The payday lending industry may soon undergo a major overhaul.
The Consumer Financial Protection Bureau targets these short term loans that carry high interest rates in an attempt to prevent borrowers from falling into an endless cycle of debt.
The bureau proposed new rules that would require payday lenders to check a borrower’s ability to afford a loan and restrict certain lending and fee practices.
Payday loans, which tend to be tied to the customer’s next payday, typically have an average annual percentage rate of around 390%, the CFPB said.
Many borrowers tend to live paycheck to paycheck with volatile income that can vary from month to month, according to research from The Pew Charitable Trusts. Loans are often used to cover basic expenses like rent or utility bills.
Here is what the CFPB offers:
1. Make sure borrowers can afford to repay a loan: The “full payment test” proposed by the CFPB would require lenders to verify that a borrower can afford to make payments while meeting basic expenses and other major financial obligations.
“Too many borrowers looking for a short-term cash flow solution are struggling with loans they cannot afford and are going into debt over the long term,” said CFPB Director Richard Cordray, in a press release. “It’s a bit like getting in a cab just to cross town and get stuck on a trip through the ruinous country.”
2. Put an end to the “debt trap” cycle: The proposals also seek to end what the CFPB has called “debt traps” by making it more difficult for lenders to reissue or refinance a borrower’s loans.
According to the CFPB, over 80% of payday loans are re-borrowed within a month.
The rules would prevent lenders from issuing a similar loan to a borrower seeking more money or seeking to renew a loan within 30 days of paying off a previous short-term debt. They would also limit when a loan could be refinanced.
3. Regulate penalty fees: Many payday lenders have access to their clients’ checking accounts so that they can automatically collect payment on payday. But unsuccessful withdrawals from an account can result in huge fees to both the debtor’s bank and the lender.
The average payday loan borrower goes into debt almost half the year and spends an average of $ 520 in fees to repeatedly borrow $ 375, according to Pew.
Under the proposed new rules, lenders must provide written notice typically at least three days before attempting to debit an account that details how much money will be withdrawn and when.
While the potential rules aim to keep borrowers from taking on insurmountable debt, some say they don’t go far enough
For starters, the government should limit the amount that payday lenders can lend, said Nick Bourke, director of small dollar loans at The Pew Charitable Trusts.
He added that the lack of federal standards pushes other lenders, such as banks and credit unions, out of the short-term loan market.
“The banks are perfectly located to offer these loans to customers … but the banks do not offer these loans because there are no federal standard on what a safe and affordable loan looks like. ”
The CFPB opens these proposals for public comment, which must be submitted by September 14.
CNNMoney (New York) First published June 2, 2016: 5:48 a.m. ET