Why the CFPB APR for installment loans is 36%

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Lenders question the legal rationale for the Consumer Financial Protection Bureau’s proposal for a 36% annual percentage rate threshold as part of its plan to curb payday lending, saying loans made at that rate are not profitable.

The centerpiece of the CFPB’s proposal would require lenders to take out small dollar payday and short-term loans to ensure they are affordable for consumers. To avoid the more stringent requirements, such as assessing a borrower’s ability to repay a loan by checking income and debts, installment lenders can opt for an alternative that effectively caps the rate at 36%.

“Basically what the office is saying is that it thinks a loan with an overall interest rate above 36% is a potentially dangerous or risky loan for consumers,” said Leonard Chanin, legal counsel. at Morrison & Foerster, which represents installment lenders.

The 36% figure has been the subject of intense debate over the past decade.

The agency is following the precedent set by the Military Loans Act of 2006, which capped payday loans to military personnel at an annual percentage rate of 36%. The office said in its proposal that many state laws impose a wear limit of 36% of the APR, making it illegal to charge more.

Consumer advocates attribute the 36% APR threshold to the passage by various states of the Uniform Small Loans Act from 1914 to 1943 and to the Russell Sage Foundation, a progressive research group.

“From a broad policy perspective, looking at the economics of lending, there is a trade-off between interest rates and costs to have a profitable model,” said Mike Calhoun, president of the Center for Responsible Lending. , which cited the “Congress Recognized Standard” of 36% in the Military Loan Act. “High interest rates mean that a large percentage of your loans are unaffordable.”

Bankers objected to the 36% figure when it was debated for military personnel a decade ago, fearing it would ultimately apply to consumers more broadly. This is exactly what the CFPB proposal would do.

Lenders are also challenging the 36% rate, as the Dodd-Frank Act prohibits the CFPB from setting interest rates. The bureau circumvented this restriction by offering lenders to make a reasonable assessment of borrowers’ ability to repay certain loans above the 36% line, citing evidence that this causes harm to consumers. Therefore, the 36% figure is not a hard cap.

Setting an annual percentage rate could help borrowers shop around, although some lenders believe it is confusing for consumers and inappropriate for small loans. A borrower looking for a $ 300 loan over two weeks usually wants to know how much the loan will cost and can compare a payday loan to the alternative of the bank overdraft fee which costs $ 35, which may have a higher APR. .

Jeremy Rosenblum, practice manager in the financial services group at Ballard Spahr, said he believed the 36% number was likely to form the basis of a lawsuit challenging a final pay rule.

“Congress has explicitly told the CFPB to stay clear of any wear limits, but this is a wear limit and it is beyond its authority,” said Rosenblum. “When they try to put a high percentage of the industry out of business, they can expect a legal challenge.”

“At one point they don’t ban it, but they make it so difficult that it amounts to a ban,” Rosenblum added.

For now, companies are focusing their attention on letters of comment due by September 14, as they can only take legal action after a final rule is released.

The CFPB views payday loans as expensive predatory products that are marketed as a source of short-term emergency credit, but which actually trap consumers in long-term debt.

The agency estimates that there will be a 60-70% reduction in payday loan volume thanks to the plan. Still, the bureau only expects a 7% to 11% reduction in the total number of payday loan borrowers under the proposal, as it seeks to eliminate the ability of lenders to allow borrowers to take out several loans, which constitute a large part of the payday loans being originated.

Additionally, lenders are worried because the CFPB is changing the way the APR is set in its plan. It would include finance charges and other costs incurred in extending credit.

As a result, the proposal would create a new interest rate standard that includes ancillary products, handling fees and credit insurance, which are currently excluded from APR calculations under Regulation Z, which implements the Truth-in-Lending Law.

One industry is alarmed by this idea.

“What is the office’s rationale for creating a whole new criterion?” Asked Don Lampe, partner at Morrison & Foerster. “They are now saying that Regulation Z does not sufficiently protect consumers and they are putting back into the APR what Reg Z and Truth in Lending have ruled out for many years. The rationale is that these consumer protections should be triggered on the basis of CFPB’s own assessment of abuse and unfairness, not under the standards of Regulation Z. ”


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