Facing down Republican opposition and industry petitions and protests, the Consumer Financial Protection Bureau has finalized a long-gestating rule “aimed at stopping payday debt traps by requiring lenders to determine upfront whether people can afford to repay their loans.”

“These strong, common-sense protections cover loans that require consumers to repay all or most of the debt at once, including payday loans, auto title loans, deposit advance products, and longer-term loans with balloon payments,” a Bureau statement says. “The rule also curtails lenders’ repeated attempts to debit payments from a borrower’s bank account, a practice that racks up fees and can lead to account closure.”

Payday loans are typically for small-dollar amounts and due in full by the borrower’s next paycheck, usually two or four weeks. They can be expensive, with annual percentage rates that can reach 300 percent or higher. Single-payment auto title loans also have expensive charges and short terms, but borrowers are also required to put up their car or truck title for collateral. Some lenders also offer longer-term loans of more than 45 days where the borrower makes a series of smaller payments before the remaining balance comes due. These longer-term loans, often referred to as balloon-payment loans, may require access to the borrower’s bank account or auto title.

According to the CFPB, many borrowers end up repeatedly rolling over or refinancing their loans, each time racking up expensive new charges. More than four out of five payday loans are re-borrowed within a month, usually right when the loan is due or shortly thereafter, is research claims. Nearly one-in-four initial payday loans are re-borrowed nine times or more, with the borrower paying far more in fees than they received in credit.

The CFPB’s new rule, announced on Oct. 5, aims “to stop debt traps by putting in place strong ability-to-repay protections.”

These protections apply to loans that require consumers to repay all or most of the debt at once. Under the new rule, lenders must conduct a “full-payment test” to determine upfront that borrowers can afford to repay their loans without re-borrowing. For certain short-term loans, lenders can skip the full-payment test if they offer a “principal-payoff option” that allows borrowers to pay off the debt more gradually.

The rule requires lenders to use credit reporting systems registered with the Bureau to report and obtain information on certain loans covered by the proposal.

The rule allows less risky loan options, including certain loans typically offered by community banks and credit unions, to forgo the full-payment test. It also includes a “debit attempt cutoff” for any short-term loan, balloon-payment loan, or longer-term loan with account access and an annual percentage rate higher than 36 percent that includes authorization for the lender to access the borrower’s checking or prepaid account. These protections are in addition to existing requirements under state or tribal law.

Full-payment test:  Under the full-payment test, lenders are required to make an upfront determination of a consumer’s ability to repay the loan.

Lenders are required to determine whether the borrower can pay the loan payments and still meet basic living expenses and major financial obligations both during the loan and for 30 days after the highest payment on the loan. For payday and auto title loans that are due in one lump sum, full payment means being able to afford the total loan amount, plus fees and finance charges within two weeks or a month.

For longer-term loans with a balloon payment, full payment means being able to afford the payments in the month with the highest total payments on the loan. To support the full-payment test, the lender must verify income and major financial obligations and estimate basic living expenses for a one-month period—the month in which the highest sum of payments is due.

The rule caps the number of short-term loans that can be made in quick succession at three. In determining ability to repay, lenders can reasonably rely on borrowers’ stated income if further verification evidence is unavailable and can reasonably rely on borrower’s stated rental housing expenses before making a loan.

For short-term loans, lenders are required to determine that the borrower has sufficient income to pay the loan and to meet major financial obligations and basic living expenses during the term of the loan and for 30 days after paying off the loan. Lenders also can take into account the income of a household member if the borrower has verified access to that income, and shared payment of major financial obligations and basic living expenses.

For longer-term loans with a balloon payment, lenders are required to ensure a borrower can pay all payments when due, including the balloon payment, as well as major financial obligations and basic living expenses during the term of the loan and for 30 days after making payments during the month with the loan’s highest payment. 

Lenders must respect a mandatory 30-day cooling-off period after the third covered short-term or longer-term balloon-payment loan in quick succession.  

Principal-payoff option for certain short-term loans: Consumers may take out a short-term loan of up to $500 without the full-payment test if it is structured to allow the borrower to get out of debt more gradually. Under this principal-payoff option, a consumer can either repay the loan in a single payment or have up to two subsequent loans where the principal is steadily paid down.

Under this option, consumers could borrow no more than $500 for an initial loan. Lenders cannot take an auto title as collateral or structure the loan as open-end credit. Lenders also cannot offer the option to consumers who have recent or outstanding short-term or balloon-payment loans.

Lenders cannot make more than three such loans in quick succession, and they cannot make loans under this option if the consumer has already had more than six short-term loans or been in debt for more than 90 days on short-term loans over a rolling 12-month period.

As part of the principal-payoff option, the lender could offer a borrower up to two additional loans, but only if the borrower pays off at least one-third of the original principal with each extension. This principal reduction feature is intended to steadily reduce consumers’ debt burden, allowing consumers to pay off the original loan in more manageable amounts to avoid a debt trap.

The rule requires a lender to provide notices before making a loan under the principal-payoff option. These notices must use plain language to inform consumers about elements of the option.

Less risky loan options:  Loans that pose less risk to consumers do not require the full-payment test or the principal-payoff option. This includes loans made by a lender who makes 2,500 or fewer covered short-term or balloon-payment loans per year and derives no more than 10 percent of its revenue from such loans.

The rule does not cover loans that generally meet the parameters of “payday alternative loans” authorized by the National Credit Union Administration. These are low-cost loans which cannot have a balloon payment with strict limitations on the number of loans that can be made over six months.

The rule also excludes from coverage certain no-cost advances and advances of earned wages made under a wage advance program. Under such a program, the employer could deduct the amount already earned and advanced from the employee’s next paycheck, or the employer’s business partner could debit the amount from the employee’s bank account on the employee’s next payday. No other collection mechanisms would be allowed.   

Reporting requirements: The rule requires lenders to use credit reporting systems registered by the Bureau to report and obtain information about loans made under the full-payment test or the principal payoff option.

Companies can apply for and will be designated as “registered information systems” by the Bureau. As consumer reporting companies, the registered information systems are subject to applicable federal laws.

Lenders are required to report basic loan information and updates to that information. If no registered information systems are available, then lenders can make loans under the full-payment test without obtaining a report from an information system but they must still check their own records. Principal-payoff loans, however, could not be made if no registered information systems are available.

Penalty-free prevention: Repeated unsuccessful withdrawal attempts by lenders to collect payment from consumers’ accounts can pile on insufficient funds fees for consumers from their financial institution and prompt returned payment fees from the lender. These attempts can also lead to bank account closures.

To protect consumers, the rule includes penalty-fee prevention measures that apply to short-term loans, balloon-payment loans, and any loan with an annual percentage rate over 36 percent that includes authorization for the lender to access the borrower’s checking or prepaid account. These protections will give consumers a chance to dispute any unauthorized or erroneous debit attempts, and to arrange to cover unanticipated payments that are due.

Lenders have to give consumers written notice before the first attempt to debit the consumer’s account to collect payment for any loan covered by the rule. This notice alerts consumers to the timing, amount, and channel of the forthcoming payment transfer. If a subsequent payment transfer is for a different amount, at a different time, or through a different payment channel than the consumer might have expected based upon past practice, the lender must give a notice specifically alerting the consumer to the change. 

After two straight unsuccessful attempts, the lender is prohibited from debiting the account again unless the lender gets a new and specific authorization from the borrower to again debit the account. An unsuccessful attempt includes a debit or withdrawal that is returned unpaid or is declined due to insufficient funds in the borrower's account. 

The penalty-fee prevention measures will not apply to banks or credit unions that make loans to their own customers if those loans cannot generate overdraft or insufficient funds fees.

Loans covered under the rule: The ability-to-repay protections apply to loans that require consumers to repay all or most of the debt at once, including payday loans, auto title loans, deposit advance products, and longer-term loans with balloon payments.

The penalty-fee prevention measures apply to a broader swath of the market, covering short-term loans, balloon-payment loans, and any loan with an annual percentage rate over 36 percent that gives the lender account access.

The final rule does not apply ability-to-repay protections to all of the longer-term loans that would have been covered under the proposal.

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