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New rules are needed to crack down on payday loans

The CFPB can help keep consumers from falling into debt traps

Published: April 02, 2015 05:45 PM

Payday loans are short-term loans loaded with high fees that are often promoted as an advance on your next paycheck. And while these loans are easy to get from storefront lenders or online, they can be very difficult to repay: A payday loan can quickly turn into overwhelming debt. For instance, if you take out a $375 payday loan, you could wind up paying an extra $520 in fees, according to the Pew Charitable Trust.

For someone living paycheck to paycheck, the short time frame of a payday loan can make it hard to accumulate the money needed to cover the loan and fees before they’re due, the Consumer Financial Protection Bureau said. And that’s when a vicious cycle can begin.

“Borrowers who cannot repay [a payday loan] are often encouraged to . . . pay more fees to delay the due date or take out a new loan to replace the old one. [F]our out of five payday loans are rolled over or renewed within two weeks. For many borrowers, what starts out as a short-term, emergency loan turns into an unaffordable, long-term debt trap,” the CFPB said.

At Consumers Union, the policy and advocacy arm of Consumer Reports, we believe that consumers who get in a financial jam and seek emergency loans shouldn’t be charged outrageous fees and interest rates that only leave them worse off financially. For years, we have been advocating for reforms to clean up the payday-loan industry.

The CFPB recently announced it is considering rules that take aim at some of the biggest problems. Under the proposed rules (PDF) a payday lender would have to make sure borrowers can pay back the loan before they sign their name on the dotted line.

This step might seem obvious, but when you look at how these lenders are generating repeat business with extra loans and extensions, you can understand why this simple standard is so important.

The CFPB proposal would also apply to other types of loans, such as vehicle title loans, deposit advance products, and certain high-cost installment loans and open-end loans.

We think these kinds of rules are long overdue. But we want to make sure there are no loopholes. The ability-to-pay requirement should apply to short-term and long-term loans alike. There is an important role for the states to play as well, to help ensure that their residents are further protected across the board from abusive lending practices.

These rules under consideration are just the first step in the process. We look forward to working with the CFPB over the next several months to help people avoid payday debt traps.

This feature is part of a regular series by Consumers Union, the policy and advocacy arm of Consumer Reports. The nonprofit organization advocates for product safety, financial reform, safer food, health reform, and other consumer issues in Washington, D.C., the states, and in the marketplace.

Read other installments of our Policy & Action feature.

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