The Consumer Financial Protection Bureau, the fledgling agency created in the aftermath of the financial crisis, outlined on Thursday the first draft of regulations to rein in payday loans, the short-term form of credit that can come with interest rates soaring beyond 400 percent.
The proposed rules could sharply reduce the number of unaffordable loans that lenders can make each year to Americans desperate for cash. The proposal covers a wide swath of credit, including certain loans backed by car titles and some installment loans that stretch longer than 45 days.
“We are taking an important step toward ending the debt traps that are so pervasive in both the short-term and longer-term credit markets,” Richard Cordray, the director of the Consumer Financial Protection Bureau, said in a statement on Thursday.
At their center, the proposed rules are based on a fundamental premise: Borrowers should be able to repay their loans, including interest, principal and fees, without falling behind or borrowing more money to cover the outstanding debt.
To do that, the rules under consideration would require lenders to assess customers’ income, other financial obligations and borrowing history to ensure that when the loan comes due, there is enough money to cover it.
Few people who have tapped short-term loans can repay them on time, the bureau found in an analysis of roughly 15 million payday loans. Borrowers, the bureau said, took out a median of 10 loans in a 12-month span. More than 80 percent of loans were rolled over or renewed within a two-week period.
The borrowing patterns speak to a stark reality underpinning the roughly $46 billion payday loan industry: The working poor in America, a group with virtually no savings and little access to traditional bank loans, use the loans to cover basic expenses.
Nearly 70 percent of borrowers use the loans, tied to their next paycheck, to pay for basic expenses, not one-time emergencies, as some in the payday lending industry have claimed. The Pew Charitable Trust found that only 16 percent of borrowers tap the loans for emergencies.
Such precarious financial footing helps explain how one loan can prove so difficult to repay.
Borrowers who take out 11 or more loans, the bureau found, account for roughly 75 percent of the fees generated.
Still, the proposed rules generated a mixed reaction from consumer advocates, including some who worried that the rules did not go far enough.
“Loopholes would permit some unaffordable high-cost loans to stay on the market,” said Lauren Saunders, associate director of the National Consumer Law Center. And lenders shown their dexterity in shifting their products slightly to get around state laws aimed at stamping out the loans.
In drafting the rules, according to interviews with people briefed on the matter, the Consumer Financial Protection Bureau, and its director, Mr. Cordray, wrestled with how to protect some of the most vulnerable consumers, without choking off credit entirely.
It is a precarious balance, the people said, reflected in some of the proposed underwriting requirements. In a second option outlined in the proposed rules, lenders would have to offer a product with great protections. The size of the loan, for example, could not exceed $500.
Under this alternative underwriting requirement, lenders could not roll over the loans more than two times during a 12-month period. Before making a second- or third-consecutive loan, the rules outline, the lenders would have to provide an affordable way to get out of the debt. Two options are being considered. In one, lenders would have to ensure that the principal decreased with each ensuing loan. And in another, the lender would have to provide a so-called off-ramp — a way for the borrower to repay the debt without racking up more fees.
Underpinning the decision to include a broader range of credit products, the people said, is an acknowledgment of just how successfully lenders have tweaked their practices to continue making expensive loans even after states enact laws intended to rein them in.
For certain longer-term loans — credit that is extended for more than 45 days — the lenders would have to put a ceiling on rates at 28 percent or structure the loans so that monthly payments do not go beyond 5 percent of borrowers pretax income.
Until now, payday lending has largely been regulated by the states. The Consumer Financial Protection Bureau’s foray into the regulation has incited concerns among consumer advocates and some state regulators who fear that payday lenders will seize on the federal rules to water down tougher state restrictions. Fifteen states including New York, where the loans are capped at 16 percent, effectively ban the loans.
The rules, which will be presented to a review panel of small businesses, are likely to set off a fresh round of lobbying from the industry, said Senator Jeff Merkley, Democrat of Oregon.
“They should instead strengthen this proposal by absolutely ensuring it is free of loopholes that would allow these predatory loans to keep trapping American families in a vortex of debt,” Senator Merkley said.