A tough new rule laid out by federal regulators Thursday will make payday loans and other types of high-risk borrowing safer for consumers.

The Consumer Financial Protection Bureau released the rule, which will:

  • Require lenders to verify a borrower’s ability to repay
  • Prohibit more than three back-to-back loans to a borrower
  • Limit attempts by lenders to debit borrowers’ checking or prepaid accounts for payment

“Too often, borrowers who need quick cash end up trapped in loans they can’t afford. The rule’s common sense ability-to-repay protections prevent lenders from succeeding by setting up borrowers to fail,” Richard Cordray, CFPB director, said in a statement announcing the rule, which was five years in the making.

The rule will largely take effect 21 months after it’s published in the Federal Register, and governs payday lending at storefronts and online. It also applies in part to auto title loans, payday installment loans with balloon payments and deposit advances.

How payday loans work

The Pew Charitable Trusts says 12 million Americans use payday loans every year and pay an estimated $9 billion in fees.

Payday loans typically are for less than $500, don’t require a good credit score, charge average annual percentage rates of 391% and are due in two weeks. To qualify, you need a bank account and a regular paycheck. Lenders access your bank account to withdraw money on payday or ask for a post-dated check.

Payday installment loans usually are due for repayment in a few months and auto title loans use your vehicle as collateral for the loan. Both types of loans typically charge interest rates of above 200%.

Four out of five payday loan borrowers roll over or renew their loans within a month, according to the CFPB. When payday lenders try to collect payments, half of the online borrowers rack up an average of $185 in bank penalty fees in an 18-month period because of repeated attempts to debit their account, the bureau says.

What’s changing for borrowers

Here’s what is set to happen after the new rule goes into effect, likely sometime in 2019:

  • You may see a different kind of payday loan. The majority of payday lenders who make loans below $500 can choose to either scrutinize your ability to repay the loan or offer loans that can be paid off more gradually. You can either repay the loan in a single payment or have up to two subsequent loans where the principal is steadily paid down, which will help you pay off the debt by making payments that reduce principal first.
  • Lenders will check your credit report and verify your income. Lenders that do not offer the principal-reduction option will be required to pull your credit report from one of the three major credit bureaus — Equifax, Experian or TransUnion — to check your debt obligations. They will also have to estimate your living expenses for one month and calculate if your income is enough to cover your debts, expenses and the loan you’re about to take, based on the paystub, bank statement or other means you provide to prove your income. If it’s not enough, you won’t get a loan.
  • Lenders can’t give you more than three back-to-back loans. The companies will have to check how many loans you have taken by using a database that collects this information. There’s a mandatory 30-day “cooling-off” period after you take three loans; you cannot take another payday loan until this has passed, preventing the cycle of debt that absorbs many borrowers today.
  • Your checking account can’t be debited more than twice without your consent. Lenders will have to give you written notice before they debit your account for a loan payment. They also cannot debit your account after two unsuccessful attempts to get paid without your written consent, saving you multiple fees for returned payments and insufficient funds.

Putting consumers first

Consumer advocates say the rule goes a long way in protecting borrowers from the most harmful practices of payday lending, but payday industry groups say it will stifle borrowers’ access to money when they need it.

“For millions of Americans living paycheck to paycheck, seeking out a loan in a time of need shouldn’t end in financial disaster. The rule is an important step that starts the process of ending the nightmare of spiraling debt for so many consumers,” says Michael Best, director of advocacy outreach at Consumer Federation of America.

The payday rule cuts off access to credit for those who need it, says Dennis Shaul, CEO of the Community Financial Services Association of America, a payday lending trade group.

About 16,000 payday loan stores operate in the 35 states that allow the practice, along with online lenders, according to the CFPB.

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