is initially processed through the check system and then processed through the ACH network because the first attempt failed for insufficient funds, the subsequent ACH attempt is not considered an electronic fund transfer under current Regulation E.[343] Similarly, consumers may provide their account and routing number to lenders for the purposes of an ACH payment, but the lender may use that information to initiate a remotely created check that is processed through the check system and thus may not receive Regulation E protections.[344]

Payment System Regulation and Private Network Requirements

Different payment mechanisms are subject to different laws and, in some cases, private network rules that affect how lenders can exercise their rights to initiate withdrawals from consumers' accounts and how consumers may attempt to limit or stop certain withdrawal activity after granting an initial authorization. Because ACH payments and post-dated checks are the most common authorization mechanisms used by payday and payday installment lenders, this section briefly outlines applicable Federal laws and National Automated Clearinghouse Association (NACHA) rules concerning stop payment rights, prohibitions on unauthorized payments, notices where payment amounts vary, and rules governing failed withdrawal attempts.

NACHA recently adopted several changes to the ACH network rules in response to complaints about problematic behavior by payday and payday installment lenders, including a rule that allows it to more closely scrutinize originators who have a high rate of returned payments.[345] Issues around monitoring and enforcing those rules and their application to problems in the market for covered loans are discussed in more detail in Market Concerns—Payments.

Stop payment rights. For preauthorized (recurring) electronic fund transfers,[346] EFTA grants consumers a right to stop payment by issuing a stop payment order through their depository institution.[347] The NACHA private rules adopt this EFTA provision along with additional stop payment rights. In contrast to EFTA, NACHA provides consumers with a stop payment right for both one-time and preauthorized transfers.[348] Specifically, for recurring transfers, NACHA Rules require financial institutions to honor a stop payment order as long as the consumer notifies the bank at least 3 banking days before the scheduled debit.[349] For one-time transfers, NACHA Rules require financial institutions to honor the stop payment order as long as the notification provides them with a “reasonable opportunity to act upon the order.” [350] Consumers may notify the bank or credit union verbally or in writing, but if the consumer does not provide written confirmation the oral stop payment order may not be binding beyond 14 days. If a consumer wishes to stop all future payments from an originator, NACHA Rules allow a bank or credit union to require the consumer to confirm in writing that she has revoked authorization from the originator.

Checks are also subject to a stop payment right under the Uniform Commercial Code (UCC).[351] Consumers have a right to stop-payment on any check by providing the bank with oral (valid for 14 days) or written (valid for 6 months) notice. To be effective, the stop payment must describe the check “with reasonable certainty” and give the Start Printed Page 47896bank enough information to find the check under the technology then existing.[352] The stop payment also must be given at a time that affords the bank a reasonable opportunity to act on the stop payment before it becomes liable for the check under U.C.C. 4-303.

Although EFTA, the UCC, and NACHA Rules provide consumers with stop payment rights, financial institutions typically charge a fee of approximately $32 for consumers to exercise those rights.[353] Further, both lenders and financial institutions often impose a variety of requirements that make the process for stopping payments confusing and burdensome for consumers. See discussion in Market Concerns—Payments.

Protection from unauthorized payments. Regulation E and NACHA Rules both provide protections with respect to payments by a consumer's financial institution if the electronic transfer is unauthorized.[354] Payments originally authorized by the consumer can become unauthorized under EFTA if the consumer notifies his or her financial institution that the originator's authorization has been revoked.[355] NACHA has a specific threshold for unauthorized returns, which involve transactions that originally collected funds from a consumer's account but that the consumer is disputing as unauthorized. Under NACHA Rules, originators are required to operate with an unauthorized return rate below 0.5 percent or they risk fines and loss of access to the ACH network.[356]

Notice of variable amounts. Regulation E and the NACHA Rules both provide that if the debit amount for a preauthorized transfer changes from the previous transfer or from the preauthorized amount, consumers must receive a notice 10 calendar days prior to the debit.[357] However, both of these rules have an exception from this requirement if consumers have agreed to a range of debit amounts and the payment does not fall outside that range.[358]

Based on outreach and market research, the Bureau does not believe that most payday and payday installment lenders making loans that would be covered under the proposed rule are providing a notice of transfers varying in amount. However, the Bureau is aware that many of these lenders take authorizations for a range of amounts. As a result, lenders use these broad authorizations rather than fall under the Regulation E requirement to send a notice of transfers varying in amount even when collecting for an irregular amount (for example, by adding fees or a past due amount to a regularly-scheduled payment). Some of these contracts provide that the consumer is authorizing the lender to initiate payment for any amount up to the full amount due on the loan.[359]

Reinitiation Cap. After a payment attempt has failed, NACHA Rules allow an originator—in this case, the lender that is trying to collect payment—to attempt to collect that same payment no more than two additional times through the ACH network.[360] NACHA Rules also require the ACH files [361] for the two additional attempts to be labeled as “reinitiated” transactions. Because the rule applies on a per-payment basis, for lenders with recurring payment authorizations, the count resets to zero when the next scheduled payment comes due.

III. Research, Outreach, and Consumer Testing

A. Research and Stakeholder Outreach

The Bureau has undertaken extensive research and conducted broad outreach with a multitude of stakeholders in the years leading up to the release of this Notice of Proposed Rulemaking. All of the input and feedback the Bureau received from this outreach has assisted the Bureau in the development of this notice.

That process began in January 2012 when the Bureau held its first public field hearing in Birmingham, Alabama, focused on small dollar lending. At the field hearing, the Bureau heard testimony and received input from consumers, civil rights groups, consumer advocates, religious leaders, industry and trade association representatives, academics, and elected representatives and other governmental officials about consumers' experiences with small dollar loan products. The Bureau transcribed that field hearing and posted the transcript on its Web site.[362] Concurrently with doing this, the Bureau placed a notice in the Federal Register inviting public comment on the issues discussed in the field hearing.[363] The Bureau received 664 public comments in response to that request.

At the Birmingham field hearing, the Bureau announced the launch of a program to conduct supervisory examinations of payday lenders pursuant to the Bureau's authority under Dodd-Frank Act section 1024. As part of the initial set of supervisory exams, the Bureau obtained loan-level records from a number of large payday lenders.

In April 2013 and March 2014, the Bureau issued two research publications reporting on findings by Bureau staff Start Printed Page 47897using the supervisory data. In conjunction with the second of these reports, the Bureau held a field hearing in Nashville, Tennessee, to gather further input from consumers, providers, and advocates alike. While the Bureau was working on these reports and in the period following their release, the Bureau held numerous meetings with stakeholders on small dollar lending in general and to hear their views on potential policy approaches.

The Bureau has conducted extensive outreach to industry, including national trade associations and member businesses, to gain knowledge of small dollar lending operations, underwriting processes, State laws, and the anticipated regulatory impact of the approaches proposed in the Small Business Review Panel Outline. Industry meetings have included non-depository lenders of different sizes, publicly traded and privately held, that offer single-payment payday loans through storefronts and online, multi-payment payday loans, vehicle title loans, open-end credit, and installment loans. The Bureau's outreach with depository lenders has likewise been extensive and included meetings with retail banks, community banks, and credit unions of varying sizes, both Federally and State-chartered. In addition, the Bureau has held extensive outreach on multiple occasions with the trade associations that represent these lenders. The Bureau's outreach also extended to specialty consumer reporting agencies utilized by some of these lenders. On other occasions, Bureau staff met to hear recommendations on responsible lending practices from a voluntarily-organized roundtable made up of lenders, advocates, and representatives of a specialty consumer reporting agency and a research organization.

As part of the process under the Small Business Regulatory Enforcement and Fairness Act (SBREFA process), which is discussed in more detail below, the Bureau released in March 2015 a summary of the rulemaking proposals under consideration in the Small Business Review Panel Outline. At the same time that the Bureau published the Small Business Review Panel Outline, the Bureau held a field hearing in Richmond, Virginia, to begin the process of gathering feedback on the proposals under consideration from a broad range of stakeholders. Immediately after the Richmond field hearing, the Bureau held separate roundtable discussions with consumer advocates and with industry members and trade associations to hear feedback on the Small Business Review Panel Outline. On other occasions, the Bureau met with members of two trade associations representing storefront payday lenders to discuss their feedback on issues presented in the Small Business Review Panel Outline.

At the Bureau's Consumer Advisory Board meeting in June 2015 in Omaha, Nebraska, a number of meetings and field events were held about payday, vehicle title, and similar loans. The Consumer Advisory Board advises and consults with the Bureau in the exercise of its functions under the Federal consumer financial laws, and provides information on emerging practices in the consumer financial products and services industry, including regional trends, concerns, and other relevant information. The Omaha events included a visit to a payday loan store and a day-long public session that focused on the Bureau's proposals in the Small Business Review Panel Outline and trends in payday and vehicle title lending. The Consumer Advisory Board has convened six other discussions on consumer lending. Two of the Bureau's other advisory bodies also discussed the proposals outlined in the Small Business Review Panel Outline: The Community Bank Advisory Council held two subcommittee discussions in March 2015 and November 2015, and the Credit Union Advisory Council conducted one Council discussion in March 2016 and held two subcommittee discussions in April 2015 and October 2015.

Bureau leaders, including its director, and staff have also spoken at events and conferences throughout the country. These meetings have provided additional opportunities to gather insight and recommendations from both industry and consumer groups about how to formulate a proposed rule. In addition to gathering information from meetings with lenders and trade associations and through regular supervisory and enforcement activities, Bureau staff has made fact-finding visits to at least 12 non-depository payday and vehicle title lenders, including those that offer single-payment and installment loans.

In conducting research, the Bureau has used not only the data obtained from the supervisory examinations previously described but also data obtained through orders issued by the Bureau pursuant to section 1022(c)(4) of the Dodd-Frank Act, data obtained through civil investigative demands made by the Bureau pursuant to section 1052 of the Dodd-Frank Act, and data voluntarily supplied to the Bureau by several lenders. Using these additional data sources, the Bureau in April and May 2016 published two research reports on how online payday lenders use access to consumers' bank accounts to collect loan payments and on consumer usage and default patterns on short-term vehicle title loans.

The Bureau also has engaged in consultation with Indian tribes regarding this rulemaking. The Bureau's Policy for Consultation with Tribal Governments provides that the Bureau “is committed to regular and meaningful consultation and collaboration with tribal officials, leading to meaningful dialogue with Indian tribes on Bureau policies that would be expressly directed to tribal governments or tribal members or that would have direct implications for Indian tribes.” [364] To date, the Bureau has held two formal consultation sessions related to this rulemaking. The first was held October 27, 2014, at the National Congress of American Indians 71st Annual Convention and Marketplace in Atlanta, Georgia, prior to the release of the SBREFA materials. At the first consultation session, tribal leaders provided input to the Bureau prior to the drafting of the proposals included in what would become the Small Business Review Panel Outline. A second consultation was held at the Bureau's headquarters on June 15, 2015, so that tribal leaders could respond to the proposals under consideration as set forth in the Small Business Review Panel Outline. All federally recognized tribes were invited to attend these consultations, which included open dialogue in which tribal leaders shared their views with senior Bureau leadership and staff about the potential impact of the rulemaking on tribes. The Bureau expects to engage in additional consultation following the release of the proposed rule, and specifically seeks comment on this Notice of Proposed Rulemaking from tribal governments.

The Bureau's outreach also has included meetings and calls with individual State Attorneys General, State financial regulators, and municipal governments, and with the organizations representing the officials charged with enforcing applicable Federal, State, and local laws. In particular, the Bureau, in developing the proposed registered information system requirements, consulted with State agencies from States that require lenders to provide information about certain covered loans to statewide databases Start Printed Page 47898and intends to continue to do so as appropriate.

As discussed in connection with section 1022 of the Dodd-Frank Act below, the Bureau has consulted with other Federal consumer protection and also Federal prudential regulators about these issues. The Bureau has provided other regulators with information about the proposals under consideration, sought their input, and received feedback that has assisted the Bureau in preparing this proposed rule.

In addition to these various forms of outreach, the Bureau's analysis has also been informed by supervisory examinations of a number of payday lenders, enforcement investigations of a number of different types of liquidity lenders, market monitoring activities, three additional research reports drawing on extensive loan-level data, and complaint information. Specifically, the Bureau has received, as of January 1, 2016, 36,200 consumer complaints relating to payday loans and approximately 10,000 more complaints relating to vehicle title and installment loan products that, in some cases, would be covered by the proposed rule.[365] Of the 36,200 payday complaints, approximately 12,200 were identified by the consumer as payday complaints and 24,000 were identified as debt collection complaints related to a payday loan.[366] The Bureau has also carefully reviewed the published literature with respect to small-dollar liquidity loans and a number of outside researchers have presented their research at seminars for Bureau staff.

B. Small Business Review Panel

In April 2015, the Bureau convened a Small Business Review Panel with the Chief Counsel for Advocacy of the SBA and the Administrator of the Office of Information and Regulatory Affairs within the Office of Management and Budget (OMB).[367] As part of this process, the Bureau prepared an outline of the proposals then under consideration and the alternatives considered (referred to above as the Small Business Review Panel Outline), which it posted on its Web site for review and comment by the general public as well as the small entities participating in the panel process.[368]

Prior to formally convening, the Panel participated in teleconferences with small groups of the small entity representatives (SERs) to introduce the Small Business Review Panel Outline and to obtain feedback. The Small Business Review Panel gathered information from representatives of 27 small entities, including small payday lenders, vehicle title lenders, installment lenders, banks, and credit unions. The meeting participants represented storefront and online lenders, in addition to State-licensed lenders and lenders affiliated with Indian tribes. The Small Business Review Panel held a full-day meeting on April 29, 2015, to discuss the proposals under consideration. The 27 small entities also were invited to submit written feedback, and 24 of them provided written comments. The Small Business Review Panel made findings and recommendations regarding the potential compliance costs and other impacts of those entities. These findings and recommendations are set forth in the Small Business Review Panel Report, which will be made part of the administrative record in this rulemaking.[369] The Bureau has carefully considered these findings and recommendations in preparing this proposal as detailed below in the section-by-section analysis on various provisions and in parts VI and VII. The Bureau specifically seeks comment on this Notice of Proposed Rulemaking from small businesses.

As discussed above, the Bureau has continued to conduct extensive outreach and engagement with stakeholders on all sides since the SBREFA process concluded.

C. Consumer Testing

In developing this notice, the Bureau engaged a third-party vendor, Fors Marsh Group (FMG), to coordinate qualitative consumer testing for disclosures under consideration in this rulemaking. The Bureau developed several prototype disclosure forms to test with participants in one-on-one interviews. Three categories of forms were developed and tested: (1) Origination disclosures that informed consumers about limitations on their ability to receive additional short-term loans; (2) upcoming payment notices that alerted consumers about lenders' future attempts to withdraw money from consumers' accounts; and (3) expired authorization notices that alerted consumers that lenders would no longer be able to attempt to withdraw money from the consumers' accounts. Observations and feedback from the testing were incorporated into the model forms proposed by the Bureau.

Through this testing, the Bureau sought to observe how consumers would interact with and understand prototype forms developed by the Bureau. In late 2015, FMG facilitated two rounds of one-on-one interviews. Each interview lasted 60 minutes and included fourteen participants. The first round was conducted in September 2015 in New Orleans, Louisiana, and the second round was conducted in October 2015 in Kansas City, Missouri. In conjunction with the release of this notice, the Bureau is making available a report prepared by FMG on the consumer testing (“FMG Report”).[370] The testing and focus groups were conducted in accordance with OMB Control Number 3170-0022.

A total of 28 individuals participated in the interviews. Of these 28 participants, 20 self-identified as having used a small dollar loan within the past two years.

Highlights from individual interview findings. FMG asked participants questions to assess how well they understood the information on the forms.

For the origination forms, the questions focused on whether participants understood that their ability to rollover this loan or take out additional loans may be limited. Each participant reviewed one of two different prototype forms: either one for loans that would require an ability-to-Start Printed Page 47899repay determination (ATR Form) or one for loans that would be offered under the conditional exemption for covered short-term loans (Alternative Loan Form). During Round 1, many participants for both form types recognized and valued information about the loan amount and due date; accordingly, that information was moved to the beginning of all the origination forms for Round 2. For the ATR Forms, few participants in Round 1 understood that the “30 days” language was describing a period when future borrowing may be restricted. Instead, several read the language as describing the loan term. In contrast, nearly all participants reviewing the Alternative Loan Form understood that it was attempting to convey that each successive loan they took out after the first in this series had to be smaller than the previous loan, and that after taking out three loans they would not be able to take out another for 30 days. Some participants also reviewed a version of this Alternative Loan Form for when consumers are taking out their third loan in a sequence. The majority of participants who viewed this notice understood it, acknowledging that they would have to wait until 30 days after the third loan was paid off to be considered for another similar loan.

During Round 2, participants reviewed two new versions of the ATR Form. One adjusted the “30 days” phrasing and the other completely removed the “30 days” language, replacing it with the phrase “shortly after this one.” The Alternative Loan Form was updated with similar rephrasing of the “30 days” language. To simplify the table, the “loan date” column was removed.

The results in Round 2 were similar to Round 1. Participants reviewing the ATR forms focused on the language notifying them they should not take out this loan if they're unable to pay the full balance by the due date. Information about restrictions on future loans went largely unnoticed. The edits appeared to positively impact comprehension since no participants interpreted either form as providing information on their loan term. There did not seem to be a difference in comprehension between the group with the “30 days” version and the group with the “shortly” version. As in Round 1, participants who reviewed the Alternative Loan Form noticed and understood the schedule detailing maximum borrowable amounts. These participants understood that the purpose of the Alternative Loan Form was to inform them that any subsequent loans must be smaller.

Questions for the payment notices focused on participants' ability to identify and understand information about the upcoming payment. Participants reviewed one of two payment notices: an Upcoming Withdrawal Notice or an Unusual Withdrawal Notice. Both forms provided details about the upcoming payment attempt and a payment breakdown table. The Unusual Withdrawal Notice also indicated that the withdrawal was unusual because the payment was higher than the previous withdrawal amount. To obtain feedback on participants' likelihood to open notices delivered in an electronic manner, these notices were presented as a sequence to simulate an email message.

In Round 1, all participants, based on seeing the subject line in the email inbox, said that they would open the Upcoming Withdrawal email and read it. Nearly all participants said they would consider the email legitimate. They reported having no concerns about the email because they would have recognized the company name, and because it included details specific to their account along with the lender contact information. When shown the full Upcoming Withdrawal Notice, participants understood that the lender would be withdrawing $40 from their account on a particular date. Several participants also pointed out that the notice described an interest-only payment. Round 1 results were similar for the Unusual Withdrawal Notice; all participants who viewed this notice said they would open the email, and all but one participant—who was deterred due to concerns with the appearance of the link's URL—would click on the link leading to additional details. The majority of participants indicated that they would want to read the email right away, because the words “alert” and “unusual” would catch their attention, and would make them want to determine what was going on and why a different amount was being withdrawn.

For Round 2, the payment amount was increased because some participants found it too low and would not directly answer questions about what they would do if they could not afford payment. The payment breakdown tables were also adjusted to address feedback about distinguishing between principal, finance charges, and loan balance. The results for both the Upcoming Payment and Unusual Payment Notices were similar to Round 1 in that the majority of participants would open the email, thought it was legitimate and from the lender, and understood the purpose.

For the consumer rights notice (referred to an “expired authorization notice” in the report), FMG asked questions about participant reactions to the notice, participant understanding of why the notice was being sent, and what participants might do in response to the notice information. As with the payment notices, these notices were presented as a sequence to simulate an email message.

In Round 1, participants generally understood that the lender had tried twice to withdraw money from their account and would not be able to make any additional attempts to withdraw payment. Most participants expressed disappointment with themselves for being in a position where they had two failed payments and interpreted the notice to be a reprimand from the lender.

For Round 2, the notice was edited to clarify that the lender was prohibited by Federal law from making additional withdrawals. For example, the email subject line was changed from “Willow Lending can no longer withdraw loan payments from your account” to “Willow Lending is no longer permitted to withdraw loan payments from your account.” Instead of simply saying “federal law prohibits us from trying to withdraw payment again,” language was added to both the email message and the full notice saying, “In order to protect your account, federal law prohibits us from trying to withdraw payment again.” More information about consumer rights and the CFPB was also added. Some participants in Round 2 still reacted negatively to this notice and viewed it as reflective of something they did wrong. However, several reacted more positively to this prototype and viewed the notice as protection.

To obtain feedback regarding consumer preferences on receiving notices through text message, participants were also presented with an image of a text of the consumer rights notice and asked how they would feel about getting this notice by text. Overall, the majority of participants in Round 1 (8 of 13) disliked the idea of receiving notices via text. One of the main concerns was privacy; many mentioned that they would be embarrassed if a text about their loan situation displayed on their phone screen while they were in a social setting. In Round 2, the text image was updated to match the new subject line of the consumer rights notice. The majority (10 of the 14) of participants had a negative reaction to the notification delivered via text message. Despite this, the majority of Start Printed Page 47900participants said that they would still open the text message and view the link.

Most participants (25 out of 28) also listened to a mock voice message of a lender contacting the participant to obtain renewed payment authorization after two payment attempts had failed. In Round 1, most participants reported feeling somewhat intimidated by the voicemail message and were inclined to reauthorize payments or call back based on what they heard. Participants had a similar reaction to the voicemail message in Round 2.

IV. Legal Authority

The Bureau is issuing this proposed rule pursuant to its authority under the Dodd-Frank Act. The proposed rule relies on rulemaking and other authorities specifically granted to the Bureau by the Dodd-Frank Act, as discussed below.

A. Section 1031 of the Dodd-Frank Act

Section 1031(b)—The Bureau's Authority To Identify and Prevent UDAAPs

Section 1031(b) of the Dodd-Frank Act provides the Bureau with authority to prescribe rules to identify and prevent unfair, deceptive, and abusive acts or practices, or UDAAPs. Specifically, Dodd-Frank Act section 1031(b) authorizes the Bureau to prescribe rules “applicable to a covered person or service provider identifying as unlawful unfair, deceptive, or abusive acts or practices in connection with any transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service.” Section 1031(b) of the Dodd-Frank Act further provides that, “Rules under this section may include requirements for the purpose of preventing such acts or practice.”

Given similarities between the Dodd-Frank Act and the Federal Trade Commission Act (FTC Act) provisions relating to unfair and deceptive acts or practices, case law and Federal agency rulemakings relying on the FTC Act provisions inform the scope and meaning of the Bureau's rulemaking authority with respect to unfair and deceptive acts or practices under section 1031(b) of the Dodd-Frank Act.[371] Courts evaluating exercise of agency rulemaking authority under the FTC Act unfairness and deception standards have held that there must be a “reasonable relation” between the act or practice identified as unlawful and the remedy chosen by the agency.[372] The Bureau agrees with this approach and therefore believes that it is reasonable to interpret Dodd-Frank Act section 1031(b) to permit the imposition of requirements to prevent acts or practices that are identified by the Bureau as unfair or deceptive so long as the preventive requirements being imposed by the Bureau have a reasonable relation to the identified acts or practices. The Bureau likewise believes it is reasonable to interpret Dodd-Frank Act section 1031(b) to provide the same degree of discretion to the Bureau with respect to the imposition of requirements to prevent acts or practices that are identified by the Bureau as abusive. Throughout this proposal, the Bureau has relied on and applied this interpretation in proposing requirements to prevent acts or practices identified as unfair or abusive.

Section 1031(c)—Unfair Acts or Practices

Section 1031(c)(1) of the Dodd-Frank Act provides that the Bureau “shall have no authority under this section to declare an act or practice in connection with a transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service, to be unlawful on the grounds that such act or practice is unfair,” unless the Bureau “has a reasonable basis” to conclude that: “(A) the act or practice causes or is likely to cause substantial injury to consumers which is not reasonably avoidable by consumers; and (B) such substantial injury is not outweighed by countervailing benefits to consumers or to competition.” [373] Section 1031(c)(2) of the Dodd-Frank Act provides that, “In determining whether an act or practice is unfair, the Bureau may consider established public policies as evidence to be considered with all other evidence. Such public policy considerations may not serve as a primary basis for such determination.” [374]

The unfairness standard under section 1031(c) of the Dodd-Frank Act—requiring primary consideration of the three elements of substantial injury, not reasonably avoidable by consumers, and countervailing benefits to consumers or to competition, and permitting secondary consideration of public policy—reflects the unfairness standard under the FTC Act.[375] Section 5(n) of the FTC Act was amended in 1994 to incorporate the principles set forth in the FTC's December 17, 1980 “Commission Statement of Policy on the Scope of Consumer Unfairness Jurisdiction” (the FTC Policy Statement on Unfairness).[376] The FTC Act unfairness standard, the FTC Policy Statement on Unfairness, FTC and other Federal agency rulemakings,[377] and related case law inform the scope and meaning of the Bureau's authority under Dodd-Frank Act section 1031(b) to issue rules that identify and prevent acts or practices that the Bureau determines are unfair pursuant to Dodd-Frank Act section 1031(c).

Substantial Injury

The first element for a determination of unfairness under section 1031(c)(1) of the Dodd-Frank Act is that the act or practice causes or is likely to cause substantial injury to consumers. As discussed above, the FTC Act unfairness standard, the FTC Policy Statement on Unfairness, FTC and other Federal agency rulemakings, and related case law inform the meaning of the elements Start Printed Page 47901of the unfairness standard under Dodd-Frank Act section 1031(c)(1). The FTC noted in the FTC Policy Statement on Unfairness that substantial injury ordinarily involves monetary harm.[378] The FTC has stated that trivial or speculative harms are not cognizable under the test for substantial injury.[379] The FTC also noted that an injury is “sufficiently substantial” if it consists of a small amount of harm to a large number of individuals or if it raises a significant risk of harm.[380] The FTC has found that substantial injury also may involve a large amount of harm experienced by a small number of individuals.[381] The FTC has said that emotional impact and other more subjective types of harm ordinarily will not constitute substantial injury,[382] but the D.C. Circuit held that psychological harm can form part of the substantial injury along with financial harm.[383]

Not Reasonably Avoidable

The second element for a determination of unfairness under section 1031(c)(1) of the Dodd-Frank Act is that the substantial injury is not reasonably avoidable by consumers. As discussed above, the FTC Act unfairness standard, the FTC Policy Statement on Unfairness, FTC and other Federal agency rulemakings, and related case law inform the meaning of the elements of the unfairness standard under Dodd-Frank Act section 1031(c)(1). The FTC has provided that knowing the steps for avoiding injury is not enough for the injury to be reasonably avoidable; rather, the consumer must also understand and appreciate the necessity of taking those steps.[384] As the FTC explained in the FTC's Policy Statement on Unfairness, most unfairness matters are brought to “halt some form of seller behavior that unreasonably creates or takes advantage of an obstacle to the free exercise of consumer decisionmaking.” [385] The D.C. Circuit has noted that where such behavior exists, there is a “market failure” and the agency “may be required to take corrective action.” [386] Reasonable avoidability also takes into account the costs of making a choice other than the one made and the availability of alternatives in the marketplace.[387]

Countervailing Benefits to Consumers or Competition

The third element for a determination of unfairness under section 1031(c)(1) of the Dodd-Frank Act is that the act or practice's countervailing benefits to consumers or to competition do not outweigh the substantial consumer injury. As discussed above, the FTC Act unfairness standard, the FTC Policy Statement on Unfairness, FTC and other Federal agency rulemakings, and related case law inform the meaning of the elements of the unfairness standard under Dodd-Frank Act section 1031(c)(1). In applying the FTC Act's unfairness standard, the FTC has stated that generally it is important to consider both the costs of imposing a remedy and any benefits that consumers enjoy as a result of the practice.[388] Authorities addressing the FTC Act's unfairness standard indicate that the countervailing benefits test does not require a precise quantitative analysis of benefits and costs, as such an analysis may be unnecessary or, in some cases, impossible; rather, the agency is expected to gather and consider reasonably available evidence.[389]

Public Policy

As noted above, section 1031(c)(2) of the Dodd-Frank Act provides that, “In determining whether an act or practice is unfair, the Bureau may consider established public policies as evidence to be considered with all other evidence. Such public policy considerations may not serve as a primary basis for such determination.” [390]

Section 1031(d)—Abusive Acts or Practices

The Dodd-Frank Act, in section 1031(b), authorizes the Bureau to identify and prevent abusive acts and practices. The Bureau believes that Congress intended for the statutory phrase “abusive acts or practices” to encompass conduct by covered persons that is beyond what would be prohibited as unfair or deceptive acts or practices, although such conduct could overlap and thus satisfy the elements for more than one of the standards.[391]

Under Dodd-Frank Act section 1031(d), the Bureau “shall have no Start Printed Page 47902authority . . . to declare an act or practice abusive in connection with the provision of a consumer financial product or service” unless the act or practice qualifies under at least one of several enumerated conditions. For example, under Dodd-Frank Act section 1031(d)(2)(A), an act or practice might “take[] unreasonable advantage of” a consumer's “lack of understanding . . . of the material risks, costs, or conditions of the [consumer financial] product or service” (i.e., the lack of understanding prong).[392] Under Dodd-Frank Act section 1031(d)(2)(B), an act or practice might “take[] unreasonable advantage of” the “inability of the consumer to protect the interests of the consumer in selecting or using a consumer financial product or service” (i.e., the inability to protect prong).[393] The Dodd-Frank Act does not further elaborate on the meaning of these terms. Rather, the statute left it to the Bureau to interpret and apply these standards.

Although the legislative history on the meaning of the Dodd-Frank Act abusiveness standard is fairly limited, it suggests that Congress was particularly concerned about the widespread practice of lenders making unaffordable loans to consumers. A primary focus was on unaffordable home mortgages.[394] However, there is some indication that Congress intended the Bureau to use the authority under Dodd-Frank Act section 1031(d) to address payday lending through the Bureau's rulemaking, supervisory, and enforcement authorities. For example, the Senate Committee on Banking, Housing, and Urban Affairs report on the Senate version of the legislation listed payday loans as one of several categories of consumer financial products and services other than mortgages where “consumers have long faced problems” because they lack “adequate federal rules and enforcement,” noting further that “[a]busive lending, high and hidden fees, unfair and deceptive practices, confusing disclosures, and other anti-consumer practices have been a widespread feature in commonly available consumer financial products such as credit cards.” [395] The same section of the Senate committee report included a description of the basic features of payday loans and the problems associated with them, specifically noting that many consumers are unable to repay the loans while meeting their other obligations and that many borrowers reborrow which results in a “perpetual debt treadmill.” [396]

B. Section 1032 of the Dodd-Frank Act

Dodd-Frank Act section 1032(a) provides that the Bureau may prescribe rules to ensure that the features of any consumer financial product or service, “both initially and over the term of the product or service,” are “fully, accurately, and effectively disclosed to consumers in a manner that permits consumers to understand the costs, benefits, and risks associated with the product or service, in light of the facts and circumstances.” [397] The authority granted to the Bureau in section 1032(a) of the Dodd-Frank Act is broad, and empowers the Bureau to prescribe rules regarding the disclosure of the “features” of consumer financial products and services generally. Accordingly, the Bureau may prescribe rules containing disclosure requirements even if other Federal consumer financial laws do not specifically require disclosure of such features. Dodd-Frank Act section 1032(c) provides that, in prescribing rules pursuant to section 1032 of the Dodd-Frank Act, the Bureau “shall consider available evidence about consumer awareness, understanding of, and responses to disclosures or communications about the risks, costs, and benefits of consumer financial products or services.” [398]

Dodd-Frank Act section 1032(b)(1) provides that “any final rule prescribed by the Bureau under this section requiring disclosures may include a model form that may be used at the option of the covered person for provision of the required disclosures.” [399] Dodd-Frank Act section 1032(b)(2) provides that such model form “shall contain a clear and conspicuous disclosure that, at a minimum—(A) uses plain language comprehensible to consumers; (B) contains a clear format and design, such as an easily readable type font; and (C) succinctly explains the information that must be communicated to the consumer.” [400] Dodd-Frank Act section 1032(b)(3) provides that any such model form “shall be validated through consumer testing.” [401] Dodd-Frank Act section 1032(d) provides that, “Any covered person that uses a model form included with a rule issued under this section shall be deemed to be in compliance with the disclosure requirements of this section with respect to such model form.” [402]

C. Other Authorities Under the Dodd-Frank Act

Section 1022(b)(1) of the Dodd-Frank Act provides that the Bureau's director “may prescribe rules and issue orders and guidance, as may be necessary or appropriate to enable the Bureau to administer and carry out the purposes and objectives of the Federal consumer financial laws, and to prevent evasions thereof.” [403] “Federal consumer financial law” includes rules prescribed under Title X of the Dodd-Frank Act,[404] including sections 1031(b) through (d) and 1032.

Section 1022(b)(2) of the Dodd-Frank Act prescribes certain standards for rulemaking that the Bureau must follow in exercising its authority under section 1022(b)(1) of the Dodd-Frank Act.[405] See part VI below for a discussion of the Bureau's standards for rulemaking under Dodd-Frank Act section 1022(b)(2).

Section 1022(b)(3)(A) of the Dodd-Frank Act authorizes the Bureau to, by rule, “conditionally or unconditionally exempt any class of covered persons, service providers, or consumer financial products or services” from any provision of Title X or from any rule issued under Title X as the Bureau determines “necessary or appropriate to carry out the purposes and objectives” of Title X, “taking into consideration the factors” set forth in section 1022(b)(3)(B) of the Dodd-Frank Act.[406] Section 1022(b)(3)(B) of the Dodd-Frank Act specifies three factors that the Start Printed Page 47903Bureau shall, as appropriate, take into consideration in issuing such an exemption.[407]

Proposed §§ 1041.16 and 1041.17 would also be authorized by additional Dodd-Frank Act authorities, such as Dodd-Frank Act sections 1021(c)(3),[408] 1022(c)(7),[409] 1024(b)(1),[410] and 1024(b)(7).[411] Additional description of the Dodd-Frank Act authorities on which the Bureau is relying for proposed §§ 1041.16 and 1041.17 is contained in the section-by-section analysis of proposed §§ 1041.16 and 1041.17.

D. Section 1041 of the Dodd-Frank Act

Section 1041(a)(1) of the Dodd-Frank Act provides that Title X of the Dodd-Frank Act, other than sections 1044 through 1048, “may not be construed as annulling, altering, or affecting, or exempting any person subject to the provisions of [Title X] from complying with,” the statutes, regulations, orders, or interpretations in effect in any State (sometimes hereinafter, State laws), “except to the extent that any such provision of law is inconsistent with the provisions of [Title X], and then only to the extent of the inconsistency.” [412] Section 1041(a)(2) of the Dodd-Frank Act provides that, for purposes of section 1041, a statute, regulation, order, or interpretation in effect in any State is not inconsistent with the Title X provisions “if the protection that such statute, regulation, order, or interpretation affords to consumers is greater than the protection provided” under Title X.[413] Section 1041(a)(2) further provides that, “A determination regarding whether a statute, regulation, order, or interpretation in effect in any State is inconsistent with the provisions of [Title X] may be made by the Bureau on its own motion or in response to a nonfrivolous petition initiated by any interested person.”

The requirements of the proposed rule would set minimum standards at the Federal level for regulation of covered loans. The Bureau believes that the requirements of the proposed rule would coexist with State laws that pertain to the making of loans that the proposed rule would treat as covered loans (hereinafter, applicable State laws). Consequently, any person subject to the proposed rule would be required to comply with both the requirements of the proposed rule and applicable State laws, except to the extent the applicable State laws are inconsistent with the requirements of the proposed rule.[414] This is consistent with the established framework of Federal and State laws in many other substantive areas, such as securities law, antitrust law, environmental law and the like.

As noted above, Dodd-Frank Act section 1041(a)(2) provides that State laws that afford greater consumer protections than provisions under Title X are not inconsistent with the provisions under Title X. As discussed in part II, different States have taken different approaches to regulating loans that would be covered loans, with some States electing to permit the making of such loans and other States choosing not to do so. The Bureau believes that the requirements of the proposed rule would coexist with these different approaches, which are reflected in applicable State laws.[415] The Bureau is aware of certain applicable State laws that the Bureau believes would afford greater protections to consumers than would the requirements of the proposed rule. For example, as described in part II, certain States have fee or interest rate caps (i.e., usury limits) that payday lenders apparently find too low to sustain their business models. The Bureau believes that the fee and interest rate caps in these States would provide greater consumer protections than, and would not be inconsistent with, the requirements of the proposed rule.

V. Section-by-Section Analysis

Subpart A—General

Section 1041.1 Authority and Purpose

Proposed § 1041.1 provides that the rule is issued pursuant to Title X of the Dodd-Frank Act (12 U.S.C. 5481, et seq.). It also provides that the purpose of proposed part 1041 (also referred to as “this part” or “this proposed part”) is to identify certain unfair and abusive acts or practices in connection with certain consumer credit transactions and to set forth requirements for preventing such acts or practices and to prescribe requirements to ensure that the features of those consumer credit transactions are fully, accurately, and effectively disclosed to consumers. It also notes the proposed part also prescribes processes and criteria for registration of information systems.

Section 1041.2 Definitions

Proposed § 1041.2 contains definitions of terms that are used across a number of sections in this rule. There are additional definitions in proposed §§ 1041.3, 1041.5, 1041.9, 1041.14, and 1041.17 of terms used in those respective individual sections.

In general, the Bureau is proposing to incorporate a number of defined terms under other statutes or regulations and related commentary, particularly Regulation Z and Regulation E as they implement TILA and EFTA, respectively. The Bureau believes that basing this proposal's definitions on previously defined terms may minimize regulatory uncertainty and facilitate compliance, particularly where the other regulations are likely to apply to the same transactions in their own right. However, as discussed further below, the Bureau is in certain definitions proposing to expand or modify the existing definitions or the concepts enshrined in such definitions for purposes of this proposal to ensure that the rule has its intended scope of effect particularly as industry practices may evolve. As reflected below with regard to individual definitions, the Bureau solicits comment on the appropriateness of this general approach and whether alternative definitions in statute or regulation would be more useful for these purposes.

2(a) Definitions

2(a)(1) Account

Proposed § 1041.2(a)(1) would define account by cross-referencing the same term as defined in Regulation E, 12 CFR part 1005. Regulation E generally defines account to include demand deposit (checking), savings, or other Start Printed Page 47904consumer asset accounts (other than an occasional or incidental credit balance in a credit plan) held directly or indirectly by a financial institution and established primarily for personal, family, or household purposes.[416] The term account is used in proposed § 1041.3(c), which would provide that a loan is a covered loan if, among other requirements, the lender or service provider obtains repayment directly from a consumer's account. This term is also used in proposed § 1041.14, which would impose certain requirements when a lender seeks to obtain repayment for a covered loan directly from a consumer's account, and in proposed § 1041.15, which would require lenders to provide notices to consumers before attempting to withdraw payments from consumers' accounts. The Bureau believes that defining this term consistently with an existing regulation would reduce the risk of confusion among consumers, industry, and regulators. The Bureau believes the Regulation E definition is appropriate because that definition is broad enough to capture the types of transactions that may implicate the concerns addressed by this part. The Bureau solicits comment on whether the Regulation E definition of account is appropriate in the context of this part and whether any additional guidance on the definition is needed.

2(a)(2) Affiliate

Proposed § 1041.2(a)(2) would define affiliate by cross-referencing the same term as defined in the Dodd-Frank Act, 12 U.S.C. 5481(1). The Dodd-Frank Act defines affiliate as any person that controls, is controlled by, or is under common control with another person. Proposed §§ 1041.6 and 1041.10 would impose certain limitations on lenders making loans to consumers who have outstanding covered loans with an affiliate of the lender. The section-by-section analyses of proposed §§ 1041.6 and 1041.10 discuss in more detail the particular requirements related to affiliates.

The Bureau believes that defining this term consistently with the Dodd-Frank Act would reduce the risk of confusion among consumers, industry, and regulators. The Bureau solicits comment on whether the Dodd-Frank Act definition of affiliate is appropriate in the context of this part and whether any additional guidance on the definition is needed.

2(a)(3) Closed-End Credit

Proposed § 1041.2(a)(3) would define closed-end credit as an extension of credit to a consumer that is not open-end credit under proposed § 1041.2(a)(14). This term is used in various parts of the rule where the Bureau is proposing to tailor provisions specifically for closed-end and open-end credit in light of their different structures and durations. Most notably, proposed § 1041.2(a)(18) would prescribe slightly different methods of calculating the total cost of credit of closed-end and open-end credit. Proposed § 1041.16(c) also would require lenders to report whether a covered loan is closed-end or open-end credit to registered information systems. The Bureau solicits comment on whether this definition of closed-end credit is appropriate in the context of proposed part 1041 and whether any additional guidance on the definition is needed.

2(a)(4) Consumer

Proposed § 1041.2(a)(4) would define consumer by cross-referencing the same term as defined in in the Dodd-Frank Act, 12 U.S.C. 5481(4). The Dodd-Frank Act defines consumer as an individual or an agent, trustee, or representative acting on behalf of an individual. The term is used in numerous provisions across proposed part 1041to refer to applicants for and borrowers of covered loans.

The Bureau believes that this definition, rather than the arguably narrower Regulation Z definition of consumer—which defines consumer as “a cardholder or natural person to whom consumer credit is offered or extended”—is appropriate to capture the types of transactions that may implicate the concerns addressed by this proposal. In particular, the Dodd-Frank Act definition expressly defines the term consumer to include agents and representatives of individuals rather than just individuals themselves. The Bureau believes that this definition may more comprehensively foreclose possible evasion of the specific consumer protections imposed by proposed part 1041 than would the Regulation Z definition. The Bureau solicits comment on whether the Dodd-Frank Act definition of consumer is appropriate in the context of proposed part 1041 and whether any additional guidance on the definition is needed.

2(a)(5) Consummation

Proposed § 1041.2(a)(5) would define consummation as the time a consumer becomes contractually obligated on a new loan, which is consistent with the definition of the term in Regulation Z § 1026.2(a)(13), or the time a consumer becomes contractually obligated on a modification of an existing loan that increases the amount of the loan. The term is used both in defining certain categories of covered loans and in defining the timing of certain proposed requirements. The time of consummation is important for the purposes of several proposed provisions. For example, under proposed § 1041.3(b)(1), whether a loan is a covered short-term loan would depend on whether the consumer is required to repay substantially all of the loan within 45 days of consummation. Under proposed § 1041.3(b)(3), the determination of whether a loan is subject to a total cost of credit exceeding 36 percent per annum would be made at the time of consummation. Pursuant to proposed §§ 1041.6 and 1041.10, certain limitations would potentially apply to lenders making covered loans based on the consummation dates of those loans. Pursuant to § 1041.15(f), lenders would have to furnish certain disclosures before a loan subject to the requirements of that section is consummated.

The Bureau believes that defining the term consistently with Regulation Z with respect to new loans would reduce the risk of confusion among consumers, industry, and regulators. The Bureau believes it is also necessary to define the term, with respect to loan modifications, in a way that would further the intent of proposed §§ 1041.3(b)(1), 1041.3(b)(2), 1041.5(b), and 1041.9(b), all of which would impose requirements on lenders at the time the loan amount increases. The Bureau believes defining these events as consummations would improve clarity for consumers, industry, and regulators. The above-referenced sections would impose no duties or limitations on lenders when a loan modification decreases the amount of the loan. Accordingly, in addition to incorporating Regulation Z commentary as to the general definition of consummation for new loans, proposed comment 2(a)(5)-2 explains the time at which certain modifications of existing loans are consummated. Proposed comment 2(a)(5)-2 explains that a modification is consummated if the modification increases the amount of the loan. Proposed comment 2(a)(5)-2 also explains that a cost-free repayment plan, or “off-ramp” as it is commonly Start Printed Page 47905known in the market, does not result in a consummation under proposed § 1041.2(a)(5). The Bureau solicits comment on whether this definition is appropriate in the context of proposed part 1041 and whether any additional guidance on the definition is needed.

The Bureau considered expressly defining the term “new loan” in order to clarify when lenders would need to make the ability-to-repay determinations prescribed in proposed §§ 1041.5 and 1041.9. The definition that the Bureau considered would have defined a new loan as a consumer-purpose loan made to a consumer that (a) is made to a consumer who is not indebted on an outstanding loan, (b) replaces an outstanding loan, or (c) modifies an outstanding loan, except when a repayment plan, or “off-ramp” extends the term of the loan and imposes no additional fees. The Bureau solicits comment on whether this approach would provide additional clarification, and if so, whether this particular definition of “new loan” would be appropriate.

2(a)(6) Covered Short-Term Loan

Proposed § 1041.3(b)(1) would describe covered short-term loans as loans in which the consumer is required to repay substantially the entire amount due under the loan within 45 days of consummation. Some provisions in proposed part 1041 would apply only to covered short-term loans described in proposed § 1041.3(b)(1). For example, proposed § 1041.5 prescribes the ability-to-repay determination that lenders are required to perform when making covered short-term loans. Proposed § 1041.6 imposes limitations on lenders making sequential covered short-term loans to consumers. The Bureau proposes to use a defined term for the loans described in § 1041.3(b)(1) for clarity. The Bureau solicits comment on whether this definition is appropriate in the context of proposed part 1041 and whether any additional guidance on the definition is needed.

2(a)(7) Covered Longer-Term Balloon-Payment Loan

Proposed § 1041.2(a)(7) would define covered longer-term balloon-payment loan as a loan described in proposed § 1041.3(b)(2) that requires the consumer to repay the loan in a single payment or repay the loan through at least one payment that is more than twice as large as any other payment under the loan. Proposed § 1041.9(b)(2) contains certain rules that lenders would have to follow when determining whether a consumer has the ability to repay a covered longer-term balloon-payment loan. Moreover, some of the restrictions imposed in proposed § 1041.10 would apply to covered longer-term balloon-payment loans in certain situations.

The term covered longer-term balloon-payment loan would include loans that are repayable in a single payment notwithstanding the fact that a loan with a “balloon” payment is often understood in other contexts to mean a loan repayable in multiple payments with one payment substantially larger than the other payments. The Bureau believes that both structures pose similar risks to consumers, and is proposing to treat both longer-term single-payment loans and multi-payment loans with a balloon payment the same for the purposes of proposed §§ 1041.9 and 1041.10. Accordingly, the Bureau is proposing to use a single defined term for both loan types to improve the proposal's readability.

Apart from including single-payment loans within the definition of covered longer-term balloon-payment loans, the term substantially tracks the definition of balloon payment contained in Regulation Z § 1026.32(d)(1), with one additional proviso. The Regulation Z definition requires the larger loan payment to be compared to other “regular periodic payments,” whereas proposed § 1041.2(a)(7) requires the larger loan payment to be compared to any other payment(s) under the loan, regardless of whether the payment is a “regular periodic payment.” Proposed comments 2(a)(7)-2 and 2(a)(7)-3 explain that “payment” in this context means a payment of principal or interest, and excludes certain charges such as late fees and payments accelerated upon the consumer's default.

The Bureau solicits comment on whether this definition is appropriate in the context of this proposal and whether any additional guidance on the definition is needed. As discussed further in proposed § 1041.3(b)(2), the Bureau also seeks comment on whether longer-term single-payment loans and longer-term loans with balloon payments should be covered regardless of whether the loans are subject to a total cost of credit exceeding a rate of 36 percent per annum, or regardless of whether the lender or service provider obtains a leveraged payment mechanism or vehicle security in connection with the loan.

2(a)(8) Covered Longer-Term Loan

Some restrictions in proposed part 1041 would apply to covered longer-term loans described in proposed § 1041.3(b)(2). Proposed § 1041.3(b)(2) describes covered longer-term loans as loans with a term of longer than 45 days, which are subject to a total cost of credit exceeding a rate of 36 percent per annum, and in which the lender or service provider obtains a leveraged payment mechanism or vehicle title. Some provisions in proposed part 1041 would apply only to covered longer-term loans described in proposed § 1041.3(b)(2). For example, proposed § 1041.9 prescribes the ability to repay determination that lenders are required to perform when making covered longer-term loans. Proposed § 1041.10 imposes limitations on lenders making covered longer-term loans to consumers in certain circumstances that may indicate the consumer lacks the ability to repay. The Bureau proposes to use a defined term for the loans described in proposed § 1041.3(b)(2) for clarity. The Bureau solicits comment on whether this definition is appropriate in the context of proposed part 1041 and whether any additional guidance on the definition is needed.

2(a)(9) Credit

Proposed § 1041.2(a)(9) would define credit by cross-referencing the same term as defined in Regulation Z, 12 CFR part 1026. Regulation Z defines credit as the right to defer payment of debt or to incur debt and defer its payment. This term is used in numerous places throughout this proposal to refer generically to the types of consumer financial products that would be subject to the requirements of proposed part 1041.

The Bureau believes that defining this term consistently with an existing regulation would reduce the risk of confusion among consumers, industry, and regulators. The Bureau also believes that the Regulation Z definition is appropriately broad so as to capture the various types of transaction structures that implicate the concerns addressed by proposed part 1041. The Bureau solicits comment on whether the Regulation Z definition of credit is appropriate in the context of proposed part 1041 and whether any additional guidance on the definition is needed.

2(a)(10) Electronic Fund Transfer

Proposed § 1041.2(a)(10) would define electronic fund transfer by cross-referencing the same term as defined in Regulation E, 12 CFR part 1005. Proposed § 1041.3(c) provides that a loan may be a covered longer-term loan if the lender or service provider obtains a leveraged payment mechanism, which can include the ability to withdraw payments from a consumer's account through an electronic fund transfer. Proposed § 1041.14 would impose Start Printed Page 47906limitations on lenders' use of various payment methods, including electronic fund transfers. The Bureau believes that defining this term consistently with an existing regulation would reduce the risk of confusion among consumers, industry, and regulators. The Bureau solicits comment on whether the Regulation E definition of electronic fund transfer is appropriate in the context of proposed part 1041 and whether any additional guidance on the definition is needed.

2(a)(11) Lender

Proposed § 1041.2(a)(11) would define lender as a person who regularly makes loans to consumers primarily for personal, family, or household purposes. This term is used throughout this proposal to refer to parties subject to the requirements of proposed part 1041. This proposed definition is broader than the general definition of creditor under Regulation Z in that, under this proposed definition, the credit that the lender extends need not be subject to a finance charge as that term is defined by Regulation Z, nor must it be payable by written agreement in more than four installments.

The Bureau is proposing a broader definition than in Regulation Z for many of the same reasons discussed in the section-by-section analyses of proposed §§ 1041.2(a)(14) and 1041.3(b)(2)(ii) for using the total cost of credit as a threshold for covering longer-term loans rather than the traditional definition of APR as defined by Regulation Z. In both cases, the Bureau is concerned that lenders might otherwise shift their fee structures to fall outside traditional Regulation Z concepts and thus outside the coverage of proposed part 1041. For example, the Bureau believes that some loans that otherwise would meet the requirements for coverage under proposed § 1041.3(b) could potentially be made without being subject to a finance charge as that term is defined by Regulation Z. If the Bureau adopted that particular Regulation Z requirement in the definition of lender, a person who regularly extended closed-end credit subject only to an application fee or open-end credit subject only to a participation fee would not be deemed to have imposed a finance charge. In addition, many of the loans that would be subject to coverage under proposed § 1041.3(b)(1) are repayable in a single payment, so those same lenders might also fall outside the Regulation Z trigger for loans payable in fewer than four installments. Thus, the Bureau is proposing to use a definition that is broader than the one contained in Regulation Z to ensure that proposed part 1041 applies as intended. The Bureau solicits comment on whether there are any alternative approaches that might be more appropriate given the concerns set forth above.

At the same time, the Bureau recognizes that some newly formed companies are providing services that, in effect, allow consumers to draw on money they have earned but not yet been paid. Some of these services do not require the consumer to pay any fees or finance charges. Some rely instead on voluntary “tips” to sustain the business, while others are compensated through electronic fund transfers from the consumer's account. Some current or future services may use other business models. The Bureau is also aware of some newly formed companies providing financial management services to low- and moderate-income consumers which include features to smooth income. The Bureau solicits comments on whether such entities are, or should be, excluded from the definition of lender, and if so, whether the definition should be revised. For example, the Bureau solicits comment on whether companies that impose no charge on the consumer, or companies that charge a regular membership fee which is unrelated to the usage of credit, should be considered lenders under the rule.

The Bureau proposes to carry over from the Regulation Z definition of creditor the requirement that a person “regularly” makes loans to a consumer primarily for personal, family, or household purposes in order to be considered a lender under proposed part 1041. As proposed comment 2(a)(11)-1 explains, the test for determining whether a person regularly makes loans is the same as in Regulation Z, and thus depends on the overall number of loans originated, not just covered loans. The Bureau believes it is appropriate to exclude from the definition of lender persons who make loans for personal, family, or household purposes on an infrequent basis so that persons who only occasionally make loans would not be subject to the requirements of proposed part 1041. Such persons could include charitable, religious, or other community institutions that make loans very infrequently or individuals who occasionally make loans to family members.

Some stakeholders have suggested to the Bureau that the definition of lender should be narrowed so as to exclude financial institutions that predominantly make loans that would not be covered loans under the proposed rule. These stakeholders have suggested that some financial institutions only make loans that would be covered loans as an accommodation to existing customers, and that providing such loans is such a small part of these institutions' overall business such that it would not be practical for the institutions to develop the required procedures for making covered loans. The Bureau solicits comment on whether to so narrow the definition of lender based on the quantity of covered loans an entity offers, and, if so, how to define such a de minimis test. The Bureau also solicits more general comment on whether this definition is appropriate in the context of proposed part 1041 and whether any additional guidance on the definition is needed.

2(a)(12) Loan Sequence or Sequence

Proposed § 1041.2(a)(12) would generally define a loan sequence or sequence as a series of consecutive or concurrent covered short-term loans in which each of the loans (other than the first loan) is made while the consumer currently has an outstanding covered short-term loan or within 30 days after the consumer ceased to have a covered short-term loan outstanding. Proposed § 1041.2(a)(12) defines both loan sequence and sequence the same because the terms are used interchangeably in various places throughout this proposal. Proposed § 1041.2(a)(12) also sets forth how a lender must determine a given loan's place within a sequence (for example, whether a loan is a first, second, or third loan in a sequence). Proposed § 1041.6 would also impose certain presumptions that lenders must take into account when making a second or third loan in a sequence, and would prohibit lenders from making a loan sequence with more than three covered short-term loans. Pursuant to proposed § 1041.6, a lender's extension of a non-covered bridge loan as defined in proposed § 1041.2(a)(13) could affect the calculation of time periods for purposes of determining whether a loan is within a loan sequence, as discussed in more detail in proposed comments 6(h)-1 and 6(h)-2.

The Bureau's rationale for proposing to define loan sequence in this manner is discussed in more detail in the section-by-section analysis of proposed §§ 1041.4 and 1041.6. The Bureau solicits comment on whether a definition of loan sequence or sequence based on a 30-day period is appropriate or whether longer or shorter periods would better address the Bureau's concerns about a consumer's inability to repay a covered loan causing the need Start Printed Page 47907for a successive covered loan. The Bureau solicits comment on whether this definition is appropriate in the context of proposed part 1041 and whether any additional guidance on the definition is needed.

2(a)(13) Non-Covered Bridge Loan

Proposed § 1041.2(a)(13) would define the term non-covered bridge loan as a non-recourse pawn loan described in proposed § 1041.3(e)(5) that (a) is made within 30 days of the consumer having an outstanding covered short-term loan or outstanding covered longer-term balloon-payment loan made by the same lender or affiliate; and (b) the consumer is required to repay substantially the entire amount due within 90 days of its consummation. Although non-recourse pawn loans would be excluded from coverage under proposed § 1041.3(e)(5), the Bureau has provided rules in proposed §§ 1041.6(h) and § 1041.10(f) to prevent this from becoming a route for evading the rule.

Specifically, proposed §§ 1041.6 and 1041.10 would impose certain limitations on lenders making covered short-term loans and covered longer-term balloon-payment in some circumstances. The Bureau is concerned that if a lender made a non-covered bridge loan between covered loans, the non-covered bridge loan could mask the fact that the consumer's need for a covered short-term loan or covered longer-term balloon-payment loan reflected the spillover effects of a prior such covered loan, suggesting that the consumer did not have the ability to repay the prior loan and that the consumer may not have the ability to repay the new covered loan. If the consumer took out a covered short-term loan or covered longer-term balloon-payment loan immediately following the non-covered pawn loan, but more than 30 days after the last such covered loan, the pawn loan effectively would have “bridged” the gap in what was functionally a sequence of covered loans. The Bureau is concerned that a lender might be able to use such a “bridging” arrangement to evade the requirements of proposed §§ 1041.6 and 1041.10. To prevent evasions of this type, the Bureau is therefore proposing that the days on which a consumer has a non-covered bridge loan outstanding must not be considered in determining whether 30 days had elapsed between covered loans.

Many lenders offer both loans that would be covered and pawn loans; thus, the Bureau believes that pawn loans are the type of non-covered loan that most likely could be used to bridge covered short-term loans or covered longer-term balloon-payment loans. Proposed § 1041.2(a)(13) would limit the definition of non-covered bridge loan to non-recourse pawn loans that consumers must repay within 90 days of consummation. The Bureau believes that loans with terms of longer than 90 days are less likely to be used as a bridge between covered short-term loans or covered longer-term balloon-payment loans.

The Bureau solicits comment on whether pawn loans can be used as a bridge between covered loans, and further solicits comment on whether other types of loans—including, specifically, balloon-payment loans with terms of longer than 45 days but that do not meet the requirements to be covered longer-term loans under proposed section 1041.3(b)(2)—are likely to be used as bridge loans and therefore should be added to the definition of “non-covered bridge loan.” The Bureau also solicits more general comment on whether this definition is appropriate in the context of proposed part 1041 and whether any additional guidance on the definition is needed.

2(a)(14) Open-End Credit

Proposed § 1041.2(a)(14) would define open-end credit by cross-referencing the same term as defined in Regulation Z, 12 CFR part 1026, but without regard to whether the credit is consumer credit, as that term is defined in Regulation Z § 1026.2(a)(12), is extended by a creditor, as that term is defined in Regulation Z § 1026.2(a)(17), or is extended to a consumer, as that term is defined in Regulation Z § 1026.2(a)(11). In general, Regulation Z § 1026.2(a)(20) provides that open-end credit is consumer credit in which the creditor reasonably contemplates repeated transactions, the creditor may impose a finance charge from time to time on an outstanding unpaid balance, and the amount of credit that may be extended to the consumer during the term of the plan (up to any limit set by the creditor) is generally made available to the extent that any outstanding balance is repaid. For the purposes of defining open-end credit under proposed part 1041, the term credit, as defined in proposed § 1041.2(a)(9), would be substituted for the term consumer credit in the Regulation Z definition of open-end credit; the term lender, as defined in proposed § 1041.2(a)(11), would be substituted for the term creditor in the Regulation Z definition of open-end credit; and the term consumer, as defined in proposed § 1041 2(a)(4), would be substituted for the term consumer in the Regulation Z definition of open-end credit.

The term open-end credit is used in various parts of the rule where the Bureau is proposing to tailor requirements separately for closed-end and open-end credit in light of their different structures and durations. Most notably, proposed § 1041.2(a)(18) would require lenders to employ slightly different methods when calculating the total cost of credit of closed-end versus open-end loans. Proposed § 1041.16(c) also would require lenders to report whether a covered loan is a closed-end or open-end loan.

The Bureau believes that generally defining this term consistently across regulations would reduce the risk of confusion among consumers, industry, and regulators. With regard to the definition of “consumer,” however, the Bureau believes that, for the reasons discussed above, it is more appropriate to incorporate the definition from the Dodd-Frank Act rather than the arguably narrower Regulation Z definition. Similarly, the Bureau believes that it is more appropriate to use the broader definition of “lender” contained in proposed § 2(a)(11) that the Regulation Z definition of “creditor.”

The Bureau solicits comment on whether the Regulation Z definition of account is appropriate in the context of proposed part 1041 and whether any additional guidance on the definition is needed, particularly as to the substitution of the definitions for “consumer” and “lender” as described above.

2(a)(15) Outstanding Loan

Proposed § 1041.2(a)(15) would define outstanding loan as a loan that the consumer is legally obligated to repay so long as the consumer has made at least one payment on the loan within the previous 180 days. Under this proposed definition, a loan is an outstanding loan regardless of whether the loan is delinquent or the loan is subject to a repayment plan or other workout arrangement if the other elements of the definition are met. Under proposed § 1041.2(a)(12), a covered short-term loan would be considered to be within the same loan sequence as a previous such loan if it is made within 30 days of the consumer having the previous outstanding loan. Proposed §§ 1041.6 and 1041.7 would impose certain limitations on lenders making covered short-term loans within loan sequences, including a prohibition on making additional covered short-term loans for 30 days after the third loan in a sequence.

The Bureau believes that if the consumer has not made any payment on the loan for an extended period of time Start Printed Page 47908it may be appropriate to stop considering the loan to be outstanding loan for the purposes of proposed §§ 1041.2(a)(11), 1041.6, 1041.7, 1041.10, 1041.11 and 1041.12. Because outstanding loans are counted as major financial obligations for purposes of underwriting and because treating a loan as outstanding would trigger certain restrictions on further borrowing by the consumer under the proposed rule, the Bureau has attempted to balance several considerations in crafting the proposed definition. One is whether it would be appropriate for very stale and effectively inactive debt to prevent the consumer from accessing credit, even if so much time has passed that it seems relatively unlikely that the new loan is a direct consequence of the unaffordability of the previous loan. Another is how to define very stale and effectively inactive debt for purposes of any cut-off, and to account for the risk that collections might later be revived or that lenders would intentionally exploit a cut-off in an attempt to encourage new borrowing by consumers.

The Bureau is proposing a 180-day threshold as striking an appropriate balance. The Bureau notes that this would generally align with the policy of the Federal Financial Institutions Examination Council, which generally requires depository institutions to charge-off open-end credit at 180 days of delinquency. Although that policy also requires that closed-end loans be charged off after 120 days, the Bureau believes that a uniform 180-day rule for both closed- and open-end loans may be more appropriate given the underlying policy considerations discussed above as well as for simplicity. Proposed comment 2(a)(15)-2 would clarify that a loan ceases to be an outstanding loan as of the earliest of the date the consumer repays the loan in full, the date the consumer is released from the legal obligation to repay, the date the loan is otherwise legally discharged, or the date that is 180 days following the last payment that the consumer has made on the loan. Additionally, proposed comment 2(a)(15)-2 would explain that any payment the consumer makes restarts the 180-day period, regardless of whether the payment is a scheduled payment or in a scheduled amount. Proposed comment 2(a)(15)-2 would further clarify that once a loan is no longer an outstanding loan, subsequent events cannot make the loan an outstanding loan. The Bureau is proposing this one-way valve to ease compliance burden on lenders and to reduce the risk of consumer confusion.

The Bureau solicits comment on whether 180 days is the most appropriate period of time or whether a shorter or longer time period should be used. The Bureau solicits comment on whether a loan should be considered an outstanding loan if it has in fact been charged off by the lender prior to 180 days of delinquency. The Bureau solicits comment on whether a loan should be considered an outstanding loan if there has been activity on a loan more than 180 days after the consumer has made a payment, such as a collections lawsuit brought by the lender or a third-party. The Bureau also solicits comment on whether a loan should be considered an outstanding loan if there has been activity on the loan with the previous 180 days regardless of whether the consumer has made a payment on the loan within the previous 180 days. The Bureau further solicits comment on whether any additional guidance on this definition is needed.

2(a)(16) Prepayment Penalty

Proposed § 1041.2(a)(16) defines prepayment penalty as any charge imposed for paying all or part of the loan before the date on which the loan is due in full. Proposed §§ 1041.11(e) and 1041.12(f) would prohibit lenders from imposing prepayment penalties in connection with certain loans that are conditionally excluded from the ability-to-repay determination required under proposed §§ 1041.9 and 1041.10. This definition is similar to the definition of prepayment penalty in Regulation Z § 1026.32(b)(6), which generally defines prepayment penalty for closed-end transactions as a charge imposed for paying all or part of the transaction's principal before the date on which the principal is due. However, the definition of prepayment penalty in proposed § 1041.2(a)(16) does not restrict the definition of prepayment penalty to charges for paying down the loan principal early, but also includes charges for paying down non-principal amounts due under the loan. The Bureau believes that this broad definition of prepayment penalty is necessary to capture all situations in which a lender may attempt to penalize a consumer for repaying a loan more quickly than a lender would prefer. As proposed comment 2(a)(16)-1 explains, whether a charge is a prepayment penalty depends on the circumstances around the assessment of the charge. The Bureau solicits comment on whether this definition is appropriate in the context of proposed part 1041 and whether any additional guidance on the definition is needed.

2(a)(17) Service Provider

Proposed § 1041.2(a)(17) would define service provider by cross-referencing the same term as defined in the Dodd-Frank Act, 12 U.S.C. 5481(26). In general, the Dodd-Frank Act defines service provider as any person that provides a material service to a covered person in connection with the offering or provision of a consumer financial product or service. Proposed § 1041.3(c) and (d) would provide that a loan is covered under proposed part 1041 if a service provider obtains a leveraged payment mechanism or vehicle title and the other coverage criteria are otherwise met.

The definition of service provider and the provisions in proposed § 1041.3(c) and (d) are designed to reflect the fact that in some States, covered short-term loans and covered longer-term loans are extended to consumers through a multi-party transaction. In these transactions, one entity will fund the loan, while a separate entity, often called a credit access business or a credit services organization, will interact directly with, and obtain a fee or fees from, the consumer. This separate entity will often service the loan and guarantee the loan's performance to the party funding the loan. In the context of covered longer-term loans, the credit access business or credit services organization, and not the party funding the loan, will in many cases obtain the leveraged payment mechanism or vehicle security. In these cases, the credit access business or credit services organization is performing the responsibilities normally performed by a party funding the loan in jurisdictions where this particular business arrangement is not used. Despite the formal division of functions between the nominal lender and the credit access business, the loans produced by such arrangement are functionally the same as those covered loans issued by a single entity and appear to present the same set of consumer protection concerns. Accordingly, the Bureau believes it is appropriate to bring loans made under these arrangements within the scope of coverage of proposed part 1041.

The Bureau believes that defining the term service provider consistently with the Dodd-Frank Act would reduce the risk of confusion among consumers, industry, and regulators. The Bureau solicits comment on whether the Dodd-Frank Act definition of service provider is appropriate in the context of proposed part 1041 and whether any additional guidance on the definition is needed. More broadly, and as further discussed in proposed § 1041.3(c) and Start Printed Page 47909(d), the Bureau solicits comment on whether the definition of service provider is sufficient to bring these loans within the coverage of proposed part 1041, or whether loans made through this or similar business arrangements should be covered using a different definition.

2(a)(18) Total Cost of Credit

Proposed § 1041.2(a)(18) would set forth the method by which lenders would calculate the total cost of credit for determining whether a loan would be a covered loan under proposed § 1041.3(b)(2). Proposed § 1041.2(a)(18) would generally define the total cost of credit as the total amount of charges associated with a loan expressed as a per annum rate, including various charges that do not meet the definition of finance charge under Regulation Z. The charges would be included even if they are paid to a party other than the lender. Under proposed § 1041.3(b)(2), a loan with a term of longer than 45 days must have a total cost of credit exceeding a rate of 36 percent per annum in order to be a covered loan.

The Bureau is proposing to use an all-in measure of the cost of credit rather than the definition of APR under Regulation Z for many of the same reasons discussed in § 1041.2(a)(11) for proposing a broader definition of lender than Regulation Z uses in defining creditor. In both cases, the Bureau is concerned that lenders might otherwise shift their fee structures to fall outside traditional Regulation Z concepts and outside of this proposal. Specifically, lenders may impose a wide range of charges in connection with a loan that are not included in the calculation of APR under Regulation Z. If these charges were not included in the calculation of the total cost of credit threshold for determining coverage under proposed part 1041, a lender would be able to avoid the threshold by shifting the costs of a loan by lowering the interest rate and imposing (or increasing) one or more fees that are not included in the calculation of APR under Regulation Z. To prevent this result, and more accurately capture the full financial impact of the credit on the consumer's finances, the Bureau proposes to include any application fee, any participation fee, any charge imposed in connection with credit insurance, and any fee for a credit-related ancillary product as charges that lenders must include in the total cost of credit.

Specifically, proposed § 1041.2(a)(18) would define the total cost of credit as the total amount of charges associated with a loan expressed as a per annum rate, determined as specified in the regulation. Proposed § 1041.2(a)(18)(i) and related commentary describes each of the charges that must be included in the total cost of credit calculation. Proposed § 1041.2(a)(18)(ii) provides that, even if a charge set forth in proposed § 1041.2(a)(18)(i)(A) through (E) would be excluded from the finance charge under Regulation Z, that charge must nonetheless be included in the total cost of credit calculation.

Proposed § 1041.2(a)(18)(i)(A) and (B) provide that charges the consumer pays in connection with credit insurance and credit-related ancillary products and services must be included in the total cost of credit calculation to the extent the charges are incurred (regardless of when the charge is actually paid) at the same time as the consumer receives the entire amount of funds that the consumer is entitled to receive under the loan or within 72 hours thereafter. Proposed § 1041.2(a)(18)(i)(A) and (B) would impose the 72-hour provision to ensure that lenders could not evade coverage under proposed § 1041.3(b)(2)(ii) conditioning the timing of loan proceeds disbursement on whether the consumer purchases credit insurance or other credit related ancillary products or services after consummation. The Bureau believes that the lender's leverage will have diminished by 72 hours after the consumer receives the entirety of the funds available under the loan, and thus it is less likely that any charge for credit insurance or other credit-related ancillary products and services that the consumer agrees to assume after that date is an attempt to avoid coverage under proposed § 1041.3(b)(2)(ii).

Proposed § 1041.2(a)(18)(iii) and related commentary would prescribe the rules for computing the total cost of credit based on those charges. Proposed § 1041.2(a)(18)(iii) contains two provisions for computing the total cost of credit, both of which track the methods already established in Regulation Z. First, for closed-end credit, proposed § 1041.2(a)(18)(iii)(A) would require a lender to follow the rules for calculating and disclosing the APR under Regulation Z, based on the charges required for the total cost of credit, as set forth in proposed § 1041.2(a)(18)(i). In general, the requirements for calculating the APR for closed-end credit under Regulation Z are found in § 1026.22(a)(1), and include the explanations and instructions for computing the APR set forth in appendix J to 12 CFR part 1026.

Second, for open-end credit, proposed § 1041.2(a)(18)(iii)(B) generally would require a lender to calculate the total cost of credit using the methods prescribed in § 1026.14(c) and (d) of Regulation Z, which describe an “optional effective annual percentage rate” for certain open-end credit products. While Regulation Z provides that these calculation methods are optional, these calculation methods would be required to determine coverage of loans under proposed § 1041.3(b)(2) (though a lender may still choose not to disclose the optional effective annual percentage rate in accordance with Regulation Z). Section 1026.14(c) of Regulation Z provides for the methods of computing the APR under three scenarios: (1) When the finance charge is determined solely by applying one or more periodic rates; (2) when the finance charge is or includes a minimum, fixed, or other charge that is not due to application of a periodic rate, other than a charge with respect to a specific transaction; and (3) when the finance charge is or includes a charge relating to a specific transaction during the billing cycle.

This approach mirrors the approach taken by the Department of Defense in defining the MAPR in 32 CFR 232.4(c). The Bureau believes this measure both includes the necessary types of charges that reflect the actual cost of the loan to the consumer and is familiar to many lenders that must make the MAPR calculation, thus reducing the compliance challenges that would result from a new computation.

At the same time, the Bureau recognizes that the total cost of credit or MAPR is a relatively unfamiliar concept for many lenders compared to the APR, which is built into many State laws and which is the cost that will be disclosed to consumers under Regulation Z. The Bureau solicits comment on whether the trigger for coverage should be based upon the total cost of credit rather than the APR. If so, the Bureau solicits comment on whether the elements listed in proposed § 1041.2(a)(18) capture the total cost of credit to the consumer and should be included in the calculation required by proposed § 1041.2(a)(18) and whether there are any additional elements that should be included or any listed elements that should be excluded. For example, some stakeholders have suggested that the amounts paid for voluntary products purchased prior to consummation, or the portion of that amount paid to unaffiliated third parties, should be excluded from the definition of total cost of credit. The Bureau solicits comments on those suggestions.

The Bureau also solicits comment on whether there are operational issues with the use of the total cost of credit Start Printed Page 47910calculation methodology for closed- or open-end loans that the Bureau should consider, and if so, whether there are any alternative methods for calculating the total cost of credit for these products that would address the operational issues. The Bureau further solicits comment on whether any additional guidance on this definition is needed.

Section 1041.3 Scope of Coverage; Exclusions

The primary purpose of proposed part 1041 is to identify and adopt rules to prevent unfair and abusive practices as defined in section 1031 of the Dodd-Frank Act in connection with certain consumer credit transactions. Based upon its research, outreach, and analysis of available data, the Bureau is proposing to identify such practices with respect to two categories of loans to which the Bureau proposes to apply this rule: (1) Consumer loans that have a duration of 45 days or less; and (2) consumer loans that have a duration of more than 45 days that have a total cost of credit above a certain threshold and that are either secured by the consumer's motor vehicle, as set forth in proposed § 1041.3(d), or are repayable directly from the consumer's income stream, as set forth in proposed § 1041.3(c).

As described below in the section-by-section analysis of proposed § 1041.4, the Bureau tentatively concludes that it is an unfair and abusive practice for a lender to make a covered short-term loan without making a reasonable determination that the consumer has the ability to repay the loan. The Bureau likewise tentatively concludes that it is an unfair and abusive practice for a lender to make a covered longer-term loan without making a reasonable determination of the consumer's ability to repay the loan. Accordingly, the Bureau proposes to apply the protections of proposed part 1041 to both categories of loans.

Proposed §§ 1041.5 and 1041.9 would require that, before making a covered loan, a lender must determine that the consumer has the ability to repay the loan. Proposed §§ 1041.6 and 1041.10 would impose certain limitations on repeat borrowing, depending on the type of covered loan. Proposed §§ 1041.7, 1041.11, and 1041.12 would provide for alternative requirements that would allow lenders to make covered loans, in certain limited situations, without first determining that the consumer has the ability to repay the loan. Proposed § 1041.14 would impose consumer protections related to repeated lender-initiated attempts to withdraw payments from consumers' accounts in connection with covered loans. Proposed § 1041.15 would require lenders to provide notices to consumers before attempting to withdraw payments on covered loans from consumers' accounts. Proposed §§ 1041.16 and 1041.17 would require lenders to check and report borrowing history and loan information to certain information systems with respect to most covered loans. Proposed § 1041.18 would require lenders to keep certain records on the covered loans that they make. Finally, proposed § 1041.19 would prohibit actions taken to evade the requirements of proposed part 1041.

The Bureau is not proposing to extend coverage to several other types of loans and is specifically proposing to exclude, to the extent they would otherwise be covered under proposed § 1041.3, certain purchase money security interest loans, certain loans secured by real estate, credit cards, student loans, non-recourse pawn loans, and overdraft services and lines of credit. The Bureau likewise proposes not to cover loans that have a term of longer than 45 days if they are not secured by a leveraged payment mechanism or vehicle security, or loans that have a total cost of credit below a rate of 36 percent per annum.

By focusing this proposed rule on the types of loans described above, and by proposing to exclude certain types of loans that might otherwise meet the definition of a covered loan from the reach of the proposed rule, the Bureau does not mean to signal any conclusions as to whether it is an unfair or abusive practice to make any other types of loans, such as loans that are not covered by proposed part 1041, without assessing a consumer's ability to repay. Moreover, the proposed rule is not intended to supersede or limit protections imposed by other laws, such as the Military Lending Act and implementing regulations. The coverage limits in this proposal reflect the fact that these are the types of loans the Bureau has studied in depth to date and has chosen to address within the scope of this proposal. Indeed, the Bureau is issuing concurrently with this proposal a Request for Information (the Accompanying RFI) which solicits information and evidence to help assess whether there are other categories of loans for which lenders do not determine the consumer's ability to repay that may pose risks to consumers. The Bureau is also seeking comment in response to the Accompanying RFI as to whether there are additional lender practices with regard to covered loans that may warrant further action by the Bureau.

The Bureau notes that all “covered persons” within the meaning of the Dodd-Frank Act have a duty not to engage in unfair, deceptive, or abusive acts or practices. The Bureau may consider on a case-by-case basis, through its supervisory or enforcement activities, whether practices akin to those addressed here are unfair, deceptive, or abusive in connection with loans not covered by this proposal. The Bureau also may engage in future rulemaking with respect to other types of loans or practices on covered loans at a later date.

3(a) General

Proposed § 1041.3(a) would provide that proposed part 1041 applies to a lender that makes covered loans.

3(b) Covered Loans

Section 1031(b) of the Dodd-Frank Act empowers the Bureau to prescribe rules to identify and prevent unfair, deceptive, or abusive acts or practices associated with consumer financial products or services. Section 1002(5) of the Dodd-Frank Act defines such products or services as those offered or provided for use by consumers primarily for personal, family, or household purposes or, in certain circumstances, those delivered, offered, or provided in connection with a consumer financial product or service. Proposed § 1041.3(b) would provide generally that a covered loan means closed-end or open-end credit that is extended to a consumer primarily for personal, family, or household purposes that is not excluded by § 1041.3(e).

By specifying that the rule would apply only to loans that are extended to consumers primarily for personal, family, or household purposes, the Bureau intends to exclude loans that are made primarily for a business, commercial, or agricultural purpose. But a lender would violate proposed part 1041 if it extended a loan ostensibly for a business purpose and failed to comply with the requirements of proposed part 1041 if the loan in fact is primarily for personal, family, or household purposes. See the section-by-section analysis of proposed § 1041.19 for further discussion of evasion issues.

Proposed comment 3(b)-1 would clarify that whether a loan is covered is generally based on the loan terms at the time of consummation. Proposed comment 3(b)-2 clarifies that a loan could be a covered loan regardless of whether it is structured as open-end or closed-end credit. Proposed comment 3(b)-3 explains that the test for determining the primary purpose of a loan is the same as the test prescribed Start Printed Page 47911by Regulation Z § 1026.3(a) and clarified by the related commentary in supplement I to part 1026. The Bureau believes that lenders are already familiar with the Regulation Z test and that it would be appropriate to apply that same test here to maintain consistency in interpretation across credit markets. Nevertheless, the related commentary in supplement I to part 1026, on which lenders are permitted to rely in interpreting proposed § 1041.3(b), does not discuss particular situations that may arise in the markets that would be covered by proposed part 1041. The Bureau solicits comment on whether the test for determining the primary purpose of a loan presents a risk of lender evasion, and whether additional clarification is needed on how to determine the primary purpose of a covered loan.

3(b)(1)

Proposed § 1041.3(b)(1) would bring within the scope of proposed part 1041 loans in which the consumer is required to repay substantially the entire amount due under the loan within 45 days of either consummation or the advance of loan proceeds. Loans of this type, as they exist in the market today, typically take the form of single-payment loans, including “payday” loans, vehicle title loans, and deposit advance products. However, coverage under proposed § 1041.3(b)(1) would not be limited to single-payment products, but rather would include any single-advance loan with a term of 45 days or less and any multi-advance loan where repayment is required within 45 days of a credit draw.[417] Under proposed § 1041.2(a)(6), this type of covered loan would be defined as a covered short-term loan.

Specifically, proposed § 1041.3(b)(1) prescribes different tests for determining whether a loan is a covered short-term loan based on whether or not the loan is closed-end credit that does not provide for multiple advances to consumers. For closed-end credit that does not provide for multiple advances to consumers, a loan would be a covered short-term loan if the consumer is required to repay substantially the entire amount of the loan within 45 days of consummation. For all other types of loans, a loan would not be a covered short-term loan if the consumer is required to repay substantially the entire amount of an advance within 45 days of the advance under the loan. As proposed comments 3(b)(1)-1 explains, a loan does not provide for multiple advances to a consumer if the loan provides for full disbursement of the loan proceeds only through disbursement on a single specific date. The Bureau believes that a different test to determine whether a loan is a covered short-term loan is appropriate for loans that provide for multiple advances to consumers because open-end credit and closed-end credit providing for multiple advances may be consummated long before the consumer incurs debt that must be repaid. If, for example, the consumer waited more than 45 days after consummation to draw on an open-end line, but the loan agreement required the consumer to repay the full amount of the draw within 45 days of the draw, the loan would not be practically different than a closed-end loan repayable within 45 days of consummation. The Bureau believes it is appropriate to treat the loans the same for the purposes of proposed § 1041.3(b)(1). The Bureau solicits comment on whether these differential coverage criteria for single-advance and multiple-advance loans are appropriate, particularly in light of unique or emerging loan structures that may pose special challenges or risks.

As described in part II, the terms of short-term loans are often tied to the date the consumer receives his or her paycheck or benefits payment. While pay periods typically vary from one week to one month, and expense cycles are typically one month, the Bureau is proposing 45 days as the upper bound for covered short-term loans in order to accommodate loans that are made shortly before a consumer's monthly income is received and that extend beyond the immediate income payment to the next income payment. These circumstances could result in loans that are somewhat longer than a month in duration but nonetheless pose similar risks of harm to consumers as loans with a duration of a month or less.

The Bureau also considered proposing to define these short-term loans as loans that are substantially repayable within either 30 days of consummation or advance, 60 days of consummation or advance, or 90 days of consummation or advance. The Bureau is not proposing the 30-day period because, as described above, some loans for some consumers who are paid on a monthly basis can be slightly longer than 30 days, and yet still essentially constitute a one-pay-cycle, one-expense-cycle loan. The Bureau is not proposing either the 60-day or 90-day period because loans with those terms encompass multiple income and expense cycles, and thus may present somewhat different risks to consumers, though such loans would be covered longer-term loans if they meet the criteria set forth in proposed § 1041.3(b)(2). The Bureau solicits comment on whether covered short-term loans should be defined to include all loans in which the consumer is required to repay substantially the entire amount due under the loan within 45 days of consummation or advance, or whether another loan term is more appropriate.

As discussed further below, the Bureau proposes to treat longer-term loans, as defined in proposed § 1041.3(b)(2), as covered loans only if the total cost of credit exceeds a rate of 36 percent per annum and if the lender or service provider obtains a leveraged payment mechanism or vehicle security as defined in proposed § 1041.3(c) and (d). The Bureau is not proposing similar limitations with respect to the definition of covered short-term loans because the evidence available to the Bureau suggests that the structure and short-term nature of these loans give rise to consumer harm even in the absence of costs above the 36 percent threshold or particular means of repayment.

Proposed comment 3(b)(1)-3 would explain that a determination of whether a loan is substantially repayable within 45 days requires assessment of the specific facts and circumstances of the loan. Proposed comment 3(b)(1)-4 provides guidance on determining whether loans that have alternative, ambiguous, or unusual payment schedules would fall within the definition. The key principle in determining whether a loan would be a covered short-term loan or a covered longer-term loan is whether, under applicable law, the consumer would be considered to be in breach of the terms of the loan agreement if the consumer failed to repay substantially the entire amount of the loan within 45 days of consummation. The Bureau solicits comment on whether the approach explained in proposed comment 3(b)(1)-3 appropriately delineates the distinction between the types of covered loans.

3(b)(2)

Proposed § 1041.3(b)(2) would bring within the scope of proposed part 1041 several types of loans for which, in contrast to loans covered under proposed § 1041.3(b)(1), the consumer is not required to repay substantially the entire amount of the loan or advance within 45 days of consummation or advance. Specifically, proposed § 1041.3(b)(2) would extend coverage to Start Printed Page 47912longer-term loans with a total cost of credit exceeding a rate of 36 percent per annum if the lender or service provider also obtains a leveraged payment mechanism as defined in proposed § 1041.3(c) or vehicle security as defined in proposed § 1041.3(d) in connection with the loan before, at the same time, or within 72 hours after the consumer receives the entire amount of funds that the consumer is entitled to receive. Under proposed § 1041.2(a)(8), this type of covered loan would be defined as a covered longer-term loan. Proposed § 1041.2(a)(7) would specifically define covered longer-term balloon-payment loan for purposes of certain provisions in proposed §§ 1041.6, 1041.9, and 1041.10.

As described in more detail in proposed § 1041.8, it appears to the Bureau to be an unfair and abusive practice for a lender to make covered longer-term loans without determining that the consumer has the ability to repay the loan. The Bureau discusses the thresholds that would trigger the definition of covered longer-term loan and seeks related comment below. The Bureau recognizes that the criteria set forth in proposed § 1041.3(b)(2) may encompass some loans that are not used for the same types of liquidity needs that have been the primary focus of the Bureau's study. For example, some lenders make unsecured loans to finance purchases of household durable goods or to enable consumers to consolidate preexisting debt. Such loans are typically for larger amounts or longer terms than, for example, a typical payday loan. On the other hand, larger and longer-term loans that have a higher cost, if secured by a leveraged payment mechanism or vehicle security, may pose enhanced risk to consumers in their own right, and an exclusion for larger or longer-term loans could provide an avenue for lender evasion of the consumer protections imposed by proposed part 1041. The Bureau also solicits comment on whether coverage under proposed § 1041.3(b)(2) should be limited by a maximum loan amount and, if so, what the appropriate amount would be. The Bureau further solicits comment on whether any such limitation should apply only with respect to fully amortizing loans in which payments are not timed to coincide with the consumer's paycheck or other expected receipt of income, and whether any other protective conditions, such as the absence of a prepayment penalty or restrictions on methods of collection in the event of a default, should accompany and such limitation.

As noted above, the Bureau is publishing an Accompanying RFI concurrent with this notice of proposed rulemaking soliciting information and evidence to help assess whether there are other categories of loans that are generally made without underwriting and as to which the failure to assess the consumer's ability to repay is unfair or abusive. Further, as the Accompanying RFI indicates, the Bureau may, in an individual supervisory or enforcement action, assess whether a lender's failure to make such an assessment is unfair or abusive. As reflected in the Accompanying RFI, the Bureau is particularly interested to seek information to determine whether loans involving a non-purchase money security in personal property or holding consumers' personal identification documents create the same lender incentives and increased risk of consumer harms as described below with regard to leveraged payment mechanisms and vehicle security.

3(b)(2)(i)

Proposed § 1041.3(b)(2)(i) would bring within the scope of proposed part 1041 the above-described longer-term loans only to the extent that they are subject to a total cost of credit, as defined in proposed § 1041.2(a)(18), exceeding a rate of 36 percent per annum. This total cost of credit demarcation would apply only to those types of loans listed in § 1041.3(b)(2); the types of loans listed in proposed § 1041.3(b)(1) would be covered even if their total cost of credit is below 36 percent per annum. The total cost of credit measure set forth in proposed § 1041.2(a)(18) includes a number of charges that are not included in the APR measure set forth in Regulation Z, 12 CFR 1026.4 in order to more fully reflect the true cost of the loan to the consumer.

Proposed § 1041.3(b)(2)(i) would bring within the scope of proposed part 1041 only longer-term loans with a total cost of credit exceeding a rate of 36 percent per annum in order to focus regulatory treatment on the segment of the longer-term credit market on which the Bureau has significant evidence of consumer harm. As explained in proposed comment 3(b)(2)-1, using a cost threshold excludes certain loans with a term of longer than 45 days and for which lenders may obtain a leveraged payment mechanism or vehicle security, but which the Bureau is not proposing to cover in this rulemaking. For example, the cost threshold would exclude from the scope of coverage low-cost signature loans even if they are repaid through the lender's access to the consumer's deposit account.

The Bureau's research has focused on loans that are typically priced with a total cost of credit exceeding a rate of 36 percent per annum. Further, the Bureau believes that as the cost of a loan increases, the risk to the consumer increases, especially where the lender obtains a leveraged payment mechanism or vehicle security. When higher-priced loans are coupled with the preferred payment position derived from a leveraged payment mechanism or vehicle security, the Bureau believes that lenders have a reduced incentive to underwrite carefully since the lender will have the ability to extract payments even from some consumers who cannot afford to repay and will in some instances be able to profit from the loan even if the consumer ultimately defaults. As discussed above in connection with proposed § 1041.2(a)(18), the Bureau believes that it may be more appropriate to use a total cost of credit threshold rather than traditional APR.

The Bureau recognizes that numerous State laws impose a 36 percent APR usury limit, meaning that it is illegal under those laws to charge an APR higher than 36 percent. That 36 percent APR ceiling reflects the judgment of those States that loans with rates above that limit are per se harmful to consumers and should be prohibited. Congress made a similar judgment in the Military Lending Act in creating a 36 percent all-in APR usury limit with respect to credit extended to servicemembers and their families. Congress, in section 1027(o) of the Dodd-Frank Act,[418] has determined that the Bureau is not to “establish a usury limit,” and the Bureau respects that determination. The Bureau is not proposing to prohibit lenders from charging interest rates, APRs, or all-in costs above the demarcation. Rather, the Bureau is proposing to require that lenders make a reasonable assessment of consumers' ability to repay certain loans above the 36 percent demarcation, in light of evidence of consumer harms in the market for loans with this characteristic.

The Bureau believes for the reasons set forth above and in the section-by-section analysis of proposed § 1041.9, that it is appropriate to focus regulatory attention on the segment of longer-term lending that poses the greatest risk of causing the types of harms to consumers Start Printed Page 47913that this proposal is meant to address, and that price is an element in defining that segment. The Bureau also believes that setting the line of demarcation at 36 percent would facilitate compliance given its use in other contexts, such as the Military Lending Act. Such differential regulation does not implicate section 1027(o) of the Dodd-Frank Act. The Bureau believes that the prohibition on the Bureau “establish[ing] a usury limit” is reasonably interpreted not to prohibit such differential regulation given that the Bureau is not proposing to prohibit lenders from charging interest rates above a specified limit.

The Bureau recognizes that a number of States impose a usury threshold lower than 36 percent per annum for various types of covered loans. Like all State usury limits, and, indeed, like all State laws and regulations that provide additional protections to consumers over and above those contained in the proposed rule, those limits would not be affected by this rule. At the same time, the Bureau is conscious that other States have set other limits and notes that the total cost of credit threshold is not meant to restrict the ability of lenders to offer higher-cost loans. The total cost of credit threshold is intended solely to demarcate loans that—when they include certain other features such as a leveraged payment mechanism or vehicle security—pose an increased risk of causing the type of harms to consumers that this proposal is meant to address. The protections imposed by this proposal would operate as a floor across the country, while leaving State and local jurisdictions to adopt additional regulatory requirements (whether a usury limit or another form of protection) above that floor as they judge appropriate to protect consumers in their respective jurisdictions.

Thus, the Bureau believes that a total cost of credit exceeding 36 percent per annum provides a useful line of demarcation. The Bureau solicits comment on whether a total cost of credit of 36 percent per annum is an appropriate measurement for the purposes of proposed § 1041.3(b)(2)(i) or whether a lower or higher measure would be more appropriate. In the discussion of proposed § 1041.2(a)(18), the Bureau has solicited comment on the components of the total cost of credit metric and the tradeoffs involved in using this metric relative to annual percentage rate.

3(b)(2)(ii)

Proposed § 1041.3(b)(2)(ii) would bring within the scope of proposed part 1041 loans in which the lender or a service provider obtains a leveraged payment mechanism, as defined by proposed § 1041.3(c), or vehicle security, as defined by proposed § 1041.3(d), before, at the same time, or within 72 hours after the consumer receives the entire amount of funds that the consumer is entitled to receive under the loan. A leveraged payment mechanism gives a lender the right to initiate a transfer of money from a consumer's account to satisfy an obligation. The Bureau believes that loans in which the lender obtains a leveraged payment mechanism may pose an increased risk of harm to consumers, especially where payment schedules are structured so that payments are timed to coincide with expected income flows into the consumer's account. As detailed in the section-by-section analyses of proposed §§ 1041.9 and 1041.13, the Bureau believes that the practice of extending higher-cost credit that has a leveraged payment mechanism or vehicle security without reasonably determining the consumer's ability to repay the loan appears to constitute an unfair and abusive act or practice.

The loans that would be covered under the proposal vary widely as to the basis for leveraged payment mechanism as well as cost, structure, and level of underwriting. Through its outreach, the Bureau is aware that some stakeholders have expressed concern that certain loans that might be considered less risky for consumers would be swept into coverage by virtue of a lien against the consumer's account granted to the depository lender by Federal statute. The Bureau is not proposing an exemption for select bases for leveraged payment mechanism but is proposing, as is set forth in §§ 1041.11 and 1041.12, conditional exemptions from certain requirements for covered loans made by any lender, including depositories, with certain features that would present less risk to consumers.

The proposed rule would not prevent a lender from obtaining a leveraged payment mechanism or vehicle security when originating a loan. The Bureau recognizes that consumers may find it a convenient or a useful form of financial management to authorize a lender to deduct loan payments automatically from a consumer's account or paycheck. The proposal would not prevent a consumer from doing so. The Bureau also recognizes that obtaining a leveraged payment mechanism or vehicle security generally reduces the lender's risk. The proposal would not prohibit a lender from doing so. Rather, the proposal would impose a duty on lenders to determine the consumer's ability to repay when a lender obtains a leveraged payment mechanism or vehicle security. As discussed above with regard to proposed § 1041.2(a)(17), the requirement would apply where either the lender or its service provider obtains a leveraged payment mechanism or vehicle security in order to assure comprehensive coverage.

The Bureau is not proposing to cover longer-term loans made without a leveraged payment mechanism or vehicle security in part because if a lender is not assured of obtaining a leveraged payment mechanism or vehicle security as of the time the lender makes the loan, the Bureau believes the lender has a greater incentive to determine the consumer's ability to repay. If, however, the lender is essentially assured of obtaining a leveraged payment mechanism or vehicle security as of the time the lender makes the loan, the Bureau believes the lender has less of an incentive to determine the consumer's ability to repay.

For this reason, as proposed comment 3(b)(2)(ii)-1 explains, a lender or service provider obtaining a leveraged payment mechanism or vehicle security would trigger coverage under proposed part 1041 only if the lender or service provider obtains the leveraged payment mechanism or vehicle security before, at the same time as, or within 72 hours after the consumer receives the entire amount of funds that the consumer is entitled to receive under the loan. A loan would not be covered under proposed § 1041.3(b)(2)(ii) if the lender or service provider obtains a leveraged payment mechanism or vehicle security more than 72 hours after the consumer receives the entire amount of funds that the consumer is entitled to receive under the loan.

The Bureau is proposing this 72-hour timeframe rather than focusing solely on obtaining leveraged payment mechanisms or vehicle security taken at consummation because the Bureau is concerned that lenders could otherwise consummate loans in reliance on the lenders' ability to exert influence over the customer and extract a leveraged payment mechanism or vehicle security while the funds are being disbursed and shortly thereafter. As discussed below, the Bureau is concerned that if the lender is confident it can obtain a leveraged payment mechanism or a vehicle security interest, the lender is less likely to evaluate carefully whether the consumer can afford the loan. The Bureau believes that the lender's leverage will ordinarily have diminished by 72 hours after the consumer receives the entirety of the Start Printed Page 47914funds available under the loan and that the proposed 72-hour rule would help to ensure that the lender will engage in appropriate consideration of the consumer's ability to repay the loan. Accordingly, the Bureau believes that it is generally appropriate to use the relative timing of disbursement and leveraged payment mechanism or vehicle security authorization to determine whether a loan should be subject to the consumer protections imposed by proposed part 1041.

However, even with this general approach, the Bureau is concerned that lenders might seek to evade the intended scope of the rule if they were free to offer incentives or impose penalties on consumers after the 72-hour period in an effort to secure a leveraged payment mechanism or vehicle security. Accordingly, as described below in connection with the anti-evasion provisions proposed in § 1041.19, the Bureau is proposing comment 19(a)-2.i.B to state that it is potentially an evasion of proposed part 1041 for a lender to offer an incentive to a consumer or create a detriment for a consumer in order to induce the consumer to grant the lender a leveraged payment mechanism or vehicle title in connection with a longer-term loan with total cost of credit exceeding a rate of 36 percent per annum unless the lender determines that the consumer has the ability to repay.

Proposed comment 3(b)(2)(ii)-2 further explains how to determine whether a consumer has received the entirety of the loan proceeds. For closed-end loans, a consumer receives the entirety of the loan proceeds if the consumer can receive no further funds without consummating another loan. For open-end loans, a consumer receives the entirety of the loan proceeds if the consumer fully draws down the entire credit plan and can receive no further funds without replenishing the credit plan, increasing the amount of the credit plan, repaying the balance, or consummating another loan. Proposed comment 3(b)(2)(ii)-3 explains that a contract provision granting the lender or service provider a leveraged payment mechanism or vehicle security contingent on some future event is sufficient to bring the loan within the scope of coverage.

The approach taken in proposed § 1041.3(b)(2)(ii) differs from the approach considered in the Small Business Review Panel Outline. Under the approach in the Small Business Review Panel Outline, a loan with a term of more than 45 days would be covered if a lender obtained a leveraged payment mechanism or vehicle security before the first payment was due on the loan. Upon further consideration, however, the Bureau believes that the approach in proposed § 1041.3(b)(2)(ii) is appropriate to ensure coverage of situations in which lenders obtain a leveraged payment mechanism or vehicle security in connection with a new extension on an open-end credit plan that was not a covered loan at original consummation, or prior to a modification or refinancing of an existing open- or closed-end credit plan that was not a covered loan at original consummation. The Bureau believes that this approach has the benefit of ensuring adequate consumer protections in origination situations in which lenders may not have an incentive to determine the consumer's ability to repay, while at the same time allowing for consumers to set up automatic repayment as a matter of convenience at a later date.

The Bureau solicits comment on the criteria for coverage set forth in proposed § 1041.3(b)(2)(ii), including whether the criteria should be limited to cover loans where the scheduled payments are timed to coincide with the consumer's expected inflow of income. In addition, the Bureau seeks comment on the basis on which, and the timing at which, a determination should be made as to whether a lender has secured a leveraged payment mechanism or vehicle security. For example, in outreach, some consumer advocates have suggested that a loan should be treated as a covered loan if the lender reasonably anticipates that it will obtain a leveraged payment mechanism or vehicle security at any time while the loan is outstanding based on the lender's experience with similar loans. The Bureau invites comments on the workability of such a test and, if adopted, where to draw the line to define the point at which the lender's prior success in obtaining a leveraged payment mechanism or vehicle security would trigger coverage for future loans.

The Bureau also notes that while consumers may elect to provide a leveraged payment mechanism post-consummation for their own convenience, it is more difficult to envision circumstances in which a consumer would choose to grant vehicle security post-consummation. One possible scenario would be that a consumer is having trouble repaying the loan and provides a security interest in the consumer's vehicle in exchange for a concession by the lender. The Bureau is concerned that a consumer who provides a vehicle security under such circumstances may face a significant risk of harm. The Bureau therefore solicits comment on whether a loan with an all-in cost of credit above 36 percent should be deemed a covered loan if, at any time, the lender obtains vehicle security. However, given the limited circumstances in which a consumer would grant vehicle security after consummation, the Bureau also seeks comment on whether, for a loan with an all-in cost of credit above 36 percent, lenders should be prohibited from taking a security interest in a vehicle after consummation.

3(c) Leveraged Payment Mechanism

Proposed § 1041.3(c) would set forth three ways that a lender or a service provider could obtain a leveraged payment mechanism that would bring the loan within the proposed coverage of proposed part 1041. A lender would obtain a leveraged payment mechanism if the lender has the right to initiate a transfer of money from the consumer's account to repay the loan, if the lender has the contractual right to obtain payment from the consumer's employer or other payor of expected income, or if the lender requires the consumer to repay the loan through payroll deduction or deduction from another source of income. In all three cases, the consumer is required, under the terms of an agreement with the lender, to cede autonomy over the consumer's account or income stream in a way that the Bureau believes changes that lender's incentives to determine the consumer's ability to repay the loan and can exacerbate the harms the consumer experiences if the consumer does not have the ability to repay the loan and still meet the consumer's major financial obligations and basic living expenses. As explained in the section-by-section analysis of proposed §§ 1041.8 and 1041.9, the Bureau believes that it is an unfair and abusive practice for a lender to make such a loan without determining that the consumer has the ability to repay.

3(c)(1)

Proposed § 1041.3(c)(1) would generally provide that a lender or a service provider obtains a leveraged payment mechanism if it has the right to initiate a transfer of money, through any means, from a consumer's account (as defined in proposed § 1041.2(a)(1)) to satisfy an obligation on a loan. For example, this would occur with a post-dated check or preauthorization for recurring electronic fund transfers. However, the proposed regulation would not define leveraged payment mechanism to include situations in which the lender or service provider initiates a one-time electronic fund Start Printed Page 47915transfer immediately after the consumer authorizes such transfer.

As proposed comment 3(c)(1)-1 explains, the key principle that makes a payment mechanism “leveraged” is whether the lender has the ability to “pull” funds from a consumer's account without any intervening action or further assent by the consumer. In those cases, the lender's ability to pull payments from the consumer's account gives the lender the ability to time and initiate payments to coincide with expected income flows into the consumer's account. This means that the lender may be able to continue to obtain payment (as long as the consumer receives income and maintains the account) even if the consumer does not have the ability to repay the loan while meeting his or her major financial obligations and basic living expenses. In contrast, a payment mechanism in which the consumer “pushes” funds from his or her account to the lender does not provide the lender leverage over the account in a way that changes the lender's incentives to determine the consumer's ability to repay the loan or exacerbates the harms the consumer experiences if the consumer does not have the ability to repay the loan.

Proposed comment 3(c)(1)-2 provides examples of the types of authorizations for lender-initiated transfers that constitute leveraged payment mechanisms. These include checks written by the consumer, authorizations for electronic fund transfers (other than immediate one-time transfers as discussed further below), authorizations to create or present remotely created checks, and authorizations for certain transfers by account-holding institutions (including a right of set-off). Proposed comment 3(c)(1)-3 explains that a lender does not obtain a leveraged payment mechanism if a consumer authorizes a third party to transfer money from the consumer's account to a lender as long as the transfer is not made pursuant to an incentive or instruction from, or duty to, a lender or service provider. The Bureau solicits comment on whether this definition of leveraged payment mechanism appropriately captures payment methods that are likely to produce the risks to consumers identified by the Bureau in the section-by-section analysis of proposed § 1041.8.

As noted above, proposed § 1041.3(c)(1) would provide that a lender or service provider does not obtain a leveraged payment mechanism by initiating a one-time electronic fund transfer immediately after the consumer authorizes the transfer. This provision is similar to what the Bureau is proposing in § 1041.15(b), which exempts lender from providing the payment notice when initiating a single immediate payment transfer at the consumer's request, as that term is defined in § 1041.14(a)(2), and is also similar to what the Bureau is proposing in § 1041.14(d), which permits lenders to initiate a single immediate payment transfer at the consumer's request even after the prohibition in proposed § 1041.14(b) on initiating further payment transfers has been triggered.

Accordingly, proposed comment 3(c)(1)-3 would clarify that if the loan agreement between the parties does not otherwise provide for the lender or service provider to initiate a transfer without further consumer action, the consumer may authorize a one-time transfer without causing the loan to be a covered loan. Proposed comment 3(c)(1)-3 further clarifies that the phrase “immediately” means that the lender initiates the transfer after the authorization with as little delay as possible, which in most circumstances will be within a few minutes.

The Bureau anticipates that scenarios involving authorizations for immediate one-time transfers will only arise in certain discrete situations. For closed-end loans, a lender is permitted to obtain a leveraged payment mechanism more than 72 hours after the consumer has received the entirety of the loan proceeds without the loan becoming a covered loan. Thus, in the closed-end context, this exception would only be relevant if the consumer was required to make a payment within 72 hours of receiving the loan proceeds—a situation which is unlikely to occur. However, the situation may be more likely to occur with open-end credit. Longer-term open-end can be covered loans if the lender obtains a leveraged payment mechanism within 72 hours of the consumer receiving the full amount of the funds which the consumer is entitled to receive under the loan. Thus, if a consumer only partially drew down the credit plan, but the consumer was required to make a payment, a one-time electronic fund transfer could trigger coverage without the one-time immediate transfer exception. The Bureau believes it is appropriate for these transfers not to trigger coverage because there is a reduced risk that such transfers will re-align lender incentives in a similar manner as other types of leveraged payment mechanisms.

The Bureau solicits comment on whether this exclusion from the definition of leveraged payment mechanism is appropriate and whether additional guidance is needed. The Bureau also solicits comment on whether any additional exceptions to the general principle of proposed § 1041.3(c)(1) are appropriate.

3(c)(2)

Proposed § 1041.3(c)(2) would provide that a lender or a service provider obtains a leveraged payment mechanism if it has the contractual right to obtain payment directly from the consumer's employer or other payor of income. This scenario typically involves a wage assignment, which, as described by the FTC, is “a contractual transfer by a debtor to a creditor of the right to receive wages directly from the debtor's employer. To activate the assignment, the creditor simply submits it to the debtor's employer, who then pays all or a percentage of debtor's wages to the creditor.” [419] These arrangements are creatures of State law and can take various forms. For example, they can be used either as a method of making regular payments during the term of the loan or as a collections tool when borrowers default. Such arrangements are legal in some jurisdictions, but illegal in others.

As discussed further in Market Concerns—Short-Term Loans, the Bureau is concerned that where loan agreements provide for assignments of income, the lender incentives and potential consumer risks can be very similar to those presented by other forms of leveraged payment mechanism defined in proposed § 1041.3(c). In particular, a lender—as when it has the right to initiate transfers from a consumer's account—can continue to obtain payment as long as the consumer receives income, even if the consumer does not have the ability to repay the loan while meeting her major financial obligations and basic living expenses. And—as when a lender has the right to initiate transfers from a consumer's account—an assignment of income can change the lender's incentives to determine the consumer's ability to repay the loan and exacerbate the harms the consumer experiences if the consumer does not have the ability to repay the loan. Thus, the Bureau believes that loan agreements that provide for assignments of income may present the same risk of harm to consumers as other types of leveraged payment mechanisms. The Bureau seeks comment on the proposed definition and whether additional guidance is needed.

The Bureau recognizes that some consumers may find it a convenient or useful form of financial management to Start Printed Page 47916repay a loan through a revocable wage assignment. The proposed rule would not prevent a consumer from doing so. Rather, the proposed rule would impose a duty on lenders to determine the consumer's ability to repay when the lender or service provider has the right to obtain payment directly from the consumer's employer or other payor of income.

3(c)(3)

Proposed § 1041.3(c)(3) would provide that a lender or a service provider obtains a leveraged payment mechanism if the loan requires the consumer to repay through a payroll deduction or deduction from another source of income. As proposed comment 3(c)(3)-1 explains, a payroll deduction involves a direction by the consumer to the consumer's employer (or other payor of income) to pay a portion of the consumer's wages or other income to the lender or service provider, rather than a direction by the lender to the consumer's employer as in a wage assignment. The Bureau is concerned that if an agreement between the lender and consumer requires the consumer to have his or her employer or other payor of income pay the lender directly, the consumer would be in the same situation and face the same risk of harm as if the lender had the ability to initiate a transfer from the consumer's account or had a right to a wage assignment.

The Bureau recognizes that just as some consumers may find it a convenient or useful form of financial management to authorize a lender to deduct loan payments automatically from a consumer's account, so, too, may some consumers find it a convenient or useful form of financial management to authorize their employer to deduct loan payments automatically from the consumer's paycheck and remit the money to the lender. The proposed rule would not prevent a consumer from doing so. Rather, the proposed rule would impose a duty on lenders to determine the consumer's ability to repay only when a lender requires the consumer to authorize such payroll deduction as a condition of the loan thereby imposing a contractual obligation on the consumer to continue such payroll deduction during the term of the loan. The Bureau solicits comment on whether a lender should have a duty to determine the consumer's ability to repay only when the lender requires payroll deduction, or whether such a duty should also apply when the lender incentivizes payroll deduction.

3(d) Vehicle Security

Proposed § 1041.3(d) would provide that a lender or service provider obtains vehicle security if the lender or service provider obtains an interest in a consumer's motor vehicle, regardless of how the transaction is characterized under State law. Under proposed § 1041.3(d), a lender or service provider could obtain vehicle security regardless of whether the lender or service provider has perfected or recorded the interest. A lender or service provider also would obtain vehicle security under proposed § 1041.3(d) if the consumer pledges the vehicle to the lender or service provider in a pawn transaction and the consumer retains possession of the vehicle during the loan. In each case, a lender or service provider would obtain vehicle security under proposed § 1041.3(d) if the consumer is required, under the terms of an agreement with the lender or service provider, to grant an interest in the consumer's vehicle to the lender in the event that the consumer does not repay the loan.

However, as noted above and discussed further below, proposed § 1041.3(e) would exclude loans made solely and expressly for the purpose of financing a consumer's initial purchase of a motor vehicle in which the lender takes a security interest as a condition of the credit, as well as non-recourse pawn loans in which the lender has sole physical possession and use of the property for the entire term of the loan. Proposed comment 3(d)(1)-1 also clarifies that mechanic liens and other situations in which a party obtains a security interest in a consumer's motor vehicle for a reason that is unrelated to an extension of credit do not trigger coverage.

The Bureau believes that when a lender obtains vehicle security in connection with the consummation of a loan, the lender effectively achieves a preferred payment position similar to the position that a lender obtains with a leveraged payment mechanism. If the loan is unaffordable, the consumer will face the difficult choice of either defaulting on the loan and putting the consumer's automobile (and potentially the consumer's livelihood) at risk or repaying the loan even if doing so means defaulting on major financial obligations or foregoing basic living needs. As a result, the lender has limited incentive to assure that the consumer has the ability to repay the loan. For these reasons, the Bureau believes that it is appropriate to include within the definition of covered longer-term loans those loans for which the lender or service provider obtains vehicle security before, at the same time as, or within 72 hours after the consumer receives all the funds the consumer is entitled to receive under the loan. However, as noted above, the Bureau solicits comment on whether a longer-term loan with an all-in cost of credit above 36% should be deemed a covered loan if, at any time, the lender obtains vehicle security.

3(d)(1)

Proposed § 1041.3(d)(1) would provide that any security interest that the lender or service provider obtains as a condition of the loan would constitute vehicle security for the purpose of determining coverage under proposed part 1041. The term security interest would include any security interest that the lender or service provider has in the consumer's vehicle, vehicle title, or vehicle registration. As proposed comment 3(d)(1)-1 clarifies, a party would not obtain vehicle security if that person obtains a security interest in the consumer's vehicle for a reason unrelated to the loan.

The security interest would not need to be perfected or recorded in order to trigger coverage under proposed § 1041.3(d)(1). The consumer may not be aware that the security interest is not perfected or recorded, nor would it matter in many cases. Perfection or recordation protects the lender's interest in the vehicle against claims asserted by other creditors, but does not necessarily affect whether the consumer's interest in the vehicle is at risk if the consumer does not have the ability to repay the loan. Even if the lender or service provider does not perfect or record its security interest, the security interest can still change a lender's incentives to determine the consumer's ability to repay the loan and exacerbate the harms the consumer experiences if the consumer does not have the ability to repay the loan.

3(d)(2)

Proposed § 1041.3(d)(2) would provide that pawn transactions generally would constitute vehicle security for the purpose of determining coverage under proposed part 1041 if the consumer pledges the vehicle in connection with the transaction and the consumer retains use of the vehicle during the term of the pawn agreement. However, pawn transactions would not trigger coverage if they fell within the scope of proposed § 1041.3(e)(5), which would exclude bona fide non-recourse pawn transactions where the lender obtains custody of the vehicle and there is no recourse against the consumer for Start Printed Page 47917the balance due if the consumer is unable to repay the loan.

The proposed language is designed to account for the fact that, in response to laws in several jurisdictions, lenders have structured higher-cost, vehicle-secured loans as pawn agreements,[420] though these “vehicle pawn” or “title pawn” loans are the functional equivalent of loans covered by proposed § 1041.3(d) in which the lender has vehicle security because the terms on which the loans are offered are similar. Further, the ramifications for both the lender and the consumer are similar in the event the consumer does not have the ability to repay the loan—the lender can repossess the consumer's vehicle and sell it. And, as also discussed in the section-by-section analysis for proposed § 1041.3(e)(5), vehicle pawn and title pawn loans often do not require the consumer to relinquish physical control of the motor vehicle while the loan is outstanding, which is likely to make the threat of repossession a more powerful form of leverage should the consumer not repay the covered loan. Accordingly, the Bureau proposes to treat vehicle title pawn loans the same as vehicle security loans for the purposes of proposed part 1041.

3(e) Exclusions

Proposed § 1041.3(e) would exclude purchase money security interest loans extended solely for the purchase of a good, real estate secured loans, certain credit cards, student loans, non-recourse pawn loans in which the consumer does not possess the pledged collateral, and overdraft services and lines of credit. The Bureau believes that notwithstanding the potential term, cost of credit, repayment structure, or security of these loans, they arise in distinct markets that the Bureau believes may pose a somewhat different set of concerns for consumers. At the same time, as discussed further below, the Bureau is concerned that there may be a risk that these exclusions would create avenues for evasion of the proposed rule.

The Bureau solicits comment on whether any of these excluded types of loans should also be covered under proposed part 1041. The Bureau further solicits comment on whether there are reasons for excluding other types of products from coverage under proposed part 1041. As noted above, the Bureau is also soliciting in the Accompanying RFI information and additional evidence to support in further assessment of whether there are other categories of loans for which lenders do not determine the consumer's ability to repay that may pose risks to consumers. The Bureau emphasizes that it may determine in a particular supervisory or enforcement matter or in a subsequent rulemaking in light of evidence available at the time that the failure to assess ability to repay when making a loan excluded from coverage here may nonetheless be an unfair or abusive act or practice.

3(e)(1) Certain Purchase Money Security Interest Loans

Proposed § 1041.3(e)(1) would exclude from coverage under proposed part 1041 loans extended for the sole and express purpose of financing a consumer's initial purchase of a good when the good being purchased secures the loan. Accordingly, loans made solely to finance the purchase of, for example, motor vehicles, televisions, household appliances, or furniture would not be subject to the consumer protections imposed by proposed part 1041 to the extent the loans are secured by the good being purchased. Proposed comment 3(e)(1)-1 explains the test for determining whether a loan is made solely for the purpose of financing a consumer's initial purchase of a good. If the item financed is not a good or if the amount financed is greater than the cost of acquiring the good, the loan is not solely for the purpose of financing the initial purchase of the good. Proposed comment 3(e)(1)-1 further explains that refinances of credit extended for the purchase of a good do not fall within this exclusion and may be subject to the requirements of proposed part 1041.

Purchase money loans are typically treated differently than non-purchase money loans under the law. The FTC's Credit Practices Rule generally prohibits consumer credit in which a lender takes a nonpossessory security interest in household goods but makes an exception for purchase money security interests.[421] The Federal Bankruptcy Code, the UCC, and some other State laws apply different standards to purchase money security interests. This differential treatment facilitates the financing of the initial purchase of relatively expensive goods, which many consumers would not be able to afford without a purchase money loan. At this time, the Bureau has not determined that purchase money loans pose similar risks to consumers as the loans covered by proposed part 1041. Accordingly, the Bureau is proposing not to cover such loans at this time. The Bureau solicits comment on this exclusion and whether there are particular types of purchase money loans that pose sufficient risk to consumers to warrant coverage under this proposed rule.

3(e)(2) Real Estate Secured Credit

Proposed § 1041.3(e)(2) would exclude from coverage under proposed part 1041 loans that are secured by real property, or by personal property used as a dwelling, and in which the lender records or perfects the security interest. The Bureau believes that even without this exemption, very few real estate secured loans would meet the coverage criteria set forth in proposed § 1041.3(b). Nonetheless, the Bureau believes a categorical exclusion is appropriate. For the most part, these loans are already subject to Federal consumer protection laws, including, for most closed-end loans, ability-to-repay requirements under Regulation Z § 1026.43. The proposed requirement that the security interest in the real estate be recorded or perfected also strongly discourages attempts to use this exclusion for sham or evasive purposes. Recording or perfecting a security interest in real estate is not a cursory exercise for a lender—recording fees are often charged and documentation is required. As proposed comment 3(e)(2)-1 explains, if the lender does not record or otherwise perfect the security interest in the property during the term of the loan, the loan does not fall under this exclusion and may be subject to the requirements of proposed part 1041. The Bureau solicits comment on this exclusion and whether there are particular types of real-estate secured loans that pose sufficient risk to consumers to warrant coverage under the proposed rule.

3(e)(3) Credit Cards

Proposed § 1041.3(e)(3) would exclude from coverage under proposed part 1041 credit card accounts meeting the definition of “credit card account under an open-end (not home-secured) consumer credit plan” in Regulation Z § 1026.2(a)(15)(ii), rather than products meeting the more general definition of credit card accounts under Regulation Z § 1026.2(a)(15). By focusing on the narrower category, the exemption would apply only to credit card accounts that are subject to the Credit CARD Act of 2009, Public Law 111-24, 123 Stat. 1734 (2009) (CARD Act), which provides various heightened safeguards for consumers. These protections include a limitation that card issuers cannot open a credit card account or increase a credit line on a card account unless the card issuer considers the ability of the consumer to make the required payments under the terms of the Start Printed Page 47918account, as well as other protections such as limitations on fees during the first year after account opening, late fee restrictions, and a requirement that card issuers give consumers “a reasonable amount of time” to pay their bill.[422]

The Bureau believes that, even without this exemption, few traditional credit card accounts would meet the coverage criteria set forth in proposed § 1041.3(b) other than some secured credit card accounts which may have a total cost of credit above 36 percent and provide for a leveraged payment mechanism in the form of a right of set-off. These credit card accounts are subject to the CARD Act protections discussed above. The Bureau believes that potential consumer harms related to credit card accounts are more appropriately addressed by the CARD Act, implementing regulations, and other applicable law. At the same time, if the Bureau were to craft a broad general exemption for all credit cards as generally defined under Regulation Z, the Bureau would be concerned that a lender seeking to evade the requirements of the rule might seek to structure a product in a way designed to take advantage of this exclusion.

The Bureau has therefore proposed a narrower definition focusing only on those credit cards accounts that are subject to the full range of protections under the CARD Act and its implementing regulations. Among other requirements, the regulations imposing the CARD Act prescribe a different ability-to-repay standard that lenders must follow, and the Bureau believes that the combined consumer protections governing credit card accounts subject to the CARD Act are sufficient for that type of credit. To further mitigate potential consumer risk, the Bureau considered adding a requirement that to be eligible for this exclusion, a credit card would have to be either (i) accepted upon presentation by multiple unaffiliated merchants that participate in a widely-accepted payment network, or (ii) accepted upon presentation solely for the bona fide purchase of goods or services at a particular retail merchant or group of merchants. The Bureau solicits comments on whether to exclude credit cards and, if so, whether the criteria proposed to define the exclusion are appropriate, or whether additional criteria should be added to limit the potential evasion risk identified above.

3(e)(4) Student Loans

Proposed § 1041.3(e)(4) would exclude from coverage under proposed part 1041 loans made, insured, or guaranteed pursuant to a Federal student loan program, and private education loans. The Bureau believes that even without this exemption, very few student loans would meet the coverage criteria set forth in proposed § 1041.3(b). Nonetheless, the Bureau believes a categorical exclusion is appropriate. Federal student loans are provided to students or parents meeting eligibility criteria established by Federal law and regulation such that the protections afforded by this proposed rule would be unnecessary. Private student loans are sometimes made to students based upon their future potential ability to repay (as distinguished from their current ability), but are typically co-signed by a party with financial capacity. These loans raise discrete issues that may warrant Bureau attention at a future time, but the Bureau believes that they are not appropriately considered along with the types of loans at issue in this rulemaking. The Bureau continues to monitor the student loan servicing market for trends and developments, unfair, deceptive, or abusive practices, and to evaluate possible policy responses, including potential rulemaking. The Bureau solicits comment on whether this exclusion is appropriate.

3(e)(5) Non-Recourse Pawn Loans

Proposed § 1041.3(e)(5) generally would exclude from coverage under proposed part 1041 loans secured by pawned property in which the lender has sole physical possession and use of the pawned property for the entire term of loan, and for which the lender's sole recourse if the consumer does not redeem the pawned property is the retention and disposal of the property. Proposed comment 3(e)(5)-1 explains that if any consumer, including a co-signor or guarantor, is personally liable for the difference between the outstanding loan balance and the value of the pawned property, the loan does not fall under this exclusion and may be subject to the requirements of proposed part 1041. As discussed above in connection with proposed § 1041.2(a)(13) and below in connection with proposed §§ 1041.6, 1041.7, and 1041.10, however, a non-recourse pawn loan can, in certain circumstances, be a non-covered bridge loan that could impact restrictions on the lender with regard to a later covered short-term loans.

The Bureau believes that bona fide, non-recourse pawn loans generally pose somewhat different risks to consumers than loans covered under proposed part 1041. As described in part II, non-recourse pawn loans involve the consumer physically relinquishing control of the item securing the loan during the term of the loan. The Bureau believes that consumers may be more likely to understand and appreciate the risks associated with physically turning over an item to the lender when they are required to do so at consummation. Moreover, in most situations, the loss of a non-recourse pawned item over which the lender has sole physical possession during the term of the loan is less likely to affect the rest of the consumer's finances than is either a leveraged payment mechanism or vehicle security. For instance, a pawned item of this nature may be valuable to the consumer, but the consumer most likely does not rely on the pawned item for transportation to work or to pay other obligations. Otherwise, the consumer likely would not have pawned the item under these terms. Finally, because the loans are non-recourse, in the event that a consumer is unable to repay the loan, the lender must accept the pawned item as fully satisfying the debt, without further collections activity on any remaining debt obligation.

In all of these ways, pawn transactions appear to differ significantly from the secured loans that would be covered under proposed part 1041. While the loans described in proposed § 1041.3(e)(5) would not be covered loans, lenders may, as described in proposed §§ 1041.6, 1041.7, and 1041.10 be subject to restrictions on making covered loans shortly following certain non-recourse pawn loans that meet certain conditions. The Bureau solicits comment on this exclusion and whether these types of pawn loans should be subject to the consumer protections imposed by proposed part 1041.

3(e)(6) Overdraft Services and Overdraft Lines of Credit

Proposed § 1041.3(e)(6) would exclude from coverage under proposed part 1041 overdraft services on deposit accounts as defined in 12 CFR 1005.17(a), as well as payments of overdrafts pursuant to a line of credit subject to Regulation Z, 12 CFR part 1026. Overdraft services generally operate on a consumer's deposit account as a negative balance, where the consumer's bank processes and pays certain payment transactions for which the consumer lacks sufficient funds in the account and imposes a fee for the Start Printed Page 47919service as an alternative to either refusing to authorize the payment (in the case of most debit and ATM transactions and ACH payments initiated from the consumer's account) or rejecting the payment and charging a non-sufficient funds fee (in the case of other ACH payments as well as paper checks). Overdraft services have been exempted from regulation under Regulation Z under certain circumstances, and are subject to specific rules under EFTA [423] and the Truth in Savings Act, and their respective implementing regulations.[424] In contrast, overdraft lines of credit are separate open-end lines of credit under Regulation Z that have been linked to a consumer's deposit account to provide automatic credit draws to cover the processing of payments for which there are not sufficient funds in the deposit account.

As discussed above in part II, the Bureau is engaged in research and other activity in anticipation of a separate rulemaking regarding overdraft products and practices.[425] Given that overdraft services and overdraft lines of credit involve complex overlays with rules regarding payment processing, deposit accounts, set-off rights, and other forms of depository account access, the Bureau believes that any discussion of whether additional regulatory protections are warranted for those two products should be reserved for that rulemaking. Accordingly, the Bureau is proposing to exempt both types of overdraft products from the scope of this rule, using definitional language in Regulation E to distinguish both overdraft services and overdraft lines of credit from other types of depository credit products. The Bureau solicits comment on whether additional guidance would be helpful to distinguish overdraft services and overdraft lines of credit from other products, whether that distinction is appropriate for purposes of this rulemaking, and whether the Bureau should factor particular product features or safeguards into the way it differentiates between depository credit products.

Subpart B—Short-Term Loans

In proposed § 1041.4, the Bureau proposes to identify an unfair and abusive act or practice with respect to the making of covered short-term loans pursuant to its authority to “prescribe rules . . . identifying as unlawful unfair, deceptive, or abusive acts or practices.” [426] In the Bureau's view, it appears to be both unfair and abusive for a lender to make such a loan without reasonably determining that the consumer has the ability to repay the loan. To avoid committing this unfair and abusive practice, a lender would have to reasonably determine that the consumer has the ability to repay the loan. Proposed §§ 1041.5 and 1041.6 would establish a set of requirements to prevent the unlawful practice by reasonably determining that the consumer has the ability to repay the loan. The Bureau is proposing the ability-to-repay requirements under its authority to prescribe rules for “the purpose of preventing [unfair and abusive] acts or practices.” [427] Proposed § 1041.7 would rely on section 1022(b)(3) of the Dodd-Frank Act to exempt from the ability-to-repay requirements in proposed §§ 1041.5 and 1041.6, as well as from the prohibition in § 1041.4 certain covered short-term loans which satisfy a set of conditions designed to avoid the harms that can result from unaffordable loans. Accordingly, lenders seeking to make covered short-term loans would have the choice, on a case by case basis, either to follow proposed §§ 1041.5 and 1041.6, or proposed § 1041.7.

The predicate for the proposed identification of an unfair and abusive act or practice in proposed § 1041.4—and thus for the prevention requirements contained in proposed §§ 1041.5 and 1041.6—is a set of preliminary findings with respect to the consumers who use storefront and online payday loans, single-payment auto title loans, and other short-term loans, and the impact on those consumers of the practice of making such loans without assessing the consumers' ability to repay.[428] Those preliminary findings are set forth in the discussion below, hereinafter referred to as Market Concerns—Short-Term Loans. After laying out these preliminary findings, the Bureau sets forth, in the section-by-section analysis of proposed § 1041.4, its reasons for proposing to identify as unfair and abusive the practice described in proposed § 1041.4. The Bureau seeks comment on all aspects of this subpart, including the intersection of the proposed interventions with existing State, tribal, and local laws and whether additional or alternative protections should be considered to address the core harms discussed below.

Market Concerns—Short-Term Loans

The Bureau is concerned that lending practices in the markets for storefront and online payday lending, single-payment vehicle title, and other short-term loans are causing harm to many consumers who use these products, including extended sequences of reborrowing, delinquency and defaults, and certain collateral harms from making unaffordable payments. This section reviews the available evidence with respect to the consumers who use payday and short-term auto title loans, their reasons for doing so, and the outcomes they experience. It also reviews the lender practices that cause these outcomes. The Bureau preliminarily finds:

  • Lower-income, lower-savings consumers. Consumers who use these products tend to come from lower or moderate income households. They generally do not have any savings to fall back on, and they have very limited access to other sources of credit; indeed, typically they have sought unsuccessfully to obtain other, lower cost, credit before turning to a short-term loan.
  • Consumers in financial difficulty. Some consumers turn to these products because they have experienced a sudden drop in income (“income shock”) or a large unexpected expense (“expense shock”). Other borrowers are in circumstances in which their expenses consistently outstrip their income. A sizable percentage of users report that they would have taken a loan on any terms offered.
  • Loans do not function as marketed. Lenders market single-payment products as short-term loans designed to provide a bridge to the consumer's next payday or other income receipt. In practice, however, the amounts due consume such a large portion of the consumer's paycheck or other periodic income source as to be unaffordable for most consumers seeking to recover from an income or expense shock and even more so for consumers with a chronic income shortfall. Lenders actively encourage consumers either simply to pay the finance charges due and roll over the loan instead of repaying the loan in full (or effectively roll over the loan by returning to reborrow in the days after repaying the loan). Indeed, lenders are dependent upon such Start Printed Page 47920reborrowing for a substantial portion of their revenue and would lose money if each borrower repaid the loan when due without reborrowing.
  • Very high reborrowing rates. Not surprisingly, most borrowers find it necessary to reborrow when their loan comes due or shortly after repaying their loan, as other expenses come due. This reborrowing occurs both with payday loans and single-payment vehicle title loans. Fifty percent of all new storefront payday loans are followed by at least three more loans and 33 percent are followed by six more loans. For single-payment vehicle title loans over half (56 percent) of all new loans are followed by at least three more loans, and more than a third (36 percent) are followed by six or more loans. Twenty-one percent of payday loans made to borrowers paid weekly, bi-weekly, or semi-monthly are in loan sequences of 20 loans or more and over forty percent of loans made to borrowers paid monthly are in loan sequences of comparable durations (i.e., 10 or more monthly loans).
  • Consumers do not expect lengthy loan sequences. Consumers who take out a payday loan do not expect to reborrow to the extent that they do. This is especially true of those consumers who end up in extended cycles of indebtedness. Research shows that when taking out loans consumers are unable accurately to predict how long it will take them to get out of debt, and that this is even truer of consumers who have borrowed heavily in the recent past. Consumers' difficulty in this regard is based, in part, on the fact that such loans involve a basic mismatch between how they appear to function as short-term credit and how they are actually designed to function in long sequences of reborrowing. This disparity creates difficulties for consumers in estimating with any accuracy how long they will remain in debt and how much they will ultimately pay for the initial extension of credit. Research regarding consumer decision-making also helps explain why consumers end up reborrowing more than they expect. People under stress, including consumers in financial crisis, tend to become very focused on their immediate problems and think less about the future. Consumers also tend to underestimate their future expenses, and may be overly optimistic about their ability to recover from the shock they have experienced or to bring their expenses in line with their incomes.
  • Very high default rates. Some consumers do succeed in repaying short-term loans without reborrowing, and others eventually repay the loan after reborrowing multiple times. But research shows that approximately 20 percent of payday loan sequences and 33 percent of single-payment vehicle title loan sequences end up with the consumer defaulting. Consumers who are delinquent or who default can become subject to often aggressive and psychologically harmful debt collection efforts. In addition, 20 percent of single-payment vehicle title loan sequences end with borrowers losing their cars or trucks to repossession. Even borrowers who eventually pay off their loans may incur penalty fees, late fees, or overdraft fees along the way, and after repaying may find themselves struggling to pay other bills or meet their basic living expenses.
  • Harms occur despite existing regulation. The research indicates that these harms from payday loans and other short-term loans persist despite existing regulatory frameworks. In particular, the Bureau is concerned that caps on the amount that a consumer can borrow, rollover limitations, and short cooling-off periods still appear to leave many consumers vulnerable to the specific harms discussed above relating to reborrowing, default, and collateral harms from making unaffordable payments.

The following discussion reviews the evidence underlying each of these preliminary findings.

a. Borrower Characteristics and Circumstances of Borrowing

Borrowers who take out payday and single-payment vehicle title loans are typically low-to-moderate income consumers who are looking for quick access to cash, who have little to no savings, who often have poor credit histories, and who have limited access to other forms of credit. The desire for immediate cash may be the result of an emergency expense or an unanticipated drop in income, but many who take out payday or vehicle title loans are consumers whose living expenses routinely exceed their income.

1. Borrower Characteristics

A number of studies have focused on the characteristics of payday borrowers. For instance, the FDIC and the U.S. Census Bureau have undertaken several special supplements to the Current Population Survey (CPS Supplement); the most recent available data come from 2013.[429] The CPS supplement found that 46 percent of payday borrowers (including storefront and online borrowers) have a family income of under $30,000.[430] A study covering a mix of storefront and online payday borrowers similarly found that 49 percent had income of $25,000 or less.[431] Other analyses of administrative data that include the income that borrowers reported to lenders are broadly consistent.[432] Additionally, the Bureau found in its analysis of confidential supervisory data that 18 percent of storefront borrowers relied on Social Security or some other form of government benefits or public assistance.[433] The FDIC study further found that payday borrowers are disproportionately Hispanic or African-American (with borrowing rates two to three times higher respectively than for non-Hispanic whites). Female-headed households are more than twice as likely as married couples to be payday borrowers.[434]

The demographic profiles of vehicle title loan borrowers appear to be roughly comparable to the Start Printed Page 47921demographics of payday borrowers.[435] Calculations from the CPS Supplement indicate that 40 percent of vehicle title borrowers have annual family incomes under $30,000.[436] Another survey likewise found that 56 percent of title borrowers reported incomes below $30,000, compared with 60 percent for payday borrowers.[437] As with payday borrowers, data from the CPS Supplement show vehicle title borrowers to be disproportionately African-American or Hispanic, and more likely to live in female-headed households.

Similarly, a survey of borrowers in three States conducted by academic researchers found that vehicle title borrowers were disproportionately female and minority. Over 58 percent of title borrowers were female. African-Americans were over-represented among borrowers compared to their share of the States' population at large. Hispanic borrowers were over-represented in two of the three states; however, these borrowers were underrepresented in Texas, the State with the highest proportion of Hispanic residents in the study.[438]

Studies of payday borrowers' credit histories show both poor credit histories and recent credit-seeking activity. An academic paper that matched administrative data from one storefront payday lender to credit bureau data found that the median credit score for a payday applicant was in the bottom 15 percent of credit scores overall.[439] The median applicant had one open credit card, but 80 percent of applicants had either no credit card or no credit available on a card. The average borrower had 5.2 credit inquiries on her credit report over the preceding 12 months before her initial application for a payday loan (three times the number for the general population), but obtained only 1.4 accounts on average. This suggests that borrowers made repeated but generally unsuccessful efforts to obtain additional other forms of credit first, and sought the payday loan as a “last resort.” They may have credit cards but likely do not have unused credit, are often delinquent on one or more cards, and have often experienced multiple overdrafts and/or NSFs on their checking accounts.[440] A recent report analyzing credit scores of borrowers from five large storefront payday lenders provides corroborative support, finding that the average borrower had a VantageScore 3.0 [441] score of 532 and that over 85 percent of borrowers had a score below 600, indicating high credit risk.[442] By way of comparison, the national average Vantage Score is 669 and only 30 percent of consumers have a Vantage Score below 600.[443]

Reports using data from a specialty consumer reporting agency indicate that online borrowers have comparable credit scores to storefront borrowers (a mean VantageScore 3.0 score of 525 versus 532 for storefront).[444] Another study based on the data from the same specialty consumer reporting agency and an accompanying survey of online small-dollar credit borrowers reports that 79 percent of those surveyed had been denied traditional credit in the past year due to having a low or no credit score, 62 percent had already sought assistance from family and friends, and 24 percent reported having negotiated with a creditor to whom they owed money.[445] Moreover, heavy use of online payday loans correlated with more strenuous credit-seeking: Compared to light (bottom quartile) users of online loans, heavy (top quartile) users were more likely to have been denied credit in the past year (87 percent of heavy users compared to 68 percent of light users).[446]

Other surveys of payday borrowers add to the picture of consumers in financial distress. For example, in a survey of payday borrowers published in 2009, fewer than half reported having any savings or reserve funds. Almost a third of borrowers (31.8 percent) reported monthly debt to income payments of 30 percent or higher, and more than a third (36.4 percent) of borrowers reported that they regularly spend all the income they receive.[447]

Similarly, a 2010 survey found that over 80 percent of payday borrowers reported making at least one late payment on a bill in the preceding three months, and approximately one quarter reported frequently paying bills late. Approximately half reported bouncing at least one check in the previous three months, and 30 percent reported doing so more than once.[448]

Likewise, a 2012 survey found that 58 percent of payday borrowers report that they struggled to pay their bills on time. More than a third (37 percent) said they would have taken out a loan on any terms offered. This figure rises to 46 percent when the respondent rated his or her financial situation as particularly poor.[449]

2. Circumstances of Borrowing

Several surveys have asked borrowers why they took out their loans or for what purpose they used the loan proceeds. These are challenging questions to study. Any survey that asks about past behavior or events runs some risk of recall errors. In addition, the fungibility of money makes this question more complicated. For example, a consumer who has an unexpected expense may not feel the effect fully until weeks later, depending on the timing of the unexpected expense relative to other expenses and the receipt of income. In that circumstance, a borrower may say either that she took Start Printed Page 47922out the loan because of the unexpected expense, or that she took out the loan to cover regular expenses. Perhaps because of this difficulty, results across surveys are somewhat inconsistent, with one finding high levels of unexpected expenses, while others find that payday loans are used primarily to pay for regular expenses.

In a 2007 survey of payday borrowers, the most common reason cited for taking out a loan was “an unexpected expense that could not be postponed,” with 71 percent of respondents strongly agreeing with this reason and 16 percent somewhat agreeing.[450]

A 2012 survey of payday loan borrowers, on the other hand, found that 69 percent of respondents took their first payday loan to cover a recurring expense, such as utilities, rent, or credit card bills, and only 16 percent took their first loan for an unexpected expense.[451]

Another 2012 survey of over 1,100 users of alternative small-dollar credit products, including pawn, payday, auto title, deposit advance products, and non-bank installment loans, asked separate questions about what borrowers used the loan proceeds for and what precipitated the loan. Responses were reported for “very short term” and “short term” credit; very short term referred to payday, pawn, and deposit advance products. Respondents could report up to three reasons for what precipitated the loan; the most common reason given for very short term borrowing (approximately 37 percent of respondents) was “I had a bill or payment due before my paycheck arrived,” which the authors of the report on the survey results interpret as a mismatch in the timing of income and expenses. Unexpected expenses were cited by 30 percent of very short term borrowers, and approximately 27 percent reported unexpected drops in income. Approximately 34 percent reported that their general living expenses were consistently more than their income. Respondents could also report up to three uses for the funds; the most common answers related to paying for routine expenses, with over 40 percent reporting the funds were used to “pay utility bills,” over 40 percent reporting the funds were used to pay “general living expenses,” and over 20 percent saying the funds were used to pay rent. Of all the reasons for borrowing, consistent shortfalls in income relative to expenses was the response most highly correlated with consumers reporting repeated usage or rollovers.[452]

A recent survey of 768 online payday users drawn from a large administrative database of payday borrowers looked at similar questions, and compared the answers of heavy and light users of online loans.[453] Based on borrowers' self-reported borrowing history, borrowers were segmented into heavy users (users with borrowing frequency in the top quartile of the dataset) and light users (bottom quartile). Heavy users were much more likely to report that they “[i]n past three months, often or always ran out of money before the end of the month” (60 percent versus 34 percent). In addition, heavy users were nearly twice as likely as light users to state their primary reason for seeking their most recent payday loan as being to pay for “regular expenses such as utilities, car payment, credit card bill, or prescriptions” (49 percent versus 28 percent). Heavy users were less than half as likely as light users to state their reason as being to pay for an “unexpected expense or emergency” (21 percent versus 43 percent). Notably, 18 percent of heavy users gave as their primary reason for seeking a payday loan online that they “had a storefront loan, needed another [loan]” as compared to just over 1 percent of light users.

b. Lender Practices

The business model of lenders who make payday and single-payment vehicle title loans is predicated on the lenders' ability to secure extensive reborrowing. As described in the Background section, the typical storefront payday loan has a principal amount of $350, and the consumer pays a typical fee of 15 percent of the principal amount. That means that if a consumer takes out such a loan and repays the loan when it is due without reborrowing, the typical loan would produce roughly $50 in revenue to the lender. Lenders would thus require a large number of “one-and-done” consumers to cover their overhead and acquisition costs and generate profits. However, because lenders are able to induce a large percentage of borrowers to repeatedly reborrow, lenders have built a model in which the typical store has, as discussed in part II, two or three employees serving around 500 customers per year. Online lenders do not have the same overhead costs, but they have been willing to pay substantial acquisition costs to lead generators and to incur substantial fraud losses because of their ability to secure more than a single fee from their borrowers.

The Bureau uses the term “reborrow” to refer to situations in which consumers either roll over a loan (which means they pay a fee to defer payment of the principal for an additional period of time), or take out a new loan within a short period time following a previous loan. Reborrowing can occur concurrently with repayment in back-to-back transactions or can occur shortly thereafter. The Bureau believes that reborrowing often indicates that the previous loan was beyond the consumer's ability to repay and meet the consumer's other major financial obligations and basic living expenses. As discussed in more detail in the section-by-section analysis of proposed § 1041.6, the Bureau believes it is appropriate to consider loans to be reborrowings when the second loan is taken out within 30 days of the consumer being indebted on a previous loan. While the Bureau's 2014 Data Point used a 14-day period and the Small Business Review Panel Outline used a 60-day period, the Bureau is using a 30-day period in this proposal to align with consumer expense cycles, which are typically a month in length. This is designed to account for the fact that where repaying a loan causes a shortfall, the consumer may seek to return during the same expense cycle to get funds to cover downstream expenses. Unless otherwise noted, this section, Market Concerns—Short-Term Loans, uses a 30-day period to determine whether a loan is part of a loan sequence.

The majority of lending revenue earned by storefront payday lenders and lenders that make single-payment vehicle title loans comes from borrowers who reborrow multiple times and become enmeshed in long loan sequences. Based on the Bureau's data analysis, more than half of payday loans are in sequences that contain 10 loans or more.[454] Looking just at loans made to borrowers who are paid weekly, bi-weekly, or semi-monthly, approximately 21 percent of loans are in sequences that are 20 loans or longer.

As discussed below, the Bureau believes that both the short term and the single-payment structure of these loans contributes to the long sequences the Start Printed Page 47923borrowers take out. Various lender practices exacerbate the problem by marketing to borrowers who are particularly likely to wind up in long sequences of loans, by failing to screen out borrowers likely to wind up in long-term debt or to establish guardrails to avoid long-term indebtedness, and by actively encouraging borrowers to continue to roll over or reborrow.

1. Loan Structure

The single-payment structure and short duration of these loans makes them difficult to repay: within the space of a single income or expense cycle, a consumer with little to no savings cushion and who has borrowed to meet an unexpected expense or income shortfall, or who chronically runs short of funds, is unlikely to have the available cash needed to repay the full amount borrowed plus the finance charge on the loan when it is due and to cover other ongoing expenses. This is true for loans of a very short duration regardless of how the loan may be categorized. Loans of this type, as they exist in the market today, typically take the form of single-payment loans, including payday loans, and vehicle title loans, though other types of credit products are possible.[455] The focus of the Bureau's research has been on payday and vehicle title loans, so the discussion in Market Concerns—Short-Term Loans centers on those types of products.

The size of single-payment loan repayment amounts (measured as loan principal plus finance charges owed) relative to the borrower's next paycheck gives some sense of how difficult repayment may be. The Bureau's storefront payday loan data shows that the average borrower being paid on a bi-weekly basis would need to devote 37 percent of her bi-weekly paycheck to repaying the loan. Single-payment vehicle title borrowers face an even greater challenge. In the data analyzed by the Bureau, the median borrower's payment on a 30-day loan is equal to 49 percent of monthly income.[456]

2. Marketing

The general positioning of short-term products in marketing and advertising materials as a solution to an immediate liquidity challenge attracts consumers facing these problems, encouraging them to focus on short-term relief rather than the likelihood that they are taking on a new longer-term debt. Lenders position the purpose of the loan as being for use “until next payday” or to “tide over” the consumer until she receives her next paycheck.[457] These types of product characterizations encourage unrealistic, overly optimistic thinking that repaying the loan will be easy, that the cash short-fall will not recur at the time the loan is due or shortly thereafter, and that the typical payday loan is experienced by consumers as a short-term obligation, all of which lessen the risk in the consumer's mind that the loan will become a long-term debt cycle. Indeed, one study reporting consumer focus group feedback noted that some participants reported that the marketing made it seem like payday loans were “a way to get a cash infusion without creating an additional bill.” [458]

In addition to presenting loans as short-term solutions, rather than potentially long-term obligations, lender advertising often focuses on how quickly and easily consumers can obtain a loan. A recent academic paper reviewing the advertisements of Texas storefront and online payday and vehicle title lenders found that speed of getting a loan is the most frequently advertised feature in both online (100 percent) and storefront (50 percent) payday and title loans.[459] Advertising that focuses on immediacy and speed may exploit borrowers' sense of urgency. Indeed, the names of many payday and vehicle title lenders include the words (in different spellings) “speedy,” “cash,” “easy,” and “quick,” emphasizing their rapid and simple loan funding.

3. Failure To Assess Ability To Repay

As discussed in part II, storefront payday, online payday, and vehicle title lenders generally gather some basic information about borrowers before making a loan. They normally collect income information, although that may just be self-reported or “stated” income. Payday lenders collect information to ensure the borrower has a checking account, and vehicle title lenders need information about the vehicle that will provide the security for the loan. Some lenders access consumer reports prepared by specialty consumer reporting agencies and engage in sophisticated screening of applicants, and at least some lenders turn down the majority of applicants to whom they have not previously made loans.

One of the primary purposes of this screening, however, is to avoid fraud and other “first payment defaults,” not to ensure that borrowers will be able to repay the loan without reborrowing. These lenders generally do not obtain information about the borrower's existing obligations or living expenses and do not prevent those with expenses chronically exceeding income, or those Start Printed Page 47924who have suffered from an income or expense shock from which they need substantially more time to recover than the term of the loan, from taking on additional obligations in the form of payday or similar loans. Thus, lenders' failure to assess the borrower's ability to repay the loan permits those consumers who have the least ability to repay the loans, and consequently are the most likely to reborrow, to obtain them. Lending to borrowers who cannot repay their loans would generally not be profitable in a traditional lending market, but as described elsewhere in this section, the factors that funnel consumers into cycles of repeat reborrowing turn the traditional model on its head by creating incentives for lenders to actually want borrowers who cannot afford to repay and instead reborrow repeatedly. Although industry stakeholders have argued that lenders making short-term loans already take steps to assess “ability to repay” and will always do so out of economic self-interest, the Bureau believes that this refers narrowly to whether the consumer will default up front on the loan, rather than whether the consumer has the capacity to repay the loan without reborrowing and while meeting other financial obligations and basic living expenses. The fact that lenders often do not perform additional underwriting when borrowers are rolling over a loan or are returning to borrow again soon after repaying a prior loan further evidences that lenders do not see reborrowing as a sign of borrowers' financial distress or as an outcome to be avoided.

4. Encouraging Long Loan Sequences

After lenders attract borrowers in financial crisis, encourage them to think of the loans as a short-term solution, and fail to screen out those for whom the loans are likely to become a long-term debt cycle, lenders then actively encourage borrowers to reborrow and continue to be indebted rather than pay down or pay off their loans. Although storefront payday lenders typically take a post-dated check which could be presented in a manner timed to coincide with deposit of the borrower's paycheck or government benefits, lenders usually encourage or even require borrowers to come back to the store to redeem the check and pay in cash.[460] When the borrowers return, they are typically presented by lender employees with two salient options: Repay the loan in full, or pay a fee to roll over the loan (where permitted under State law). If the consumer does not return, the lender will proceed to attempt to collect by cashing the check. On a $300 loan at a typical charge of $15 per $100 borrowed, the cost to defer the due date for another 14 days until the next payday is $45, while repaying in full would cost $345, which may leave the borrower with insufficient remaining income to cover expenses over the ensuing month and therefore prompt reborrowing. Requiring repayment in person gives staff at the stores the opportunity to frame for borrowers a choice between repaying in full or just paying the finance charge and to encourage them to choose the less immediately painful option of paying just the finance charge. Based on its experience from supervising payday lenders, the Bureau believes that store employees are generally incentivized to maximize a store's loan volume and understand that reborrowing is crucial to achieving that goal.[461]

The Bureau's research shows that payday borrowers rarely reborrow a smaller amount than the initial loan, which would effectively amortize their loans by reducing the principal amount owed over time, thereby reducing their costs and the likelihood that they will need to take seven or ten loans out in a loan sequence. Lenders contribute to this outcome when they encourage borrowers to pay the minimum amount and roll over or reborrow the full amount of the earlier loan. In fact, as discussed in part II, some online payday loans automatically roll over at the end of the loan term unless the consumer takes affirmative action in advance of the due date such as notifying the lender in writing at least 3 days before the due date. Single-payment vehicle title borrowers, or at least those who ultimately repay rather than default, are more likely than payday borrowers to reduce the size of loans taken out in quick succession.[462] This may reflect the effects of State laws regulating vehicle title loans that require some reduction in loan size across a loan sequence. It may also be influenced by the larger median size of vehicle title loans, which is $694, as compared to $350 median loan size of payday loans.

Lenders also actively encourage borrowers who they know are struggling to repay their loans to roll over and continue to borrow. In supervisory examinations and in an enforcement action, the Bureau has found evidence that lenders maintain training materials that promote borrowing by struggling borrowers.[463] In the enforcement matter, the Bureau found that if a borrower did not repay in full or pay to roll over the loan on time, personnel would initiate collections. Store personnel or collectors would then offer new loans as a source of relief from the collections activities. This “cycle of debt” was depicted graphically as part of the standard “loan process” in the company's new hire training manual. The Bureau is aware of similar practices in the vehicle title lending market, where store employees offer borrowers additional cash during courtesy calls and when calling about past-due accounts, and company training materials instruct employees to “turn collections calls into sales calls” and encourage delinquent borrowers to refinance to avoid default and repossession of their vehicles.

It also appears that lenders do little to affirmatively promote the use of “off ramps” or other alternative repayment options, when those are required by law to be available. Such alternative repayment plans could help at least some borrowers avoid lengthy cycles of reborrowing. By discouraging the use of repayment plans, lenders can make it more likely that such consumers will instead reborrow. Lenders that are members of one of the two national trade associations for storefront payday lenders have agreed to offer an extended payment plan to borrowers but only if the borrower makes a request at least one day prior to the date on which the loan is due.[464] (The second national Start Printed Page 47925trade association reports that its members provide an extended payment plan option but details on that option are not available.) In addition, about 20 States require payday lenders to offer repayment plans to borrowers who encounter difficulty in repaying payday loans. The usage rate of these repayment plans varies widely but in all cases is relatively low.[465] One explanation for the low take-up rate on these repayment plans may be lender disparagement of the plans or lenders' failure to promote their availability.[466] The Bureau's supervisory examinations uncovered evidence that one or more payday lenders train employees not to mention repayment plans until after the employees have offered renewals, and only then to mention repayment plans if borrowers specifically ask about them.

5. Payment Mechanisms and Vehicle Title

Where lenders collect payments through post-dated checks, ACH authorizations, and/or obtain security interests in borrowers' vehicles, these mechanisms also can be used to encourage borrowers to reborrow to avoid negative consequences for their transportation or bank account. For example, consumers may feel significantly increased pressure to return to a storefront to roll over a payday or vehicle title loan that includes such features rather than risk suffering vehicle repossession or fees in connection with an attempt to deposit the consumer's post-dated check, such as an overdraft fee or an NSF fees from the bank and returned item fee from the lender if the check were to bounce. The pressure can be especially acute when the lender obtains vehicle security.

And in cases in which consumers do ultimately default on their loans, these mechanisms often increase the degree of harm suffered due to consumers losing their transportation, from account and lender fees, and sometimes from closure of their bank accounts. As discussed in more detail below in Market Concerns—Payments, in its research the Bureau has found that 36 percent of borrowers who took out online payday or payday installment loans and had at least one failed payment during an eighteen-month period had their checking accounts closed by the bank by the end of that period.[467]

c. Patterns of Lending and Extended Loan Sequences

The characteristics of the borrowers, the circumstances of borrowing, the structure of the short-term loans, and the practices of the lenders together lead to dramatic negative outcomes for many payday and vehicle title borrowers. There is strong evidence that a meaningful share of borrowers who take out payday and single-payment vehicle title loans end up with very long sequences of loans, and the loans made to borrowers with these negative outcomes make up a majority of all the loans made by these lenders.[468]

Long loan sequences lead to very high total costs of borrowing. Each single-payment loan carries the same cost as the initial loan that the borrower took out. For a storefront borrower who takes out the average-sized payday loan of $350 with a typical fee of $15 per $100, each reborrowing means paying fees of $45. After just three reborrowings, the borrower will have paid $140 simply to defer payment of the original principal amount by an additional six weeks to three months.

The cost of reborrowing for auto title borrowers is even more dramatic given the higher price and larger size of those loans. The Bureau's data indicates that the median loan size for single-payment vehicle title loans is $694. One study found that the most common APR charged on the typical 30-day title loan is 300 percent, which equates to a rate $25 per $100 borrowed, which is a common State limit.[469] A typical reborrowing thus means that the consumer pays a fee of around $175. After just three reborrowings, a consumer will typically have paid about $525 simply to defer payment of the original principal amount by three additional months.

Evidence for the prevalence of long sequences of payday and auto title loans comes from the Bureau's own work, from analysis by independent researchers and analysts commissioned by industry, and from statements by industry stakeholders. The Bureau has published several analyses of storefront payday loan borrowing.[470] Two of these have focused on the length of loan sequences that borrowers take out. In these publications, the Bureau defined a loan sequence as a series of loans where each loan was taken out either on the day the prior loan was repaid or within Start Printed Page 47926some number of days from when the loan was repaid. The Bureau's 2014 Data Point used a 14-day window to define a sequence of loans. That data has been further refined in the CFPB Report on Supplemental Findings and shows that when a borrower who is not currently in a loan sequence takes out a payday loan, borrowers wind up taking out at least four loans in a row before repaying 43 percent of the time, take out at least seven loans in a row before repaying 27 percent of the time, and take out at least 10 loans in a row before repaying 19 percent of the time.[471] In the CFPB Report on Supplemental Findings, the Bureau re-analyzed the data using 30-day and 60-day definitions of sequences. The results are similar, although using longer windows leads to longer sequences of more loans. Using the 30-day definition of a sequence, 50 percent of loan sequences contain at least four loans, 33 percent of sequences contain at least seven loans, and 24 percent of sequences contain at least 10 loans.[472] A borrower who takes out a fourth loan in a sequence has a 66 percent likelihood of taking out at least three more loans, of a total sequence length of seven loans, a 48 percent likelihood of taking out at least 6 more loans, for a total sequence length of 10 loans.[473]

These findings are mirrored in other analyses. During the SBREFA process, a SER submitted an analysis prepared by Charles River Associates (CRA) of loan data from several small storefront payday lenders.[474] Using a 60-day sequence definition, CRA found patterns of borrowing very similar to those the Bureau found. Compared to the Bureau's results using a 60-day sequence definition, in the CRA analysis there were more loans where the borrower defaulted on the first loan or repaid without reborrowing (roughly 44 percent versus 25 percent), and fewer loans that had 11 or more loans in the sequence, but otherwise the patterns were nearly identical.[475]

Similarly, in an analysis funded by an industry research organization, researchers found a mean sequence length, using a 30-day sequence definition, of nearly seven loans.[476] This is slightly higher than the mean 30-day sequence length in the Bureau's analysis (5.9 loans).

Analysis of a multi-lender, multi-year dataset by a research group affiliated with a specialty consumer reporting agency found that over a period of approximately four years the average borrower had at least one sequence of 9 loans; that 25 percent of borrowers had at least one loan sequence of 11 loans; and that 10 percent of borrowers had at least one loan sequence of 22 loans.[477] Looking at these same borrowers for a period of 11 months—one month longer than the duration analyzed by the Bureau—the researchers found that on average the longest sequence these borrowers experienced over the 11 months was 5.3 loans, that 25 percent of borrowers had a sequence of at least 7 loans, and that 10 percent of borrowers had a sequence of at least 12 loans.[478] This research group also identified a core of users with extremely persistent borrowing. They found that 30 percent of borrowers who took out a loan in the first month of the four-year period also took out a loan in the last month.[479] The median time in debt for this group of extremely persistent borrowers was over 1,000 days, more than half of the four-year period. The median borrower in this group of extremely persistent borrowers had at least one loan sequence of 23 loans long or longer (nearly two years for borrowers paid monthly). Perhaps most alarming, nine percent of this group borrowed continuously for the entire period.[480]

The Bureau has also analyzed single-payment vehicle title loans using the same basic methodology.[481] Using a 30-day definition of loan sequences, the Bureau found that short-term (30-day) single-payment vehicle title loans had loan sequences that were similar to payday loans. More than half, 56 percent, of single-payment vehicle title sequences contained at least four loans; 36 percent contained seven or more loans; and 23 percent had 10 or more loans. Other sources on vehicle title lending are more limited than for payday lending, but are generally consistent. For instance, the Tennessee Department of Financial Institutions publishes a biennial report on 30-day single-payment vehicle title loans. The most recent report shows very similar results to those the Bureau found in its research, with 49 percent of borrowers taking out four or more loans in row, 35 percent taking out more than seven loans in a row, and 25 percent taking out more than 10 loans in a row.[482]

In addition to direct measures of the length of loan sequences, there is ample indirect evidence from the cumulative number of loans that borrowers take out that borrowers are often getting stuck in a long-term debt cycle. The Bureau has measured total borrowing by payday borrowers in two ways. In one study, the Bureau took a snapshot of borrowers in lenders' portfolios at a point in time (measured as borrowing in a particular month) and tracked them for an additional 11 months (for a total of 12 months) to assess overall loan use. This Start Printed Page 47927study found that the median borrowing level was 10 loans over the course of a year, and more than half of the borrowers had loans outstanding for more than half of the year.[483] In another study, the Bureau measured the total number of loans taken out by borrowers beginning new loan sequences. It found that these borrowers had lower total borrowing than borrowers who may have been mid-sequence at the beginning of the period, but the median number of loans for the new borrowers was six loans over a slightly shorter (11-month) time period.[484] Research by others finds similar results, with average or median borrowing, using various data sources and various samples, of six to 13 loans per year.[485]

Given differences in the regulatory context and the overall nature of the market, less information is available on online lending than storefront lending. Borrowers who take out payday loans online are likely to change lenders more frequently than storefront borrowers, which makes measuring the duration of loan sequences much more challenging. The limited information that is available suggests that online borrowers take out fewer loans than storefront borrowers, but that borrowing is highly likely to be under-counted. A report commissioned by an online lender trade association, using data from three online lenders making single-payment payday loans, reported an average loan length of 20 days and average days in debt per year of 73 days.[486] The report combines medians of each statistic across the three lenders, making interpretation difficult, but these findings suggest that borrowers take out three to four loans per year at these lenders.

Additional analysis is available based on the records of a specialty consumer reporting agency. These show similar loans per borrower, 2.9, but over a multi-year period.[487] These loans, however, are not primarily single-payment payday loans. A small number are installment loans, while most are “hybrid” loans that typically have a duration of roughly four pay cycles. In addition, this statistic likely understates usage because online lenders may not report all of the loans they make, and some may only report the first loan they make to a borrower. Borrowers may also be more likely to change lenders online, and many lenders do not report to the specialty consumer reporting agency that provided the data for the analysis, so that when borrowers change lenders it may often be the case that their subsequent loans are not in the data analyzed.

d. Consumer Expectations and Understanding of Loan Sequences

Extended sequences of loans raise concerns about the market for short-term loans. This concern is exacerbated by the available empirical evidence regarding consumer understanding of such loans, which strongly indicates that borrowers who take out long sequences of payday loans and vehicle title loans do not anticipate those long sequences.

Measuring consumers' expectations about reborrowing is inherently challenging. When answering survey questions about loan repayment, there is the risk that borrowers may conflate repaying an individual loan with completing an extended sequence of borrowing. Asking borrowers retrospective questions about their expectations at the time they started borrowing is likely to suffer from recall problems, as people have difficulty remembering what they expected at some time in the past. The recall problem is likely to be compounded by respondents tending to want to avoid saying that they made a mistake. Asking about expectations for future borrowing may also be imperfect, as some consumers may not be thinking explicitly about how many times they will roll a loan over when taking out their first loan. Asking the question may cause people to think about it more than they otherwise would have.

Two studies have asked payday and vehicle title borrowers at the time they took out their loans about their expectations about reborrowing, either the behavior of the average borrower or their own borrowing, and compared their responses with actual repayment behavior of the overall borrower population. One 2009 survey of payday borrowers found that over 40 percent of borrowers thought that the average borrower would have a loan outstanding for only two weeks. Another 25 percent responded with four weeks. Translating weeks into loans, the four-week response likely reflects borrowers who believe the average number of loans a borrower take out before repaying is one loan or two loans, depending on the mix of respondents paid bi-weekly or monthly. The report did not provide data on actual reborrowing, but based on analysis by the Bureau and others, this suggests that respondents were, on average, somewhat optimistic about reborrowing behavior.[488] However, it is difficult to be certain that some survey respondents did not conflate the time loans are outstanding with the contract term of individual loans, because the researchers asked borrowers, “What's your best guess of how long it takes the average person to pay back in full a $300 payday loan?”, which some borrowers may have interpreted to refer to the specific loan being taken out, and not subsequent rollovers. Borrowers' beliefs about their own reborrowing behavior could also vary from their beliefs about average borrowing behavior by others.

In a study of vehicle title borrowers, researchers surveyed borrowers about their expectations about how long it would take to repay the loan.[489] The report did not have data on borrowing, but compared the responses with the distribution of repayment times reported by the Tennessee Department of Financial Institutions and found that Start Printed Page 47928borrowers were slightly optimistic, on average, in their predictions.[490]

The two studies just described compared borrowers' predictions of average borrowing with overall average borrowing levels, which is only informative about how accurate borrowers' predictions are on average. A 2014 study by Columbia University Professor Ronald Mann [491] surveyed borrowers at the point at which they were borrowing about their expectations for repaying their loans and compared their responses with their subsequent actual borrowing behavior, using loan records to measure how accurate their predictions were. The results described in Mann's report, combined with subsequent analysis that Professor Mann shared with Bureau staff, show the following.[492]

First, borrowers are very poor at predicting long sequences of loans. Fewer borrowers expected to experience long sequences of loans than actually did experience long sequences. Only 10 percent of borrowers expected to be in debt for more than 70 days (five two-week loans), and only five percent expected to be in debt for more than 110 days (roughly eight two-week) loan, yet the actual numbers were substantially higher. Indeed, approximately 12 percent of borrowers remained in debt after 200 days (14 two-week loans).[493] Borrowers who experienced long sequences of loans had not expected those long sequences when they made their initial borrowing decision; in fact they had not predicted that their sequences would be longer than borrowers overall. And while some borrowers did expect long sequences, those borrowers did not in fact actually have unusually long sequences; as Mann notes, “it appears that those who predict long borrowing periods are those most likely to err substantially in their predictions.” [494]

Second, Mann's analysis shows that many borrowers do not appear to learn from their past borrowing experience. Those who had borrowed the most in the past did not do a better job of predicting their future use; they were actually more likely to underestimate how long it would take them to repay fully. As Mann noted in his paper, “heavy users of the product tend to be those that understand least what is likely to happen to them.” [495]

Finally, Mann found that borrowers' predictions about the need to reborrow at least once versus not at all were optimistic, with 60 percent of borrowers predicting they would not roll over or reborrow within one pay cycle and only 40 percent actually not doing so.

A trade association commissioned two surveys which suggest that consumers are able to predict their borrowing patterns.[496] These surveys, which were very similar to each other, were of storefront payday borrowers who had recently repaid a loan and had not taken another loan within a specified period of time, and were conducted in 2013 and 2016. Of these borrowers, 94 to 96 percent reported that when they took out the loan they understood well or very well “how long it would take to completely repay the loan” and a similar percentage reported that they, in fact, were able to repay their loan in the amount of time they expected. These surveys suffers from the challenge of asking people to describe their expectations about borrowing at some time in the past, which may lead to recall problems, as described earlier. It is also unclear what the borrowers understood the phrase “completely repay” to mean—whether they took it to mean the specific loan they had recently repaid or the original loan that ultimately led to the loan they repaid. For these reasons, the Bureau does not believe that these studies undermine the evidence above indicating that consumers are generally not able to predict accurately the number of times that they will need to reborrow, particularly with respect to long-term reborrowing.

There are several factors that may contribute to consumers' lack of understanding of the risk of reborrowing that will result from loans that prove unaffordable. As explained above in the section on lender practices, there is a mismatch between how these products are marketed and described by industry and how they operate in practice. Although lenders present the loans as a temporary bridge option, only a minority of payday loans are repaid without any reborrowing. These loans often produce lengthy cycles of rollovers or new loans taken out shortly after the prior loans are repaid. Not surprisingly, many borrowers are not able to tell when they take out the first loan how long their cycles will last and how much they will ultimately pay for the initial disbursement of cash. Even borrowers who believe they will be unable to repay the loan immediately—and therefore expect some amount of reborrowing—are generally unable to predict accurately how many times they will reborrow and at what cost. As noted above, this is especially true for borrowers who reborrow many times.

Moreover, research suggests that financial distress could also be a factor in borrowers' decision making. As discussed above, payday and vehicle title loan borrowers are often in financial distress at the time they take out the loans. Their long-term financial condition is typically very poor. For example, as described above, studies find that both storefront and online payday borrowers have little to no savings and very low credit scores, which is a sign of overall poor financial condition. They may have credit cards but likely do not have unused credit, are often delinquent on one or more cards, and have often experienced multiple overdrafts and/or NSFs on their checking accounts.[497] They typically have tried and failed to obtain other forms of credit before turning to a payday lender or they otherwise may perceive that such other options would not be available to them and that there is no time to comparison shop when facing an imminent liquidity crisis.

Research has shown that when people are under pressure they tend to focus on Start Printed Page 47929the immediate problem they are confronting and discount other considerations, including the longer-term implications of their actions. Researchers sometimes refer to this phenomenon as “tunneling,” evoking the tunnel-vision decision making people can engage in. Consumers experiencing a financial crisis deciding on whether to take out a loan are a prime example of this behavior.[498] Even when consumers are not facing a crisis, research shows that they tend to underestimate their near-term expenditures,[499] and, when estimating how much financial “slack” they will have in the future, discount even the expenditures they do expect to incur.[500] Finally, regardless of their financial situation, research suggests consumers may generally have unrealistic expectations about their future earnings, their future expenses, and their ability to save money to repay future obligations. Research documents that consumers in many contexts demonstrate “optimism bias” about future events and their own future performance.[501]

Each of these behavioral biases, which are exacerbated when facing a financial crisis, contribute to consumers who are considering taking out a payday loan or single-payment vehicle title loan failing to assess accurately the likely duration of indebtedness, and, consequently, the total costs they will pay as a result of taking out the loan. Tunneling may cause consumers not to focus sufficiently on the future implications of taking out a loan. To the extent that consumers do comprehend what will happen when the loan comes due, underestimation of future expenditures and optimism bias will cause them to misunderstand the likelihood of repeated reborrowing due to their belief that they are more likely to be able to repay the loan without defaulting or reborrowing than they actually are. And consumers who recognize at origination that they will have difficulty paying back the loan and that they may need to roll the loan over or reborrow may still underestimate the likelihood that they will wind up rolling over or reborrowing multiple times and the high cost of doing so.

Regardless of the underlying explanation, the empirical evidence indicates that borrowers do not expect to be in very long sequences and are overly optimistic about the likelihood that they will avoid rolling over or reborrowing their loans at all.

e. Delinquency and Default

In addition to the harm caused by unanticipated loan sequences, the Bureau is concerned that many borrowers suffer other harms from unaffordable loans in the form of the costs that come from being delinquent or defaulting on the loans. Many borrowers, when faced with unaffordable payments, will be late in making loan payments, and may ultimately cease making payments altogether and default on their loans.[502] They may take out multiple loans before defaulting—69 percent of payday loan sequences that end in default are multi-loan sequences in which the borrower has rolled over or reborrowed at least once before defaulting—either because they are simply delaying the inevitable or because their financial situation deteriorates over time to the point where they become delinquent and eventually default rather than continuing to pay additional reborrowing fees.

While the Bureau is not aware of any data directly measuring the number of late payments across the industry, studies of what happens when payments are so late that the lenders deposit the consumers' original post-dated checks suggest that late payment rates are relatively high. For example, one study of payday borrowers in Texas found that in 10 percent of all loans, the post-dated checks were deposited and bounced.[503] Looking at the borrower level, the study found that half of all borrowers had a check deposited and bounce over the course of the year following their first payday loan.[504] An analysis of data collected in North Dakota showed a lower, but still high, rate of lenders depositing checks that subsequently bounced or attempting to collect loan payment via an ACH payment request that failed. It showed that 39 percent of new borrowers experienced a failed loan payment of this type in the year following their first payday loans, and 46 percent did so in the first two years following their first payday loan.[505] In a public filing, one large storefront payday lender reported a lower rate, 6.5 percent, of depositing checks, of which nearly two-thirds were returned for insufficient funds.[506] In Bureau analysis of ACH payments initiated by online payday and payday installment lenders, 50 percent of online borrowers had at least one overdraft or non-sufficient funds transaction in connection with their loans over an 18 month period. These borrowers' depository accounts incurred an average total of $185 in fees.[507]

Bounced checks and failed ACH payments can be quite costly for borrowers. The median bank NSF fee is $34,[508] which is equivalent to the cost of a rollover on a $300 storefront loan. If the lender makes repeated attempts to collect using these methods, this leads to repeated fees. The Bureau's research indicates that when one attempt fails, online payday lenders make a second attempt to collect 75 percent of the time but are unsuccessful in 70 percent of Start Printed Page 47930those cases. The failure rate increases with each subsequent attempt.[509]

In addition to incurring NSF fees from a bank, in many cases when a check bounces the consumer can be charged a returned check fee by the lender; late fees are restricted in some but not all States.[510]

Default can also be quite costly for borrowers. These costs vary with the type of loan and the channel through which the borrower took out the loan. As noted, default may come after a lender has made repeated attempts to collect from the borrower's deposit account, such that a borrower may ultimately find it necessary to close the account, or the borrower's bank or credit union may close the account if the balance is driven negative and the borrower is unable for an extended period of time to return the balance to positive. And borrowers of vehicle title loans stand to suffer the greatest harm from default, as it may lead to the repossession of their vehicle. In addition to the direct costs of the loss of an asset, this can seriously disrupt people's lives and put at risk their ability to remain employed.

Default rates on individual payday loans appear at first glance to be fairly low. This figure is three percent in the data the Bureau has analyzed.[511] But because so many borrowers respond to the unaffordability of these loans by reborrowing in sequences of loans rather than by defaulting immediately, a more meaningful measure of default is the share of loan sequences that end in default. The Bureau's data show that, using a 30-day sequence definition, 20 percent of loan sequences end in default. A recent report based on a multi-lender dataset showed similar results, with a 3 percent loan-level default rate and a 16 percent sequence-level default rate.[512]

Other researchers have found similarly high levels of default at the borrower level. One study of Texas borrowers found that 4.7 percent of loans were charged off, while 30 percent of borrowers had a loan charged off in their first year of borrowing.[513]

Default rates on single-payment vehicle title loans are higher than those on storefront payday loans. In the data analyzed by the Bureau, the default rate on all vehicle title loans is 6 percent, and the sequence-level default rate is 33 percent.[514] The Bureau's research suggests that title lenders repossess a vehicle slightly more than half the time when a borrower defaults on a loan. In the data the Bureau has analyzed, three percent of all single-payment vehicle title loans lead to repossession, which represents approximately 50 percent of loans on which the borrower defaulted. At the sequence level, 20 percent of sequences end with repossession. In other words, one in five borrowers is unable to escape debt without losing their car.

Borrowers of all types of covered loans are also likely to be subject to collection efforts. The Bureau observed in its consumer complaint data that from November 2013 through December 2015 approximately 24,000 debt collection complaints had payday loan as the underlying debt. More than 10 percent of the complaints the Bureau has received about debt collection stem from payday loans.[515] These collections efforts can include harmful and harassing conduct such as repeated phone calls from collectors to the borrower's home or place of work, as well as in-person visits to consumers' homes and worksites. Some of this conduct, depending on facts and circumstances, may be illegal. Aggressive calling to the borrower's workplace can put at risk the borrower's employment and jeopardize future earnings. Many of these practices can cause psychological distress and anxiety in borrowers who are already under financial pressure. In addition, the Bureau's enforcement and supervisory examination processes have uncovered evidence of numerous illegal collection practices by payday lenders. These include: Illegal third-party calls; false threats to add new fees; false threats of legal action or referral to a non-existent in-house “collections department”; and deceptive messages regarding non-existent “special promotions” to induce borrowers to return calls.[516]

Even if a vehicle title borrower does not have her vehicle repossessed, the threat of repossession in itself may cause harm to borrowers. It may cause them to forgo other essential expenditures in order to make the payment and avoid repossession.[517] And there may be psychological harm in addition to the stress associated with the possible loss of a vehicle. Lenders recognize that consumers often have a “pride of ownership” in their vehicle and, as discussed above in part II, one or more lenders exceed their maximum loan amount guidelines and consider the vehicle's sentimental or use value to the consumer when assessing the amount of funds they will lend.

The potential impacts of the loss of a vehicle depend on the transportation needs of the borrower's household and the available transportation alternatives. According to two surveys of vehicle title loan borrowers, 15 percent of all borrowers report that they would have no way to get to work or school if they lost their vehicle to repossession.[518] More than one-third (35 percent) of borrowers pledge the title to the only working vehicle in the household (Pew 2015). Even those with a second vehicle or the ability to get rides from friends or take public transportation would presumably experience significant inconvenience or even hardship from the loss of a vehicle.

The Bureau analyzed online payday and payday installments lenders' attempts to withdraw payments from borrowers' deposit accounts, and found that six percent of payment attempts Start Printed Page 47931that were not preceded by a failed payment attempt themselves fail.[519] An additional six percent succeed despite a lack of sufficient available funds in the borrower's account because the borrower's depository institution makes the payment as an overdraft, in which case the borrower was also likely charged a similar fee. Default rates are more difficult to determine, but 36 percent of checking accounts with failed online loan payments are subsequently closed. This provides a rough measure of default on these loans, but more importantly demonstrates the harm borrowers suffer in the process of defaulting on these loans.

The risk that they will default and the costs associated with default are likely to be under-appreciated by borrowers when obtaining a payday or vehicle title loan. Consumers are unlikely, when deciding whether to take out a loan, to be thinking about what will happen if they were to default or what it will take to avoid default. They may be overly focused on their immediate needs relative to the longer-term picture. The lender's marketing materials may have succeeded in convincing the consumer of the value of a loan to bridge until their next paycheck. Some of the remedies a lender might take, such as repeatedly attempting to collect from a borrower's checking account or using remotely created checks, may be unfamiliar to borrowers. Realizing that this is even a possibility would depend on the borrower investigating what would happen in the case of an event they do not expect to occur, such as a default.

f. Collateral Harms From Making Unaffordable Payments

In addition to the harms associated with delinquency and default, borrowers who take out these loans may experience other financial hardships as a result of making payments on unaffordable loans. These may arise if the borrower feels compelled to prioritize payment on the loan and does not wish to reborrow. This course may result in defaulting on other obligations or forgoing basic living expenses. If a lender has taken a security interest in the borrower's vehicle, for example, the borrower is likely to feel compelled to prioritize payments on the title loan over other bills or crucial expenditures because of the leverage that the threat of repossession gives to the lender.

The repayment mechanisms for other short-term loans can also cause borrowers to lose control over their own finances. If a lender has the ability to withdraw payment directly from a borrower's checking account, especially when the lender is able to time the withdrawal to align with the borrower's payday or the day the borrower receives periodic income, the borrower may lose control over the order in which payments are made and may be unable to choose to make essential expenditures before repaying the loan.

The Bureau is not able to directly observe the harms borrowers suffer from making unaffordable payments. The rates of reborrowing and default on these loans indicate that many borrowers do struggle to repay these loans, and it is therefore reasonable to infer that many borrowers are suffering harms from making unaffordable payments particularly where a leveraged payment mechanism and vehicle security strongly incentivize consumers to prioritize short-term loans over other expenses.

g. Harms Remain Under Existing Regulatory Approaches

Based on Bureau analysis and outreach, the harms the Bureau perceives from payday loans, single-payment vehicle title loans, and other short-term loans persist in these markets despite existing regulatory frameworks. In particular, the Bureau believes that existing regulatory frameworks in those States that have authorized payday and/or vehicle title lending have still left many consumers vulnerable to the specific harms discussed above relating to reborrowing, default, and collateral harms from making unaffordable payments.

Several different factors have complicated State efforts to effectively apply their regulatory frameworks to payday loans and other short-term loans. For example, lenders may adjust their product offerings or their licensing status to avoid State law restrictions, such as by shifting from payday loans to vehicle title or installment loans or open-end credit or by obtaining licenses under State mortgage lending laws.[520] States also have faced challenges in applying their laws to certain online lenders, including lenders claiming tribal affiliation or offshore lenders.[521]

As discussed above in part II, States have adopted a variety of different approaches for regulating payday loans and other short-term loans. For example, fourteen States and the District of Columbia have interest rate caps or other restrictions that, in effect, prohibit payday lending. Although consumers in these States may still be exposed to potential harms from short-term lending, such as online loans made by lenders that claim immunity from these State laws or from loans obtained in neighboring States, these provisions provide strong protections for consumers by substantially reducing their exposure to the harms from payday loans.

The 36 States that permit payday loans in some form have taken a variety of different approaches to regulating such loans. Some States have restrictions on rollovers or other reborrowing. Among other things, these restrictions may include caps on the total number of permissible loans in a given period, or cooling-off periods between loans. Some States prohibit a lender from making a payday loan to a borrower who already has an outstanding payday loan. Some States have adopted provisions with minimum income requirements. For example, some States provide that a payday loan cannot exceed a percentage (most commonly 25 percent) of a consumer's gross monthly income. Some State payday or vehicle title lending statutes require that the lender consider a consumer's ability to repay the loan, though none of them specify what steps lenders must take to determine whether the consumer has the ability to repay a loan. Some States require that consumers have the opportunity to repay a short-term loan through an extended payment plan over the course of a longer period of time. Additionally, some jurisdictions require lenders to provide specific disclosures to alert borrowers of potential risks.

While these provisions may have been designed to target some of the same or Start Printed Page 47932similar potential harms identified above, these provisions do not appear to have had a significant impact on reducing reborrowing and other harms that confront consumers of short-term loans. In particular, as discussed above, the Bureau's primary concern for payday loans and other short-term loans is that many consumers end up reborrowing over and over again, turning what was ostensibly a short-term loan into a long-term cycle of debt. The Bureau's analysis of borrowing patterns in different States that permit payday loans indicates that most States have very similar rates of reborrowing, with about 80 percent of loans followed by another loan within 30 days, regardless of the restrictions that are in place.[522] In particular, laws that prevent direct rollovers of loans, as well as laws that impose short cooling-off periods between loans, such as Florida's prohibition on same-day reborrowing, have very little impact on reborrowing rates measured over periods longer than one day. The 30-day reborrowing rate in all States that prohibit rollovers is 80 percent, and in Florida the rate is 89 percent. Several States, however, do stand out as having substantially lower reborrowing rates than other States. These include Washington, which limits borrowers to no more than eight loans in a rolling 12-month period and has a 30-day reborrowing rate of 63 percent, and Virginia, which imposes a minimum loan length of two pay periods and imposes a 45-day cooling off period once a borrower has had [five] loans in a rolling six-month period, and has a 30-day reborrowing rate of 61 percent.

Likewise, the Bureau believes that disclosures are insufficient to adequately reduce the harm that consumers suffer when lenders do not determine consumers' ability to repay, for two primary reasons.[523] First, disclosures do not address the underlying incentives in this market for lenders to encourage borrowers to reborrow and take out long sequences of loans. As discussed above, the prevailing business model in the short-term loan market involves lenders deriving a very high percentage of their revenues from long loan sequences. While enhanced disclosures would provide additional information to consumers, the Bureau believes that the loans would remain unaffordable for most consumers, lenders would have no greater incentive to underwrite more rigorously, and lenders would remain dependent on long-term loan sequences for revenues.

Second, empirical evidence suggests that disclosures have only modest impacts on consumer borrowing patterns for short-term loans generally and negligible impacts on whether consumers reborrow. Evidence from a field trial of several disclosures designed specifically to warn of the risks of reborrowing and the costs of reborrowing showed that these disclosures had a marginal effect on the total volume of payday borrowing.[524] Analysis by the Bureau of similar disclosures implemented by the State of Texas showed a reduction in loan volume of 13 percent after the disclosure requirement went into effect, relative to the loan volume changes for the study period in comparison States.[525] The Bureau believes these findings confirm the limited magnitude of the impacts from the field trial. In addition, analysis by the Bureau of the impacts of the disclosures in Texas shows that the probability of reborrowing on a payday loan declined by only approximately 2 percent once the disclosure was put in place. Together, these findings indicate that high levels of reborrowing and long sequences of payday loans remain a significant source of consumer harm even after a disclosure regime is put into place. Further, as discussed above in Market Concerns—Short-Term Loans, the Bureau has observed that consumers have a very high probability of winding up in a very long sequence once they have taken out only a few loans in a row.[526] The contrast of the very high likelihood that a consumer will wind up in a long-term debt cycle after taking out only a few loans with the near negligible impact of a disclosure on consumer reborrowing patterns provides further evidence of the insufficiency of disclosures to address what the Bureau believes are the core harms to consumers in this credit market.

During the SBREFA process, many of the SERs urged the Bureau to reconsider the proposals under consideration and defer to existing regulation of these credit markets by the States or to model Federal regulation on the laws or regulations of certain States. In the Small Business Review Panel Report, the Panel recommended that the Bureau continue to consider whether regulations in place at the State level are sufficient to address concerns about unaffordable loan payments and that the Bureau consider whether existing State laws and regulations could provide a model for elements of the Federal regulation. The Bureau has examined State laws closely in connection with preparing the proposed rule, as discussed in part II. Moreover, based on the Bureau's data analysis as noted above, the regulatory frameworks in most States do not appear to have had a significant impact on reducing reborrowing and other harms that confront consumers of short-term loans. For these and the other reasons discussed in Market Concerns—Short-Term Loans, the Bureau believes that Federal intervention in these markets is warranted at this time.

Section 1041.4 Identification of Abusive and Unfair Practice—Short-Term Loans

In most consumer lending markets, it is standard practice for lenders to assess whether a consumer has the ability to repay a loan before making the loan. In certain markets, Federal law requires this.[527] The Bureau has not determined whether, as a general rule, it is an unfair or abusive practice for any lender to make a loan without making such a determination. Nor is the Bureau proposing to resolve that question in this rulemaking. Rather, the focus of Subpart B of this proposed rule is on a specific set of loans which the Bureau has carefully studied, as discussed in more detail in part II and Market Concerns—Short-Term Loans. Based on the evidence described in part II and Market Concerns—Short-Term Loans, and pursuant to its authority under section 1031(b) of the Dodd-Frank Act, Start Printed Page 47933the Bureau is proposing in § 1041.4 to identify it as both an abusive and an unfair act or practice for a lender to make a covered short-term loan without reasonably determining that the consumer has the ability to repay the loan. “Ability to repay” in this context means that the consumer has the ability to repay the loan without reborrowing and while meeting the consumer's major financial obligations and basic living expenses. The Bureau's preliminary findings with regard to abusiveness and unfairness are discussed separately below. The Bureau is making these preliminary findings based on the specific evidence cited below in the section-by-section analysis of proposed § 1041.4, as well as the evidence discussed in part II and Market Concerns—Short-Term Loans.

Abusiveness

Under § 1031(d)(2)(A) and (B) of the Dodd-Frank Act, the Bureau may find an act or practice to be abusive in connection with a consumer financial product or service if the act or practice takes unreasonable advantage of (A) a lack of understanding on the part of the consumer of the material risks, costs, or conditions of the product or service or of (B) the inability of the consumer to protect the interests of the consumer in selecting or using a consumer financial product or service. It appears to the Bureau that consumers generally do not understand the material risks and costs of taking out a payday, vehicle title, or other short-term loan, and further lack the ability to protect their interests in selecting or using such loans. It also appears to the Bureau that lenders take unreasonable advantage of these consumer vulnerabilities by making loans of this type without reasonably determining that the consumer has the ability to repay the loan.

Consumers Lack an Understanding of Material Risks and Costs

As discussed in Market Concerns—Short-Term Loans, short-term payday and vehicle title loans can and frequently do lead to a number of negative consequences for consumers, which range from extensive reborrowing to defaulting to being unable to pay other obligations or basic living expenses as a result of making an unaffordable payment. All of these—including the direct costs that may be payable to lenders and the collateral consequences that may flow from the loans—are risks or costs of these loans, as the Bureau understands and reasonably interprets that phrase.

The Bureau recognizes that consumers who take out a payday, vehicle title, or other short-term loan understand that they are incurring a debt which must be repaid within a prescribed period of time and that if they are unable to do so, they will either have to make other arrangements or suffer adverse consequences. The Bureau does not believe, however, that such a generalized understanding suffices to establish that consumers understand the material costs and risks of these products. Rather, the Bureau believes that it is reasonable to interpret “understanding” in this context to mean more than a mere awareness that it is within the realm of possibility that a particular negative consequence may follow or cost may be incurred as a result of using the product. For example, consumers may not understand that a risk is very likely to materialize or that—though relatively rare—the impact of a particular risk would be severe.

As discussed above in Market Concerns—Short-Term Loans, the single largest risk to a consumer of taking out a payday, vehicle title, or similar short-term loan is that the initial loan will lead to an extended cycle of indebtedness. This occurs in large part because the structure of the loan usually requires the consumer to make a lump-sum payment within a short period of time, typically two weeks, or a month, which would absorb such a large share of the consumer's disposable income as to leave the consumer unable to pay the consumer's major financial obligations and basic living expenses. Additionally, in States where it is permitted, lenders often offer borrowers the enticing, but ultimately costly, alternative of paying a smaller fee (such as 15 percent of the principal) and rolling over the loan or making back-to-back repayment and reborrowing transactions rather than repaying the loan in full—and many borrowers choose this option. Alternatively, borrowers may repay the loan in full when due but find it necessary to take out another loan a short time later because the large amount of cash needed to repay the first loan relative to their income leaves them without sufficient funds to meet their other obligations and expenses. This cycle of indebtedness affects a large segment of borrowers: As described in Market Concerns—Short-Term Loans, 50 percent of storefront payday loan sequences contain at least four loans. One-third contain seven loans or more, by which point consumers will have paid charges equal to 100 percent of the amount borrowed and still owe the full amount of the principal. Almost one-quarter of loan sequences contain at least 10 loans in a row. And looking just at loans made to borrowers who are paid weekly, biweekly, or semi-monthly, 21 percent of loans are in sequences consisting of at least 20 loans. For loans made to borrowers who are paid monthly, 46 percent of loans are in sequences consisting of at least 10 loans.

The evidence summarized in Market Concerns—Short-Term Loans also shows that consumers who take out these loans typically appear not to understand when they first take out a loan how long they are likely to remain in debt and how costly that will be for them. Payday borrowers tend to overestimate their likelihood of repaying without reborrowing and underestimate the likelihood that they will end up in an extended loan sequence. For example, one study found that while 60 percent of borrowers predict they would not roll over or reborrow their payday loan, only 40 percent actually did not roll over or reborrow. The same study found that consumers who end up reborrowing numerous times—i.e., the consumers who suffer the most harm—are particularly bad at predicting the number of times they will need to reborrow. Thus, many consumers who expected to be in debt only a short amount of time can find themselves in a months-long cycle of indebtedness, paying hundreds of dollars in fees above what they expected while struggling to repay the original loan amount.

The Bureau has observed similar outcomes for borrowers of single-payment vehicle title loans. For example, 83 percent of vehicle title loans being reborrowed on the same day that a previous loan was due, and 85 percent of vehicle title loans are reborrowed within 30 days of a previous vehicle title loan. Fifty-six percent of vehicle title loan sequences consist of more than three loans, 36 percent consist of at least seven loans, and almost one quarter—23 percent—consist of more than 10 loans. While there is no comparable research on the expectations of vehicle title borrowers, the Bureau believes that the research in the payday context can be extrapolated to these other products given the significant similarities in the product structures, the characteristics of the borrowers, and the outcomes borrowers experience, as detailed in part II and Market Concerns—Short-Term Loans.

Consumers are also exposed to other material risks and costs in connection with covered short-term loans. As discussed in more detail in Market Concerns—Short-Term Loans, the unaffordability of the payments for Start Printed Page 47934many consumers creates a substantial risk of default. Indeed, 20 percent of payday loan sequences and 33 percent of title loan sequences end in default. And 69 percent of payday loan defaults occur in loan sequences in which the consumer reborrows at least once. For a payday borrower, the cost of default generally includes the cost of at least one, and often multiple, NSF fees assessed by the borrower's bank when the lender attempts to cash the borrower's postdated check or debit the consumer's account via ACH transfer and the attempt fails. NSFs are associated with a high rate of bank account closures. Defaults also often expose consumers to aggressive debt collection activities by the lender or a third-party debt collector. The consequences of default can be even more dire for a vehicle title borrower, including the loss of the consumer's vehicle—which is the result in 20 percent of single-payment vehicle title loan sequences.

The Bureau does not believe that many consumers who take out payday, vehicle title, or other short-term loans understand the magnitude of these additional risks—for example, that they have at least a one in five (or for auto title borrowers a one in three) chance of defaulting. Nor are payday borrowers likely to factor into their decision on whether to take out the loan the many collateral consequences of default, including expensive bank fees, aggressive collections, or the costs of having to get to work or otherwise from place to place if their vehicle is repossessed.

As discussed in Market Concerns—Short-Term Loans, several factors can impede consumers' understanding of the material risks and costs of payday, vehicle title, and other short-term loans. To begin with, there is a mismatch between how these loans are structured and how they operate in practice. Although the loans are presented as standalone short-term products, only a minority of payday loans are repaid without any reborrowing. These loans often instead produce lengthy cycles of rollovers or new loans taken out shortly after the prior loans are repaid. Empirical evidence shows that consumers are not able to accurately predict how many times they will reborrow, and thus are not able to tell when they take out the first loan how long their cycles will last and how much they will ultimately pay for the initial disbursement of loan proceeds. Even consumers who believe they will be unable to repay the loan immediately and therefore expect some amount of reborrowing are generally unable to predict accurately how many times they will reborrow and at what cost. This is especially true for consumers who reborrow many times.

In addition, consumers in extreme financial distress tend to focus on their immediate liquidity needs rather than potential future costs in a way that makes them particularly susceptible to lender marketing, and payday and vehicle title lenders often emphasize the speed with which the lender will provide funds to the consumer.[528] In fact, numerous lenders select company names that emphasize rapid loan funding. But there is a substantial disparity between how these loans are marketed by lenders and how they are actually experienced by many consumers. While covered short-term loans are marketed as short-duration loans intended for short-term or emergency use only,[529] a substantial percentage of consumers do not repay the loan quickly and thus either default, or, in a majority of the cases, reborrow—often many times. Moreover, consumers who take out covered short-term loans may be overly optimistic about their future cash flow. Such incorrect expectations may lead consumers to misunderstand whether they will have the ability to repay the loan, or to expect that they will be able to repay it after reborrowing only a few times. These consumers may find themselves caught in a cycle of reborrowing that is both very costly and very difficult to escape.

Consumer Inability to Protect Interests

Under section 1031(d)(2)(B) of the Dodd-Frank Act, an act or practice is abusive if it takes unreasonable advantage of the inability of the consumer to protect the interests of the consumer in selecting or using a consumer financial product or service. Consumers who lack an understanding of the material risks and costs of a consumer financial product or service often will also lack the ability to protect their interests in selecting or using that consumer financial product or service. For instance, as discussed above, the Bureau believes that consumers are unlikely to be able to protect their interests in selecting or using payday, vehicle title, and other short-term loans because they do not understand the material risks and costs associated with these products.

But it is reasonable to also conclude from the structure of section 1031(d), which separately declares it abusive to take unreasonable advantage of consumer lack of understanding or of consumers' inability to protect their interests in using or selecting a product or service that, in some circumstances, consumers may understand the risks and costs of a product, but nonetheless be unable to protect their interests in selecting or using the product. The Bureau believes that consumers who take out an initial payday loan, vehicle title loan, or other short-term loan may be unable to protect their interests in selecting or using such loans, given their immediate need for credit and their inability in the moment to search out or develop alternatives that would either enable them to avoid the need to borrow or to borrow on terms that are within their ability to repay.

As discussed in Market Concerns—Short-Term Loans, consumers who take out payday or short-term vehicle title loans typically have exhausted other sources of credit such as their credit card(s). In the months leading up to their liquidity shortfall, they typically have tried and failed to obtain other forms of credit. Their need is immediate. Moreover, consumers facing an immediate liquidity shortfall may believe that a short-term loan is their only choice; one study found that 37 percent of borrowers say they have been in such a difficult financial situation that they would take a payday loan on any terms offered.[530] They may not have the time or other resources to seek out, develop, or take advantage of alternatives. These factors may place consumers in such a vulnerable position when seeking out and taking these loans that they are potentially unable to protect their interests.

The Bureau also believes that once consumers have commenced a loan sequence they may be unable to protect their interests in the selection or use of subsequent loans. After the initial loan in a sequence has been consummated, the consumer is legally obligated to repay the debt. Consumers who do not have the ability to repay that initial loan are faced with making a choice among three bad options: They can either default on the loan, skip or delay payments on major financial obligations or living expenses in order to repay the Start Printed Page 47935loan, or, as is most often the case, take out another loan and soon face the same predicament again. At that point, at least some consumers may gain a fuller awareness of the risks and costs of this type of loan,[531] but by then it may be too late for the consumer to be able to protect her interests. Each of these choices results in increased costs to consumers—often very high and unexpected costs—which harm consumers' interests. An unaffordable first loan can thus ensnare consumers in a cycle of debt from which consumers have no reasonable means to extricate themselves, rendering them unable to protect their interests in selecting or using covered short-term loans.

Practice Takes Unreasonable Advantage of Consumer Vulnerabilities

Under section 1031(d)(2) of the Dodd-Frank Act, a practice is abusive if it takes unreasonable advantage of consumers' lack of understanding or inability to protect their interests. The Bureau believes that the lender practice of making covered short-term loans without determining that the consumer has the ability to repay may take unreasonable advantage both of consumers' lack of understanding of the material risks, costs, and conditions of such loans, and consumers' inability to protect their interests in selecting or using the loans.

The Bureau recognizes that in any transaction involving a consumer financial product or service there is likely to be some information asymmetry between the consumer and the financial institution. Often, the financial institution will have superior bargaining power as well. Section 1031(d) of the Dodd-Frank Act does not prohibit financial institutions from taking advantage of their superior knowledge or bargaining power to maximize their profit. Indeed, in a market economy, market participants with such advantages generally pursue their self-interests. However, section 1031 of the Dodd-Frank Act makes plain that there comes a point at which a financial institution's conduct in leveraging its superior information or bargaining power becomes unreasonable advantage-taking and thus is abusive.[532]

The Dodd-Frank Act delegates to the Bureau the responsibility for determining when that line has been crossed. The Bureau believes that such determinations are best made with respect to any particular act or practice by taking into account all of the facts and circumstances that are relevant to assessing whether such an act or practice takes unreasonable advantage of consumers' lack of understanding or of consumers' inability to protect their interests. Several interrelated considerations lead the Bureau to believe that the practice of making payday, vehicle title, and other short-term loans without regard to the consumer's ability to repay may cross the line and take unreasonable advantage of consumers' lack of understanding and inability to protect their interests.

The Bureau first notes that the practice of making loans without regard to the consumer's ability to repay stands in stark contrast to the practice of lenders in virtually every other credit market, and upends traditional notions of responsible lending enshrined in safety-and-soundness principles as well as in a number of other laws.[533] The general presupposition of credit markets is that the interests of lenders and borrowers are closely aligned: lenders succeed (i.e., profit) only when consumers succeed (i.e., repay their loan according to its terms). For example, lenders in other markets, including other subprime lenders, typically do not make loans without first making an assessment that consumers have the capacity to repay the loan according to the loan terms. Indeed, “capacity” is one of the traditional three “Cs” of lending and is often embodied in tests that look at debt as a proportion of the consumer's income or at the consumer's residual income after repaying the debt.

In the markets for payday, vehicle title, and similar short-term loans, however, lenders have built a business model that—unbeknownst to borrowers—depends upon the consumer's lack of capacity to repay such loans without needing to reborrow. As explained above, the costs of maintaining business operations (which include customer acquisition costs and overhead expenses) often exceed the revenue that could be generated from making individual short-term loans that are repaid without reborrowing. Thus, lenders' business model depends upon a substantial percentage of consumers not being able to repay their loans when due and, instead, taking out multiple additional loans in quick succession. Indeed, upwards of half of all payday and single-payment vehicle title loans are made to—and an even higher percentage of revenue is derived from—borrowers in a sequence of ten loans or more. This dependency on revenue from long-term debt cycles has been acknowledged by industry stakeholders. For example, as noted in Market Concerns—Short-Term Loans, an attorney for a national trade association representing storefront payday lenders asserted in a letter to the Bureau that, “[i]n any large, mature payday loan portfolio, loans to repeat borrowers generally constitute between 70 and 90 percent of the portfolio, and for some lenders, even more.”

Also relevant in assessing whether the practice at issue here involves unreasonable advantage-taking is the vulnerability of the consumers seeking these types of loans. As discussed in Market Concerns—Short-Term Loans, payday and vehicle title borrowers—and by extension borrowers of similar short-term loans—generally have modest incomes, little or no savings, and have tried and failed to obtain other forms of credit. They generally turn to these products in times of need as a “last resort,” and when the loan comes due and threatens to take a large portion of their income, their situation becomes, if anything, even more desperate.

In addition, the evidence described in Market Concerns—Short-Term Loans suggests that lenders engage in practices that further exacerbate the risks and costs to the interests of consumers. Lenders market these loans as being for use “until next payday” or to “tide over” consumers until they receive income, thus encouraging overly optimistic thinking about how the consumer is likely to use the product. Lender advertising also focuses on immediacy and speed, which may increase consumers' existing sense of urgency. Lenders make an initial short-term loan and then roll over or make new loans to consumers in close proximity to the prior loan, compounding the consumer's initial inability to repay. Lenders make this reborrowing option easy and salient to consumers in comparison to repayment Start Printed Page 47936of the full loan principal. Moreover, lenders do not appear to encourage borrowers to reduce the outstanding principal over the course of a loan sequence, which would help consumers extricate themselves from the cycle of indebtedness more quickly and reduce their costs from reborrowing. Storefront lenders in particular encourage loan sequences because they encourage or require consumers to repay in person in an effort to frame the consumer's experience in a way to encourage reborrowing. Lenders often give financial incentives to employees to reward maximizing loan volume.

By not determining that consumers have the ability to repay their loans, lenders potentially take unreasonable advantage of a lack of understanding on the part of the consumer of the material risks of those loans and of the inability of the consumer to protect the interests of the consumer in selecting or using those loans.

Unfairness

Under section 1031(c)(1) of the Dodd-Frank Act, an act or practice is unfair if it causes or is likely to cause substantial injury to consumers which is not reasonably avoidably by consumers and such injury is not outweighed by countervailing benefits to consumers or to competition. Under section 1031(c)(2), the Bureau may consider established public policies as evidence in making this determination. The Bureau believes that it may be an unfair act or practice for a lender to make a covered short-term loan without reasonably determining that the consumer has the ability to repay the loan.

Practice Causes or Is Likely To Cause Substantial Injury

As noted in part IV, the Bureau's interpretation of the various prongs of the unfairness test is informed by the FTC Act, the FTC Policy Statement on Unfairness, and FTC and other Federal agency rulemakings and related case law.[534] Under these authorities, as discussed in part IV, substantial injury may consist of a small amount of harm to a large number of individuals or a larger amount of harm to a smaller number of individuals. In this case, the practice at issue causes or is likely to cause both—a substantial number of consumers suffer a high degree of harm, and a large number of consumers suffer a lower but still meaningful degree of harm.

The Bureau believes that the practice of making a covered short-term loan without assessing the consumer's ability to repay may cause or be likely to cause substantial injury. When a loan is structured to require repayment within a short period of time, the payments may outstrip the consumer's ability to repay since the type of consumers who turn to these products cannot absorb large loan payments on top of their major financial obligations and basic living expenses. If a lender nonetheless makes such loans without determining that the loan payments are within the consumer's ability to repay, then it appears the lender's conduct causes or is likely to cause the injuries described below.

In the aggregate, the consumers who suffer the greatest injury are those consumers who have exceedingly long loan sequences. As discussed above in Market Concerns—Short-Term Loans, consumers who become trapped in long loan sequences pay substantial fees for reborrowing, and they usually do not reduce the principal amount owed when they reborrow. For example, roughly half of payday loan sequences consist of at least three rollovers, at which point, in a typical two-week loan, a storefront payday borrower will have paid over a period of eight weeks charges equal to 60 percent or more of the loan amount—and will still owe the full amount borrowed. Roughly one-third of consumers roll over or renew their loan at least six times, which means that, after three and a half months with a typical two-week loan, the consumer will have paid to the lender a sum equal to 100 percent of the loan amount and made no progress in repaying the principal. Almost one-quarter of loan sequences consist of at least 10 loans in a row, and 50 percent of all loans are in sequences of 10 loans or more. And looking just at loans made to borrowers who are paid weekly, biweekly, or semi-monthly, approximately 21 percent of loans are in sequences consisting of at least 20 loans. For loans made to borrowers who are paid monthly, 42 percent of loans are in sequences consisting of at least 10 loans. In many instances, such consumers also incur bank penalty fees (such as NSF fees) and lender penalty fees (such as late fees and/or returned check fees) before rolling over a loan. Similarly, for vehicle title loans, the Bureau found that more than half, 56 percent, of single-payment vehicle title sequences consist of at least four loans in a row; over a third, 36 percent, consist of seven or more loans in a row; and 23 percent had 10 or more loans.

Moreover, consumers whose loan sequences are shorter may still suffer meaningful injury from reborrowing beyond expected levels, albeit to a lesser degree than those in longer sequences. Even a consumer who reborrows only once or twice—and, as described in Market Concerns—Short-Term Loans, 22 percent of payday and 23 percent of vehicle title loan sequences show this pattern—will still incur substantial costs related to reborrowing or rolling over the loans.

The injuries resulting from default on these loans also appear to be significant in magnitude. As described in section Market Concerns—Short-Term Loans, 20 percent of payday loan sequences end in default, while 33 percent of vehicle title sequences end in default. Because short-term loans (other than vehicle title loans) are usually accompanied by some means of payment collection—typically a postdated check for storefront payday loans and an authorization to submit electronic debits to the consumer's account for online payday loans—a default means that the lender was unable to secure payment despite using those tools. That means that a default is preceded by failed payment withdrawal attempts which generate bank fees (such as NSF fees), that can put the consumer's account at risk and lender fees (such as late fees or returned check fees) which add to the consumer's Start Printed Page 47937indebtedness. Additionally, as discussed in Market Concerns—Short-Term Loans, where lenders' attempts to extract money directly from the consumer's account fails, the lender often will resort to other collection techniques, some of which—such as repeated phone calls, in-person visits to homes and worksites, and lawsuits leading to wage garnishments—can inflict significant financial and psychological damage on consumers.[535]

For consumers with a short-term vehicle title loan, the injury from default can be even greater. In such cases lenders do not have access to the consumers' bank account but instead have the ability to repossess the consumer's vehicle. As discussed above, almost one in five vehicle title loan sequences end with the consumer's vehicle being repossessed. Consumers whose vehicles are repossessed may end up either wholly dependent upon public transportation, or family, or friends to get to work, to shop, or to attend to personal needs, or in many areas of the country without any effective means of transportation at all.

Moreover, the Bureau believes that many consumers, regardless of whether they ultimately manage to pay off the loan, suffer collateral consequences as they struggle to make payments that are beyond their ability to repay. For instance, they may be unable to meet their other major financial obligations or be forced to forgo basic living expenses as a result of prioritizing a loan payment and other loan charges—or having it prioritized for them by the lender's exercise of its leveraged payment mechanism.

Injury Not Reasonably Avoidable

As previously noted in part IV, under the FTC Act unfairness standard, the FTC Policy Statement on Unfairness, FTC and other Federal agency rulemakings, and related case law, which inform the Bureau's interpretation and application of the unfairness test, an injury is not reasonably avoidable where “some form of seller behavior . . . unreasonably creates or takes advantage of an obstacle to the free exercise of consumer decision-making,” [536] or, put another way, unless consumers have reason to anticipate the injury and the means to avoid it. It appears that, in a significant proportion of cases, consumers are unable to reasonably avoid the substantial injuries caused or likely to be caused by the identified practice. Prior to entering into a payday, vehicle title, or other short-term loan, consumers are unable to reasonably anticipate the likelihood and severity of injuries that frequently results from such loans, and after entering into the loan, consumers do not have the means to avoid the injuries that may result should the loan prove unaffordable.

As discussed above in Market Concerns—Short-Term Loans, a confluence of factors creates obstacles to the free exercise of consumers' decision-making, preventing them from reasonably avoiding injury caused by unaffordable short-term loans. Such loans involve a basic mismatch between how they appear to function as short term credit and how they are actually designed to function in long sequences of reborrowing. Lenders present short-term loans as short-term, liquidity-enhancing products that consumers can use to bridge an income shortfall until their next paycheck. But in practice, these loans often do not operate that way. The disparity between how these loans appear to function and how they actually function creates difficulties for consumers in estimating with any accuracy how long they will remain in debt and how much they will ultimately pay for the initial extension of credit. Consumer predictions are often overly optimistic, and consumers who experience long sequences of loans often do not expect those long sequences when they make their initial borrowing decision. As detailed in Market Concerns—Short-Term Loans, empirical evidence demonstrates that consumer predictions of how long the loan sequence will last tend to be inaccurate, with many consumers underestimating the length of their loan sequence. Consumers are particularly poor at predicting long sequences of loans, and many do not appear to improve the accuracy of their predictions as a result of past borrowing experience.[537]

Likewise, consumers are unable to reasonably anticipate the likelihood and severity of the consequences of being unable to repay the loan. The consequences include, for example, the risk of accumulating numerous penalty fees on their bank account and on their loan, and the risk that their vehicle will be repossessed, leading to numerous direct and indirect costs. The typical consumer does not have the information to understand the frequency with which these adverse consequences do occur or the likelihood of such consequences befalling a typical consumer of such a loan.

In analyzing reasonable avoidability under the FTC Act unfairness standard, the Bureau notes that the FTC and other agencies have at times focused on factors such as the vulnerability of affected consumers,[538] as well as those consumers' perception of the availability of alternative products.[539] Likewise, the Bureau believes that the substantial injury from short-term loans may not be reasonably avoidable in part because of the consumers' precarious financial situation at the time they borrow and their reasonable belief that searching for alternatives will be fruitless and costly. As discussed in part Market Concerns—Short-Term Loans, consumers who take out payday or short-term vehicle title loans typically have tried and failed to obtain other forms of credit before turning to these Start Printed Page 47938loans as a “last resort.” Thus, based on their prior negative experience with attempting to obtain credit, they may reasonably perceive that alternative options would not be available. Consumers facing an imminent liquidity crisis may also reasonably believe that their situation is so dire that they do not have time to shop for alternatives and that doing so could prove costly.

Not only are consumers unable to reasonably anticipate potential harms before entering into a payday, vehicle title, or other short-term loan, once they have entered into a loan, they do not have the means to avoid the injuries should the loan prove unaffordable. Consumers who obtain a covered short-term loan beyond their ability to repay face three options: Either reborrow, default, or repay the loan but defer or skip payments on their major financial obligations and for basic living expenses. In other words, for a consumer facing an unaffordable payment, some form of substantial injury is almost inevitable regardless of what actions are taken by the consumer. And as discussed above, lenders engage in a variety of practices that further increase the degree of harm, for instance by encouraging additional reborrowing even among consumers who are already experiencing substantial difficulties and engaging in payment collection practices that are likely to cause consumers to incur substantial additional fees beyond what they already owe.

Injury Not Outweighed by Countervailing Benefits to Consumers or to Competition

As noted in part IV, the Bureau's interpretation of the various prongs of the unfairness test is informed by the FTC Act, the FTC Policy Statement on Unfairness, and FTC and other Federal agency rulemakings and related case law. Under those authorities, it generally is appropriate for purposes of the countervailing benefits prong of the unfairness standard to consider both the costs of imposing a remedy and any benefits that consumers enjoy as a result of the practice, but the determination does not require a precise quantitative analysis of benefits and costs.

It appears to the Bureau that the current practice of making payday, vehicle title, and other short-term loans without determining that the consumer has the ability to repay does not result in benefits to consumers or competition that outweigh the substantial injury that consumers cannot reasonably avoid. As discussed above, the amount of injury that is caused by the unfair practice, in the aggregate, appears to be extremely high. Although some individual consumers may be able to avoid the injury, as noted above, a significant number of consumers who end up in very long loan sequences can incur extremely severe financial injuries that were not reasonably avoidable. Moreover, some consumers whose short-term loans become short- to medium-length loan sequences incur various degrees of injury ranging from modest to severe depending on the particular consumer's circumstances (such as the specific loan terms, whether and how much the consumer expected to reborrow, and the extent to which the consumer incurred collateral harms from making unaffordable payments). In addition, many borrowers also experience substantial injury that is not reasonably avoidable as a result of defaulting on a loan or repaying a loan but not being able to meet other obligations and expenses.

Against this very significant amount of harm, the Bureau must weigh several potential countervailing benefits to consumers or competition of the practice in assessing whether it is unfair. The Bureau believes it is helpful to divide consumers into several groups of different borrowing experiences when analyzing whether the practice of extending covered short-term loans without determining that the consumer has the ability to repay yields countervailing benefits to consumers.

The first group consists of borrowers who repay their loan without reborrowing. The Bureau refers to these borrowers as “repayers” for purposes of this countervailing benefits analysis. As discussed in Market Concerns—Short-Term Loans, 22 percent of payday loan sequences and 12 percent of vehicle title loan sequences end with the consumer repaying the initial loan in a sequence without reborrowing. Many of these consumers may reasonably be determined, before getting a loan, to have the ability to repay their loan, such that the ability-to-repay requirement in proposed § 1041.5 would not have a significant impact on their eligibility for this type of credit. At most, it would reduce somewhat the speed and convenience of applying for a loan under the current practice. Under the status quo, the median borrower lives five miles from the nearest payday store. Consumers generally can obtain payday loans simply by traveling to the store and showing a paystub and evidence of a checking account; online payday lenders may require even less. For vehicle title loans, all that is generally required is that the consumer owns their vehicle outright without any encumbrance.

As discussed in more detail in part VI, there could be a significant contraction in the number of payday stores if lenders were required to assess consumers' ability to pay in the manner required by the proposal, but the Bureau projects that 93 to 95 percent of borrowers would not have to travel more than five additional miles. Lenders likely would require more information and documentation from the consumer. Indeed, under the proposed rule consumers may be required in certain circumstances to provide documentation of their income for a longer period of time than their last paystub and may be required to document their rental expenses. Consumers would also be required to complete a written statement with respect to their expected future income and major financial obligations.

Additionally, when a lender makes a loan without determining a consumer's ability to repay, the lender can make the loan instantaneously upon obtaining a consumer's paystub or vehicle title. In contrast, if lenders assessed consumers' ability to repay, they might secure extrinsic data, such as a consumer report from a national consumer reporting agency, which could slow the process down. Indeed, under the proposed rule lenders would be required to review the consumer's borrowing history using the lender's own records and a report from a registered information system, and lenders would also be required to review a credit report from a national credit reporting agency. Using this information, along with verified income, lenders would have to project the consumer's residual income.

As discussed below in the section-by-section analysis of proposed § 1041.5, the proposed rule has been designed to enable lenders to obtain electronic income verification, to use a model to estimate rental expenses, and to automate the process of securing additional information and assessing the consumer's ability to repay. If the proposed ability-to-repay requirements are finalized, the Bureau anticipates that consumers who are able to demonstrate the ability to repay under proposed § 1041.5 would be able to obtain credit to a similar extent as they do in the current market. While the speed and convenience fostered by the current practice may be reduced for these consumers under the proposed rule's requirements, the Bureau does not believe that the proposed requirements will be overly burdensome in this respect. As described in part VI, the Bureau estimates that the required ability-to-repay determination would Start Printed Page 47939take essentially no time for a fully automated electronic system and between 15 and 20 minutes for a fully manual system.

While the Bureau believes that most repayers would be able to demonstrate the ability to repay under proposed § 1041.5, the Bureau recognizes that there is a sub-segment of repayers who could not demonstrate their ability to repay if required to do so by a lender. For them, the current lender practice of making loans without determining their ability to repay enables these consumers to obtain credit that, by hypothesis, may actually be within their ability to repay. The Bureau acknowledges that for this group of “false negatives” there may be significant benefits of being able to obtain covered loans without having to demonstrate their ability to repay in the way prescribed by proposed § 1041.5.

However, the Bureau believes that under the proposed rule lenders will generally be able to identify consumers who are able to repay and that the size of any residual “false negative” population will be small. This is especially true to the extent that this class of consumers is disproportionately drawn from the ranks of those whose need to borrow is driven by a temporary mismatch in the timing between their income and expenses rather than those who have experienced an income or expense shock or those with a chronic cash shortfall. It is very much in the interest of these borrowers to attempt to demonstrate their ability to repay in order to receive the loan and for the same reason lenders will have every incentive to err on the side of finding such an ability. Moreover, even if these consumers could not qualify for the loan they would have obtained absent an ability-to-pay requirement, they may still be able to get different credit within their demonstrable ability to repay, such as a smaller loan or a loan with a longer term.[540] For these reasons, the Bureau does not believe that there would be a large false negative population if lenders made loans only to those with the ability to repay.

Finally, some of the repayers may not actually be able to afford the loan, but choose to repay it nonetheless, rather than reborrow or default—which may result in their incurring costs in connection with another obligation, such as a late fee on a utility bill. Such repayers would not be able to obtain under proposed § 1041.5 the same loan that they would have obtained absent an ability-to-repay requirement, but any benefit they receive under the current practice would appear to be small, at most.

The second group consists of borrowers who eventually default on their loan, either on the first loan or later in a loan sequence after having reborrowed. The Bureau refers to these borrowers as “defaulters” for purposes of this countervailing benefits analysis. As discussed in Market Concerns—Short-Term Loans, borrowers of 20 percent of payday and 33 percent of vehicle title loan sequences fall within this group. For these consumers, the current lender practice of making loans without regard to their ability to repay may enable them to obtain what amounts to a temporary “reprieve” from their current situation. They can obtain some cash which may enable them to pay a current bill or current expense. However, for many consumers, the reprieve can be exceedingly short-lived: 31 percent of payday loan sequences that default are single loan sequences, and an additional 27 percent of loan sequences that default are two or three loans long (meaning that 58 percent of defaults occur in loan sequences that are one, two, or three loans long). Twenty-nine percent of single-payment vehicle title loan sequences that default are single loan sequences, and an additional 26 percent of loan sequences that default are two or three loans long.

These consumers thus are merely substituting a payday lender or vehicle title lender for a preexisting creditor, and in doing so, end up in a deeper hole by accruing finance charges, late fees, or other charges at a high rate. Vehicle title loans can have an even more dire consequence for defaulters: 20 percent have their vehicle repossessed. The Bureau thus does not believe that defaulters obtain benefits from the current lender practice of not determining ability to repay.[541]

The final and largest group of consumers consists of those who neither default nor repay their loans without reborrowing but who, instead, reborrow before eventually repaying. The Bureau refers to consumers with such loan sequences as “reborrowers” for purposes of this countervailing benefits discussion. These consumers represent 58 percent of payday loan sequences and 56 percent of auto title loan sequences. For these consumers, as for the defaulters, the practice of making loans without regard to their ability to repay enables them to obtain a temporary reprieve from their current situation. But for this group, that reprieve can come at a greater cost than initially expected, sometimes substantially greater.

Some reborrowers are able to end their borrowing after a relatively small number of additional loans; for example, approximately 22 percent of payday loan sequences and 23 percent of vehicle title loan sequences are repaid after the initial loan is reborrowed once or twice. But even among this group, many consumers do not anticipate before taking out a loan that they will need to reborrow. These consumers cannot reasonably avoid their injuries, and while their injuries may be somewhat less severe than the injuries suffered by consumers with extremely long loan sequences, their injuries can nonetheless be substantial, particularly in light of their already precarious finances. Conversely, some of these consumers may expect to reborrow and may accurately predict how many times they will have to reborrow. For consumers who accurately predict their reborrowing, the Bureau is not counting their reborrowing costs as substantial injury that should be placed on the “injury” side of the countervailing benefits scale.

While some reborrowers end their borrowing after a relatively small number of additional loans, a large percentage of reborrowers end up in significantly longer loan sequences. Of storefront payday loan sequences, for instance, one-third percent contain seven or more loans, meaning that consumers pay finance charges equal to or greater than 100 percent of the amount borrowed. About a quarter percent of loan sequences contain 10 or more loans in succession. For vehicle title borrowers, the picture is similarly dramatic: Only 23 percent of loan sequences taken out by vehicle title reborrowers are repaid after two or three successive loans whereas 23 percent of sequences are for 10 or more loans in succession. The Bureau does not believe any significant number of consumers anticipate such lengthy sequences.

Thus, the Bureau believes that the substantial injury suffered by the defaulters and reborrowers—the categories that represent the vast majority of overall short-term payday and vehicle title borrowers—dwarfs any benefits these groups of borrowers may Start Printed Page 47940receive in terms of a temporary reprieve and also dwarfs the speed and convenience benefits that the repayers may experience. The Bureau acknowledges that any benefits derived by the aforementioned “false negatives” may be reduced under the proposed rule, but the Bureau believes that the benefits this relatively small group receives is outweighed by the substantial injuries to the defaulters and reborrowers as discussed above. Further, the Bureau believes that under the proposed intervention, many of these borrowers may find more sustainable options, such as underwritten credit on terms that are tailored to their budget and more affordable.

Turning to benefits of the practice for competition, the Bureau acknowledges, as discussed further in part II, that the current practice of lending without regard to consumers' ability to repay has enabled the payday industry to build a business model in which 50 percent or more of the revenue comes from consumers who borrow 10 or more times in succession. This, in turn, has enabled a substantial number of firms to extend such loans from a substantial number of storefront locations. As discussed in part II, the Bureau estimates that the top ten storefront payday lenders control only about half of the market, and that there are 3,300 storefront payday lenders that are small entities as defined by the SBA. The Bureau also acknowledges that, as discussed above and further in part VI, the anticipated effect of limiting lenders to loans that consumers can afford to repay will be to substantially shrink the number of loans per consumer which may, in turn, result in a more highly concentrated markets in some geographic areas. Moreover, the current practice enables to lenders to avoid the procedural costs that the proposed rule would impose.

However, the Bureau does not believe the proposed rule will reduce the competitiveness of the payday or vehicle title markets. As discussed in part II, most States in which such lending takes place have established a maximum price for these loans. Although in any given State there are a large number of lenders making these loans, typically in close proximity to one another, research has shown that there is generally no meaningful price competition among these firms. Rather, in general, the firms currently charge the maximum price allowed in any given State. Lenders who operate in multiple States generally vary their prices from State to State to take advantage of whatever local law allows. Thus, for example, lenders operating in Florida are permitted to charge $10 per $100 loaned,[542] and those same lenders, when lending in South Carolina, charge $15 per $100.[543]

In sum, it appears that the benefits of the identified unfair practice for consumers and competition do not outweigh the substantial, not reasonably avoidable injury caused or likely to be cause by the practice. On the contrary, it appears that the very significant injury caused by the practice outweighs the relatively modest benefits of the practice to consumers.

Consideration of Public Policy

Section 1031(c)(2) of the Dodd-Frank Act allows the Bureau to “consider established public policies as evidence to be considered with all other evidence” in determining whether a practice is unfair as long as the public policy considerations are not the primary basis of the determination. In addition to the evidence described above and in Market Concerns—Short-Term Loans, established public policy supports the proposed finding that it is an unfair act or practice for lenders to make covered short-term loans without determining that the consumer has the ability to repay.

Specifically, as noted above, several consumer financial statutes, regulations, and guidance documents require or recommend that covered lenders assess their customers' ability to repay before extending credit. These include the Dodd-Frank Act with regard to closed-end mortgage loans,[544] the CARD Act with regard to credit cards,[545] guidance from the OCC on abusive lending practices,[546] guidance from the FDIC on small dollar lending,[547] and guidance from the OCC [548] and FDIC [549] on deposit advance products. In addition, the Federal Reserve Board promulgated a rule requiring an ability-to-repay determination regarding higher priced mortgages, although that rule has since been superseded by the Dodd-Frank Act's ability-to-repay requirement and its implementation regulations which apply generally to mortgages regardless of price.[550] In short, Congress, State legislatures,[551] and other agencies have found consumer harm to result from lenders failing to determine that consumer have the ability to repay credit. These established policies support a finding that it is unfair for a lender to make covered short-term loans without determining that the consumer has the ability to repay, and evince public policy that supports the Bureau's proposed imposition of the consumer protections in proposed part 1041. The Bureau gives weight to this policy and bases its proposed finding that the identified practice is unfair, in part, on this significant body of public policy.

The Bureau seeks comment on the evidence and proposed findings and conclusions in proposed § 1041.4 and Market Concerns—Short-Term Loans above. As discussed further below in connection with proposed § 1041.7, the Bureau also seeks comment on whether making loans with the types of consumer protections contained in proposed § 1041.7(b) through (e) should not be included in the practice identified in proposed § 1041.4.

Section 1041.5 Ability-To-Repay Determination Required

As discussed in the section-by-section analysis of § 1041.4 above, the Bureau has tentatively concluded that it is an unfair and abusive act or practice to Start Printed Page 47941make a covered short-term loan without reasonably determining that the consumer will have the ability to repay the loan. Section 1031(b) of the Dodd-Frank Act provides that the Bureau's rules may include requirements for the purpose of preventing unfair or abusive acts or practices. The Bureau is proposing to prevent the abusive and unfair practice by including in proposed §§ 1041.5 and 1041.6 minimum requirements for how a lender may reasonably determine that a consumer has the ability to repay a covered short-term loan.

Proposed § 1041.5 sets forth the prohibition against making a covered short-term loan (other than a loan that satisfies the protective conditions in proposed § 1041.7) without first making a reasonable determination that the consumer will have the ability to repay the covered short term loan according to its terms. It also, in combination with proposed § 1041.6, specifies minimum elements of a baseline methodology that would be required for determining a consumer's ability to repay, using a residual income analysis and an assessment of the consumer's prior borrowing history. In crafting the baseline ability-to-repay methodology established in proposed §§ 1041.5 and 1041.6, the Bureau is attempting to balance carefully several considerations, including the need for consumer protection, industry interests in regulatory certainty and manageable compliance burden, and preservation of access to credit.

Proposed § 1041.5 would generally require the lender to make a reasonable determination that a consumer will have sufficient income, after meeting major financial obligations, to make payments under a prospective covered short-term loan and to continue meeting basic living expenses. However, based on feedback from a wide range of stakeholders and its own internal analysis, as well as the Bureau's belief that consumer harm has resulted despite more general standards in State law, the Bureau believes that merely establishing such a general requirement would provide insufficient protection for consumers and insufficient certainty for lenders.

Many lenders have informed the Bureau that they conduct some type of underwriting on covered short-term loans and assert that it should be sufficient to meet the Bureau's standards. However, as discussed above, such underwriting often is designed to screen primarily for fraud and to assess whether the lender will be able to extract payments from the consumer. It typically makes no attempt to assess whether the consumer might be forced to forgo basic necessities or to default on other obligations in order to repay the covered loan. Moreover, such underwriting essentially treats reborrowing as a neutral or positive outcome, rather than as a sign of the consumer's distress, because reborrowing does not present a risk of loss or decreased profitability to the lender. On the contrary, new fees from each reborrowing contribute to the lender's profitability. In the Bureau's experience, industry underwriting typically goes no further than to predict the consumer's propensity to repay rather than the consumer's financial capacity (i.e., ability) to repay consistent with the consumer's other obligations and need to cover basic living expenses. Such underwriting ignores the fact that repayment may force the consumer to miss other obligations or to be unable to cover basic living expenses.

The Bureau believes that to prevent the abusive and unfair practices that appear to be occurring in the market, it would be appropriate not only to require lenders to make a reasonable determination of a consumer's ability to repay before making a covered short term loan but also to specify minimum elements of a baseline methodology for evaluating consumers' individual financial situations, including their borrowing history. The baseline methodology is not intended to be a substitute for lender screening and underwriting methods, such as those designed to screen out fraud or predict and avoid other types of lender losses. Accordingly, lenders would be permitted to supplement the baseline methodology with other underwriting and screening methods.

The baseline methodology in proposed § 1041.5 rests on a residual income analysis—that is, an analysis of whether, given the consumer's projected income and major obligations, the consumer will have sufficient remaining (i.e., residual) income to cover the payments on the proposed loan and still meet basic living expenses. The Bureau recognizes that in other markets and under other regulatory regimes financial capacity is more typically measured by establishing a maximum debt-to-income (DTI) ratio.[552] DTI tests generally rest on the assumption that so long as a consumer's debt burden does not exceed a certain threshold percentage of the consumer's income, the remaining share of income will be sufficient for a consumer to be able meet non-debt obligations and other expenses. However, for low- and moderate-income consumers, the Bureau believes that assumption is less likely to be true: A DTI ratio that might seem quite reasonable for the “average” consumer can be quite unmanageable for a consumer at the lower end of the income spectrum and the higher end of the debt burden range.[553] Ultimately, whether a particular loan is affordable will depend upon how much money the consumer will have left after paying existing obligations and whether that amount is sufficient to cover the proposed new obligation while still meeting basic living expenses.

In addition, in contrast with other markets in which there are long-established norms for DTI levels that are consistent with sustainable indebtedness, the Bureau does not believe that there exist analogous norms for sustainable DTI levels for consumers taking covered short-term loans. Thus, the Bureau believes that residual income is a more direct test of ability to repay than DTI and a more appropriate test with respect to the types of products covered in this rulemaking and the types of consumers to whom these loans are made.

The Bureau has designed the residual income methodology requirements specified in proposed §§ 1041.5 and 1041.6 in an effort to ensure that ability-to-repay determinations can be made through scalable underwriting models. The Bureau is proposing that the most critical inputs into the determination rest on documentation but the Bureau's proposed methodology would allow for various means of documenting major financial obligations and also establishes alternatives to documentation where appropriate. It recognizes that rent, in particular, often cannot be readily documented and therefore would allow for estimation of rental expense. See the section-by-section analysis of § 1041.5(c)(3)(ii)(D), below. The Bureau's proposed Start Printed Page 47942methodology also would not mandate verification or detailed analysis of every individual consumer expenditure. The Bureau believes that such detailed analysis may not be the only method to prevent unaffordable loans and is concerned that it would substantially increase costs to lenders and borrowers. See the discussion of basic living expenses, below.

Finally, the Bureau's proposed methodology would not dictate a formulaic answer to whether, in a particular case, a consumer's residual income is sufficient to make a particular loan affordable. Instead, the proposed methodology would allow lenders to exercise discretion in arriving at a reasonable determination with respect to that question. Because this type of underwriting is so different from what many lenders currently engage in, the Bureau is particularly conscious of the need to leave room for lenders to innovate and refine their methods over time, including by building automated systems to assess a consumer's ability to repay so long as the basic elements are taken into account.

Proposed § 1041.5 outlines the methodology for assessing the consumer's residual income as part of the assessment of ability to repay. Proposed § 1041.5(a) would set forth definitions used throughout proposed §§ 1041.5 and 1041.6. Proposed § 1041.5(b) would establish the requirement for a lender to determine that a consumer will have the ability to repay a covered short-term loan and would set forth minimum standards for a reasonable determination that a consumer will have the ability to repay such a covered loan. The standards in proposed § 1041.5(b) would generally require a lender to determine that the consumer's income will be sufficient for the consumer to make payments under a covered short-term loan while accounting for the consumer's payments for major financial obligations and the consumer's basic living expenses. Proposed § 1041.5(c) would establish standards for verification and projections of a consumer's income and major financial obligations on which the lender would be required to base its determination under proposed § 1041.5. Proposed § 1041.6 would impose certain additional presumptions, prohibitions, and requirements where the consumer's reborrowing during the term of the loan or shortly after having a prior loan outstanding suggests that the prior loan was not affordable for the consumer, so that the consumer may have particular difficulty in repaying a new covered short-term loan with similar repayment terms.

In explaining the requirements of the various provisions of proposed § 1041.5, the Bureau is mindful that substantially all of the loans being made today which would fall within the definition of covered short-term loans are single-payment loans, either payday loans or single-payment vehicle title loans. The Bureau recognizes, however, that the definition of covered short-term loan could encompass loans with multiple payments and a term of 45 days or less, for example, a 30-day loan payable in two installments. Accordingly, in the discussion that follows, the Bureau generally refers to payments in the plural and uses phrases such as the “highest payment due.” For most covered short-term loans the highest payment would be the only payment and the determinations required by proposed § 1041.5 would be made only for a single payment and the 30 days following such payment.

As an alternative to the proposed ability-to-repay requirement, the Bureau considered whether lenders should be required to provide disclosures to borrowers warning them of the costs and risks of reborrowing, default, and collateral harms from unaffordable payments associated with taking out covered short-term loans. However, the Bureau believes that such a disclosure remedy would be significantly less effective in preventing the consumer harms described above, for three reasons.

First, disclosures do not address the underlying incentives in this market for lenders to encourage borrowers to reborrow and take out long sequences of loans. As discussed in Market Concerns—Short-Term Loans, the prevailing business model involves lenders deriving a very high percentage of their revenues from long loan sequences. While enhanced disclosures would provide additional information to consumers, the loans would remain unaffordable for consumers, lenders would have no greater incentive to underwrite more rigorously, and lenders would remain dependent on long-term loan sequences for revenues.

Second, empirical evidence suggests that disclosures have only modest impacts on consumer borrowing patterns for short-term loans generally and negligible impacts on whether consumers reborrow. Evidence from a field trial of several disclosures designed specifically to warn of the risks of reborrowing and the costs of reborrowing showed that these disclosures had a marginal effect on the total volume of payday borrowing.[554] Further, the Bureau has analyzed the impacts of the change in law in Texas (effective January 1, 2012) requiring payday lenders and short-term vehicle title lenders to provide a new disclosure to prospective borrowers before each payday loan transaction.[555] The Bureau observed that with respect to payday loan transactions, using the Bureau's supervisory data, there was an overall 13 percent decline in loan volume in Texas after the disclosure requirement went into effect, relative to the loan volume changes for the study period in comparison States.[556] The Bureau's analysis of the impacts of the Texas disclosures also shows that the probability of reborrowing on a payday loan declined by approximately 2 percent once the disclosure was put in place.[557] This finding indicates that high levels of reborrowing and long sequences of payday loans remain a significant source of consumer harm even with a disclosure regime in place.[558] Further, as discussed in Market Concerns—Short-Term Loans, the Bureau has observed that borrowers have a very high probability of winding up in a very long sequence once they have taken out only a few loans in a row. The contrast of the extremely high likelihood that a consumer will wind up in a long-term debt cycle after taking out only a few loans with the near negligible impact of a disclosure on consumer reborrowing patterns provides further evidence of the insufficiency of disclosures to address what the Bureau believes are the core harms to consumers in this credit market.

Third, as discussed in part VI, the Bureau believes that behavioral factors make it likely that disclosures to consumers taking out covered short-term loans would be ineffective in warning consumers of the risks and preventing the harms that the Bureau seeks to address with the proposal. Due to the potential for tunneling in their decision-making and general optimism bias, as discussed in more detail in Market Concerns—Short-Term Loans, Start Printed Page 47943consumers are likely to dismiss warnings of possible negative outcomes as not applying to them, and to not focus on disclosures of the possible harms associated with outcomes—reborrowing and default—that they do not anticipate experiencing themselves. To the extent the borrowers have thought about the likelihood that they themselves will reborrow or default (or both) on a loan, a general warning about how often people reborrow or default (or both) is unlikely to cause them to revise their own expectations about the chances they themselves will reborrow or default (or both).

The Bureau requests comment on the appropriateness of all aspects of the proposed approach. For example, the Bureau requests comment on whether a simple prohibition on making covered short-term loans without determining ability to repay, without specifying the elements of a minimum baseline methodology, would provide adequate protection to consumers and clarity to industry about what would constitute compliance. Similarly, the Bureau requests comment on the adequacy of a less prescriptive requirement for lenders to “consider” specified factors, such as payment amount under a covered short-term loan, income, debt service payments, and borrowing history, rather than a requirement to determine that residual income is sufficient. (Such an approach could be similar to that of the Bureau's ability-to-repay requirements for residential mortgage loans.) Specifically, the Bureau requests comment on whether there currently exist sufficient norms around the levels of such factors that are and are not consistent with a consumer's ability to repay, such that a requirement for a lender to “consider” such factors would provide adequate consumer protection, as well as adequate certainty for lenders regarding what determinations of ability to repay would and would not reflect sufficient consideration of those factors.

Also during outreach, some stakeholders suggested that the Bureau should adopt underwriting rules of thumb—for example, a maximum payment-to-income (PTI) ratio—to either presumptively or conclusively demonstrate compliance with the rule. The Bureau solicits comment on whether the Bureau should define such rules of thumb and, if so, what metrics should be included in a final rule and what significance should be given to such metrics.

5(a) Definitions

Proposed § 1041.5(a) would provide definitions of several terms used in proposed § 1041.5 in assessing the consumer's financial situation and proposed § 1041.6 in assessing consumers' borrowing history before determining whether a consumer has the ability to repay a new covered short-term loan. In particular, proposed § 1041.5(a) includes definitions for various categories of income and expenses that are used in proposed § 1041.5(b), which would establish the methodology that would generally be required for assessing consumers' ability to repay covered short-term loans. The substantive requirements for making the calculations for each category of income and expenses, as well as the overall determination of a consumer's ability to repay, are provided in proposed § 1041.5(b) and (c), and in their respective commentary. These proposed definitions are discussed in detail below.

5(a)(1) Basic Living Expenses

Proposed § 1041.5(a)(1) would define the basic living expenses component of the ability-to-repay determination that would be required in proposed § 1041.5(b). It would define basic living expenses as expenditures, other than payments for major financial obligations, that a consumer makes for goods and services necessary to maintain the consumer's health, welfare, and ability to produce income, and the health and welfare of members of the consumer's household who are financially dependent on the consumer. Proposed § 1041.5(b) would require the lender to reasonably determine a dollar amount that is sufficiently large so that the consumer would likely be able to make the loan payments and meet basic living expenses without having to default on major financial obligations or having to rely on new consumer credit during the applicable period.

Accordingly, the proposed definition of basic living expenses is a principle-based definition and does not provide a comprehensive list of the expenses for which a lender must account. Proposed comment 5(a)(1)-1 provides illustrative examples of expenses that would be covered by the definition. It provides that food and utilities are examples of goods and services that are necessary for maintaining health and welfare, and that transportation to and from a place of employment and daycare for dependent children, if applicable, are examples of goods and services that are necessary for maintaining the ability to produce income.

The Bureau recognizes that provision of a principle-based definition leaves some ambiguity about, for example, what types and amounts of goods and services are “necessary” for the stated purposes. Lenders would have flexibility in how they determine dollar amounts that meet the proposed definition, provided that they do not rely on amounts that are so low that they are not reasonable for consumers to pay for the types and level of expenses in the definition.

The Bureau's proposed methodology also would not mandate verification or detailed analysis of every individual consumer expenditure. In contrast to major financial obligations (see below), a consumer's recent expenditures may not necessarily reflect the amounts a consumer needs for basic living expenses during the term of a prospective loan, and the Bureau is concerned that such a requirement could substantially increase costs for lenders and consumers while adding little protection for consumers.

The Bureau solicits comment on its principle-based approach to defining basic living expenses, including whether limitation of the definition to “necessary” expenses is appropriate, and whether an alternative, more prescriptive approach would be preferable. For example, the Bureau solicits comment on whether the definition should include, rather than expenses of the types and in amounts that are “necessary” for the purposes specified in the proposed definition, expenses of the types that are likely to recur through the term of the loan and in amounts below which a consumer cannot realistically reduce them. The Bureau also solicits comment on whether there are standards used in other contexts that could be relied upon by the Bureau. For example, the Bureau is aware that the Internal Revenue Service and bankruptcy courts have their own respective standards for calculating amounts an individual needs for expenses while making payments toward a delinquent tax liability or under a bankruptcy-related repayment plan.

5(a)(2) Major Financial Obligations

Proposed § 1041.5(a)(2) would define the major financial obligations component of the ability-to-repay determination specified in proposed § 1041.5(b). Proposed § 1041.5(b) would generally require a lender to determine that a consumer will have sufficient residual income, which is net income after subtracting amounts already committed for making payments for major financial obligations, to make payments under a prospective covered short term loan and to meet basic living expenses. Payments for major financial obligations would be subject to the consumer statement and verification Start Printed Page 47944evidence provisions under proposed § 1041.5(c)(3).

Specifically, proposed § 1041.5(a)(2) would define the term to mean a consumer's housing expense, minimum payments and any delinquent amounts due under debt obligations (including outstanding covered loans), and court- or government agency-ordered child support obligations. Comment 5(a)(2)-1 would further clarify that housing expense includes the total periodic amount that the consumer applying for the loan is responsible for paying, such as the amount the consumer owes to a landlord for rent or to a creditor for a mortgage. It would provide that minimum payments under debt obligations include periodic payments for automobile loan payments, student loan payments, other covered loan payments, and minimum required credit card payments.

Expenses that the Bureau has included in the proposed definition are expenses that are typically recurring, that can be significant in the amount of a consumer's income that they consume, and that a consumer has little or no ability to change, reduce or eliminate in the short run, relative to their levels up until application for a covered short-term loan. The Bureau believes that the extent to which a particular consumer's net income is already committed to making such payments is highly relevant to determining whether that consumer has the ability to make payments under a prospective covered short-term loan. As a result, the Bureau believes that a lender should be required to inquire about such payments, that they should be subject to verification for accuracy and completeness to the extent feasible, and that a lender should not be permitted to rely on consumer income already committed to such payments in determining a consumer's ability to repay. Expenses included in the proposed definition are roughly analogous to those included in total monthly debt obligations for calculating monthly debt-to-income ratio and monthly residual income under the Bureau's ability-to-repay requirements for certain residential mortgage loans. (See 12 CFR 1026.43(c)(7)(i)(A).)

The Bureau has adjusted its approach to major financial obligations based on feedback from SERs and other industry stakeholders on the Small Business Review Panel Outline. In the SBREFA process, the Bureau stated that it was considering including within the category of major financial obligations “other legally required payments,” such as alimony, and that the Bureau had considered an alternative approach that would have included utility payments and regular medical expenses. However, the Bureau now believes that it would be unduly burdensome to require lenders to make individualized projections of a consumer's utility or medical expenses. With respect to alimony, the Bureau believes that relatively few consumers seeking covered loans have readily verifiable alimony obligations and that, accordingly, inquiring about alimony obligations would impose unnecessary burden. The Bureau also is not including a category of “other legally required payments” because the Bureau believes that category, which was included in the Small Business Review Panel Outline, would leave too much ambiguity about what other payments are covered. For further discussion of burden on small businesses associated with verification requirements, see the section-by-section analysis of proposed § 1041.5(c)(3), below.

The Bureau invites comment on whether the items included in the proposed definition of major financial obligations are appropriate, whether other items should be included and, if so, whether and how the items should be subject to verification. For example, the Bureau invites comment on whether there are other obligations that are typically recurring, significant, and not changeable by the consumer, such as, for example, alimony, daycare commitments, health insurance premiums (other than premiums deducted from a consumer's paycheck, which are already excluded from the proposed definition of net income), or unavoidable medical expenses. The Bureau likewise invites comment on whether there are types of payments to which a consumer may be contractually obligated, such as payments or portions of payments under contracts for telecommunication services, that a consumer is unable to reduce from their amounts as of consummation, such that the payments should be included in the definition of major financial obligations. The Bureau also invites comment on the inclusion in the proposed definition of delinquent amounts due, such as on the practicality of asking consumers about delinquent amounts due on major financial obligations, of comparing stated amounts to any delinquent amounts that may be included in verification evidence (e.g., in a national consumer report), and of accounting for such amounts in projecting a consumer's residual income during the term of the prospective loan. The Bureau also invites comment on whether the Bureau should specify additional rules for addressing major financial obligations that are joint obligations of a consumer applying for a covered short-term loan (and of a consumer who is not applying for the loan), or whether the provision in proposed § 1041.5(c)(1) allowing lenders to consider consumer explanations and other evidence is sufficient.

5(a)(3) National Consumer Report

Proposed § 1041.5(a)(3) would define national consumer report to mean a consumer report, as defined in section 603(d) of the Fair Credit Reporting Act (FCRA), 15 U.S.C. 1681a(d), obtained from a consumer reporting agency that compiles and maintains files on consumers on a nationwide basis, as defined in section 603(p) of the Fair Credit Reporting Act, 15 U.S.C. 1681a(p). Proposed § 1041.5(c)(3)(ii) would require a lender to obtain a national consumer report as verification evidence for a consumer's required payments under debt obligations and required payments under court- or government agency-ordered child support obligations. Reports that meet the proposed definition are often referred to informally as a credit report or credit history from one of the three major credit reporting agencies or bureaus. A national consumer report may be furnished to a lender from a consumer reporting agency that is not a nationwide consumer reporting agency, such as a consumer reporting agency that is a reseller.

5(a)(4) Net Income

Proposed § 1041.5(a)(4) would define the net income component of the ability-to-repay determination calculation specified in proposed § 1041.5(b). Specifically, it would define the term as the total amount that a consumer receives after the payer deducts amounts for taxes, other obligations, and voluntary contributions that the consumer has directed the payer to deduct, but before deductions of any amounts for payments under a prospective covered short term loan or for any major financial obligation. Proposed § 1041.5(b) would generally require a lender to determine that a consumer will have sufficient residual income to make payments under a prospective covered short-term loan and to meet basic living expenses. Proposed § 1041.5(a)(6), discussed below, would define residual income as the sum of net income that the lender projects the consumer will receive during a period, minus the sum of amounts that the lender projects will be payable by the consumer for major financial obligations during the period. Net income would be Start Printed Page 47945subject to the consumer statement and verification evidence provisions under proposed § 1041.5(c)(3).

The proposed definition is similar to what is commonly referred to as “take-home pay” but is phrased broadly to apply to income received from employment, government benefits, or other sources. It would exclude virtually all amounts deducted by the payer of the income, whether deductions are required or voluntary, such as voluntary insurance premiums or union dues. The Bureau believes that the total dollar amount that a consumer actually receives after all such deductions is the amount that is most instructive in determining a consumer's ability to repay. Certain deductions (e.g., taxes) are beyond the consumer's control. Other deductions may not be revocable, at least for a significant period of time, as a result of contractual obligations to which the consumer has entered. Even with respect to purely voluntary deductions, most consumers are unlikely to be able to reduce or eliminate such deductions, between consummation of a loan and the time when payments under the loan would fall due. The Bureau also believes that the net amount a consumer actually receives after all such deductions is likely to be the amount most readily known to consumers applying for a covered short-term loan (rather than, for example, periodic gross income) and is also the amount that is most readily verifiable by lenders through a variety of methods. The proposed definition would clarify, however, that net income is calculated before deductions of any amounts for payments under a prospective covered short-term loan or for any major financial obligation. The Bureau proposes the clarification to prevent double counting any such amounts when making the ability-to-repay determination.

The Bureau invites comment on the proposed definition of net income and whether further guidance would be helpful.

5(a)(5) Payment Under the Covered Short-Term Loan

Proposed § 1041.5(a)(5) would define payment under the covered short-term loan, which is a component of the ability-to-repay determination calculation specified in proposed § 1041.5(b). Proposed § 1041.5(b) would generally require a lender to determine that a consumer will have sufficient residual income to make payments under a covered short-term loan and to meet basic living expenses. Specifically, the definition of payment under the covered short-term loan in proposed § 1041.5(a)(5)(i) and (ii) would include all costs payable by the consumer at a particular time after consummation, regardless of how the costs are described in an agreement or whether they are payable to the lender or a third party. Proposed § 1041.5(a)(5)(iii) provides special rules for projecting payments under the covered short-term loan on lines of credit for purposes of the ability to repay test, since actual payments for lines of credit may vary depending on usage.

Proposed § 1041.5(a)(5)(i) would apply to all covered short-term loans. It would define payment under the covered short-term loan broadly to mean the combined dollar amount payable by the consumer in connection with the covered short-term loan at a particular time following consummation. Under proposed § 1041.5(b), the lender would be required to reasonably determine the payment amount under this proposed definition as of the time of consummation. The proposed definition would further provide that, for short-term loans with multiple payments, in calculating each payment under the covered loan, the lender must assume that the consumer has made preceding required payments and that the consumer has not taken any affirmative act to extend or restructure the repayment schedule or to suspend, cancel, or delay payment for any product, service, or membership provided in connection with the covered loan. Proposed § 1041.5(a)(5)(ii) would similarly apply to all covered short-term loans and would clarify that payment under the covered loan includes all principal, interest, charges, and fees.

The Bureau believes that a broad definition, such as the one proposed, is necessary to capture the full dollar amount payable by the consumer in connection with the covered short-term loan, including amounts for voluntary insurance or memberships and regardless of whether amounts are due to the lender or another person. It is the total dollar amount due at each particular time that is relevant to determining whether or not a consumer has the ability to repay the loan based on the consumer's projected net income and payments for major financial obligations. The amount of the payment is what is important, not whether the components of the payment include principal, interest, fees, insurance premiums, or other charges. The Bureau recognizes, however, that under the terms of some covered short-term loans, a consumer may have options regarding how much the consumer must pay at any given time and that the consumer may in some cases be able to select a different payment option. The proposed definition would include any amount payable by a consumer in the absence of any affirmative act by the consumer to extend or restructure the repayment schedule, or to suspend, cancel, or delay payment for any product, service, or membership provided in connection with the covered short-term loan. Proposed comment 5(a)(5)(i) and 5(a)(5)(ii)-1 includes three examples applying the proposed definition to scenarios in which the payment under the covered short-term loan includes several components, including voluntary fees owed to a person other than the lender, as well as scenarios in which the consumer has the option of making different payment amounts.

Proposed § 1041.5(a)(5)(iii) would include additional provisions for calculating the projected payment amount under a covered line of credit for purposes of assessing a consumer's ability to repay the loan. As explained in proposed comment 5(a)(5)(iii)-1, such rules are necessary because the amount and timing of the consumer's actual payments on a line of credit after consummation may depend on the consumer's utilization of the credit (i.e., the amount the consumer has drawn down) or on amounts that the consumer has repaid prior to the payments in question. As a result, if the definition of payment under the covered short-term loan did not specify assumptions about consumer utilization and repayment under a line of credit, there would be uncertainty as to the amounts and timing of payments to which the ability-to-repay requirement applies. Proposed § 1041.5(a)(5)(iii) therefore would prescribe assumptions that a lender must make in calculating the payment under the covered short-term loan. It would require the lender to assume that the consumer will utilize the full amount of credit under the covered loan as soon as the credit is available to the consumer and that the consumer will make only minimum required payments under the covered loan. The lender would then apply the ability-to-repay determination to that assumed repayment schedule.

The Bureau believes these assumptions about a consumer's utilization and repayment are important to ensure that the lender makes its ability-to-repay determination based on the most challenging loan payment that a consumer may face under the covered loan. They also reflect what the Bureau believes to be the likely borrowing and repayment behavior of many consumers who obtain covered loans with a line of credit. Such consumers are typically Start Printed Page 47946facing an immediate liquidity need and, in light of the relatively high cost of credit, would normally seek a line of credit approximating the amount of the need. Assuming the lender does not provide a line of credit well in excess of the consumer's need, the consumer is then likely to draw down the full amount of the line of credit shortly after consummation. Liquidity-constrained consumers may make only minimum required payments under a line of credit and, if the terms of the covered loan provide for an end date, may then face having to repay the outstanding balance in one payment at a time specified under the terms of the covered short-term loan. It is such a payment that is likely to be the highest payment possible under the terms of the covered short-term loan and therefore the payment for which a consumer is least likely to have the ability to repay.

The Bureau invites comment on the proposed definition of payment under the covered short-term loan. Specifically, the Bureau invites comment on whether the provisions of proposed § 1041.5(a)(5) are sufficiently comprehensive and clear to allow for determination of payment amounts under covered short-term loans, especially for lines of credit.

5(a)(6) Residual Income

Proposed § 1041.5(a)(6) would define the residual income component of the ability-to-repay determination calculation specified in proposed § 1041.5(b). Specifically, it would define the term as the sum of net income that the lender projects the consumer obligated under the loan will receive during a period, minus the sum of amounts that the lender projects will be payable by the consumer for major financial obligations during the period, all of which projected amounts must be based on verification evidence, as provided under proposed § 1041.5(c). Proposed § 1041.5(b) would generally require a lender to determine that a consumer will have sufficient residual income to make payments under a covered short-term loan and to meet basic living expenses.

The proposed definition would ensure that a lender's ability-to-repay determination cannot rely on the amount of a consumer's net income that, as of the time a prospective loan would be consummated, is already committed to pay for major financial obligations during the applicable period. For example, a consumer's net income may be greater than the amount of a loan payment, so that the lender successfully obtains the loan payment from a consumer's deposit account once the consumer's income is deposited into the account. But if the consumer is then left with insufficient funds to make payments for major financial obligations, such as a rent payment, then the consumer may be forced to choose between failing to pay rent when due, forgoing basic needs, or reborrowing.

5(b) Reasonable Determination Required

Proposed § 1041.5(b) would prohibit lenders from making covered short-term loans without first making a reasonable determination that the consumer will have the ability to repay the loan according to its terms, unless the loans are made in accordance with proposed § 1041.7. Specifically, proposed § 1041.5(b)(1) would require lenders to make a reasonable determination of ability to repay before making a new covered short-term loan, increasing the credit available under an existing loan, or before advancing additional credit under a covered line of credit if more than 180 days have expired since the last such determination. Proposed § 1041.5(b)(2) specifies minimum elements of a baseline methodology that would be required for determining a consumer's ability to repay, using a residual income analysis and an assessment of the consumer's prior borrowing history. It would require the assessment to be based on projections of the consumer's net income, major financial obligations, and basic living expenses that are made in accordance with proposed § 1041.5(c). It would require that, using such projections, the lender must reasonably conclude that the consumer's residual income will be sufficient for the consumer to make all payments under the loan and still meet basic living expenses during the term of the loan. It would further require that a lender must conclude that the consumer, after making the highest payment under the loan (typically, the last payment), will continue to be able to meet major financial obligations as they fall due and meet basic living expenses for a period of 30 additional days. Finally, proposed § 1041.5(b)(2) would require that, in situations in which the consumer's recent borrowing history suggests that she may have difficulty repaying a new loan as specified in proposed § 1041.6, a lender must satisfy the requirements in proposed § 1041.6 before extending credit.

5(b)(1)

Proposed § 1041.5(b)(1) would provide generally that, except as provided in § 1041.7, a lender must not make a covered short-term loan or increase the credit available under a covered short-term loan unless the lender first makes a reasonable determination of ability to repay for the covered short-term loan. The provision would also impose a requirement to determine a consumer's ability to repay before advancing additional funds under a covered short-term loan that is a line of credit if such advance would occur more than 180 days after the date of a previous required determination.

Proposed § 1041.5(b)(1)(i) would provide that a lender is not required to make the determination when it makes a covered short-term loan under the conditions set forth in § 1041.7. The conditions that apply under § 1041.7 provide alternative protections from the harms caused by covered short-term loan payments that exceed a consumer's ability to repay, such that the Bureau is proposing to allow lenders to make such loans in accordance with the regulation without engaging in an ability-to-repay determination under §§ 1041.5 and 1041.6. (See the discussions of § 1041.7, below.)

The Bureau notes that proposed § 1041.5(b)(1) would require the ability-to-repay determination before a lender actually takes one of the triggering actions. The Bureau recognizes that lenders decline covered loan applications for a variety of reasons, including to prevent fraud, avoid possible losses, and to comply with State law or other regulatory requirements. Accordingly, the requirements of § 1041.5(b)(1) would not require a lender to make the ability-to-repay determination for every covered short-term loan application it receives, but rather only before taking one of the enumerated actions with respect to a covered short-term loan. Similarly, nothing in proposed § 1041.5(b)(1) would prohibit a lender from applying screening or underwriting approaches in addition to those required under proposed § 1041.5(b) prior to making a covered short-term loan.

Proposed § 1041.5(b)(1)(ii) would provide that, for a covered short-term loan that is a line of credit, a lender must not permit a consumer to obtain an advance under the line of credit more than 180 days after the date of a prior required determination, unless the lender first makes a new reasonable determination that the consumer will have the ability to repay the covered short-term loan. Under a line of credit, a consumer typically can obtain advances up to the maximum available credit at the consumer's discretion, often long after the covered loan was Start Printed Page 47947consummated. Each time the consumer obtains an advance under a line of credit, the consumer becomes obligated to make a new payment or series of payments based on the terms of the covered loan. But when significant time has elapsed since the date of a lender's prior required determination, the facts on which the lender relied in determining the consumer's ability to repay may have changed significantly. During the Bureau's outreach to industry, the Small Dollar Roundtable urged the Bureau to require a lender to periodically make a new reasonable determination of ability to repay in connection with a covered loan that is a line of credit. The Bureau believes that the proposed requirement to make a new determination of ability to repay for a line of credit 180 days following a prior required determination appropriately balances the burden on lenders and the protective benefit for consumers.

Reasonable Determination

Proposed § 1041.5(b) would require a lender to make a reasonable determination that a consumer will be able to repay a covered short-term loan according to its terms. As discussed above and as reflected in the provisions of proposed § 1041.5(b), a consumer has the ability to repay a covered short-term loan according to its terms only if the consumer is able to make all payments under the covered loan as they fall due while also making payments under the consumer's major financial obligations as they fall due and continuing to meet basic living expenses without, as a result of making payments under the covered loan, having to reborrow.

Proposed comment 5(b)-1 provides an overview of the baseline methodology that would be required as part of a reasonable determination of a consumer's ability to repay in proposed §§ 1041.5(b)(2) and (c) and 1041.6.

Proposed comment 5(b)-2 would identify standards for evaluating whether a lender's ability-to-repay determinations under proposed § 1041.5 are reasonable. It would clarify minimum requirements of a reasonable ability-to-repay determination; identify assumptions that, if relied upon by the lender, render a determination not reasonable; and establish that the overall performance of a lender's covered short-term loans is evidence of whether the lender's determinations for those covered loans are reasonable.

The proposed standards would not impose bright line rules prohibiting covered short-term loans based on fixed mathematical ratios or similar distinctions. Moreover, the Bureau does not anticipate that a lender would need to perform a manual analysis of each prospective loan to determine whether it meets all of the proposed standards. Instead, each lender would be required under proposed § 1041.18 to develop and implement policies and procedures for approving and making covered loans in compliance with the proposed standards and based on the types of covered loans that the lender makes. A lender would then apply its own policies and procedures to its underwriting decisions, which the Bureau anticipates could be largely automated for the majority of consumers and covered loans.

Minimum requirements. Proposed comment 5(b)-2.i would describe some of the specific respects in which a lender's determination must be reasonable. For example, it would note that the determination must include the applicable determinations provided in proposed § 1041.5(b)(2), be based on reasonable projections of a consumer's net income and major financial obligations in accordance with proposed § 1041.5(c), be based on reasonable estimates of a consumer's basic living expenses under proposed § 1041.5(b), and appropriately account for the possibility of volatility in a consumer's income and basic living expenses during the term of the loan under proposed § 1041.5(b)(2)(i). It would also have to be consistent with the lender's written policies and procedures required under proposed § 1041.18(b).

Proposed comment 5(b)-2.i would also provide that to be reasonable, a lender's ability-to-repay determination must be grounded in reasonable inferences and conclusions in light of information the lender is required to obtain or consider. As discussed above, each lender would be required under proposed § 1041.18 to develop policies and procedures for approving and making covered loans in compliance with the proposal. The policies and procedures would specify the conclusions that the lender makes based on information it obtains, and lenders would then be able to largely automate application of those policies and procedures for most consumers. For example, proposed § 1041.5(c) would require a lender to obtain verification evidence for a consumer's net income and payments for major financial obligations, but it would provide for lender discretion in resolving any ambiguities in the verification evidence to project what the consumer's net income and payments for major financial obligations will be following consummation of the covered short-term loan.

Finally, proposed comment 5(b)-2.i would provide that for a lender's ability-to-repay determination to be reasonable, the lender must appropriately account for information known by the lender, whether or not the lender is required to obtain the information under proposed § 1041.5, that indicates that the consumer may not have the ability to repay a covered short-term loan according to its terms. The provision would not require a lender to obtain information other than information specified in proposed § 1041.5. However, a lender might become aware of information that casts doubt on whether a particular consumer would have the ability to repay a particular prospective covered short-term loan. For example, proposed § 1041.5 would not require a lender to inquire about a consumer's individual transportation or medical expenses, and the lender's ability-to-repay method might comply with the proposed requirement to estimate consumers' basic living expenses by factoring into the estimate of basic living expenses a normal allowance for expenses of this type. But if the lender learned that a particular consumer had a transportation or recurring medical expense dramatically in excess of an amount the lender used in estimating basic living expenses for consumers generally, proposed comment 5(b)-2.i would clarify that the lender could not simply ignore that fact. Instead, it would have to consider the transportation or medical expense and then reach a reasonable determination that the expense does not negate the lender's otherwise reasonable ability-to-repay determination.

Similarly, in reviewing borrowing history records a lender might learn that the consumer completed a three-loan sequence of covered short-term loans made either under proposed §§ 1041.5 and 1041.6 or under proposed § 1041.7, waited for 30 days before seeking to reborrow as required by proposed § 1041.6 or proposed § 1041.7 and then sought to borrow on the first permissible day under those sections, and that this has been a recurring pattern for the consumer in the past. While the fact that the consumer on more than one occasion has sought a loan on the first possible day that the consumer is free to do so may be attributable to new needs that arose following the conclusion of each prior sequence, an alternative—and perhaps more likely explanation—is that the consumer's consistent need to borrow as soon as possible is attributable to spillover effects from having repaid the last loan sequence. In these circumstances, a lender's decision Start Printed Page 47948that the consumer has the ability to repay a new loan of the same amount and on the same terms as the prior loans might not be reasonable if the lender did not take into account these circumstances.

The Bureau invites comments on the minimum requirements for making a reasonable determination of ability to repay, including whether additional specificity should be provided in the regulation text or in the commentary with respect to circumstances in which a lender is required to take into account information known by the lender.

Determinations that are not reasonable. Proposed comment 5(b)-2.ii would provide an example of an ability-to-repay determination that is not reasonable. The example is a determination that relies on an assumption that the consumer will obtain additional consumer credit to be able to make payments under the covered short-term loan, to make payments under major financial obligations, or to meet basic living expenses. The Bureau believes that a consumer whose net income would be sufficient to make payments under a prospective covered short-term loan, to make payments under major financial obligations, and to meet basic living expenses during the applicable period only if the consumer supplements that net income by borrowing additional consumer credit is a consumer who, by definition, lacks the ability to repay the prospective covered short-term loan. Although the Bureau believes this reasoning is clear, it is proposing the commentary example because some lenders have argued that the mere fact that a lender successfully secures repayment of the full amount due from a consumer's deposit account shows that the consumer had the ability to repay the loan, even if the consumer then immediately has to reborrow to meet the consumer's other obligations and expenses. Inclusion of the example in commentary would confirm that an ability-to-repay determination is not reasonable if it relies on an implicit assumption that a consumer will have the ability to repay a covered short-term loan for the reason that the consumer will obtain further consumer credit to make payments under major financial obligations or to meet basic living expenses.

The Bureau invites comment on whether it would be useful to articulate additional specific examples of ability-to-repay determinations that are not reasonable, and if so which specific examples should be listed. In this regard, the Bureau has considered whether there are any circumstances under which basing an ability-to-repay determination for a covered short-term loan on assumed future borrowing or assumed future accumulation of savings would be reasonable, particularly in light of the nature of consumer circumstances when they take out such loans. The Bureau seeks comment on this question.

Performance of a lender's short-term covered loans as evidence. In determining whether a lender has complied with the requirements of proposed § 1041.5, there is a threshold question of whether the lender has carried out the required procedural steps, for example by obtaining consumer statements and verification evidence, projecting net income and payments under major financial obligations, and making determinations about the sufficiency of a consumer's residual income. In some cases, a lender might have carried out these steps but still have violated § 1041.5 by making determinations that are facially unreasonable, such as if a lender's determinations assume that a consumer needs amounts to meet basic living expenses that are clearly insufficient for that purpose.

In other cases the reasonableness or unreasonableness of a lender's determinations might be less clear. Accordingly, proposed comment 5(b)-2.iii would provide that evidence of whether a lender's determinations of ability to repay are reasonable may include the extent to which the lender's determinations subject to proposed § 1041.5 result in rates of delinquency, default, and reborrowing for covered short-term loans that are low, equal to, or high, including in comparison to the rates of other lenders making similar covered loans to similarly situated consumers.

As discussed above, the Bureau recognizes that the affordability of loan payments is not the only factor that affects whether a consumer repays a covered loan according to its terms without reborrowing. A particular consumer may obtain a covered loan with payments that are within the consumer's ability to repay at the time of consummation, but factors such as the consumer's continual opportunity to work, willingness to repay, and financial management may affect the performance of that consumer's loan. Similarly, a particular consumer may obtain a covered loan with payments that exceed the consumer's ability to repay at the time of consummation, but factors such as a lender's use of a leveraged payment mechanism, taking of vehicle security, and collection tactics, as well as the consumer's ability to access informal credit from friends or relatives, might result in repayment of the loan without indicia of harm that are visible through observations of loan performance and reborrowing. However, if a lender's determinations subject to proposed § 1041.5 regularly result in rates of delinquency, default, or reborrowing that are significantly higher than those of other lenders making similar short-term covered loans to similarly situated consumers, that fact is evidence that the lender may be systematically underestimating amounts that consumers generally need for basic living expenses, or is in some other way overestimating consumers' ability to repay.

Proposed comment 5(b)-2.iii would not mean that a lender's compliance with the requirements of proposed § 1041.5 for a particular loan could be determined based on the performance of that loan. Nor would proposed comment 5(b)-2.iii mean that comparison of the performance of a lender's covered short-term loans with the performance of covered short-term loans of other lenders could be the sole basis for determining whether that lender's determinations of ability to repay comply or do not comply with the requirements of proposed § 1041.5. For example, one lender may have default rates that are much lower than the default rates of other lenders because it uses aggressive collection tactics, not because its determinations of ability to repay are reasonable. Similarly, the fact that one lender's default rates are similar to the default rates of other lenders does not necessarily indicate that the lenders' determinations of ability to repay are reasonable; the similar rates could also result from the fact that the lenders' respective determinations of ability to repay are similarly unreasonable. The Bureau believes, however, that such comparisons will provide important evidence that, considered along with other evidence, would facilitate evaluation of whether a lender's ability-to-repay determinations are reasonable.

For example, a lender may use estimates for a consumer's basic living expenses that initially appear unrealistically low, but if the lender's determinations otherwise comply with the requirements of proposed § 1041.5 and otherwise result in covered short-term loan performance that is materially better than that of peer lenders, the covered short-term loan performance may help show that the lender's determinations are reasonable. Similarly, an online lender might experience default rates significantly in excess of those of peer lenders, but other Start Printed Page 47949evidence may show that the lender followed policies and procedures similar to those used by other lenders and that the high default rate resulted from a high number of fraudulent applications. On the other hand, if consumers experience systematically worse rates of delinquency, default, and reborrowing on covered short-term loans made by lender A, compared to the rates of other lenders making similar loans, that fact may be important evidence of whether that lender's estimates of basic living expenses are, in fact, unrealistically low and therefore whether the lender's ability-to-repay determinations are reasonable.

The Bureau invites comment on whether and, if so, how the performance of a lender's portfolio of covered short-term loans should be factored in to an assessment of whether the lender has complied with its obligations under the rule, including whether the Bureau should specify thresholds which presumptively or conclusively establish compliance or non-compliance and, if so, how such thresholds should be determined.

Payments Under the Covered Short-Term Loan

Proposed comment 5(b)-3 notes that a lender is responsible for calculating the timing and amount of all payments under the covered short-term loan. The timing and amount of all loan payments under the covered short-term loan are an essential component of the required reasonable determination of a consumer's ability to repay under proposed § 1041.5(b)(2)(i), (ii), and (iii). Calculation of the timing and amount of all payments under a covered loan is also necessary to determine which component determinations under proposed § 1041.5(b)(2)(i), (ii), and (iii) apply to a particular prospective covered loan. Proposed comment 5(b)-3 cross references the definition of payment under a covered short-term loan in proposed § 1041.5(a)(5), which includes requirements and assumptions that apply to a lender's calculation of the amount and timing of all payments under a covered short-term loan.

Basic Living Expenses

A lender's ability-to-repay determination under proposed § 1041.5(b) would be required to account for a consumer's need to meet basic living expenses during the applicable period while also making payments for major financial obligations and payments under a covered short-term loan. As discussed above, proposed § 1041.5(a)(1) would define basic living expenses as expenditures, other than payments for major financial obligations, that the consumer must make for goods and services that are necessary to maintain the consumer's health, welfare, and ability to produce income, and the health and welfare of members of the consumer's household who are financially dependent on the consumer. If a lender's ability-to-repay determination did not account for a consumer's need to meet basic living expenses, and instead merely determined that a consumer's net income is sufficient to make payments for major financial obligations and for the covered short-term loan, the determination would greatly overestimate a consumer's ability to repay a covered short-term loan and would be unreasonable. Doing so would be the equivalent of determining, under the Bureau's ability-to-repay rule for residential mortgage loans, that a consumer has the ability to repay a mortgage from income even if that mortgage would result in a debt-to-income ratio of 100 percent. The Bureau believes there would be nearly universal consensus that such a determination would be unreasonable.

However, the Bureau recognizes that in contrast with payments under most major financial obligations, which the Bureau believes a lender can usually ascertain and verify for each consumer without unreasonable burden, it would be extremely challenging to determine a complete and accurate itemization of each consumer's basic living expenses. Moreover, a consumer may have somewhat greater ability to reduce in the short-run some expenditures that do not meet the Bureau's proposed definition of major financial obligations. For example, a consumer may be able for a period of time to reduce commuting expenses by ride sharing.

Accordingly, the Bureau is not proposing to prescribe a particular method that a lender would be required to use for estimating an amount of funds that a consumer requires to meet basic living expenses for an applicable period. Instead, proposed comment 5(b)-4 would provide the principle that whether a lender's method complies with the proposed § 1041.5 requirement for a lender to make a reasonable ability-to-repay determination depends on whether it is reasonably designed to determine whether a consumer would likely be able to make the loan payments and meet basic living expenses without defaulting on major financial obligations or having to rely on new consumer credit during the applicable period.

Proposed comment 5(b)-4 would provide a non-exhaustive list of methods that may be reasonable ways to estimate basic living expenses. The first method is to set minimum percentages of income or dollar amounts based on a statistically valid survey of expenses of similarly situated consumers, taking into consideration the consumer's income, location, and household size. This example is based on a method that several lenders have told the Bureau they currently use in determining whether a consumer will have the ability to repay a loan and is consistent with the recommendations of the Small Dollar Roundtable. The Bureau notes that the Bureau of Labor Statistics conducts a periodic survey of consumer expenditures which may be useful for this purpose. The Bureau invites comment on whether the example should identify consideration of a consumer's income, location, and household size as an important aspect of the method.

The second method is to obtain additional reliable information about a consumer's expenses other than the information required to be obtained under proposed § 1041.5(c), to develop a reasonably accurate estimate of a consumer's basic living expenses. The example would not mean that a lender is required to obtain this information but would clarify that doing so may be one effective method of estimating a consumer's basic living expenses. The method described in the second example may be more convenient for smaller lenders or lenders with no experience working with statistically valid surveys of consumer expenses, as described in the first example.

The third example is any method that reliably predicts basic living expenses. The Bureau is proposing to include this broadly phrased example to clarify that lenders may use innovative and data-driven methods that reliably estimate consumers' basic living expenses, even if the methods are not as intuitive as the methods in the first two examples. The Bureau would expect to evaluate the reliability of such methods by taking into account the performance of the lender's covered short-term loans in absolute terms and relative to other lenders, as discussed in proposed comment 5(b)-3.iii.

Proposed comment 5(b)-4 would provide a non-exhaustive list of unreasonable methods of determining basic living expenses. The first example is a method that assumes that a consumer needs no or implausibly low amounts of funds to meet basic living expenses during the applicable period and that, accordingly, substantially all of a consumer's net income that is not required for payments for major Start Printed Page 47950financial obligations is available for loan payments. The second example is a method of setting minimum percentages of income or dollar amounts that, when used in ability-to-repay determinations for covered short-term loans, have yielded high rates of default and reborrowing, in absolute terms or relative to rates of default and reborrowing of other lenders making covered short-term loans to similarly situated consumers.

The Bureau solicits comment on all aspects of the proposed requirements for estimating basic living expenses, including the methods identified as reasonable or unreasonable, whether additional methods should be specified, or whether the Bureau should provide either a more prescriptive method for estimating basic living expenses or a safe harbor methodology (and, if so, what that methodology should be). The Bureau also solicits comment on whether lenders should be required to ask consumers to identify, on a written questionnaire that lists common types of basic living expenses, how much they typically spend on each type of expense. The Bureau further solicits comment on whether and how lenders should be required to verify the completeness and correctness of the amounts the consumer lists and how a lender should be required to determine how much of the identified or verified expenditures is necessary or, under the alternative approach to defining basic living expenses discussed above, is recurring and not realistically reducible during the term of the prospective loan.

5(b)(2)

Proposed § 1041.5(b)(2) would set forth the Bureau's specific proposed methodology for making a reasonable determination of a consumer's ability to pay a covered short-term loan. Specifically, it would provide that a lender's determination of a consumer's ability to repay is reasonable only if, based on projections in accordance with proposed § 1041.5(c), the lender reasonably makes the applicable determinations provided in proposed §§ 1041.5(b)(2)(i), (ii), and (iii). Proposed § 1041.5(b)(2)(i) would require an assessment of the sufficiency of the consumer's residual income during the term of the loan, and proposed § 1041.5(b)(2)(ii) would require assessment of an additional period in light of the special harms associated with loans with short-term structures. Proposed § 1041.5(b)(2)(iii) would require compliance with additional requirements in proposed § 1041.6 in situations in which the consumer's borrowing history suggests that he or she may have difficulty repaying additional credit.

5(b)(2)(i)

Proposed § 1041.5(b)(2)(i) would provide that for any covered short-term loan subject to the ability-to-repay requirement of proposed § 1041.5, a lender must reasonably conclude that the consumer's residual income will be sufficient for the consumer to make all payments under the covered short-term loan and to meet basic living expenses during the term of covered short-term loan. As defined in proposed § 1041.5(a)(6), residual income is the amount of a consumer's net income during a period that is not already committed to payments under major financial obligations during the period. If the payments for a covered short-term loan would consume so much of a consumer's residual income that the consumer would be unable to meet basic living expenses, then the consumer would likely suffer injury from default or reborrowing, or suffer collateral harms from unaffordable payments.

In proposing § 1041.5(b)(2)(i) the Bureau recognizes that, even when lenders determine at the time of consummation that consumers will have the ability to repay a covered short-term loan, some consumers may still face difficulty making payments under covered short-term loans because of changes that occur after consummation. For example, some consumers would experience unforeseen decreases in income or increases in expenses that would leave them unable to repay their loans. Thus, the fact that a consumer ended up in default is not, in and of itself, evidence that the lender failed to make a reasonable assessment of the consumer's ability to repay ex ante. Rather, proposed § 1041.5(b)(2)(i) looks to the facts as reasonably knowable prior to consummation and would mean that a lender is prohibited from making a covered short-term loan subject to proposed § 1041.5 if there is not a reasonable basis at consummation for concluding that the consumer will be able to make payments under the covered loan while also meeting the consumer's major financial obligations and meeting basic living expenses.

While some consumers may have so little (or no) residual income as to be unable to afford any loan, for other consumers the ability to repay will depend on the amount and timing of the required repayments. Thus, even if a lender concludes that there is not a reasonable basis for believing that a consumer can pay a particular prospective loan, proposed § 1041.5(b)(2)(i) would not prevent a lender from making a different covered loan with more affordable payments to such a consumer, provided that the more affordable payments would not consume so much of a consumer's residual income that the consumer would be unable to meet basic living expenses and provided further that the alternative loan is consistent with applicable State law.

Applicable Period for Residual Income

As discussed above, under proposed § 1041.5(b)(2)(i) a lender must reasonably conclude that the consumer's residual income will be sufficient for the consumer to make all payments under the covered short-term loan and to meet basic living expenses during the term of the covered short-term loan. To provide greater certainty, facilitate compliance, and reduce burden, the Bureau is proposing a comment to explain how lenders could comply with proposed § 1041.5(b)(2)(i).

Proposed comment 5(b)(2)(i)-1 would provide that a lender complies with the requirement in § 1041.5(b)(2)(i) if it reasonably determines that the consumer's projected residual income during the shorter of the term of the loan or the period ending 45 days after consummation of the loan will be greater than the sum of all payments under the covered short-term loan plus an amount the lender reasonably estimates will be needed for basic living expenses during the term of the covered short-term loan. The method of compliance would allow the lender to make one determination based on the sum of all payments that would be due during the term of the covered short-term loan, rather than having to make a separate determination for each respective payment and payment period in isolation, in cases where the short-term loan provide for multiple payments. However, the lender would have to make the determination for the actual term of the loan, accounting for residual income (i.e., net income minus payments for major financial obligations) that would actually accrue during the shorter of the term of the loan or the period ending 45 days after consummation of the loan.

The Bureau believes that for a covered loan with short duration, a lender should make the determination based on net income the consumer will actually receive during the term of the loan and payments for major financial obligations that will actually be payable during the term of the covered short-term loan, rather than, for example, based on a monthly period that may or may not coincide with the loan term. Start Printed Page 47951When a covered loan period is under 45 days, determining whether the consumer's residual income will be sufficient to make all payments and meet basic living expenses depends a great deal on, for example, how many paychecks the consumer will actually receive during the term of the loan and whether the consumer will also have to make no rent payment, one rent payment, or two rent payments during the term of the loan.

The Bureau is proposing to clarify that the determination must be based on residual income “during the shorter of the term of the loan or the period ending 45 days after consummation of the loan” because the definition of a covered short-term loan includes a loan under which the consumer is required to repay “substantially” the entire amount of the loan within 45 days of consummation. The clarification would ensure that, if an unsubstantial amount were due after 45 days following consummation, the lender could not rely on residual income projected to accrue after the forty-fifth day to determine that the consumer would have sufficient residual income as required under proposed § 1041.5(b)(2)(i). Proposed comment 5(b)(2)(i)-1.i includes an example applying the method of compliance to a covered short-term loan payable in one payment 16 days after the lender makes the covered short-term loan.

The Bureau invites comment on its proposed applicable time period for assessing residual income.

Sufficiency of Residual Income

As discussed above, under proposed § 1041.5(b)(2)(i) a lender must reasonably conclude that the consumer's residual income will be sufficient for the consumer to make all payments under the covered short-term loan and to meet basic living expenses during the shorter of the term of the loan or the period ending 45 days after consummation of the loan. Proposed comment 5(b)(2)(i)-2 would clarify what constitutes “sufficient” residual income for a covered short-term loan. For a covered short-term loans, comment 5(b)(2)(i)-2.i would provide that residual income is sufficient so long as it is greater than the sum of payments that would be due under the covered loan plus an amount the lender reasonably estimates will be needed for basic living expenses.

5(b)(2)(ii)

Proposed § 1041.5(b)(2)(ii) would provide that for a covered short-term loan subject to the ability-to-repay requirement of proposed § 1041.5, a lender must reasonably conclude that the consumer will be able to make payments required for major financial obligations as they fall due, to make any remaining payments under the covered short-term loan, and to meet basic living expenses for 30 days after having made the highest payment under the covered short-term loan on its due date. Proposed comment 5(b)(2)(ii)-1 notes that a lender must include in its determination under proposed § 1041.5(b)(2)(ii) the amount and timing of net income that it projects the consumer will receive during the 30-day period following the highest payment, in accordance with proposed § 1041.5(c). Proposed comment 5(b)(2)(ii)-1 also includes an example of a covered short-term loan for which a lender could not make a reasonable determination that the consumer will have the ability to repay under proposed § 1041.5(b)(2)(ii).

The Bureau proposes to include the requirement in § 1041.5(b)(2)(ii) for covered short-term loans because the Bureau's research has found that these loan structures are particularly likely to result in reborrowing shortly after the consumer repays an earlier loan. As discussed above in Market Concerns—Short-Term Loans, when a covered loan's terms provide for it to be substantially repaid within 45 days following consummation the fact that the consumer must repay so much within such a short period of time makes it especially likely that the consumer will be left with insufficient funds to make subsequent payments under major financial obligations and to meet basic living expenses. The consumer may then end up falling behind on payments under major financial obligations, being unable to meet basic living expenses, or borrowing additional consumer credit. Such consumers may be particularly likely to borrow new consumer credit in the form of a new covered loan.

This shortfall in a consumer's funds is most likely to occur following the highest payment under the covered short-term loan (which is typically but not necessarily the final payment) and before the consumer's subsequent receipt of significant income. However, depending on regularity of a consumer's income payments and payment amounts, the point within a consumer's monthly expense cycle when the problematic covered short-term loan payment falls due, and the distribution of a consumer's expenses through the month, the resulting shortfall may not manifest until a consumer has attempted to meet all expenses in the consumer's monthly expense cycle, or even longer. Indeed, many payday loan borrowers who repay a first loan and do not reborrow during the ensuing pay cycle (i.e., within 14 days) nonetheless do find it necessary to reborrow before the end of the expense cycle (i.e., within 30 days).

In the Small Business Review Panel Outline, the Bureau described a proposal to require lenders to determine that a consumer will have the ability to repay a covered short-term loan without needing to reborrow for 60 days, consistent with the proposal in the same document to treat a loan taken within 60 days of having a prior covered short-term loan outstanding as part of the same sequence. Several consumer advocates have argued that consumers may be able to juggle expenses and financial obligations for a time, so that an unaffordable loan may not result in reborrowing until after a 30-day period. For the reasons discussed further below in the section-by-section analyses of § 1041.6, the Bureau is now proposing a 30-day period for both purposes.

The Bureau believes that the incidence of reborrowing caused by such loan structures would be somewhat ameliorated simply by determining that a consumer will have residual income during the term of the loan that exceeds the sum of covered loan payments plus an amount necessary to meet basic living expenses during that period. But if the loan payments consume all of a consumer's residual income during the period beyond the amount needed to meet basic living expenses during the period, then the consumer will be left with insufficient funds to make payments under major financial obligations and meet basic living expenses after the end of that period, unless the consumer receives sufficient net income shortly after the end of that period and before the next set of expenses fall due. Often, though, the opposite is true: A lender schedules the due dates of loan payments under covered short-term loans so that the loan payment due date coincides with dates of the consumer's receipts of income. This practice maximizes the probability that the lender will timely receive the payment under the covered short-term loan, but it also means the term of the loan (as well as the relevant period for the lender's determination that the consumer's residual income will be sufficient under proposed § 1041.5(b)(2)(i)) ends on the date of the consumer's receipt of income, with the result that the time between the end of the loan term and the consumer's subsequent receipt of income is maximized.Start Printed Page 47952

Thus, even if a lender made a reasonable determination under proposed § 1041.5(b)(2)(i) that the consumer would have sufficient residual income during the loan term to make loan payments under the covered short-term loan and meet basic living expenses during the period, there would remain a significant risk that, as a result of an unaffordable highest payment (which may be the only payment, or the last of equal payments), the consumer would be forced to reborrow or suffer collateral harms from unaffordable payments. The example included in proposed comment 5(b)(2)(ii)-1 illustrates just such a result.

The Bureau invites comment on the necessity of the requirement in proposed § 1041.5(b)(2)(ii) to prevent consumer harms and on any alternatives that would adequately prevent consumer harm while reducing burden for lenders. The Bureau also invites comment on whether the 30-day period in proposed § 1041.5(b)(2)(ii) is the appropriate period of time to use or whether a shorter or longer period of time, such as the 60-day period described in the Small Business Review Panel Outline, would be appropriate. The Bureau also invites comment on whether the time period chosen should run from the date of the final payment, rather than the highest payment, in cases where the highest payment is other than the final payment.

5(b)(2)(iii)

Proposed § 1041.5(b)(2)(iii) would provide that for a covered short-term loan for which a presumption of unaffordability applies under proposed § 1041.6, the lender determine that the requirements of proposed § 1041.6 are satisfied. As discussed below, proposed § 1041.6 would apply certain presumptions, requirements, and prohibitions when the consumer's borrowing history indicates that he or she may have particular difficulty in repaying a new covered loan with certain payment amounts or structures.

5(c) Projecting Consumer Net Income and Payments for Major Financial Obligations

Proposed § 1041.5(c) provides requirements that would apply to a lender's projections of net income and major financial obligations, which in turn serve as the basis for the lender's reasonable determination of ability to repay. Specifically, it would establish requirements for obtaining information directly from a consumer as well as specified types of verification evidence. It would also provide requirements for reconciling ambiguities and inconsistencies in the information and verification evidence.

5(c)(1) General

As discussed above, proposed § 1041.5(b)(2) would provide that a lender's determination of a consumer's ability to repay is reasonable only if the lender determines that the consumer will have sufficient residual income during the term of the loan and for a period thereafter to repay the loan and still meet basic living expenses. Proposed § 1041.5(b)(2) thus carries with it the requirement for a lender to make projections with respect to the consumer's net income and major financial obligations—the components of residual income—during the relevant period of time. And, proposed § 1041.5(b)(2) further provides that to be reasonable such projections must be made in accordance with proposed § 1041.5(c).

Proposed § 1041.5(c)(1) would provide that for a lender's projection of the amount and timing of net income or payments for major financial obligations to be reasonable, the lender must obtain both a written statement from the consumer as provided for in proposed § 1041.5(c)(3)(i), and verification evidence as provided for in proposed § 1041.5(c)(3)(ii), each of which are discussed below. Proposed § 1041.5(c)(1) further provides that for a lender's projection of the amount and timing of net income or payments for major financial obligations to be reasonable it may be based on a consumer's statement of the amount and timing only to the extent the stated amounts and timing are consistent with the verification evidence.

The Bureau believes verification of consumers' net income and payments for major financial obligations is an important component of the reasonable ability-to-repay determination. Consumers seeking a loan may be in financial distress and inclined to overestimate net income or to underestimate payments under major financial obligations to improve their chances of being approved. Lenders have an incentive to encourage such misestimates to the extent that as a result consumers find it necessary to reborrow. This result is especially likely if a consumer perceives that, for any given loan amount, lenders offer only one-size-fits-all loan repayment structure and will not offer an alternative loan with payments that are within the consumer's ability to repay. An ability-to-repay determination that is based on unrealistic factual assumptions will yield unrealistic and unreliable results, leading to the consumer harms that the Bureau's proposal is intended to prevent.

Accordingly, proposed § 1041.5(c)(1) would permit a lender to base its projection of the amount and timing of a consumer's net income or payments under major financial obligations on a consumer's written statement of amounts and timing under proposed § 1041.5(c)(3)(i) only to the extent the stated amounts and timing are consistent with verification evidence of the type specified in proposed § 1041.5(c)(3)(ii). Proposed § 1041.5(c)(1) would further provide that in determining whether and the extent to which such stated amounts and timing are consistent with verification evidence, a lender may reasonably consider other reliable evidence the lender obtains from or about the consumer, including any explanations the lender obtains from the consumer. The Bureau believes the proposed approach would appropriately ensure that the projections of a consumer's net income and payments for major financial obligations will generally be supported by objective, third-party documentation or other records.

However, the proposed approach also recognizes that reasonably available verification evidence may sometimes contain ambiguous, out-of-date, or missing information. For example, the net income of consumers who seek covered loans may vary over time, such as for a consumer who is paid an hourly wage and whose work hours vary from week to week. In fact, a consumer is more likely to experience financial distress, which may be a consumer's reason for seeking a covered loan, immediately following a temporary decrease in net income from their more typical levels. Accordingly, the proposed approach would not require a lender to base its projections exclusively on the consumer's most recent net income receipt shown in the verification evidence. Instead, it allows the lender reasonable flexibility in the inferences the lender draws about, for example, a consumer's net income during the term of the covered loan, based on the consumer's net income payments shown in the verification evidence, including net income for periods earlier than the most recent net income receipt. At the same time, the proposed approach would not allow a lender to mechanically assume that a consumer's immediate past income as shown in the verification evidence will continue into the future if, for example, the lender has reason to believe that the consumer has been laid off or is no longer employed.Start Printed Page 47953

In this regard, the proposed approach recognizes that a consumer's own statements, explanations, and other evidence are important components of a reliable projection of future net income and payments for major financial obligations. Proposed comment 5(c)(1)-1 includes several examples applying the proposed provisions to various scenarios, illustrating reliance on consumer statements to the extent they are consistent with verification evidence and how a lender may reasonably consider consumer explanations to resolve ambiguities in the verification evidence. It includes examples of when a major financial obligation in a consumer report is greater than the amount stated by the consumer and of when a major financial obligation stated by the consumer does not appear in the consumer report at all.

The Bureau anticipates that lenders would develop policies and procedures, in accordance with proposed § 1041.18, for how they project consumer net income and payments for major financial obligations in compliance with proposed § 1041.5(c)(1) and that a lender's policies and procedures would reflect its business model and practices, including the particular methods it uses to obtain consumer statements and verification evidence. The Bureau believes that many lenders and vendors would develop methods of automating projections, so that for a typical consumer, relatively little labor would be required.

The Bureau invites comments on the proposed approach to verification and to making projections based upon verified evidence, including whether the Bureau should permit projections that vary from the most recent verification evidence and, if so, whether the Bureau should be more prescriptive with respect to the permissible range of such variances.

5(c)(2) Changes Not Supported by Verification Evidence

Proposed § 1041.5(c)(2) would provide an exception to the requirement in proposed § 1041.5(c)(1) that projections must be consistent with the verification evidence that a lender would be required to obtain under proposed 1041.5(c)(3)(ii). As discussed below, the required verification evidence will normally consist of third-party documentation or other reliable records of recent transactions or of payment amounts. Proposed § 1041.5(c)(2) would permit a lender to project a net income amount that is higher than an amount that would otherwise be supported under proposed § 1041.5(c)(1), or a payment amount under a major financial obligation that is lower than an amount that would otherwise be supported under proposed § 1041.5(c)(1), only to the extent and for such portion of the term of the loan that the lender obtains a written statement from the payer of the income or the payee of the consumer's major financial obligation of the amount and timing of the new or changed net income or payment.

The exception would accommodate situations in which a consumer's net income or payment for a major financial obligation will differ from the amount supportable by the verification evidence. For example, a consumer who has been unemployed for an extended period of time but who just accepted a new job may not be able to provide the type of verification evidence of net income generally required under proposed § 1041.5(c)(3)(ii)(A). Proposed § 1041.5(c)(2) would permit a lender to project a net income amount based on, for example, an offer letter from the new employer stating the consumer's wage, work hours per week, and frequency of pay. The lender would be required to retain the statement in accordance with proposed § 1041.18.

The Bureau invites comments as to whether lenders should be permitted to rely on such evidence in projecting residual income.

5(c)(3) Evidence of Net Income and Payments for Major Financial Obligations

5(c)(3)(i) Consumer Statements

Proposed § 1041.5(c)(3)(i) would require a lender to obtain a consumer's written statement of the amount and timing of the consumer's net income, as well as of the amount and timing of payments required for categories of the consumer's major financial obligations (e.g., credit card payments, automobile loan payments, housing expense payments, child support payments, etc.). The lender would then use the statements as an input in projecting the consumer's net income and payments for major financial obligations during the term of the loan. The lender would also be required to retain the statements in accordance with proposed § 1041.18. As discussed above, the Bureau believes it is important to require lenders to obtain this information directly from consumers in addition to obtaining reasonably available verification evidence under proposed § 1041.5(c)(3)(ii) because the latter sources of information may sometimes contain ambiguous, out-of-date, or missing information. Accordingly, the Bureau believes that projections based on both sources of information will be more reliable than either one standing alone.

Proposed comment 5(c)(3)(i)-1 clarifies that a consumer's written statement includes a statement the consumer writes on a paper application or enters into an electronic record, or an oral consumer statement that the lender records and retains or memorializes in writing and retains. It further clarifies that a lender complies with a requirement to obtain the consumer's statement by obtaining information sufficient for the lender to project the dates on which a payment will be received or paid through the period required under proposed § 1041.5(b)(2). Proposed comment 5(c)(3)(i)-1 includes the example that a lender's receipt of a consumer's statement that the consumer is required to pay rent every month on the first day of the month is sufficient for the lender to project when the consumer's rent payments are due. Proposed § 1041.5(c)(3)(i) would not specify any particular form or even particular questions or particular words that a lender must use to obtain the required consumer statements.

The Bureau invites comments on whether to require a lender to obtain a written statement from the consumer with respect to the consumer's income and major financial obligations, including whether the Bureau should establish any procedural requirements with respect to securing such a statement and the weight that should be given to such a statement. The Bureau also invites comments on whether a written memorialization by the lender of a consumer's oral statement should not be considered sufficient.

5(c)(3)(ii) Verification Evidence

Proposed § 1041.5(c)(3)(ii) would require a lender to obtain verification evidence for the amounts and timing of the consumer's net income and payments for major financial obligations for a period of time prior to consummation. It would specify the type of verification evidence required for net income and each component of major financial obligations. The proposed requirements are intended to provide reasonable assurance that the lender's projections of a consumer's net income and payments for major financial obligations are based on accurate and objective information, while also allowing lenders to adopt innovative, automated, and less burdensome methods of compliance.

5(c)(3)(ii)(A)

Proposed § 1041.5(c)(3)(ii)(A) would specify that for a consumer's net Start Printed Page 47954income, the applicable verification evidence would be a reliable record (or records) of an income payment (or payments) covering sufficient history to support the lender's projection under proposed § 1041.5(c)(1). It would not specify a minimum look-back period or number of net income payments for which the lender must obtain verification evidence. The Bureau does not believe it is necessary or appropriate to require verification evidence covering a lookback period of a prescribed length. Rather, sufficiency of the history for which a lender obtains verification evidence may depend upon the source or type of income, the length of the prospective covered longer-term loan, and the consistency of the income shown in the verification evidence the lender initially obtains, if applicable. Lenders would be required to develop and maintain policies and procedures for establishing the sufficient history of net income payments in verification evidence, in accordance with proposed § 1041.18.

Proposed comment 5(c)(3)(ii)(A)-1 would clarify that a reliable transaction record includes a facially genuine original, photocopy, or image of a document produced by or on behalf of the payer of income, or an electronic or paper compilation of data included in such a document, stating the amount and date of the income paid to the consumer. It would further clarify that a reliable transaction record also includes a facially genuine original, photocopy, or image of an electronic or paper record of depository account transactions, prepaid account transactions (including transactions on a general purpose reloadable prepaid card account, a payroll card account, or a government benefits card account), or money services business check-cashing transactions showing the amount and date of a consumer's receipt of income.

The Bureau believes that the proposed requirement would be sufficiently flexible to provide lenders with multiple options for obtaining verification evidence for a consumer's net income. For example, a paper paystub would generally satisfy the requirement, as would a photograph of the paystub uploaded from a mobile phone to an online lender. In addition, the requirement would also be satisfied by use of a commercial service that collects payroll data from employers and provides it to creditors for purposes of verifying a consumer's employment and income. Proposed comment 5(c)(3)(ii)(A)-1 would also allow verification evidence in the form of electronic or paper bank account statements or records showing deposits into the account, as well as electronic or paper records of deposits onto a prepaid card or of check-cashing transactions. Data derived from such sources, such as from account data aggregator services that obtain and categorize consumer deposit account and other account transaction data, would also generally satisfy the requirement. During outreach, service providers informed the Bureau that they currently provide such services to lenders.

Several SERs expressed concern during the SBREFA process that the Bureau's approach to income verification described in the Small Business Review Panel Outline was too burdensome and inflexible. Several other lender representatives expressed similar concerns during the Bureau's outreach to industry. Many perceived that the Bureau would require outmoded or burdensome methods of obtaining verification evidence, such as always requiring a consumer to submit a paper paystub or transmit it by facsimile (fax) to a lender. Others expressed concern about the Bureau requiring income verification at all, stating that many consumers are paid in cash and therefore have no employer-generated records of income.

The Bureau's proposed approach is intended to respond to many of these concerns by providing for a wide range of methods for obtaining verification evidence for a consumer's net income, including electronic methods that can be securely automated through third-party vendors with a consumer's consent. In developing this proposal, Bureau staff met with more than 30 lenders, nearly all of which stated they already use some method—though not necessarily the precise methods the Bureau is proposing—to verify consumers' income as a condition of making a covered loan. The Bureau's proposed approach thus would accommodate most of the methods they described and that the Bureau is aware of from other research and outreach. It is also intended to provide some accommodation for making covered loans to many consumers who are paid in cash. For example, under the Bureau's proposed approach, a lender may be able to obtain verification evidence of net income for a consumer who is paid in cash by using deposit account records (or data derived from deposit account transactions), if the consumer deposits income payments into a deposit account. Lenders often require consumers to have deposit accounts as a condition of obtaining a covered loan, so the Bureau believes that lenders would be able to obtain verification evidence for many consumers who are paid in cash in this manner.

The Bureau recognizes that there are some consumers who receive a portion of their income in cash and also do not deposit their cash income into a deposit account or prepaid card account. For such consumers, a lender may not be able to obtain verification evidence for that portion of a consumer's net income, and therefore generally could not base its projections and ability-to-repay determinations on that portion of such consumers' income. The Bureau, however, does not believe it is appropriate to make an ability-to-repay determination for a covered loan based on income that cannot be reasonably substantiated through any verification evidence. When there is no verification evidence for a consumer's net income, the Bureau believes the risk is too great that projections of net income would be overstated and that payments under a covered short-term loan consequently would exceed the consumer's ability to repay, resulting in the harms targeted by this proposal.

For similar reasons, the Bureau is not proposing to permit the use of predictive models designed to estimate a consumer's income or to validate the reasonableness of a consumer's statement of her income. Given the risks associated with unaffordable short-term loans, the Bureau believes that such models—which the Bureau believes typically are used to estimate annual income—lack the precision required to reasonably project an individual consumer's net income for a short period of time.

The Bureau notes that it has received recommendations from the Small Dollar Roundtable, comprised of a number of lenders making loans the Bureau proposes to cover in this rulemaking and a number of consumer advocates, recommending that the Bureau require income verification.

The Bureau invites comment on the types of verification evidence permitted by the proposed rule and what, if any, other types of verification evidence should be permitted, especially types of verification evidence that would be at least as objective and reliable as the types provided for in proposed § 1041.5(c)(3)(ii)(A) and comment 5(c)(3)(ii)(A)-1. For example, the Bureau is aware of service providers who are seeking to develop methods to verify a consumer's stated income based upon extrinsic data about the consumer or the area in which the consumer lives. The Bureau invites comment on the reliability of such methods, their ability to provide information that is sufficiently current and granular to Start Printed Page 47955address a consumer's stated income for a particular and short period of time, and, if they are able to do so, whether income amounts determined under such methods should be a permissible as a form of verification evidence. The Bureau also invites comments on whether the requirements for verification evidence should be relaxed for a consumer whose principal income is documented but who reports some amount of supplemental cash income and, if so, what approach would be appropriate to guard against the risk of consumers' overstating their income and obtaining an unaffordable loan.

5(c)(3)(ii)(B)

Proposed § 1041.5(c)(3)(ii)(B) would specify that for a consumer's required payments under debt obligations, the applicable verification evidence would be a national consumer report, the records of the lender and its affiliates, and a consumer report obtained from an information system currently registered pursuant to § 1041.17(c)(2) or § 1041.17(d)(2), if available. The Bureau believes that most typical consumer debt obligations other than covered loans would appear in a national consumer report. Many covered loans are not included in reports generated by the national consumer reporting agencies, so the lender would also be required to obtain, as verification evidence, a consumer report from a currently registered information system. As discussed above, proposed § 1041.5(c)(1) would permit a lender to base its projections on consumer statements of amounts and timing of payments for major financial obligations (including debt obligations) only to the extent the statements are consistent with the verification evidence. Proposed comment 5(c)(1)-1 includes examples applying that proposed requirement in scenarios when a major financial obligation shown in the verification evidence is greater than the amount stated by the consumer and of when a major financial obligation stated by the consumer does not appear in the verification evidence at all.

Proposed comment 5(c)(3)(ii)(B)-1 would clarify that the amount and timing of a payment required under a debt obligation are the amount the consumer must pay and the time by which the consumer must pay it to avoid delinquency under the debt obligation in the absence of any affirmative act by the consumer to extend, delay, or restructure the repayment schedule. The Bureau anticipates that in some cases, the national consumer report the lender obtains will not include a particular debt obligation stated by the consumer, or that the national consumer report may include, for example, the payment amount under the debt obligation but not the timing of the payment. Similar anomalies could occur with covered loans and a consumer report obtained from a registered information system. To the extent the national consumer report and consumer report from a registered information system omit information for a payment under a debt obligation stated by the consumer, the lender would simply base its projections on the amount and timing stated by the consumer.

The Bureau notes that proposed § 1041.5(c)(3)(ii)(B) does not require a lender to obtain a credit report unless the lender is otherwise prepared to make a loan to a particular consumer, Because obtaining a credit report will add some cost, the Bureau expects that lenders will order such reports only after determining that the consumer otherwise satisfies the ability-to-repay test so as to avoid incurring these costs for applicants who would be declined without regard to the contents of the credit report. For the reasons previously discussed, the Bureau believes that verification evidence is critical to ensuring that consumers in fact have the ability to repay a loan, and that therefore the costs are justified to achieve the objectives of the proposal.

The Bureau invites comment on whether to require lenders to obtain credit reports from a national credit reporting agency and from a registered information system. In particular, and in accordance with the recommendation of the Small Business Review Panel, the Bureau invites comments on ways of reducing the operational burden for small businesses of verifying consumers' payments under major financial obligations.

5(c)(3)(ii)(C)

Proposed § 1041.5(c)(3)(ii)(C) would specify that for a consumer's required payments under court- or government agency-ordered child support obligations, the applicable verification evidence would be a national consumer report, which also serves as verification evidence for a consumer's required payments under debt obligations, in accordance with proposed § 1041.5(c)(3)(ii)(B). The Bureau anticipates that some required payments under court- or government agency-ordered child support obligations will not appear in a national consumer report. To the extent the national consumer report omits information for a required payment, the lender could simply base its projections on the amount and timing stated by the consumer, if any. The Bureau intends this clarification to address concerns from some lenders, including from SERs, that a requirement to obtain verification evidence for payments under court- or government agency-ordered child support obligations from sources other than a national consumer report would be onerous and create great uncertainty.

5(c)(3)(ii)(D)

Proposed § 1041.5(c)(3)(ii)(D) would specify that for a consumer's housing expense (other than a payment for a debt obligation that appears on a national consumer report obtained by the lender), the applicable verification evidence would be either a reliable transaction record (or records) of recent housing expense payments or a lease, or an amount determined under a reliable method of estimating a consumer's housing expense based on the housing expenses of consumers with households in the locality of the consumer.

Proposed comment 5(c)(3)(ii)(D)-1 explains that the proposed provision means a lender would have three methods that it could choose from for complying with the requirement to obtain verification evidence for a consumer's housing expense. Proposed comment 5(c)(3)(ii)(D)-1.i explains that under the first method, which could be used for a consumer whose housing expense is a mortgage payment, the lender may obtain a national consumer report that includes the mortgage payment. A lender would be required to obtain a national consumer report as verification evidence of a consumer's payments under debt obligations generally, pursuant to proposed § 1041.5(c)(3)(ii)(B). A lender's compliance with that requirement would satisfy the requirement in proposed § 1041.5(c)(3)(ii)(D), provided the consumer's housing expense is a mortgage payment and that mortgage payment appears in the national consumer report the lender obtains.

Proposed comment 5(c)(3)(ii)(D)-1.ii explains that the second method is for the lender to obtain a reliable transaction record (or records) of recent housing expense payments or a rental or lease agreement. It clarifies that for purposes of this method, reliable transaction records include a facially genuine original, photocopy or image of a receipt, cancelled check, or money order, or an electronic or paper record of depository account transactions or prepaid account transactions (including transactions on a general purpose reloadable prepaid card account, a payroll card account, or a government Start Printed Page 47956benefits card account), from which the lender can reasonably determine that a payment was for housing expense as well as the date and amount paid by the consumer. This method mirrors options a lender would have for obtaining verification evidence for net income. Accordingly, data derived from a record of depository account transactions or of prepaid account transactions, such as data from account data aggregator services that obtain and categorize consumer deposit account and other account transaction data, would also generally satisfy the requirement. Bureau staff have met with service providers that state that they currently provide services to lenders and are typically able to identify, for example, how much a particular consumer expends on housing expense as well as other categories of expenses.

Proposed comment 5(c)(3)(ii)(D)-1.iii explains that the third method is for a lender to use an amount determined under a reliable method of estimating a consumer's share of housing expense based on the individual or household housing expenses of similarly situated consumers with households in the locality of the consumer seeking a covered loan. Proposed comment 5(c)(3)(ii)(D)-1.iii provides, as an example, that a lender may use data from a statistical survey, such as the American Community Survey of the United States Census Bureau, to estimate individual or household housing expense in the locality (e.g., in the same census tract) where the consumer resides. It provides that, alternatively, a lender may estimate individual or household housing expense based on housing expense and other data (e.g., residence location) reported by applicants to the lender, provided that it periodically reviews the reasonableness of the estimates that it relies on using this method by comparing the estimates to statistical survey data or by another method reasonably designed to avoid systematic underestimation of consumers' shares of housing expense. It further explains that a lender may estimate a consumer's share of household expense based on estimated household housing expense by reasonably apportioning the estimated household housing expense by the number of persons sharing housing expense as stated by the consumer, or by another reasonable method.

Several SERs expressed concern during the SBREFA process that the Bureau's approach to housing expense verification described in the Small Business Review Panel Outline was burdensome and impracticable for many consumers and lenders. Several lender representatives expressed similar concerns during the Bureau's outreach to industry. The Small Business Review Panel Outline referred to lender verification of a consumer's rent or mortgage payment using, for example, receipts, cancelled checks, a copy of a lease, and bank account records. But some SERs and other lender representatives stated many consumers would not have these types of documents readily available. Few consumers receive receipts or cancelled checks for rent or mortgage payments, they stated, and bank account statements may simply state the check number used to make a payment, providing no way of confirming the purpose or nature of the payment. Consumers with a lease would not typically have a copy of the lease with them when applying for a covered loan, they stated, and subsequently locating and transmitting or delivering a copy of the lease to a lender would be unduly burdensome, if not impracticable, for both consumers and lenders.

The Bureau believes that many consumers would have paper or electronic records that they could provide to a lender to establish their housing expense. In addition, as discussed above, information presented to the Bureau during outreach suggests that data aggregator services may be able to electronically and securely obtain and categorize, with a consumer's consent, the consumer's deposit account or other account transaction data to reliably identify housing expenses payments and other categories of expenses.

Nonetheless, the Bureau intends its proposal to be responsive to these concerns by providing lenders with multiple options for obtaining verification evidence for a consumer's housing expense, including by using estimates based on the housing expenses of similarly situated consumers with households in the locality of the consumer seeking a covered loans. The Bureau's proposal also is intended to facilitate automation of the methods of obtaining the verification evidence, making projections of a consumer's housing expense, and calculating the amounts for an ability-to-repay determination, such as residual income.

A related concern raised by SERs is that a consumer may be the person legally obligated to make a rent or mortgage payment but may receive contributions toward it from other household members, so that the payment the consumer makes, even if the consumer can produce a record of it, is much greater than the consumer's own housing expense. Similarly, a consumer may make payments in cash to another person, who then makes the payment to a landlord or mortgage servicer covering the housing expenses of several residents. During outreach with industry, one lender stated that many of its consumers would find requests for documentation of housing expense to be especially intrusive or offensive, especially consumers with informal arrangements to pay rent for a room in someone else's home.

To address these concerns, the Bureau is proposing the option of estimating a consumer's housing expense based on the individual or apportioned household housing expenses of similarly situated consumers with households in the locality. The Bureau believes the proposed approach would address the concerns raised by SERs and other lenders while also reasonably accounting for the portion of a consumer's net income that is consumed by housing expenses and, therefore, not available for payments under a prospective loan. The Bureau notes that if the method the lender uses to obtain verification evidence of housing expense for a consumer—including the estimated method—indicates a higher housing expense amount than the amount in the consumer's statement under proposed § 1041.5(c)(3)(i), then proposed § 1041.5(c)(1) would generally require a lender to rely on the higher amount indicated by the verification evidence. Accordingly, a lender may prefer use one of the other two methods for obtaining verification evidence, especially if doing so would result in verification evidence indicating a housing expense equal to that in the consumer's written statement of housing expense.

The Bureau recognizes that in some cases the consumer's actual housing expense may be lower than the estimation methodology would suggest but may not be verifiable through documentation. For example, some consumers may live for a period of time rent-free with a friend or relative. However, the Bureau does not believe it is possible to accommodate such situations without permitting lenders to rely solely on the consumer's statement of housing expenses, and for the reasons previously discussed the Bureau believes that doing so would jeopardize the objectives of the proposal. The Bureau notes that the approach it is proposing is consistent with the recommendation of the Small Dollar Roundtable which recommended that the Bureau permit rent to be verified Start Printed Page 47957through a “geographic market-specific . . . valid, reliable proxy.”

The Bureau invites comment on whether the proposed methods of obtaining verification evidence for housing expense are appropriate and adequate.

§ 1041.6 Additional Limitations on Lending—Covered Short-Term Loans

Background

Proposed § 1041.6 would augment the basic ability-to-repay determination required by proposed § 1041.5 in circumstances in which the consumer's recent borrowing history or current difficulty repaying an outstanding loan provides important evidence with respect to the consumer's financial capacity to afford a new covered short-term loan. In these circumstances, proposed § 1041.6 would require the lender to factor this evidence into the ability-to-repay determination and, in certain instances, would prohibit a lender from making a new covered short-term loan under proposed § 1041.5 to the consumer for 30 days. The Bureau proposes the additional requirements in § 1041.6 for the same basic reason that it proposes § 1041.5: To prevent the unfair and abusive practice identified in proposed § 1041.4, and the consumer injury that results from it. The Bureau believes that these additional requirements may be needed in circumstances in which proposed § 1041.5 alone may not be sufficient to prevent a lender from making a covered short-term loan that the consumer might not have the ability to repay.

Proposed § 1041.6 would generally impose a presumption of unaffordability on continued lending where evidence suggests that the prior loan was not affordable for the consumer such that the consumer may have particular difficulty repaying a new covered short-term loan. Specifically, such a presumption would apply when a consumer seeks a covered short-term loan during the term of a covered short-term loan made under proposed § 1041.5 or a covered longer-term balloon-payment loan made under proposed § 1041.9 and for 30 days thereafter, or seeks to take out a covered short-term loan when there are indicia that an outstanding loan with the same lender or its affiliate is unaffordable for the consumer. Proposed § 1041.6 would also impose a mandatory cooling-off period prior to a lender making a fourth loan covered short-term loan in a sequence and would prohibit lenders from making a covered short-term loan under proposed § 1041.5 during the term of and for 30 days thereafter a covered short-term loan made under proposed § 1041.7.

A central component of the preventive requirements in proposed § 1041.6 is the concept of a reborrowing period—a period following the payment date of a prior loan during which a consumer's borrowing of a covered short-term loan is deemed evidence that the consumer is seeking additional credit because the prior loan was unaffordable. When consumers have the ability to repay a covered short-term loan, the loan should not cause consumers to have the need to reborrow shortly after repaying the loan. As discussed in Market Concerns—Short-Term Loans, however, the Bureau believes that the fact that covered short-term loans require repayment so quickly after consummation makes such loans more difficult for consumers to repay the loan consistent with their other major financial obligations and basic living expenses without needing to reborrow. Moreover, most covered short-term loans—including payday loans and short-term vehicle title loans—also require payment in a single lump sum, thus exacerbating the challenge of repaying the loan without needing to reborrow.

For these loans, the Bureau believes that the fact that a consumer returns to take out another covered short-term loan shortly after having a previous covered short-term loan outstanding frequently indicates that the consumer did not have the ability to repay the prior loan and meet the consumer's other major financial obligations and basic living expenses. This also may provide strong evidence that the consumer will not be able to afford a new covered short-term loan. A second covered short-term loan shortly following a prior covered short-term loan may result from a financial shortfall caused by repayment of the prior loan.

Frequently, reborrowing occurs on the same day that a loan is due, either in the form of a rollover (where permitted by State law) or a new loan taken out on the same day that the prior loan was repaid. Some States require a cooling-off period between loans, typically 24 hours, and the Bureau has found that in those States, if consumers take out successive loans, they generally do so at the earliest time that is legally permitted.[559] The Bureau interprets these data to indicate that these consumers could not afford to repay the full amount of the loan when due and still meet their financial obligations and basic living expenses.

Whether a particular loan taken after a consumer has repaid a prior loan (and after the expiration of any mandated cooling-off period) is a reborrowing prompted by unaffordability of the prior payment is less facially evident. The fact that consumers may cite a particular income or expense shock is not dispositive since a prior unaffordable loan may be the reason that the consumer cannot absorb the new change. On balance, the Bureau believes that for new loans taken within a short period of time after a prior loan ceases to be outstanding, the most likely explanation is the unaffordability of the prior loan, i.e., the fact that the size of the payment obligation on the prior loan left these consumers with insufficient income to make it through their monthly expense cycle.

To provide a structured process that accounts for the likelihood that the unaffordability of an existing or prior loan is driving reborrowing and that ensures a rigorous analysis of consumers' individual circumstances, the Bureau believes that the most appropriate approach may be a presumptions framework rather than an open-ended inquiry. The Bureau is thus proposing to delineate a specific reborrowing period—i.e., a period during which a new loan will be presumed to be a reborrowing.[560]

In determining the appropriate length of the reborrowing period, the Bureau considered several time periods. In particular, in addition to the 30-day period being proposed, the Bureau considered periods of 14, 45, 60, or 90 days in length. The Bureau also considered an option that would tie the length of the reborrowing period to the term of the preceding loan. In evaluating the alternative options for defining the reborrowing period (and in turn the loan Start Printed Page 47958sequence definition), the Bureau sought to strike a balance between a reborrowing period that would be too short, thereby not capturing substantial numbers of subsequent loans that are in fact the result of the spillover effect of the unaffordability of the prior loan and inadequately preventing consumer injury, and a reborrowing period that would be too long, thereby covering substantial numbers of subsequent loans that are the result of a new need for credit, independent of such effects. This concept of a reborrowing period is intertwined with the definition of loan sequence. Under proposed § 1041.2(a)(12), loan sequence is defined as a series of consecutive or concurrent covered short-term loans in which each of the loans is made while the consumer currently has an outstanding covered short-term loan or within 30 days after the consumer ceased to have a covered short-term loan outstanding.

The Bureau's 2014 Data Point analyzed repeated borrowing on payday loans using a 14-day reborrowing period reflecting a bi-weekly pay cycle, the most common pay cycle for consumers in this market.[561] For the purposes of the 2014 Data Point, a loan was considered part of a sequence if it was made within 14 days of the prior loan. The Bureau adopted this approach in the Bureau's early research in order to obtain a relatively conservative measure of reborrowing activity relative to the most frequent date for the next receipt of income. However, the 14-day definition had certain disadvantages, including the fact that many consumers are paid on a monthly cycle, and a 14-day definition thus does not adequately reflect how different pay cycles can cause slightly different reborrowing patterns.

Upon further consideration of what benchmarks would sufficiently protect consumers from reborrowing harm, the Bureau turned to the typical consumer expense cycle, rather than the typical income cycle, as the most appropriate metric.[562] Consumer expense cycles are typically a month in length with housing expenses, utility payments, and other debt obligations generally paid on a monthly basis. Thus, where repaying a loan causes a shortfall, the consumer may seek to return during the same expense cycle to get funds to cover downstream expenses.

The proposals under consideration in the Small Business Review Panel Outline relied on a 60-day reborrowing period based upon the premise that consumers for whom repayment of a loan was unaffordable may nonetheless be able to juggle their expenses for a period of time so that the spillover effects of the loan may not manifest until the second expense cycle following repayment. Upon additional analysis and extensive feedback from a broad range of stakeholders, the Bureau has now tentatively concluded that the 30-day definition incorporated into the Bureau's proposal may strike a more appropriate balance between competing considerations.

Because so many expenses are paid on a monthly basis, the Bureau believes that loans obtained during the same expense cycle are relatively likely to indicate that repayment of a prior loan may have caused a financial shortfall. Additionally, in analysis of supervisory data, the Bureau has found that a considerable segment of consumers who repay a loan without an immediate rollover or reborrowing nonetheless return within the ensuing 30 days to reborrow.[563] Accordingly, if the consumer returns to take out another covered short-term loan—or, as described with regard to proposed § 1041.10, certain types of covered longer-term loans—within the same 30-day period, the Bureau believes that this pattern of reborrowing indicates that the prior loan was unaffordable and that the following loan may likewise be unaffordable.

On the other hand, the Bureau believes that for loans obtained more than 30 days after a prior loan, there is an increased possibility that the loan is prompted by a new need on the part of the borrower, not directly related to potential financial strain from repaying the prior loan. While a previous loan's unaffordability may cause some consumers to need to take out a new loan as many as 45 days or even 60 days later, the Bureau believes that the effects of the previous loan are more likely to dissipate once the consumer has completed a full expense cycle following the previous loan's conclusion. Accordingly, the Bureau believes that a 45-day or 60-day definition may be too broad. A reborrowing period which varies with the length of the preceding loan term would be operationally complex for lenders to implement and, for consumers paid weekly or bi-weekly, may also be too narrow.

Accordingly, using this 30-day reborrowing window, the Bureau is proposing a presumption of unaffordability in situations in which the Bureau believes that the fact that the consumer is seeking to take out a new covered short-term loan during the term of, or shortly after repaying, a prior loan generally suggests that the new loan, like the prior loan, will exceed the consumer's ability to repay. The presumption is based on concerns that the prior loan may have triggered the need for the new loan because it exceeded the consumer's ability to repay, and that, absent a sufficient improvement of the consumer's financial capacity, the new loan will also be unaffordable for the consumer.

The presumption can be overcome, however, in circumstances that suggest that there is sufficient reason to believe that the consumer would, in fact, be able to afford the new loan even though he or she is seeking to reborrow during the term of or shortly after a prior loan. The Bureau recognizes, for example, that there may be situations in which the prior loan would have been affordable but for some unforeseen disruption in income that occurred during the prior expense cycle and which is not reasonably expected to recur during the term of the new loan. The Bureau also recognizes that there may be circumstances, albeit less common, in which even though the prior loan proved to be unaffordable, a new loan would be affordable because of a reasonably projected increase in net income or decrease in major financial obligations—for example, if the consumer has obtained a second job that will increase the consumer's residual income going forward or the consumer has moved since obtaining the prior loan and will have lower housing expenses going forward.

Proposed § 1041.6(b) through (d) define a set of circumstances in which the Bureau believes that a consumer's recent borrowing history makes it unlikely that the consumer can afford a new covered short-term loan, including concurrent loans.[564] In such Start Printed Page 47959circumstances, a consumer would be presumed to not have the ability to repay a covered short-term loan under proposed § 1041.5. Proposed § 1041.6(e) would define the additional determinations that a lender would be required to make in cases where the presumption applies in order for the lender's determination under proposed § 1041.5 that the consumer will have the ability to repay a new covered short-term loan to be reasonable despite the unaffordability of the prior loan.

The Bureau believes that it is extremely unlikely that a consumer who twice in succession returned to reborrow during the reborrowing period and who seeks to reborrow again within 30 days of having the third covered short-term loan outstanding would be able to afford another covered short-term loan. Because of lenders' strong incentives to facilitate reborrowing that is beyond the consumer's ability to repay, the Bureau believes it is appropriate, in proposed § 1041.6(f), to impose a mandatory 30-day cooling-off period after the third covered short-term loan in a sequence, during which time the lender cannot make a new covered short-term loan under proposed § 1041.5 to the consumer. This period would ensure that after three consecutive ability-to-repay determinations have proven inconsistent with the consumer's actual experience, the lender could not further worsen the consumer's financial situation by encouraging the consumer to take on additional unaffordable debt. Additionally, proposed § 1041.6(g) would prohibit a lender from combining sequences of covered short-term loans made under proposed § 1041.5 with loans made under the conditional exemption in proposed § 1041.7, as discussed further below.

The Bureau notes that this overall proposed approach is fairly similar to the framework included in the Small Business Review Panel Outline. There, the Bureau included a presumption of inability to repay for the second and third covered short-term loan and covered longer-term balloon-payment loan in a loan sequence and a mandatory cooling-off period following the third loan in a sequence. The Bureau considered a “changed circumstances” standard for overcoming the presumption that would have required lenders to obtain and verify evidence of a change in consumer circumstances indicating that the consumer had the ability to repay the new loan according to its terms. The Bureau also, as noted above, included a 60-day reborrowing period (and corresponding definition of loan sequence) in the Small Business Review Panel Outline.

SERs and other stakeholders that offered feedback on the Outline urged the Bureau to provide greater flexibility with regard to using a presumptions framework to address concerns about repeated borrowing despite the contemplated requirement to determine ability to repay. The SERs and other stakeholders also urged the Bureau to provide greater clarity and flexibility in defining the circumstances that would permit a lender to overcome the presumption of unaffordability.

The Small Business Review Panel Report recommended that the Bureau request comment on whether a loan sequence could be defined with reference to a period shorter than the 60 days under consideration during the SBREFA process. The Small Business Review Panel Report further recommended that the Bureau consider additional approaches to regulation, including whether existing State laws and regulations could provide a model for elements of the Bureau's proposed interventions. In this regard, the Bureau notes that some States have cooling-off periods of one to seven days, as well as longer periods that apply after a longer sequence of loans. The Bureau's prior research has examined the effectiveness of these cooling-off periods [565] and, in the CFPB Report on Supplemental Findings, the Bureau is publishing research showing how different definitions of loan sequence affect the number of loan sequences and the number of loans deemed to be part of a sequence.[566] In the CFPB Report on Supplemental Findings, the Bureau is publishing additional analysis on the impacts of State cooling-off periods.[567] The latter analysis is also discussed in Market Concerns—Short-Term Loans.

The Bureau has made a number of adjustments to the presumptions framework in response to this feedback. For instance, the Bureau is proposing a 30-day definition of loan sequence and 30-day cooling-off period rather than a 60-day definition of loan sequence and 60-day cooling-off period. The Bureau has also provided greater specificity and flexibility about when a presumption of unaffordability would apply, for example, by proposing certain exceptions to the presumption of unaffordability for a sequence of covered short-term loans. The proposal also would provide somewhat more flexibility about when a presumption of unaffordability could be overcome by permitting lenders to determine that there would be sufficient improvement in financial capacity for the new loan because of a one-time drop in income since obtaining the prior loan (or during the prior 30 days, as applicable). The Bureau has also continued to assess potential alternative approaches to the presumptions framework, discussed below.

The Bureau solicits comment on all aspects of the proposed presumptions of unaffordability and mandatory cooling-off periods, and other aspects of proposed § 1041.6, including the circumstances in which the presumptions apply (e.g., the appropriate length of the reborrowing period and the appropriateness of other circumstances giving rise to the presumptions), the requirements for overcoming a presumption of unaffordability, and the circumstances in which a lender would be prohibited from making a covered short-term loan under proposed § 1041.5 during a 30-day cooling-off period or cooling-off period of a different length. In addition, and consistent with the recommendations of the Small Business Review Panel Report, the Bureau solicits comment on whether the 30-day reborrowing period is appropriate for the presumptions and prohibitions, or whether a longer or shorter period would better address the Bureau's concerns about repeat borrowing. The Bureau also seeks comment on whether lenders should be required to provide disclosures as part of the origination process for covered loans and, if so, whether an associated model form would be appropriate; on the specific elements of such disclosures; and on the burden and benefits to consumers and lenders of providing disclosures as described above.

Alternatives Considered

The Bureau has considered a number of alternative approaches to address reborrowing on covered short-term loans in circumstances indicating the consumer was unable to afford the prior loan.[568] One possible approach would Start Printed Page 47960be to limit the overall number of covered short-term loans that a consumer could take within a specified period of time, rather than using the loan sequence and presumption concepts as part of the determination of consumers' ability to repay subsequent loans in a sequence and when and if a mandatory cooling-off period should apply. By imposing limits on reborrowing while avoiding the complexity of the presumptions, this approach could provide a more flexible way to protect consumers whose borrowing patterns suggest that they may not have the ability to repay their loans. This approach could, for example, limit the number of covered short-term loans to three within a 120-day period when the loan has a duration of 15 days or less. For loans with a longer duration, the applicable period of time correspondingly could be longer. However, depending on individual consumers' usage patterns, such an approach could also result in much longer cooling-off periods for individuals who borrow several times early in the designated period. Alternatively, a similar approach could impose a cooling-off period of varying lengths depending on the consumer's time in debt during a specified period.

The Bureau has also considered an alternative approach under which, instead of defining the circumstances in which a formal presumption of unaffordability applies and the determinations that a lender must make when such a presumption applies to a transaction, the Bureau would identify circumstances indicative of a consumer's inability to repay that would be relevant to whether a lender's determination under proposed § 1041.5 is reasonable. This approach would likely involve a number of examples of indicia requiring greater caution in underwriting and examples of countervailing factors that might support the reasonableness of a lender's determination that the consumer could repay a subsequent loan despite the presence of such indicia. This alternative approach would be less prescriptive than the proposed framework, and thus leave more discretion to lenders to make such a determination. However, it would also provide less certainty as to when a lender's particular ability-to-repay determination is reasonable.

In addition, the Bureau has considered whether there is a way to account for unusual expenses within the presumptions framework without creating an exception that would swallow the rule. In particular, the Bureau considered permitting lenders to overcome the presumptions of unaffordability in the event that the consumer provided evidence that the reason the consumer was struggling to repay the outstanding loan or was seeking to reborrow was due to a recent unusual and non-recurring expense. For example, under such an approach, a lender could overcome the presumption of unaffordability by finding that the reason the consumer was seeking a new covered short-term loan was as a result of an emergency car repair or furnace replacement or an unusual medical expense during the term of the prior loan or the reborrowing period, so long as the expense is not reasonably likely to recur during the period of the new loan. The Bureau considered including such circumstances as an additional example of sufficient improvement in financial capacity, as described with regard to proposed § 1041.6(e) below.

While such an addition could provide more flexibility to lenders and to consumers to overcome the presumptions of unaffordability, an unusual and non-recurring expense test would also present several challenges. To effectuate this test, the Bureau would need to define, in ways that lenders could implement, what would be a qualifying “unusual and non-recurring expense,” a means of assessing whether a new loan was attributable to such an expense rather than to the unaffordability of the prior loan, and standards for how such an unusual and non-recurring expense could by documented (e.g., through transaction records). Such a test would have substantial implications for the way in which the ability-to-repay requirements in proposed § 1041.5 (and proposed § 1041.9 for covered longer-term loans) address the standards for basic living expenses and accounting for potential volatility over the term of a loan. Most significantly, the Bureau is concerned that if a lender were permitted to overcome the presumption of unaffordability by finding that the consumer faced an unusual and non-recurring expense during repayment of the prior or outstanding loan, this justification would be invoked in cases in which the earlier loan had, in fact, been unaffordable. As discussed above, the fact that a consumer may cite a particular expense shock when seeking to reborrow does not necessarily mean that a recent prior loan was affordable; if a consumer, in fact, lacked the ability to repay the prior loan, it would be a substantial factor in why the consumer could not absorb the expense. Accordingly, the Bureau believes that it may be difficult to parse out causation and to differentiate between types of expense shocks and the reasonableness of lenders' ability-to-repay determinations where such shocks are asserted to have occurred.

In light of these competing considerations, the Bureau has chosen to propose the approach of supplementing the proposed § 1041.5 determination with formal presumptions. The Bureau is, however, broadly seeking comment on alternative approaches to addressing the issue of repeat borrowing in a more flexible manner, including the alternatives described above and on any other framework for assessing consumers' borrowing history as part of an overall determination of ability to repay. The Bureau specifically seeks comment on whether to apply a presumption of unaffordability or mandatory cooling-off period based on the total number of loans that a consumer has obtained or the total amount of time in which a consumer has been in debt during a specified period of time. The Bureau also solicits comment on the alternative of defining indicia of unaffordability, as described above. For such alternatives, the Bureau solicits comment on the appropriate time periods and on the manner in which such frameworks would address reborrowing on loans of different lengths. In addition, the Bureau specifically seeks comment on whether to permit lenders to overcome a presumption of unaffordability by finding that the consumer had experienced an unusual and non-recurring expense and, if so, on measures to address the challenges described above.

Legal Authority

As discussed in the section-by-section analysis of proposed § 1041.4 above, the Bureau believes that it may be an unfair and abusive practice to make a covered Start Printed Page 47961short-term loan without determining that the consumer will have the ability to repay the loan. Accordingly, in order to prevent that unfair and abusive practice, proposed § 1041.5 would require lenders prior to making a covered short-term loan—other than a loan made under the conditional exemption to the ability-to-repay requirements in proposed § 1041.7—to make a reasonable determination that the consumer has sufficient income after meeting major financial obligations, to make payments under a prospective covered short-term loan and to continue meeting basic living expenses. Proposed § 1041.6 would augment the basic ability-to-repay determination required by proposed § 1041.5 in circumstances in which the consumer's recent borrowing history or current difficulty repaying an outstanding loan provides important evidence with respect to the consumer's financial capacity to afford a new covered short-term loan. The Bureau is proposing § 1041.6 based on the same source of authority that serves as the basis for proposed § 1041.5: The Bureau's authority under section 1031(b) of the Dodd-Frank Act, which provides that the Bureau's rules may include requirements for the purposes of preventing unfair, deceptive, or abusive acts or practices.[569]

As with proposed § 1041.5, the Bureau proposes the requirements in § 1041.6 to prevent the unfair and abusive practice identified in proposed § 1041.4, and the consumer injury that results from it. The Bureau believes that the additional requirements of proposed § 1041.6 may be needed in circumstances in which proposed § 1041.5 alone may not be sufficient to prevent a lender from making a covered short-term loan that would exacerbate the impact of an initial unaffordable loan. Accordingly, the Bureau believes that the requirements set forth in proposed § 1041.6 bear a reasonable relation to preventing the unfair and abusive practice identified in proposed § 1041.4. In addition, as further discussed in the section-by-section analysis of proposed § 1041.6(h), the Bureau proposes that provision pursuant to both the Bureau's authority under section 1031(b) of the Dodd-Frank Act and the Bureau's authority under section 1022(b)(1) of the Dodd-Frank Act to prevent evasions of the purposes and objectives of Federal consumer financial laws, including Bureau rules issued pursuant to rulemaking authority provided by Title X of the Dodd-Frank Act.[570]

6(a) Additional Limitations on Making a Covered Short-Term Loan Under § 1041.5

Proposed § 1041.6(a) would set forth the general additional limitations on making a covered short-term loan under proposed § 1041.5. Proposed § 1041.6(a) would provide that when a consumer is presumed not to have the ability to repay a covered short-term loan under proposed § 1041.6(b), (c), or (d), a lender's determination that the consumer will have the ability to repay the loan is not reasonable, unless the lender can overcome the presumption of unaffordability. Proposed § 1041.6(a) would further provide that a lender is prohibited from making a covered short-term loan to a consumer if the mandatory cooling-off periods in proposed § 1041.6(f) or (g) apply. In order to determine whether the presumptions and prohibitions in proposed § 1041.6 apply to a particular transaction, proposed § 1041.6(a)(2) would require a lender to obtain and review information about the consumer's borrowing history from its own records, the records of its affiliates, and a consumer report from an information system currently registered under proposed § 1041.17(c)(2) or (d)(2), if one is available.

The Bureau notes that, as drafted, the proposed presumptions and prohibitions in § 1041.6 would apply only to making specific additional covered short-term loans. The Bureau solicits comment on whether a presumption of unaffordability, mandatory cooling-off periods, or other additional limitations on lending also would be appropriate for transactions involving an increase in the credit available under an existing covered loan, making an advance on a line of credit under a covered short-term loan, or other circumstances that may evidence repeated borrowing. If such limitations would be appropriate, the Bureau requests comment on how they should be tailored in light of relevant considerations.

In this regard, the Bureau further notes that the presumptions of unaffordability depend on the definition of outstanding loan in proposed § 1041.2(a)(15) and therefore would not cover circumstances in which the consumer is more than 180 days delinquent on the prior loan. The Bureau solicits comment on whether additional requirements should apply to the ability-to-repay determination for a covered short-term loan in these circumstances; for instance, whether to generally prohibit lenders from making a new covered short-term loan to a consumer for the purposes of satisfying a delinquent obligation on an existing loan with the same lender or its affiliate. In addition, the Bureau solicits comment on whether additional requirements should apply to covered short-term loans that are lines of credit; for instance, whether a presumption of unaffordability should apply at the time of the ability-to-repay determination required under § 1041.5(b)(1)(ii) for a consumer to obtain an advance under a line of credit more than 180 days after the date of a prior ability-to-repay determination.

The Bureau also solicits comment on the proposed standard in § 1041.6(a) and on any alternative approaches to the relationship between proposed § 1041.5 and proposed § 1041.6 that would prevent consumer harm while reducing the burden on lenders. In particular, the Bureau solicits comment on whether the formal presumption and prohibition approach in § 1041.6 is an appropriate supplement to the § 1041.5 determination.

6(a)(1) General

Proposed § 1041.6(a)(1) would provide that if a presumption of unaffordability applies, a lender's determination that the consumer will have the ability to repay a covered short-term loan is not reasonable unless the lender makes the additional determination set forth in proposed § 1041.6(e), and discussed in detail below, and the requirements set forth in proposed § 1041.5 are satisfied. Under proposed § 1041.6(e), a lender can make a covered short-term loan notwithstanding the presumption of unaffordability if the lender reasonably determines, based on reliable evidence, that there will be sufficient improvement in the consumer's financial capacity such that the consumer would have the ability to repay the new loan according to its terms despite the unaffordability of the prior loan. Proposed § 1041.6(a)(1) would further provide that a lender must not make a covered short-term loan under proposed § 1041.5 to a consumer during the mandatory cooling-off periods specified in proposed § 1041.6(f) and (g).

Proposed comment 6(a)(1)-1 clarifies that the presumptions and prohibitions would apply to making a covered short-term loan and are triggered, if applicable, at the time of consummation of the new covered short-term loan. Proposed comment 6(a)(1)-2 clarifies that the presumptions and prohibitions would apply to rollovers and renewals of a covered short-term loan when such transactions are permitted under State Start Printed Page 47962law. Proposed comment 6(a)(1)-3 clarifies that a lender's determination that a consumer will have the ability to repay a covered short-term loan is not reasonable within the meaning of proposed § 1041.5 if under proposed § 1041.6 the consumer is presumed to not have the ability to repay the loan and that presumption of unaffordability has not been overcome in the manner set forth in proposed § 1041.6(e). Thus, if proposed § 1041.6 prohibits a lender from making a covered short-term loan, then the lender must not make the loan, regardless of the lender's determination under proposed § 1041.5. Nothing in proposed § 1041.6 would displace the requirements of § 1041.5; on the contrary, the determination under proposed § 1041.6 would be, in effect, an additional component of the proposed § 1041.5 determination of ability to repay in situations in which the basic requirements of proposed § 1041.5 alone would be insufficient to prevent the unfair and abusive practice.

6(a)(2) Borrowing History Review

Proposed § 1041.6(a)(2) would require a lender to obtain and review information about a consumer's borrowing history from the records of the lender and its affiliates, and from a consumer report obtained from an information system currently registered pursuant to § 1041.17(c)(2) or (d)(2), if available, and to use this information to determine a potential loan's compliance with the requirements of proposed § 1041.6. Proposed comment 6(a)(2)-1 clarifies that a lender satisfies its obligation under § 1041.6(a)(2) to obtain a consumer report obtained from an information system currently registered pursuant to § 1041.17(c)(2) or (d)(2), if available, when it complies with the requirement in § 1041.5(c)(3)(ii)(B) to obtain this same consumer report. Proposed comment 6(a)(2)-2 clarifies that if no information systems currently registered pursuant to § 1041.17(c)(2) or (d)(2) are currently available, the lender is nonetheless required to obtain information about a consumer's borrowing history from the records of the lender and its affiliates.

Based on outreach to lenders, including feedback from SERs, the Bureau believes that lenders already generally review their own records for information about a consumer's history with the lender prior to making a new loan to the consumer. The Bureau understands that some lenders in the market for covered short-term loans also pull a consumer report from a specialty consumer reporting agency as part of standardized application screening, though practices in this regard vary widely across the market.

As detailed below in the section-by-section analysis of proposed §§ 1041.16 and 1041.17, the Bureau believes that information regarding the consumer's borrowing history is important to facilitate reliable ability-to-repay determinations. If the consumer already has a relationship with a lender or its affiliates, the lender can obtain some historical information regarding borrowing history from its own records. However, without obtaining a report from an information system currently registered pursuant to § 1041.17(c)(2) or (d)(2), the lender will not know if its existing customers or new customers have obtained covered short-term loans or a prior covered longer-term balloon-payment loan from other lenders, as such information generally is not available in national consumer reports. Accordingly, the Bureau is proposing in § 1041.6(a)(2) to require lenders to obtain a report from an information system currently registered pursuant to § 1041.17(c)(2) or (d)(2), if one is available.

The section-by-section analysis of proposed § 1041.16 and 1041.17, and part VI below explain the Bureau's attempts to minimize burden in connection with furnishing information to and obtaining a consumer report from an information system currently registered pursuant to proposed § 1041.17(c)(2) or (d)(2). Specifically, the Bureau estimates that each report would cost approximately $0.50. Consistent with the recommendations of the Small Business Review Panel Report, the Bureau requests comment on the cost to small entities of obtaining information about consumer borrowing history and on potential ways to further reduce the operational burden of obtaining this information.

6(b) Presumption of Unaffordability for Sequence of Covered Short-Term Loans Made Under § 1041.5

6(b)(1) Presumption

Proposed § 1041.6(b)(1) would provide that a consumer is presumed not to have the ability to repay a covered short-term loan under proposed § 1041.5 during the time period in which the consumer has a covered short-term loan made under proposed § 1041.5 outstanding and for 30 days thereafter. Proposed comment 6(b)(1)-1 clarifies that a lender cannot make a covered short-term loan under § 1041.5 during the time period in which the consumer has a covered short-term loan made under § 1041.5 outstanding and for 30 days thereafter unless the exception to the presumption applies or the lender can overcome the presumption. A lender would be permitted to overcome the presumption of unaffordability in accordance with proposed § 1041.6(e) for the second and third loan in a sequence, as defined in proposed § 1041.2(a)(12); as noted in proposed comment 6(b)(1)-1, prior to the fourth covered short-term loan in a sequence, proposed § 1041.6(f) would impose a mandatory cooling-off period, as discussed further below.

Proposed § 1041.6(b)(1) would apply to situations in which, notwithstanding a lender's determination prior to consummating an earlier covered short-term loan that the consumer would have the ability to repay the loan according to its terms, the consumer seeks to take out a new covered short-term loan during the term of the prior loan or within 30 days thereafter.

As discussed above in the background to the section-by-section analysis of § 1041.6, the Bureau believes that when a consumer seeks to take out a new covered short-term loan during the term of or within 30 days of having a prior covered short-term loan outstanding, there is substantial reason for concern that the need to reborrow is caused by the unaffordability of the prior loan. The Bureau proposes to use the 30-day reborrowing period discussed above to define the circumstances in which a new loan would be considered a reborrowing. The Bureau believes that even in cases where the determination of ability to repay was reasonable based upon what was known at the time that the prior loan was originated, the fact that the consumer is seeking to reborrow in these circumstances is relevant in assessing whether a new and similar loan—or rollover or renewal of the existing loan—would be affordable for the consumer. For example, the reborrowing may indicate that the consumer's actual basic living expenses exceed what the lender projected for the purposes of § 1041.5 for the prior loan. In short, the Bureau believes that when a consumer seeks to take out a new covered short-term loan that would be part of a loan sequence, there is substantial reason to conduct a particularly careful review to determine whether the consumer can afford to repay the new covered short-term loan.

In addition, the fact that the consumer is seeking to reborrow in these circumstances may indicate that the initial determination of affordability was unreasonable when made. Indeed, the Bureau believes that if, with respect to a particular lender making covered short-term loans pursuant to proposed § 1041.5, a substantial percentage of Start Printed Page 47963consumers returned within 30 days to obtain a second loan, that fact would provide evidence that the lender's determinations under proposed § 1041.5 were not reasonable. And this would be even more so the case where a substantial percentage of consumers returned within 30 days of the second loan to obtain a third loan.

Given these considerations, to prevent the unfair and abusive practice identified in proposed § 1041.4, proposed § 1041.6(b) would create a presumption of unaffordability for a covered short-term loan during the time period in which the consumer has a covered short-term loan made under § 1041.5 outstanding and for 30 days thereafter unless the exception in proposed § 1041.6(b)(2) applies. As a result of this presumption, it would not be reasonable for a lender to determine that the consumer will have the ability to repay the new covered short-term loan without taking into account the fact that the consumer did need to reborrow after obtaining a prior loan and making a reasonable determination that the consumer will be able to repay the new covered short-term loan without reborrowing. Proposed § 1041.6(e), discussed below, defines the elements for such a determination.

The Bureau solicits comment on the appropriateness of the proposed presumption to prevent the unfair and abusive practice and on any alternatives that would adequately prevent consumer harm while reducing the burden on lenders. In particular, the Bureau solicits comment on alternative approaches to preventing consumer harm from repeat borrowing on covered short-term loans, including other methods of supplementing the basic ability-to-repay determination required for a covered short-term loan shortly following a prior covered short-term loan.

The Bureau also solicits comment on whether there are other circumstances—such as a pattern of heavy usage of covered short-term loans that would not meet the proposed definition of a loan sequence or the overall length of time in which a consumer is in debt on covered short-term loans over a specified period of time—that would also warrant a presumption of unaffordability.

6(b)(2) Exception

Proposed § 1041.6(b)(2) would provide an exception to the presumption in proposed § 1041.6(b)(1) where the subsequent covered short-term loan would meet specific conditions. The conditions under either proposed § 1041.6(b)(2)(i)(A) or (B) must be met, along with the condition under proposed § 1041.6(b)(2)(ii). First, under proposed § 1041.6(b)(2)(i)(A), the consumer must have paid the prior covered short-term loan in full and the amount that would be owed by the consumer for the new covered short-term loan could not exceed 50 percent of the amount that the consumer paid on the prior loan. Second, under proposed § 1041.6(b)(2)(i)(B), in the event of a rollover the consumer would not owe more on the new covered short-term loan (i.e., the rollover) than the consumer paid on the prior covered short-term loan (i.e., the outstanding loan that is being rolled over). Third, under proposed § 1041.6(b)(2)(ii), the new covered short-term loan would have to be repayable over a period that is at least as long as the period over which the consumer made payment or payments on the prior loan. Proposed comment 6(b)(2)-1 provides general clarification for the proposed provision.

The rationale for the presumption defined in proposed § 1041.6(b)(1) is generally that the consumer's need to reborrow in the specified circumstances evidences the unaffordability of the prior loan and thus warrants a presumption that the new loan will likewise be unaffordable for the consumer.

But when a consumer is seeking to reborrow no more than half of the amount that the consumer has already paid on the prior loan, including situations in which the consumer is seeking to roll over no more than the amount the consumer repays, the Bureau believes that the predicate for the presumption may no longer apply. For example, if a consumer paid off a prior $400, 45-day duration loan and later returns within 30 days to request a new $100, 45-day duration loan, the lender may be able to reasonably infer that such second $100 loan would be affordable for the consumer, even if a second $400 loan would not be. Given that result, assuming that the lender satisfies the requirements of proposed § 1041.5, the lender may be able to reasonably infer that the consumer will have the ability to repay the new loan for $100. Thus, the Bureau believes that an exception to the presumption of unaffordability may be appropriate in this situation.

However, this is not the case when the amount owed on the new loan would be greater than 50 percent of the amount paid on the prior loan, the consumer would roll over an amount greater than he or she repays, or the term of the new loan would be shorter than the term of the prior loan. For example, if the consumer owes $450 on a covered short-term loan, pays only $100 and seeks to roll over the remaining $350, this result would not support an inference that the consumer will have the ability to repay $350 for the new loan. Accordingly, the new loan would be subject to the presumption of unaffordability. Similarly, with the earlier example, the lender could not infer based on the payment of $400 over 45 days that a consumer could afford $200 in one week. Rather, the Bureau believes that it would be appropriate in such circumstances for the lender to go through the process to overcome the presumption in the manner set forth in proposed § 1041.6(e).

On the basis of the preceding considerations, the Bureau is proposing this exception to the presumption in proposed § 1041.6(b). The Bureau's rationale is the same for the circumstances in both proposed § 1041.6(b)(2)(i)(A) and (B); as explained below, the formula is slightly modified in order to account for the particular nature of the rollover transaction when permitted under applicable State law (termed a renewal in some States).

The Bureau solicits comment on the appropriateness of the proposed exception to the presumption of unaffordability and on any other circumstances that would also warrant an exception to the presumption. In particular, the Bureau solicits comment on the specific thresholds in proposed § 1041.6(b)(2)(i)(A) and (B). In addition, the Bureau solicits comment on the timing requirement in proposed § 1041.6(b)(2)(ii) and whether alternative formulations of the timing requirement would be appropriate; for instance, whether an exception should be available if the new covered short-term loan would be repayable over a period that is proportional to the prior payment history.

6(b)(2)(i)(A)

Proposed § 1041.6(b)(2)(i)(A) would set out the formula for transactions in which the consumer has paid off the prior loan in full and is then returning for a new covered short-term loan during the reborrowing period. Proposed § 1041.6(b)(2)(i)(A) would define paid in full to include the amount financed, charges included in the total cost of credit, and charges excluded from the total cost of credit such as late fees. Proposed § 1041.6(b)(2)(i)(A) would further specify that to be eligible for the exception, the consumer would not owe, in connection with the new covered short-term loan, more than 50 percent of the amount that the consumer paid on the prior covered short-term loan (including the amount financed Start Printed Page 47964and charges included in the total cost of credit, but excluding any charges excluded from the total cost of credit such as late fees). Proposed comment 6(b)(2)(i)(A)-1 clarifies that a loan is considered paid in full whether or not the consumer's obligations were satisfied timely under the loan contract and also clarifies how late fees are treated for purposes of the exception requirements. Proposed comment 6(b)(2)(i)(A)-2 provides illustrative examples. The Bureau solicits comment on whether a consumer should be eligible for the exception under proposed § 1041.6(b)(2)(i)(A) when the prior loan was paid in full but the consumer had previously triggered late fees or otherwise was delinquent on payments for the prior loan, as such history of late payments could be a relevant consideration toward whether the consumer has the ability to repay a similarly-structured loan.

6(b)(2)(i)(B)

Proposed § 1041.6(b)(2)(i)(B) would set out the formula for transactions in which the consumer provides partial payment on a covered short-term loan and is seeking to roll over the remaining balance into a new covered short-term loan. Proposed § 1041.6(b)(2)(i)(B) would specify that to be eligible for the exception, the consumer would not owe more on the new covered short-term loan than the consumer paid on the prior covered short-term loan that is being rolled over (including the amount financed and charges included in the total cost of credit, but excluding any charges that are excluded from the total cost of credit such as late fees). Proposed comment 6(b)(2)(i)(B)-1 clarifies that rollovers are subject to applicable State law (sometimes called renewals) and cross-references proposed comment 6(a)(1)-2. Proposed comment 6(b)(2)(i)(B)-1 also clarifies that the prior covered short-term loan is the outstanding loan being rolled over, the new covered short-term loan is the rollover, and that for the conditions of § 1041.6(b)(2)(i)(B) to be satisfied, the consumer will repay at least 50 percent of the amount owed on the loan being rolled over. Proposed comment 6(b)(2)(i)(B)-2 provides an illustrative example.

As discussed above with regard to the reborrowing period, the Bureau considers rollovers and other forms of reborrowing within 30 days of the prior loan outstanding to be the same. Given the particular nature of the rollover transaction when permitted by State law, slightly different calculations are needed for the exception to effectuate this equal treatment.

6(b)(2)(ii)

Proposed § 1041.6(b)(2)(ii) would set forth the condition that the new covered short-term loan be repayable over a period that is at least as long as the period over which the consumer made payment or payments on the prior covered short-term loan. The Bureau believes that both the amount of the new loan and the duration of the new loan relative to the prior loan are important to determining whether there is a risk that the second loan would be unaffordable and thus whether a presumption should be applied. Absent this condition, situations could arise in which the 50 percent condition were satisfied but where the Bureau would still have concern about not applying the presumption. As noted above, from the fact that the consumer paid in full a $450 loan with a term of 45 days, it does not follow that the consumer can afford a $200 loan with a term of one week, even though $200 is less than 50 percent of $450. In that instance, the consumer would owe $200 in only a week, which may be very difficult to repay.

6(c) Presumption of Unaffordability for a Covered Short-Term Loan Following a Covered Longer-Term Balloon-Payment Loan Made Under § 1041.9

Proposed § 1041.6(c) would provide that a consumer is presumed not to have the ability to repay a covered short-term loan under proposed § 1041.5 during the time period in which the consumer has a covered longer-term balloon-payment loan made under proposed § 1041.9 outstanding and for 30 days thereafter. The presumption in proposed § 1041.6(c) uses the same 30-day reborrowing period used in proposed § 1041.6(b) and discussed in the background to the section-by-section analysis of § 1041.6 to define when there is sufficient risk that the need for the new loan was triggered by the unaffordability of the prior loan and, as a result, warrants a presumption that the new loan would be unaffordable.

The Bureau believes that when a consumer seeks to take out a new covered short-term loan that would be part of a loan sequence, there is substantial reason for concern that the need to reborrow is being triggered by the unaffordability of the prior loan. Similarly, covered longer-term balloon-payment loans, by definition, require a large portion of the loan to be paid at one time. As discussed below in Market Concerns—Longer-Term Loans, the Bureau's research suggests that the fact that a consumer seeks to take out another covered longer-term balloon-payment loan shortly after having a previous covered longer-term balloon-payment loan outstanding will frequently indicate that the consumer did not have the ability to repay the prior loan and meet the consumer's other major financial obligations and basic living expenses. The Bureau found that the approach of the balloon payment coming due is associated with significant reborrowing.[571] However, the need to reborrow caused by an unaffordable covered longer-term balloon is not necessarily limited to taking out a new loan of the same type. If the borrower takes out a new covered short-term loan in such circumstances, it also is a reborrowing. Accordingly, in order to prevent the unfair and abusive practice identified in proposed § 1041.4, the Bureau proposes a presumption of unaffordability for a covered short-term loan that would be concurrent with or shortly following a covered longer-term balloon-payment loan.

Unlike the presumption in § 1041.6(b), the Bureau does not propose an exception to the presumption based on the amount to be repaid on each loan. The rationale for that exception relies on the consumer repaying the new covered short-term loan over a period of time that is at least as long as the time that the consumer repaid the prior covered short-term loan. By definition, a covered longer-term balloon-payment loan has a longer duration than a covered short-term loan, so the circumstances for which the Bureau believes an exception is appropriate in § 1041.6(b)(2) would not be applicable to the transactions governed by proposed § 1041.6(c).

The Bureau solicits comment on the appropriateness of the proposed presumption to prevent the unfair and abusive practice and on any alternatives that would adequately prevent consumer harm while reducing the burden on lenders. The Bureau also solicits comment on whether proposed § 1041.6(c) and the provisions of proposed § 1041.6 more generally would adequately protect against the potential for lenders to make covered loans of different lengths (e.g., a covered short-term loan immediately followed by a 46-day covered longer-term balloon-payment loan) in order to avoid operation of the presumptions and prohibitions in proposed § 1041.6, and Sta