It is not every day that Congress creates a new federal regulator, let alone one with authority to change an entire market in ways that will help millions of Americans. But that is what happened in 2010, when the Consumer Financial Protection Bureau (CFPB) was formed as part of the Dodd-Frank financial reform law created to better protect consumers from harmful financial products, including, specifically, payday loans. Now, five years later, we have seen the first outline of what the bureau will do with this mandate.
Pew research has found that payday loans, and similar products such as auto title loans, hurt millions of borrowers annually. A typical payday loan is for $375 and is due in full in just two weeks. With fees, this lump-sum payment consumes 36 percent of a typical borrower’s pretax paycheck, which is just too much for most people to handle. In fact, most payday loans are taken out to cover shortfalls created by paying back a previous payday loan. The average borrower ends up in debt for nearly half the year and pays more than $520 in fees for that $375 loan.
The CFPB is working to address this problem, and it released its reform proposal last March. Pew recently published an issue brief summarizing the bureau’s complicated plan. Overall, the proposal would transform the market in positive ways and has the potential to connect consumers with safer, lower-cost loans that better serve borrowers’ needs. It rightly emphasizes ensuring affordable payments and safe loan structures, requiring that most products become installment loans with smaller, manageable payments. That is what the vast majority of borrowers want, according to Pew’s survey research.
Certain important modifications are needed, however. The proposal does not do enough to control the risk that lenders will build excessively long durations and unreasonable costs into installment loans. For example, lenders currently offer a $500 loan for which borrowers pay $1,126 in fees over an 18-month payment period. This loan could continue to exist under the CFPB’s proposal. As written, the plan still makes it too easy for lenders to offer dangerous loans and a little too hard for them to provide safe ones.
By implementing Pew’s recommendations, including limiting loan durations and curtailing lenders’ preferred payment positions (e.g., access to a borrower’s bank account or control of an auto title), the CFPB can strengthen its proposal and create a safer and more transparent market for payday loans. Similar policies have already helped consumers in Colorado without limiting access to credit.
Thanks to the CFPB, this largely unregulated and fragmented market will soon be subject to federal rules to help protect consumers and create a level playing field for the industry, which states can build on over time. In the five years since the passage of the Dodd-Frank Act, the CFPB has shown great promise, and the next five years are crucial to cementing the bureau’s role as a strong federal agency that ensures fair market practices and promotes consumers’ financial well-being.