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CFPB Proposed Payday/Installment Loan Rule

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August 16, 2016

The Consumer Financial Protection Bureau (the “CFPB” or the “Bureau”) released their Proposed Payday, Vehicle Title and Certain High Cost Installment Loans Rule (the “Proposed Rule”) on June 2, 2016 in conjunction with their planned Field Hearing on Small Dollar Lending. While the Proposed Rule is predominantly aimed at the payday and vehicle title loan industry, it will also impact traditional consumer finance lenders and even some depository institutions making small higher cost consumer loans with ancillary products by virtue of its use of several new overly broad definitional terms.

The Proposed Rule adds a new Part to Chapter X in Title 12 of the Code of Federal Regulations making it an abusive and unfair practice for a lender to:

  • Make a covered short-term loan or covered longer-term loan (collectively referred to as a “Covered Loan”), without reasonably determining that the consumer has the ability to repay the loan; or
  • 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 the consumer’s new and specific authorization to make further withdrawals from the account.

The Proposed Rule also imposes significant new reporting requirements for any financial institution making a Covered Loan, and imposes added recordkeeping and general compliance burdens.

This Client Alert will address the following issues with respect to the Proposed Rule:

  1. Scope of the Proposed Rule
  2. Requirements For A Covered Loan
  3. Safe Harbor For Qualifying Covered Loans
  4. Payments
  5. Recordkeeping, Reporting And General Compliance Burdens

This Alert will only address the impact of the Proposed Rule on financial institutions extending traditional installment loans, and does not address those provisions impacting payday lenders making short-term covered loans. 

  1. Scope of the Proposed Rule
  1. What Is A Covered Loan?

    A Covered Loan is a closed-end or open-end loan extended to a consumer primarily for personal, family, or household purposes, that is not considered exempt. There are two categories of Covered Loans:

    1. Covered Short-Term Loans - loans with a duration of forty-five (45) days or less (traditional payday loans).[1]
    2.Covered Longer-Term Loans - loans with a duration of more than forty-five (45) days[2] extended to a consumer primarily for personal, family or household purposes if the “total cost of credit” exceeds thirty-six percent (36%) per annum and the creditor obtains either a “leveraged payment mechanism” or “vehicle security” at the same time or within seventy-two (72) hours after the consumer receives the entire amount of funds they are entitled to receive under the loan. (traditional short term or small dollar loans).

If your institution offers a consumer loan that meets these definitional standards, regardless of the state usury laws in your state, you will be required to comply with the added requirements for a Covered Loan.

  1. Key Definitions
  1. Total Cost of Credit - this is a new and far more inclusive definition of what the borrower pays for their loan than the definition of a finance charge under Regulation Z. The Proposed Rule defines the Total Cost of Credit as the total amount of charges associated with the loan expressed as a per annum rate, and includes the following charges to the extent they are imposed in connection with the loan:
  • Credit insurance, including any charges the consumer incurs (regardless of when the charge is actually paid) in connection with the credit insurance before, at the same time, or within seventy-two (72) hours after receiving all loan proceeds, for application, sign-up, or participation in a credit insurance plan, and any charges for a debt cancellation or debt suspension agreement;
  • Credit related ancillary products, services or memberships sold before, at the same time as, or within seventy-two (72) hours after receiving all loan proceeds;
  • Finance charges associated with the credit as set forth by Regulation Z;
  • Application fees; and
  • Participation fees.
  1. Leveraged Payment Mechanism - The Proposed Rule defines a Leveraged Payment Mechanism as:
    • The right to initiate a transfer of money from a consumer’s account to satisfy an obligation on a loan;
    • The contractual right to obtain payment on a loan through payroll deduction or deduction from another source of income; or
    • Requiring the consumer to repay the loan through a payroll deduction or deduction from another source of income.
  1. Vehicle Security - The Proposed Rule defines Vehicle Security as any security interest in the vehicle, the vehicle title or vehicle registration obtained as a condition of credit whether or not the interest is perfected or recorded.
  1. Exemptions

The following credit transactions are excluded from the scope of the Proposed Rule:

  • Purchase money security interest loans;[3]
    • The exemption only applies to 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”
    • If the item being financed is not a good, or if the amount financed is greater than the cost of acquiring the good, the loan is not considered to be made solely for the purpose of financing the initial purchase of the good
    • Refinances of credit extended for the purchase of a good do not qualify for the exemption
  • Real estate secured credit;[4]
  • Credit cards - limited to the definition used for the CARD Act;[5]
  • Student loans;[6]
  • Non-recourse pawn loans;[7] and
  • Overdraft services and lines of credit[8]
    • Overdraft Service means a service under which a financial institution assesses a fee or charge on a consumer's account held by the institution for paying a transaction (including a check or other item) when the consumer has insufficient or unavailable funds in the account
    • Overdraft Service does not include any payment of overdrafts pursuant to a line of credit subject to Regulation Z (12 CFR part 1026), including transfers from a credit card account, home equity line of credit, or overdraft line of credit.
  1. Requirements For A Covered Loan
  1. Requirements for a Covered Longer-Term Loan

    The Proposed Rule makes it 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.
     
  2. How do I “reasonably determine” the consumer’s ability to repay?

    A lender’s determination of ability to repay is only considered reasonable if it concludes the consumer’s “residual income” is sufficient to make all payments and meet “basic living expenses” during the loan term; however, if the loan is presumed to be unaffordable, it must also meet added requirements. To assess the consumer’s ability to repay, a lender has to project the consumer’s “net income” and payments for “major financial obligations.”

    A lender will only be considered to have reasonably determined a borrower’s ability to repay if they:
  • Confirm the consumer’s residual income will be sufficient to make all payments and meet basic living expenses during the loan term;
  • Be based on reasonable projections of a consumer’s net income and major financial obligations;
  • Be based on reasonable estimates of a consumer’s basic living expenses;
  • Be consistent with a lender’s written policies and procedures and grounded in reasonable inferences and conclusions as to a consumer’s ability to repay according to its terms based on the information the lender is required to obtain;
  • Appropriately account for information known by the lender, whether or not the lender is required to obtain the information under this part, that indicates that the consumer may not have the ability to repay a covered longer-term loan according to its terms; and
  • Appropriately account for the possibility of volatility in a consumer’s income and basic living expenses during the term of the loan.

    If the loan is presumed to be unaffordable, the lender must satisfy the additional requirements overcoming this presumption.
  1. When is a determination of ability to repay not reasonable?

    A determination of ability to repay not reasonable if the creditor relies on an implicit assumption that the consumer will obtain additional consumer credit to be able to make payments under the covered longer-term loan, to make payments under major financial obligations, or to meet basic living expenses or relies on an assumption that a consumer will accumulate savings while making one or more payments under a covered longer-term loan and that, because of such assumed savings, the consumer will be able to make a subsequent loan payment under the loan.

    Evidence of whether a lender’s determinations of ability to repay are reasonable may include the extent to which the lender’s ability to repay determinations result in rates of delinquency, default, and re-borrowing for covered longer-term loans that are low, equal to, or high, including in comparison to the rates of other lenders making similar covered longer-term loans to similarly situated consumers.
     
  2. When is a loan presumed to be unaffordable?

    While traditional installment lenders will not be impacted by the most onerous provisions of the Proposed Rule targeting payday lenders, they will be impacted by the presumption associated with making a covered longer-term loan to a borrower who currently also has a covered short-term loan. Prior to making a covered longer-term loan, a lender must obtain and review information about the consumer’s borrowing history from the records of the lender and its affiliates, and from a consumer report obtained from an “Information System” registered with the Bureau.

    A consumer is presumed not to have the ability to repay a covered longer-term loan during the time period in which the consumer has a covered short-term loan or a covered longer-term balloon-payment loan outstanding and for 30 days thereafter; or if, at the time of the lender’s determination, the consumer currently has a covered or non-covered loan outstanding that was made or is being serviced by the same lender or its affiliate and one or more of the following conditions are present:
  • The consumer is or has been delinquent by more than 7 days within the past 30 days on a scheduled payment on the outstanding loan;
  • The consumer expresses or has expressed within the past 30 days an inability to make one or more payments on the outstanding loan;
  • The period of time between consummation of the new covered longer-term loan and the first scheduled payment on that loan would be longer than the period of time between consummation of the new covered longer-term loan and the next regularly scheduled payment on the outstanding loan; or
  • The new covered longer-term loan would result in the consumer receiving no disbursement of loan proceeds or an amount of funds as disbursement of the loan proceeds that would not substantially exceed the amount of payment or payments that would be due on the outstanding loan within 30 days of consummation of the new covered longer-term loan.

Exception. The presumption of unaffordability does not apply if either the size of every payment on the new covered longer-term loan would be substantially smaller than the size of every payment on the outstanding loan; or the new covered longer-term loan would result in a substantial reduction in the total cost of credit for the consumer relative to the outstanding loan.
 

  1. Safe Harbor For Qualifying Covered Loans

The Proposed Rule provides a conditional exemption from certain provisions for Covered Loans meeting a long list of very specific requirements:

  1. Conditional Exemption for Covered Longer-Term Loans of up to 6 Months[9]

The Proposed Rule provides a conditional exemption from its provisions with respect to the ability to repay,[10] additional limitations,[11] and disclosure of a scheduled payment from the consumer’s account,[12] for a covered longer-term loan that:

  • Is not structured as an open-end credit;
  • Has a term of not more than six months;
  • Has a principal loan amount of not less than $200 and not more than $1,000;
  • Is repayable in two or more payments due no less frequently than monthly and has payments that are equal in amount and occur at equal intervals;
  • Amortizes during the term of the loan and the payment schedule calls for allocating the consumer’s payments to outstanding principal, interest and fees as they accrue only by applying a fixed periodic rate of interest to the outstanding loan balance every repayment period for the term of the loan;
  • Carries a total cost of credit of not more than the NCUA restrictions for credit unions (28%);

    AND, where the lender:
     
  • Confirms the loan will not result in the consumer being indebted to the lender or one of its affiliates within an 180 day period;
  • Maintains and complies with policies and procedures for documenting proof of income; and
  • Does not impose a Prepayment Penalty and in the event the lender holds funds in the consumer’s name, exercise any kind of sweep, set-off right or hold on the consumer’s account in response to an actual or expected delinquency or default.

    Lender’s availing themselves of this exemption must either furnish loan information to each information system or to a consumer reporting agency.
  1. Conditional Exemption for Covered Longer-Term Loans of up to 24 Months[13]

The Proposed Rule provides a conditional exemption from its provisions with respect to the ability to repay,[14] additional limitations,[15] and disclosure of a scheduled payment from the consumer’s account,[16] for a covered longer-term loan that:

  • Is not structured as an open-end credit;
  • Has a term of not more than 24 months;
  • Is repayable in two or more payments due no less frequently than monthly and has payments that are equal in amount and occur at equal intervals;
  • Amortizes during the term of the loan and the payment schedule calls for allocating the consumer’s payments to outstanding principal, interest and fees as they accrue only by applying a fixed periodic rate of interest to the outstanding loan balance every repayment period for the term of the loan;
  • Has a “Modified Total Cost of Credit”[17] of less than or equal to 36%;

    AND, where the lender:
     
  • Confirms the loan will not result in the consumer being indebted to the lender or one of its affiliates within a 180 day period;
  • Maintains and complies with policies and procedures for effectuating an underwriting method designed to result in a portfolio default rate that will be less than or equal to 5% per year;
  • If the default rate exceeds 5% refunds any origination fee excluded from the modified total cost of credit within 30 days of identifying the excessive default rate; and
  • Does not impose a Prepayment Penalty, and in the event the lender holds funds in the consumer’s name, exercise any kind of sweep, set-off right or hold on the consumer’s account in response to an actual or expected delinquency or default.

    Further, under this exemption the lender’s determination of ability to repay is only reasonable if they reasonably conclude the consumer’s residual income will be sufficient to make all loan payments and meet basic living expenses during the loan term. A lender must apply additional conditions if the loan is a covered longer term balloon-payment loan, or made during the time period in which the consumer has a covered short term loan or a covered longer term loan, or for thirty days after.

    Lender’s availing themselves of this exemption must furnish loan information to all information systems or to a consumer reporting agency.
  1. PAYMENTS
     
  2. Creates a New Unfair and Abusive Act

    The Proposed Rule makes it an unfair and abusive act or practice for a lender to withdraw payment from a consumer’s account in connection with a covered loan after the second consecutive attempt has failed due to lack of sufficient funds, unless the lender obtains a new and specific authorization to make further withdrawals from the account.
     
  3. Key Definitions
     
  4. Payment Transfer - The Proposed Rule defines a “Payment Transfer” as any lender-initiated debit or withdrawal of funds from a consumer’s account for the purpose of collecting any amount due or purported to be due in connection with a covered loan.  If a Payment Transfer fails two consecutive times, the lender must provide a “Consumer Rights Notice” no later than three business days after it receives information that the second attempt has failed, that is substantially similar to the Model Form provided by the Proposed Rule.[18]
  1. New Authorization for Additional Payment Transfers

    A lender may initiate additional payment transfers after two consecutive failures if the additional transfers are authorized by the consumer and they meet certain requirements, or if the consumer requests a single immediate payment transfer that meets certain requirements.[19]

    The lender must request consumer authorization for the additional payment transfer no earlier than the date on which they provide the Consumer Rights Notice. The request can be made in writing, by mail, by e-mail (if the consumer has consented to receive electronic disclosures) or by oral telephonic communication.

    Oral consent is permitted only if the consent is recorded, the recording is retained by the lender, the lender provides a memorialization of the consent in a retainable form to the consumer no later than the date on which the first payment transfer is initiated.
     
  2. Single Immediate Payment Transfer Exception

    After a lender’s second consecutive payment transfer has failed, a lender may initiate a Single Immediate Payment Transfer, if it is made at the consumer’s request, via EFT or a signature check no earlier than the date the Consumer Rights Notice is provided to the consumer, or the date the consumer contacts the lender to discuss payment options, whichever is sooner.
     
  3. Disclosures Required for Payment Transfer Attempts

    Prior to initiating a Payment Transfer from a consumer’s account, a lender must provide a payment notice.[20] Disclosures must be substantially similar to the Model Form provided in the Proposed Rule, and be provided no later than six business days prior to initiating the transfer for disclosure by mail, or three business days for disclosure by e-mail. There is a limited exception to this rule for loans meeting the safe harbor for covered longer-term loans of 6 month or 24 month duration; the first payment transfer from a consumer’s account after the consumer authorizes an additional payment transfer; and a single immediate payment transfer initiated at the consumer’s request.
     
  4. Recordkeeping, Reporting And General Compliance Burdens
     
  5. Registered Information Systems

    The Proposed Rule creates a registration program for qualified entities as “Information Systems” with the CFPB. In addition to stringent compliance standards with respect to compliance and data security, these information systems must be capable of receiving information from lenders and providing reports on covered loans. Similar database programs currently exist in several states across the country to service the payday lending industry.
     
  6. Information Furnishing Requirements

    The Proposed Rule applies information furnishing requirements to all Covered Loans except those meeting the safe harbor for covered longer-term loans of 6 month or 24 month duration, and requires a lender to furnish the following information at loan consummation for every Covered Loan it makes:
  • Information necessary to uniquely identify the loan;
  • Information necessary to allow the information system to identify the specific consumer(s) responsible for the loan;
  • A lender must furnish any update to information previously furnished “within a reasonable period” of the event that causes the information previously furnished to be out of date;
  • A lender must furnish the following information no later than the date the loan ceases to be an outstanding loan or as close in time as feasible to the date the loan ceases to be an outstanding loan:
    • The date as of which the loan ceased to be an outstanding loan; and
    • For a covered short-term loan:
      • Whether all amounts owed in connection with the loan were paid in full, including the amount financed, charges included in the total cost of credit, and charges excluded from the total cost of credit; and
      • If all amounts owed in connection with the loan were paid in full, the amount paid on the loan, including the amount financed and charges included in the total cost of credit but excluding any charges excluded from the total cost of credit.
  1. Compliance Program and Record Keeping Requirements

    A lender making a covered loan must develop and follow written policies and procedures that are reasonably designed to ensure compliance with the requirements in this part. These written policies and procedures must be appropriate to the size and complexity of the lender and its affiliates, and the nature and scope of the covered loan lending activities of the lender and its affiliates. A lender must retain evidence of compliance with the Proposed Rule for 36 months after the date on which a covered loan is outstanding.

CONCLUSION

The Proposed Rule, if adopted in its current form, will undoubtedly lead to significant changes in the financial services industry for those extending subprime credit, or in some instances those making higher cost small dollar loans that may include charges for ancillary products. Lenders will be forced to decide whether they are willing to submit to the significant added regulatory burdens associated with making a Covered Loan, or if they will avoid the scope of the Proposed Rule by altering their products to either stay below the Total Cost of Credit threshold, or forego taking a vehicle security interest or a Leveraged Payment Mechanism.

For those financial institutions that choose to lend above the Total Cost of Credit threshold but forego taking a vehicle security interest or a Leveraged Payment Mechanism, the reprieve may be short lived. On June 2, 2016 the Bureau also issued a Request for Information on Payday Loans, Vehicle Title Loans, Installment Loans, and Open-End Lines of Credit (the “RFI”), seeking public comment to be used in future rulemaking on any other products that should be included within the scope of the Proposed Rule, including loans that lack a vehicle security interest or a Leveraged Payment Mechanism.

                Public Comment to the Proposed Rule is open until October 7, 2016, and comment to the RFI is open until November 7, 2016.  A final Rule is anticipated from the CFPB in early to mid-2017 with a likely effective date of mid-2018. Members of the Krieg DeVault Financial Institutions Practice Group are closely monitoring developments in this area, and able to answer any questions you may have about the impact of these proposals on your financial institution.

 

[1] For closed-end credit that does not provide for multiple advances to consumers, the consumer is required to repay substantially the entire amount of the loan within 45 days of consummation, or for all other loans, the consumer is required to repay substantially the entire amount of the advance within 45 days of the advance under the loan

[2] For closed-end credit that does not provide for multiple advances to consumers, the consumer is not required to repay substantially the entire amount of the loan within 45 days of consummation, or for all other loans, the consumer is not required to repay substantially the entire amount of the loan within 45 days of an advance under the loan.

[3] Proposed Rule § 1041.3(e)(1)

[4] Proposed Rule § 1041.3(e)(2)

[5] Proposed Rule § 1041.3(e)(3). Existing 12 CFR 1026.2(a)(15)(ii) defines a credit card account under an open-end (not home-secured) consumer credit plan to mean any open-end credit account that is accessed by a credit card, except a home-equity plan subject to the requirements of §1026.40 that is accessed by a credit card; or an overdraft line of credit that is accessed by a debit card or an account number.

[6] Proposed Rule § 1041.3(e)(4)

[7] Proposed Rule § 1041.3(e)(5)

[8]  Proposed Rule § 1041.3(e)(6)

[9] See Proposed Rule §  1041.11

[10] See Proposed Rule §§ 1041.8 and 1041.9

[11] See Proposed Rule § 1041.10

[12] See Proposed Rule § 1041.15(b)

[13] Proposed Rule § 1041.12

[14] See Proposed Rule §§ 1041.8 and 1041.9

[15] See Proposed Rule § 1041.10

[16] See Proposed Rule § 1041.15(b)

[17] Modified Total Cost of Credit is the same as total cost of credit, less an origination fee of either $50, or a fee that represents a reasonable proportion of the lenders cost of underwriting the loan.

[18] Proposed Rule § 1041.15(d)

[19] Proposed Rule § 1041.14(c)

[20] Proposed Rule § 1041.15(b)