Payday, Vehicle Title, and Certain High-Cost Installment Loans

AGENCY:

Bureau of Consumer Financial Protection.

ACTION:

Final rule; official interpretations.

SUMMARY:

The Bureau of Consumer Financial Protection (Bureau or CFPB) is issuing this final rule establishing regulations creating consumer protections for certain consumer credit products and the official interpretations to the rule. First, the rule identifies it as an unfair and abusive practice for a lender to make covered short-term or longer-term balloon-payment loans, including payday and vehicle title loans, without reasonably determining that consumers have the ability to repay the loans according to their terms. The rule exempts certain loans from the underwriting criteria prescribed in the rule if they have specific consumer protections. Second, for the same set of loans along with certain other high-cost longer-term loans, the rule identifies it as an unfair and abusive practice to make attempts to withdraw payment from consumers' accounts after two consecutive payment attempts have failed, unless the consumer provides a new and specific authorization to do so. Finally, the rule prescribes notices to consumers before attempting to withdraw payments from their account, as well as processes and criteria for registration of information systems, for requirements to furnish and obtain information from them, and for compliance programs and record retention. The rule prohibits evasions and operates as a floor leaving State and local jurisdictions to adopt further regulatory measures (whether a usury limit or other protections) as appropriate to protect consumers.

DATES:

Effective Date: This regulation is effective January 16, 2018. Compliance Date: Sections 1041.2 through 1041.10, 1041.12, and 1041.13 have a compliance date of August 19, 2019.

Application Deadline: The deadline to submit an application for preliminary approval for registration pursuant to § 1041.11(c)(1) is April 16, 2018.

FOR FURTHER INFORMATION CONTACT:

Sarita Frattaroli, Counsel; Mark Morelli, Michael G. Silver, Steve Wrone, Senior Counsels; Office of Regulations; Consumer Financial Protection Bureau, at 202-435-7700 or cfpb_reginquiries@cfpb.gov.

SUPPLEMENTARY INFORMATION:

I. Summary of the Final Rule

On June 2, 2016, the Bureau issued proposed consumer protections for payday loans, vehicle title loans, and certain high-cost installment loans. The proposal was published in the Federal Register on July 22, 2016. Following a public comment period and review of comments received, the Bureau is now issuing this final rule with consumer protections governing the underwriting of covered short-term and longer-term balloon-payment loans, including payday and vehicle title loans. The rule also contains disclosure and payment withdrawal attempt requirements for covered short-term loans, covered longer-term balloon-payment loans, and certain high-cost covered longer-term loans.

Covered short-term loans are typically used by consumers who are living paycheck to paycheck, have little to no access to other credit products, and seek funds to meet recurring or one-time expenses. The Bureau has conducted extensive research on these products, in addition to several years of outreach and review of the available literature. The Bureau issues these regulations primarily pursuant to its authority under section 1031 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) to identify and prevent unfair, deceptive, or abusive acts or practices. The Bureau is also using authorities under section 1022 of the Dodd-Frank Act to prescribe rules and make exemptions from such rules as is necessary or appropriate to carry out the purposes and objectives of the Federal consumer financial laws, section 1024 of the Dodd-Frank Act to facilitate supervision of certain non-bank financial service providers, and section 1032 of the Dodd-Frank Act to require disclosures to convey the costs, benefits, and risks of particular consumer financial products or services.

The Bureau is not, at this time, finalizing the ability-to-repay determination requirements proposed for certain high-cost installment loans, but it is finalizing those requirements as to covered short-term and longer-term balloon-payment loans. The Bureau is also finalizing certain disclosure, notice, and payment withdrawal attempt requirements as applied to covered short-term loans, longer-term balloon-payment loans, and high-cost longer-term loans at this time.

The Bureau is concerned that lenders that make covered short-term loans have developed business models that deviate substantially from the practices in other credit markets by failing to assess consumers' ability to repay their loans according to their terms and by engaging in harmful practices in the course of seeking to withdraw payments from consumers' accounts. The Bureau has concluded that there is consumer harm in connection with these practices because many consumers struggle to repay unaffordable loans and in doing so suffer a variety of adverse consequences. In particular, many consumers who take out these loans appear to lack the ability to repay them and face one of three options when an unaffordable loan payment is due: Take out additional covered loans (“re-borrow”), default on the covered loan, or make the payment on the covered loan and fail to meet basic living expenses or other major financial obligations. As a result of these dynamics, a substantial population of consumers ends up in extended loan sequences of unaffordable loans. Longer-term balloon-payment loans, which are less common in the marketplace today, raise similar risks.

In addition, many lenders may seek to obtain repayment of covered loans directly from consumers' accounts. The Bureau is concerned that consumers may be subject to multiple fees and other harms when lenders make repeated unsuccessful attempts to withdraw funds from their accounts. In these circumstances, further attempts to withdraw funds from consumers' accounts are very unlikely to succeed, yet they clearly result in further harms to consumers.

A. Scope of the Rule

The rule applies to two types of covered loans. First, it applies to short-term loans that have terms of 45 days or less, including typical 14-day and 30-day payday loans, as well as short-term vehicle title loans that are usually made for 30-day terms, and longer-term balloon-payment loans. The underwriting portion of the rule applies to these loans. Second, certain parts of the rule apply to longer-term loans with terms of more than 45 days that have (1) a cost of credit that exceeds 36 percent per annum; and (2) a form of “leveraged payment mechanism” that gives the lender a right to withdraw payments from the consumer's account. The payments part of the rule applies to both categories of loans. The Bureau had proposed parallel underwriting requirements for high-cost covered longer-term loans. However, at this time, the Bureau is not finalizing the ability-to-repay portions of the rule as to covered longer-term loans other than those with balloon payments.

The rule excludes or exempts several types of consumer credit, including: (1) Loans extended solely to finance the purchase of a car or other consumer good in which the good secures the loan; (2) home mortgages and other loans secured by real property or a dwelling if recorded or perfected; (3) credit cards; (4) student loans; (5) non-recourse pawn loans; (6) overdraft services and lines of credit; (7) wage advance programs; (8) no-cost advances; (9) alternative loans (similar to loans made under the Payday Alternative Loan program administered by the National Credit Union Administration); and (10) accommodation loans.

B. Ability-to-Repay Requirements and Alternative Requirements for Covered Short-Term Loans

The rule identifies it as an unfair and abusive practice for a lender to make covered short-term or longer-term balloon-payment loans without reasonably determining that the consumers will have the ability to repay the loans according to their terms. The rule prescribes requirements to prevent this practice and thus the specific harms to consumers that the Bureau has identified as flowing from the practice, including extended loan sequences for a substantial population of consumers.

The first set of requirements addresses the underwriting of these loans. A lender, before making a covered short-term or longer-term balloon-payment loan, must make a reasonable determination that the consumer would be able to make the payments on the loan and be able to meet the consumer's basic living expenses and other major financial obligations without needing to re-borrow over the ensuing 30 days. Specifically, a lender is required to:

• Verify the consumer's net monthly income using a reliable record of income payment, unless a reliable record is not reasonably available;
• Verify the consumer's monthly debt obligations using a national consumer report and a consumer report from a “registered information system” as described below;
• Verify the consumer's monthly housing costs using a national consumer report if possible, or otherwise rely on the consumer's written statement of monthly housing expenses;
• Forecast a reasonable amount for basic living expenses, other than debt obligations and housing costs; and
• Determine the consumer's ability to repay the loan based on the lender's projections of the consumer's residual income or debt-to-income ratio.

Furthermore, a lender is prohibited from making a covered short-term loan to a consumer who has already taken out three covered short-term or longer-term balloon-payment loans within 30 days of each other, for 30 days after the third loan is no longer outstanding.

Second, and in the alternative, a lender is allowed to make a covered short-term loan without meeting all the specific underwriting criteria set out above, as long as the loan satisfies certain prescribed terms, the lender confirms that the consumer meets specified borrowing history conditions, and the lender provides required disclosures to the consumer. Among other conditions, under this alternative approach, a lender is allowed to make up to three covered short-term loans in short succession, provided that the first loan has a principal amount no larger than $500, the second loan has a principal amount at least one-third smaller than the principal amount on the first loan, and the third loan has a principal amount at least two-thirds smaller than the principal amount on the first loan. In addition, a lender is not allowed to make a covered short-term loan under the alternative requirements if it would result in the consumer having more than six covered short-term loans during a consecutive 12-month period or being in debt for more than 90 days on covered short-term loans during a consecutive 12-month period. A lender is not permitted to take vehicle security in connection with loans that are made according to this alternative approach.

C. Payment Practices Rules

The rule identifies it as an unfair and abusive practice for a lender to make attempts to withdraw payment from consumers' accounts in connection with a short-term, longer-term balloon-payment, or high-cost longer-term loan after the lender's second consecutive attempts to withdraw payments from the accounts from which the prior attempts were made have failed due to a lack of sufficient funds, unless the lender obtains the consumers' new and specific authorization to make further withdrawals from the accounts. The Bureau found that in these circumstances, further attempted withdrawals are highly unlikely to succeed, but clearly impose harms on consumers who are affected. This prohibition on further withdrawal attempts applies whether the two failed attempts are initiated through a single payment channel or different channels, such as the automated clearinghouse system and the check network. The rule requires that lenders must provide notice to consumers when the prohibition has been triggered and follow certain procedures in obtaining new authorizations.

In addition to the requirements related to the prohibition on further payment withdrawal attempts, a lender is required to provide a written notice, depending on means of delivery, a certain number of days before its first attempt to withdraw payment for a covered loan from a consumer's checking, savings, or prepaid account or before an attempt to withdraw such payment in a different amount than the regularly scheduled payment amount, on a date other than the regularly scheduled payment date, by a different payment channel than the prior payment, or to re-initiate a returned prior transfer. The notice must contain key information about the upcoming payment attempt and, if applicable, alert the consumer to unusual payment attempts. A lender is permitted to provide electronic notices as long as the consumer consents to electronic communications.

D. Additional Requirements

The rule requires lenders to furnish to provisionally registered and registered information systems certain information concerning covered short-term and longer-term balloon-payment loans at loan consummation, during the period that the loan is an outstanding loan, and when the loan ceases to be an outstanding loan. To be eligible to become a provisionally registered or registered information system, an entity must satisfy the eligibility criteria prescribed in the rule. The rule provides for a registration process that will allow information systems to be registered, and lenders to be ready to furnish required information, at the time the furnishing obligation in the rule takes effect. Consumer reports provided by registered information systems will include a reasonably comprehensive record of a consumer's recent and current use of covered short-term and longer-term balloon-payment loans. Before making covered short-term and longer-term balloon-payment loans, a lender is required to obtain and consider a consumer report from a registered information system.

A lender is required to establish and follow a compliance program and retain certain records. A lender is also required to develop and follow written policies and procedures that are reasonably designed to ensure compliance with the requirements in this rule. Furthermore, a lender is required to retain the loan agreement and documentation obtained for any covered loan or an image thereof, as well as electronic records in tabular format regarding origination calculations and determinations for a short-term or longer-term balloon-payment loan, and regarding loan type and terms. The rule also includes an anti-evasion clause to address the kinds of concerns the Bureau noted in connection with the evasive actions that lenders in this market took in response to the regulations originally adopted on loans made to servicemembers under the Military Lending Act.

E. Effective and Compliance Dates/Application Deadline

The final rule will become effective January 16, 2018, 60 days after publication of the final rule in the Federal Register. Compliance with §§ 1041.2 through 1041.10, 1041.12, and 1041.13 will be required beginning August 19, 2019, 21 months after publication of the final rule in the Federal Register. The deadline to submit an application for preliminary approval for registration pursuant to § 1041.11(c)(1) will be April 16, 2018, 150 days after publication of the final rule in the Federal Register. The effective and compliance dates and application deadline are structured to facilitate an orderly implementation process.

II. Background

A. Introduction

For most consumers, credit provides a means of purchasing goods or services and spreading the cost of repayment over time. This is true of the three largest consumer credit markets: The market for mortgages ($10.3 trillion in outstanding balances), for student loans ($1.4 trillion), and for auto loans ($1.1 trillion). This is also one way in which certain types of open-end credit—including home equity loans ($0.13 trillion) and lines of credit ($0.472 trillion)—and at least some credit cards and revolving credit ($1.0 trillion)—can be used.

In addition to the credit markets described above, consumers living paycheck to paycheck and with little to no savings have also used credit as a means of coping with financial shortfalls. These shortfalls may be due to mismatched timing between income and expenses, misaligned cash flows, income volatility, unexpected expenses or income shocks, or expenses that simply exceed income. According to a recent survey conducted by the Board of Governors of the Federal Reserve System (Federal Reserve Board), 44 percent of adults reported they would either be unable to cover an emergency expense costing $400 or would have to sell something or borrow money to cover it, and 30 percent reported that they found it “difficult to get by” or were “just getting by” financially. Whatever the cause of these financial shortfalls, consumers in these situations sometimes seek what may broadly be termed a “liquidity loan.” There are a variety of loans and products that consumers use for these purposes including credit cards, deposit account overdraft, pawn loans, payday loans, vehicle title loans, and installment loans.

Credit cards and deposit account overdraft services are each already subject to specific Federal consumer protection regulations and requirements. The Bureau generally considers these markets to be outside the scope of this rulemaking as discussed further below. The Bureau is also separately engaged in research and evaluation of potential rulemaking actions on deposit account overdraft. Another liquidity option—pawn—generally involves non-recourse loans made against the value of whatever item a consumer chooses to give the lender in return for the funds. The consumer has the option to either repay the loan or permit the pawnbroker to retain and sell the pawned property at the end of the loan term, relieving the borrower from any additional financial obligation. This feature distinguishes pawn loans from most other types of liquidity loans. The Bureau is excluding non-recourse possessory pawn loans, as described in proposed § 1041.3(e)(5), from the scope of this rulemaking.

This rulemaking is focused on two general categories of liquidity loan products: (1) Short-term loans and longer-term balloon-payment loans; and (2) with regard to payment practices, a broader set of liquidity loan products that also includes certain higher-cost longer-term installment loans. The largest category of short-term loans are “payday loans,” which are generally required to be repaid in a lump-sum single-payment on receipt of the borrower's next income payment, and short-term vehicle title loans, which are also almost always due in a lump-sum single-payment, typically within 30 days after the loan is made. The final rule's underwriting requirements also apply to depository advance products and other loans of 45 days or less in duration, as well as certain longer-term balloon-payment loans that generally involve a series of small, often interest-only, payments followed by a single final large lump sum payment. The final rule's payment presentment requirements apply to short-term and longer-term balloon-payment products, as well as to certain higher-cost longer-term installment loans. That latter category includes what are often referred to as “payday installment loans”—that is, loans that are repaid in multiple installments with each installment typically due on the borrower's payday or regularly scheduled income payment and with the lender having the ability to automatically collect payments from an account into which the income payment is deposited. In addition, the latter category includes certain high-cost installment loans made by more traditional finance companies.

This rulemaking includes both closed-end loans and open-end lines of credit. As described in the section-by-section analysis, the Bureau has been studying these markets for liquidity loans for over five years, gaining insights from a variety of sources. During this time the Bureau has conducted supervisory examinations of a number of payday lenders and enforcement investigations of a number of different types of liquidity lenders, which have given the Bureau insights into the business models and practices of such lenders. Through these processes, and through market monitoring activities, the Bureau also has obtained extensive loan-level data that the Bureau has studied to better understand risks to consumers. The Bureau has published five reports based upon these data. The Bureau has also carefully reviewed the published literature with respect to small-dollar liquidity loans and a number of outside researchers have presented their research at seminars for Bureau staff. In addition, over the course of the past five years the Bureau has engaged in extensive outreach with a variety of stakeholders in both formal and informal settings, including several Bureau field hearings across the country specifically focused on the subject of small-dollar lending, meetings with the Bureau's standing advisory groups, meetings with State and Federal regulators, meetings with consumer advocates, religious groups, and industry trade associations, Tribal consultations, and through a Small Business Review Panel process as described further below. As described in Summary of the Rulemaking Process, the Bureau received and reviewed over one million comments on its proposal, mostly from lenders and borrowers within the respective markets.

This Background section provides a brief description of the major components of the markets for short-term loans and longer-term balloon-payment loans, describing the product parameters, industry size and structure, lending practices, and business models of major market segments. The Background section also provides a brief overview of the additional markets for higher-cost longer-term installment loans that are subject to the payment practices components of the final rule. This section also describes recent State and Federal regulatory activity in connection with these various product markets. Market Concerns—Underwriting below, provides a more detailed description of consumer experiences with short-term loans describing research about which consumers use the products, why they use the products, and the outcomes they experience as a result of the product structures and industry practices. The Background section also includes an extensive description of the methods by which lenders initiate payments from consumers' accounts. Market Concerns—Payments, below, describes consumer experiences and concerns with these payment practices. Most of the comments received on the proposal's Background section agreed in general terms with the descriptions of the markets and products described below, although there may be slight differences in individual lenders' loan products and business practices. Comments that provided significantly different information are noted below.

B. Short-Term, Hybrid, and Balloon-Payment Loans

Providing short-term loans for liquidity needs has been a long-term challenge in the consumer financial services market due to the fixed costs associated with loan origination regardless of loan size. At the beginning of the twentieth century, concern arose with respect to companies that were responding to liquidity needs by offering to “purchase” a consumer's paycheck in advance of it being paid. These companies charged fees that, if calculated as an annualized interest rate, were as high as 400 percent. To address these concerns, between 1914 and 1943, 34 States enacted a form of the Uniform Small Loan Law, which was a model law developed by the Russell Sage Foundation. That law provided for lender licensing and permitted interest rates of between 2 and 4 percent per month, or 24 to 48 percent per year. Those rates were substantially higher than pre-existing usury limits (which generally capped interest rates at between 6 and 8 percent per year) but were viewed by proponents as “equitable to both borrower and lender.”

New forms of short-term small-dollar lending appeared in several States in the 1990s, starting with check cashing outlets that would hold a customer's personal check for a period of time for a fee before cashing it (“check holding” or “deferred presentment”). One of the larger payday lenders began making payday loans in Kansas in 1992, and that same year at least one State regulator issued an administrative interpretation holding that deferred presentment activities were consumer loans subject to that State's licensing and consumer lending laws. One commenter described his role in developing and expanding the deferred presentment lending industry in Tennessee in the early 1990s prior to any regulation in that State, while noting that those same activities required lending licenses in two nearby States.

Several market factors converged around the same time that spurred the development of these new forms of short-term small-dollar lending. Consumers were using credit cards more frequently for short-term liquidity lending needs, a trend that continues today. Storefront finance companies, described below in part II.C, that had provided small loans changed their focus to larger, collateralized products, including vehicle financing and real estate secured loans. At the same time there was substantial consolidation in the storefront installment lending industry. Depository institutions similarly moved away from short-term small-dollar loans.

Around the same time, a number of State legislatures amended their usury laws to allow lending by a broader group of both depository and non-depository lenders by increasing maximum allowable State interest rates or eliminating State usury laws, while other States created usury carve-outs or special rules for short-term loans. The confluence of these trends has led to the development of markets offering what are commonly referred to as payday loans (also known as cash advance loans, deferred deposit, and deferred presentment loans depending on lender and State law terminology), and short-term vehicle title loans that are much shorter in duration than vehicle-secured loans that have traditionally been offered by storefront installment lenders and depository institutions. Although payday loans initially were distributed through storefront retail outlets, they are now also widely available on the Internet. Vehicle title loans are typically offered exclusively at storefront retail outlets.

These markets as they have evolved over the last two decades are not strictly segmented. There is substantial overlap between market products and the borrowers who use them. For example, in a 2015 survey, almost 14.8 percent of U.S. households that had used a payday loan in the prior year had also used a vehicle title loan. There is also an established trend away from “monoline” or single-product lending companies. Thus, for example, a number of large payday lenders also offer vehicle title and installment loans. The following discussion nonetheless provides a description of major product types.

Storefront Payday Loans

The market that has received the greatest attention among policy makers, advocates, and researchers is the market for single-payment payday loans. These payday loans are short-term small-dollar loans generally repayable in a single payment due when the consumer is scheduled to receive a paycheck or other inflow of income (e.g., government benefits). For most borrowers, the loan is due in a single payment on their payday, although State laws with minimum loan terms—seven days for example—or lender practices may affect the loan duration in individual cases. The Bureau refers to these short-term payday loans available at retail locations as “storefront payday loans,” but the requirements for borrowers taking online payday loans are generally similar, as described below. There are now 35 States that either have created a carve-out from their general usury cap for payday loans or have no usury caps on consumer loans. The remaining 15 States and the District of Columbia either ban payday loans or have fee or interest rate caps that payday lenders apparently find too low to sustain their business models. As discussed further below, several of these States previously had authorized payday lending but subsequently changed their laws.

Product definition and regulatory environment. As noted above, payday loans are typically repayable in a single payment on the borrower's next payday. In order to help ensure repayment, in the storefront environment the lender generally holds the borrower's personal check made out to the lender—usually post-dated to the loan due date in the amount of the loan's principal and fees—or the borrower's authorization to electronically debit the funds from her checking account, commonly known as an automated clearing house (ACH) transaction. Payment methods are described in more detail below in part II.D.

Payday loan sizes vary depending on State law limits, individual lender credit models, and borrower demand. Many States set a limit on payday loan size; $500 is a common loan limit although the limits range from $300 to $1,000. In 2013, the Bureau reported that the median loan amount for storefront payday loans was $350, based on supervisory data. This finding is broadly consistent with other studies using data from one or more lenders as well as with self-reported information in surveys of payday borrowers and State regulatory reports.

The fee for a payday loan is generally structured as a percentage or dollar amount per $100 borrowed, rather than a periodic interest rate based on the amount of time the loan is outstanding. Many State laws set a maximum amount for these fees, with 15 percent ($15 per $100 borrowed) being the most common limit. The median storefront payday loan fee is $15 per $100; thus for a $350 loan, the borrower must repay $52.50 in finance charges together with the $350 borrowed for a total repayment amount of $402.50. The annual percentage rate (APR) on a 14-day loan with these terms is 391 percent. For payday borrowers who receive monthly income and thus receive a 30-day or monthly payday loan—many of whom are Social Security recipients —a $15 per $100 charge on a $350 loan for a term of 30 days equates to an APR of about 180 percent. The Bureau has found the median loan term for a storefront payday loan to be 14 days, with an average term of 18.3 days. The longer average loan duration is due to State laws that require minimum loan terms that may extend beyond the borrower's next pay date. Fees and loan amounts are higher for online loans, described in more detail below.

On the loan's due date, the terms of the loan obligate the borrower to repay the loan in full. Although the States that created exceptions to their usury limits for payday lending generally did so on the theory these were short-term loans to which the usual usury rules did not easily apply, in 18 of the States that authorize payday lending the lender is permitted to roll over the loan when it comes due. A rollover occurs when, instead of repaying the loan in full at maturity, the consumer pays only the fees due and the lender agrees to extend the due date. By rolling over, the loan repayment of the principal is extended for another period of time, usually equivalent to the original loan term, in return for the consumer's agreement to pay a new set of fees calculated in the same manner as the initial fees (e.g., 15 percent of the loan principal). The rollover fee is not applied to reduce the loan principal or amortize the loan. As an example, if the consumer borrows $300 with a fee of $45 (calculated as $15 per $100 borrowed), the consumer will owe $345 on the due date, typically 14 days later. On the due date, if the consumer cannot afford to repay the entire $345 due or is otherwise offered the option to roll over the loan, she will pay the lender $45 for another 14 days. On the 28th day, the consumer will owe the original $345 and if she pays the loan in full then, will have paid a total of $90 for the loan.

In some States in which rollovers are permitted they are subject to certain limitations such as a cap on the number of rollovers or requirements that the borrower amortize—repay part of the original loan amount—on the rollover. Other States have no restrictions on rollovers. Specially, 17 of the States that authorize single-payment payday lending prohibit lenders from rolling over loans and 11 more States impose some rollover limitations. However, in most States where rollovers are prohibited or limited, there is no restriction on the lender immediately making a new loan to the consumer (with new fees) after the consumer has repaid the prior loan. New loans made the same day, or “back-to-back” loans, effectively replicate a rollover because the borrower remains in debt to the lender on the borrower's next payday. Ten States have implemented a cooling-off period before a lender may make a new loan. The most common cooling-off period is one day, although some States have longer periods following a specified number of rollovers or back-to-back loans.

At least 17 States have adopted laws that require payday lenders to offer borrowers the option of taking an extended repayment plan when they encounter difficulty in repaying payday loans. Details about the extended repayment plans vary including: Borrower eligibility (in some States only prior to the lender instituting collections or litigation); how borrowers may elect to participate in repayment plans; the number and timing of payments; the length of plans; permitted fees for plans; requirements for credit counseling; requirements to report plan payments to a statewide database; cooling-off or “lock-out” periods for new loans after completion of plans; and the consequences of plan defaults. Two States more generally allow lenders the discretion to offer borrowers an extension of time to repay or enter into workout agreements with borrowers having repayment difficulties. The effects of these various restrictions are discussed further below in Market Concerns—Underwriting.

Industry size and structure. There are various estimates as to the number of consumers who use payday loans on an annual basis. One survey found that 2.5 million households (2 percent of U.S. households) used payday loans in 2015. In another survey, 3.4 percent of households reported taking out a payday loan in the past year. These surveys referred to payday loans generally, and did not specify whether they were referring to loans made online or at storefront locations. One report estimated the number of individual borrowers, rather than households, was higher at approximately 12 million annually and included both storefront and online loans. See Market Concerns—Underwriting for additional information on borrower characteristics.

There are several ways to gauge the size of the storefront payday loan industry. Typically, the industry has been measured by counting the total dollar value of each loan made during the course of a year, counting each rollover, back-to-back loan or other re-borrowing as a new loan that is added to the total. By this metric, one industry analyst estimated that from 2009 to 2014, storefront payday lending generated approximately $30 billion in new loans per year and that by 2015 the volume had declined to $23.6 billion, although these numbers may include products other than single-payment loans. The analyst's estimate for combined storefront and online payday loan volume was $45.3 billion in 2014 and $39.5 billion in 2015, down from a peak of about $50 billion in 2007.

Alternatively, the industry can be measured by calculating the dollar amount of loan balances outstanding. Given the amount of payday loan re-borrowing, which results in the same funds of the lender being used to finance multiple loan originations to the same borrower, the dollar amount of loan balances outstanding may provide a more nuanced sense of the industry's scale. Using this metric, the Bureau estimates that in 2012, storefront payday lenders held approximately $2 billion in outstanding single-payment loans. In 2015, industry revenue (fees paid on storefront payday loans) was an estimated $3.6 billion, representing 15 percent of loan originations. Combined storefront and online payday revenue was estimated at $8.7 billion in 2014 and $6.7 billion in 2015, down from a peak of over $9 billion in 2012.

In the last several years, it has become increasingly difficult to identify the largest payday lenders due to firm mergers, diversification by many lenders into a range of products including installment loans and retraction by others into pawn loans, and the lack of available data because most firms are privately held. However, there are at least 10 lenders with approximately 200 or more storefront locations. Only a few of these firms are publicly traded companies. Most large payday lenders are privately held, and the remaining payday loan stores are owned by smaller regional or local entities. The Bureau estimates there are about 2,400 storefront payday lenders that are small entities as defined by the Small Business Administration (SBA). Several industry commenters, an industry trade association commenter, and a number of payday lenders noted that they offer non-credit products and services at their locations including check cashing, money transmission and bill payments, sale of prepaid cards, and other services, some of which require them to comply with other laws as “money service businesses.”

According to one industry analyst, there were an estimated 16,480 payday loan stores in 2015 in the United States, a decline from 19,000 stores in 2011 and down from the industry's 2007 peak of 24,043 storefronts.

The average number of payday loan stores in a county with a payday loan store is 6.32. The Bureau has analyzed payday loan store locations in States which maintain lists of licensed lenders and found that half of all stores are less than one-third of a mile from another store, and three-quarters are less than a mile from the nearest store. Even the 95th percentile of distances between neighboring stores is only 4.3 miles. Stores tend to be closer together in counties within metropolitan statistical areas (MSA). In non-MSA counties the 75th percentile of distance to the nearest store is still less than one mile, but the 95th percentile is 22.9 miles.

Research and the Bureau's own market outreach indicate that payday loan stores tend to be relatively small with, on average, three full-time equivalent employees. An analysis of loan data from 29 States found that the average store made 3,541 advances in a year. Given rollover and re-borrowing rates, a report estimated that the average store served fewer than 500 customers per year.

Marketing, underwriting, and collections practices. Payday loans tend to be marketed as a short-term bridge to cover emergency expenses. For example, one lender suggests that, for consumers who have insufficient funds on hand to meet such an expense or to avoid a penalty fee, late fee, or utility shut-off, a payday loan can “come in handy” and “help tide you over until your next payday.” Some lenders offer new borrowers their initial loans at no fee (“first loan free”) to encourage consumers to try a payday loan. Stores are typically located in high-traffic commuting corridors and near shopping areas where consumers obtain groceries and other staples.

The evidence of price competition among payday lenders is mixed. In their financial reports, publicly traded payday lenders have reported their key competitive factors to be non-price related. For instance, they cite location, customer service, and convenience as some of the primary factors on which payday lenders compete with one another, as well as with other financial service providers. Academic studies have found that, in States with rate caps, loans are almost always made at the maximum rate permitted. Another study likewise found that in States with rate caps, firms lent at the maximum permitted rate, and that lenders operating in multiple States with varying rate caps raise their fees to those caps rather than charging consistent fees company-wide. The study found, however, that in States with no rate caps, different lenders operating in those States charged different rates. The study reviewed four lenders that operate in Texas and observed differences in the cost to borrow $300 per two-week pay period: two lenders charged $61 in fees, one charged $67, and another charged $91, indicating some level of price variation between lenders (ranging from about $20 to $32 per $100 borrowed). One industry commenter cited the difference in average loan pricing between storefront (generally lower) and online loans (generally higher), as evidence of price competition but that is more likely due to the fact that state-licensed lenders are generally constrained in the amount they can charge rather than competitive strategies adopted by those lenders. That commenter also notes as evidence of price competition that it sometimes discounts its own loans from its advertised prices; the comment did not address whether such discounts were offered to meet competition.

The application process for a payday loan is relatively simple. For a storefront payday loan, a borrower must generally provide some verification of income (typically a pay stub) and evidence of a personal deposit account. Although a few States impose limited requirements that lenders consider a borrower's ability to repay, storefront payday lenders generally do not consider a borrower's other financial obligations or require collateral (other than the check or electronic debit authorization) for the loan. Most storefront payday lenders do not consider traditional credit reports or credit scores when determining loan eligibility, nor do they report any information about payday loan borrowing history to the nationwide consumer reporting agencies, TransUnion, Equifax, and Experian. From market outreach activities and confidential information gathered in the course of statutory functions, the Bureau is aware that a number of storefront payday lenders obtain data from one or more specialty consumer reporting agencies during the loan application process to check for previous payday loan defaults, identify recent inquiries that suggest an intention to not repay the loan, and perform other due diligence such as identity and deposit account verification. Some storefront payday lenders use analytical models and scoring that attempt to predict likelihood of default. Through market outreach and confidential information gathered in the course of statutory functions, the Bureau is aware that many storefront payday lenders only conduct their limited underwriting for first-time borrowers or those returning after an absence.

From market outreach, the Bureau is aware that the specialty consumer reporting agencies contractually require any lender that obtains data to also report data to them, although compliance may vary. Reporting usually occurs on a real-time or same-day basis. Separately, 14 States require lenders to check statewide databases before making each loan in order to ensure that their loans comply with various State restrictions. These States likewise require lenders to report certain lending activity to the database, generally on a real-time or same-day basis. As discussed in more detail above, these State restrictions may include prohibitions on consumers having more than one payday loan at a time, cooling-off periods, or restrictions on the number of loans consumers may take out per year.

Although a consumer is generally required when obtaining a loan to provide a post-dated check or authorization for an electronic debit of the consumer's account which could be presented to the consumer's bank, consumers in practice generally return to the store when the loan is due to “redeem” the check either by repaying the loan or by paying the finance charges and rolling over the loan. For example, a major payday lender with a predominantly storefront loan portfolio reported that in 2014, over 90 percent of its payday loan volume was repaid in cash at its branches by consumers either paying in full or by paying the “original loan fee” (finance charges) and rolling over the loan (signing a new promissory note and leaving a new check or payment authorization).

An industry commenter stated that repayment in cash reflects customers' preferences. However, borrowers are strongly encouraged and in some cases required by lenders to return to the store when payment is due. Some lenders give borrowers appointment cards with a date and time to encourage them to return with cash. For example, one major storefront payday lender explained that after loan origination “the customer then makes an appointment to return on a specified due date, typically his or her next payday, to repay the cash advance . . . . Payment is usually made in person, in cash at the center where the cash advance was initiated . . . .”

The Bureau is aware, from confidential information gathered in the course of statutory functions and from market outreach, that lenders routinely make reminder calls to borrowers a few days before loan due dates to encourage borrowers to return to the store. One large lender reported this practice in a public filing. Another storefront payday lender requires its borrowers to return to the store to repay. Its Web site states: “All payday loans must be repaid with either cash or money order. Upon payment, we will return your original check to you.”

The Bureau is also aware, from confidential information gathered in the course of statutory functions, that one or more storefront payday lenders have operating policies that specifically state that cash is preferred because only half of their customers' checks would clear if deposited on the loan due dates. Encouraging or requiring borrowers to return to the store on the due date provides lenders an opportunity to offer borrowers the option to roll over the loan or, where rollovers are prohibited by State law, to re-borrow following repayment or after the expiration of any cooling-off period. Most storefront lenders examined by the Bureau employ monetary incentives that reward employees and store managers for loan volumes, although one industry commenter described the industry's incentives to employees as rewards for increases in net revenue. Since as discussed below, a majority of loans result from rollovers of existing loans or re-borrowing contemporaneously with or shortly after loans have been repaid, rollovers and re-borrowing contribute substantially to employees' compensation. From confidential information gathered in the course of statutory functions, the Bureau is aware that rollover and re-borrowing offers are made when consumers log into their accounts online, during “courtesy calls” made to remind borrowers of upcoming due dates, and when borrowers repay in person at storefront locations. In addition, some lenders train their employees to offer rollovers during courtesy calls when borrowers notified lenders that they had lost their jobs or suffered pay reductions.

Store personnel often encourage borrowers to roll over their loans or to re-borrow, even when consumers have demonstrated an inability to repay their existing loans. In an enforcement action, the Bureau found that one lender maintained training materials that actively directed employees to encourage re-borrowing by struggling borrowers. It further found that if a borrower did not repay or pay to roll over the loan on time, store personnel would initiate collections. Store personnel or collectors would then offer the option to take out a new loan to pay off an existing loan, or refinance or extend the loan as a source of relief from the potentially negative outcomes (e.g., lawsuits, continued collections). This “cycle of debt” was depicted graphically as part of “The Loan Process” in the company's new hire training manual. In Mississippi, another lender employed a companywide practice in which store personnel encouraged borrowers with monthly income or benefits payments to use the proceeds of one loan to pay off another loan, although State law prohibited these renewals or rollovers.

In addition, though some States require lenders to offer borrowers the option of extended repayment plans and some trade associations have designated provision of such plans as a best practice, individual lenders may often be reluctant to offer them. In Colorado, for instance, some payday lenders reported, prior to a regulatory change in 2010, that they had implemented practices to restrict borrowers from obtaining the number of loans needed to be eligible for the State-mandated extended payment plan option and that some lenders had banned borrowers who had exercised their rights to elect payment plans from taking new loans. The Bureau is also aware, from confidential information gathered in the course of statutory functions, that one or more lenders used training manuals that instructed employees not to mention these plans until after employees first offered rollovers, and then only if borrowers specifically asked about the plans. Indeed, details on implementation of the repayment plans that have been designated by two national trade associations for storefront payday lenders as best practices are unclear, and in some cases place a number of limitations on exactly how and when a borrower must request assistance to qualify for these “off-ramps.” For instance, one trade association representing more than half of all payday loan stores states that as a condition of membership, members must offer an “extended payment plan” but that borrowers must request the plan at least one day prior to the date on which the loan is due, generally in person at the store where the loan was made or otherwise by the same method used to originate the loan. Another trade association with over 1,300 members, including both payday lenders and firms that offer non-credit products such as check cashing and money transmission, states that members will provide the option of extended payment plans in the absence of State-mandated plans to customers unable to repay, but details of the plans are not publicly available on its Web site.

From confidential information gathered in the course of statutory functions and market outreach, the Bureau is aware that if a borrower fails to return to the store when a loan is due, the lender may attempt to contact the consumer and urge the consumer to make a cash payment before eventually depositing the post-dated check that the consumer had provided at origination or electronically debiting the account. The Bureau is also aware of some situations in which lenders have obtained electronic payments from borrowers' bank accounts and also accepted cash payments from borrowers at storefronts. The Bureau is aware, from confidential information gathered in the course of its statutory functions and from market outreach, that lenders may use various methods to try to ensure that a payment will clear before presenting a check or ACH. These efforts may range from storefront lenders calling the borrower's bank to ask if a check of a particular size would clear the account to the use of software offered by a number of vendors that attempts to model likelihood of repayment (“predictive ACH”). If these attempts are unsuccessful, store personnel at either the storefront level or at a centralized location will then generally engage in collection activity.

Collection activity may involve further in-house attempts to collect from the borrower's bank account. If the first attempt fails, the lender may make subsequent attempts at presentment by splitting payments into smaller amounts in hopes of increasing the likelihood of obtaining at least some funds, a practice for which the Bureau recently took enforcement action against a small-dollar lender. Or, the lender may attempt to present the payment multiple times, a practice that the Bureau has noted in supervisory examinations. A more detailed discussion of payments practices is provided in part D and Markets Concerns—Payments.

Eventually, the lender may attempt other means of collection. The Bureau is aware of in-house debt collections activities, by both storefront employees and employees at centralized collections divisions, including calls, letters, and visits to consumers and their workplaces, as well as the sale of debt to third-party collectors. The Bureau recently conducted a survey of consumer debt collection experiences; 11 percent of consumers contacted about a debt in collection reported the collection activity was related to payday loan debt. Further, the Bureau observed in its consumer complaint data that from November 2013 through December 2016, more than 31,000 debt collection complaints had “payday loan” as the underlying debt. In more than 11 percent of the complaints the Bureau handled about debt collection, consumers selected “payday loans” as the underlying debt.

In addition, in 2016, the Bureau handled approximately 4,400 complaints in which consumers reported “payday loan” as the complaint product and about 26,600 complaints about credit cards. As noted above, there are about 12 million payday loan borrowers annually, and approximately 156 million consumers have one or more credit cards. Therefore, by way of comparison, for every 10,000 payday loan borrowers, the Bureau handled about 3.7 complaints, while for every 10,000 credit card holders, the Bureau handled about 1.7 complaints.

Some payday lenders sue borrowers who fail to repay their loans. A study of small claims court cases filed in Utah from 2005 to 2010 found that 38 percent of cases were attributable to payday loans. A recent news report found that the majority of non-traffic civil cases filed in 14 Utah justice courts are payday loan collection lawsuits, and in one justice court, the percentage was as high as 98.8 percent. In 2013, the Bureau entered into a Consent Order with a large national payday and installment lender based, in part, on the filing of flawed court documents in about 14,000 debt collection lawsuits. However, an industry trade association commenter states that many payday lenders do not file lawsuits on defaulted debt.

Business model. As previously noted, the storefront payday industry has built a distribution model that involves a large number of small retail outlets, each serving a relatively small number of consumers. That implies that the overhead cost on a per consumer basis is relatively high.

Additionally, the loss rates on storefront payday loans—the percentage or amounts of loans that are charged off by the lender as uncollectible—are relatively high. Loss rates on payday loans often are reported on a per-loan basis but, given the frequency of rollovers and renewals, that metric understates the amount of principal lost to borrower defaults. For example, if a lender makes a $100 loan that is rolled over nine times, at which point the consumer defaults, the per-loan default rate would be 10 percent whereas the lender would have in fact lost 100 percent of the amount loaned. In this example, the lender would still have received substantial revenue, as the lender would have collected fees for each rollover prior to default. The Bureau estimates that during the 2011-2012 time frame, charge-offs (i.e., uncollectible loans defaulted on and never repaid) equaled nearly one-half of the average amount of outstanding loans during the year. In other words, for every $1.00 loaned, only $.50 in principal was eventually repaid. One academic study found loss rates to be even higher.

To sustain these significant costs, the payday lending business model is dependent upon a large volume of re-borrowing—that is, rollovers, back-to-back loans, and re-borrowing within a short period of paying off a previous loan—by those borrowers who do not default on their first loan. The Bureau's research found that over the course of a year, 90 percent of all loan fees comes from consumers who borrowed seven or more times and 75 percent comes from consumers who borrowed 10 or more times. Similarly, when the Bureau identified a cohort of borrowers and tracked them over 10 months, the Bureau found that more than two-thirds of all loans were in sequences of at least seven loans, and that over half of all loans were in sequences of 10 or more loans. The Bureau defines a sequence as an initial loan plus one or more subsequent loans renewed within 30 days after repayment of the prior loan; a sequence thus captures not only rollovers and back-to-back loans but also re-borrowing that occurs within a short period of time after repayment of a prior loan either at the point at which a State-mandated cooling-off period ends or at the point at which the consumer, having repaid the prior loan, runs out of money. A more detailed discussion of sequence length is provided in the section-by-section discussion of §§ 1041.2(a)(14) and 1041.5 and in Market Concerns—Underwriting.

Other studies are broadly consistent. For example, a 2013 report based on lender data from Florida, Kentucky, Oklahoma, and South Carolina found that 85 percent of loans were made to borrowers with seven or more loans per year, and 62 percent of loans were made to borrowers with 12 or more loans per year. These four States have restrictions on payday loans such as cooling-off periods and limits on rollovers that are enforced by State-regulated databases, as well as voluntary extended repayment plans. An updated report on Florida payday loan usage derived from the State database noted this trend has continued, with 83 percent of payday loans in 2015 made to borrowers with seven or more loans and 57 percent of payday loans that same year made to borrowers with 12 or more loans. In Alabama's first year of tracking payday loans with a single database, it reported that almost 50 percent of borrowers had seven or more payday loans and almost 37 percent of borrowers had 10 or more payday loans. Other reports have found that over 80 percent of total payday loans and loan volume is due to repeat borrowing within 30 days of a prior loan. One trade association has acknowledged that “[i]n any large, mature payday loan portfolio, loans to repeat borrowers generally constitute between 70 and 90 percent of the portfolio, and for some lenders, even more.” A recent report by a specialty consumer reporting agency confirms that the industry's business model relies on repeat customers, noting that over half of all loans are made to returning customers and stating “[t]his finding suggests that even though new customers are critical, existing customers are the most productive.” Market Concerns—Underwriting below discusses the impact of these outcomes for consumers who are unable to repay and either default or re-borrow.

Recent regulatory and related industry developments. A number of Federal and State regulatory developments have occurred over the last 15 years as concerns about the effects of payday lending have spread. Regulators have found that the industry has tended to shift to new models and products in response.

Since 2000, it has been clear from commentary added to Regulation Z, that payday loans constitute “credit” under the Truth in Lending Act (TILA) and that cost of credit disclosures are required to be provided in payday loan transactions, regardless of how State law characterizes payday loan fees.

In 2006, Congress enacted the Military Lending Act (MLA) to address concerns that servicemembers and their families were becoming over-indebted in high-cost forms of credit. The MLA, as implemented by the Department of Defense's regulation, imposes two broad classes of requirements applicable to a creditor. First, the creditor may not impose a military annual percentage rate (MAPR) greater than 36 percent in connection with an extension of consumer credit to a covered borrower. Second, when extending consumer credit, the creditor must satisfy certain other terms and conditions, such as providing certain information, both orally and in a form the borrower can keep, before or at the time the borrower becomes obligated on the transaction or establishes the account; refraining from requiring the borrower to submit to arbitration in the case of a dispute involving the consumer credit; and refraining from charging a penalty fee if the borrower prepays all or part of the consumer credit. In 2007, the Department of Defense issued its initial regulation under the MLA, limiting the Act's application to closed-end loans with a term of 91 days or less in which the amount financed did not exceed $2,000; closed-end vehicle title loans with a term of 181 days or less; and closed-end tax refund anticipation loans. However, the Department found that evasions developed in the market as “the extremely narrow definition of `consumer credit' in the [then-existing rule] permits a creditor to structure its credit products in order to reduce or avoid altogether the obligations of the MLA.”

As a result, effective October 2015 the Department of Defense expanded its definition of covered credit to include open-end credit and longer-term loans so that the MLA protections generally apply to all credit subject to the requirements of Regulation Z of the Truth in Lending Act, other than certain products excluded by statute. In general, creditors must comply with the new regulations for extensions of credit after October 3, 2016; for credit card accounts, creditors are required to comply with the new rule starting October 3, 2017.

At the State level, the last States to enact legislation authorizing payday lending—Alaska and Michigan—did so in 2005. At least 11 States and jurisdictions that previously had authorized payday loans have taken steps to restrict or eliminate payday lending. In 2001, North Carolina became the first State that had previously permitted payday loans to adopt an effective ban by allowing the authorizing statute to expire. In 2004, Georgia also enacted a law banning payday lending.

In 2008, the Ohio legislature adopted the Short Term Lender Act with a 28 percent APR cap, including all fees and charges, for short-term loans and repealed the existing Check-Cashing Lender Law that authorized higher rates and fees. In a referendum later that year, Ohioans voted against reinstating the Check-Cashing Lender Law, leaving the 28 percent APR cap and the Short Term Lending Act in effect. After the vote, some payday lenders began offering vehicle title loans. Other lenders continued to offer payday loans utilizing Ohio's Credit Service Organization Act and the Mortgage Loan Act; the latter practice was upheld by the State Supreme Court in 2014. Also in 2008, the District of Columbia banned payday lending which had been a permissible activity under the District's check cashing law, making the loans subject to the District's 24 percent per annum maximum interest rate cap.

In 2010, Colorado's legislature banned short-term single-payment balloon loans in favor of longer-term, six-month loans. Colorado's regulatory framework is described in more detail in the discussion of payday installment lending below.

As of July 1, 2010, Arizona effectively prohibited payday lending after the authorizing statute expired and a statewide referendum that would have continued to permit payday lending failed to pass. However, small-dollar lending activity continues in the State. The State financial regulator issued an alert in 2013, in response to complaints about online unlicensed lending, advising consumers and lenders that payday and consumer loans of $1,000 or less are generally subject to a rate of 36 percent per annum and loans in violation of those rates are void. In addition, vehicle title loans continue to be made in Arizona as secondary motor vehicle finance transactions. The number of licensed vehicle title lenders has increased by about 300 percent since the payday lending law expired and now exceeds the number of payday lenders that were licensed prior to the ban.

In 2009, Virginia amended its payday lending law. It extended the minimum loan term to the length of two income periods, added a 45-day cooling-off period after substantial time in debt (the fifth loan in a 180-day period) and a 90-day cooling-off period after completing an extended payment plan, and implemented a database to enforce limits on loan amounts and frequency. The payday law applies to closed-end loans. Virginia has no interest rate regulations or licensure requirements for open-end credit. After the amendments, a number of lenders that were previously licensed as payday lenders in Virginia, and that offer closed-end payday loans in other States, switched to offering open-end credit in Virginia without State licenses.

Washington and Delaware have restricted repeat borrowing by imposing limits on the number of payday loans consumers may obtain. In 2009, Washington made several changes to its payday lending law. These changes, effective January 1, 2010, include a cap of eight loans per borrower from all lenders in a rolling 12-month period where there had been no previous limit on the number of total loans, an extended repayment plan for any loan, and a database to which lenders are required to report all payday loans. In 2013, Delaware, a State with no fee restrictions for payday loans, implemented a cap of five payday loans, including rollovers, in any 12-month period. Delaware defines payday loans as loans due within 60 days for amounts up to $1,000. Some Delaware lenders have shifted from payday loans to longer-term installment loans with interest-only payments followed by a final balloon payment of the principal and an interest fee payment—sometimes called a “flexpay” loan.

In 2016, South Dakota voters approved a ballot measure instituting a 36 percent APR limit for all consumer loans made by licensed lenders. The measure passed with approximately 75 percent of voters supporting it. Subsequently, a number of lenders previously licensed to do business in the State either declined to renew their licenses or indicated that they would not originate new loans that would be subject to the cap.

New Mexico enacted legislation in 2017 that will effectively prohibit single payment payday loans. It requires small-dollar loans to have minimum loan terms of 120 days and be repaid in four or more installments. The legislation will take effect on January 1, 2018. The legislation also sets a usury limit of 175 percent APR and will apply to short-term vehicle title loans.

In 2017, several other States also passed legislation related to payday lending. Arkansas passed a law clarifying that fees charged by credit service organizations are interest under the State's constitutional usury limit of 17 percent per annum. Utah amended its existing law that prohibits rollovers of payday loans for more than 10 weeks by prohibiting lenders from originating new loans for borrowers to repay prior ones.

At least 41 Texas municipalities have adopted local ordinances setting business regulations on payday lending (and vehicle title lending). Some of the ordinances, such as those in Dallas, El Paso, Houston, and San Antonio, include requirements such as limits on loan amounts (no more than 20 percent of the borrower's gross annual income for payday loans), limits on the number of rollovers, required amortization of the principal loan amount on repeat loans—usually in 25 percent increments, record retention for at least three years, and a registration requirement. On a statewide basis, there are no Texas laws specifically governing payday lenders or payday loan terms; credit access businesses that act as loan arrangers or broker payday loans (and vehicle title loans) are regulated and subject to licensing, reporting, and requirements to provide consumers with disclosures about repayment and re-borrowing rates.

Online Payday Lending

With the growth of the Internet, a significant online payday lending industry has developed. Some storefront lenders use the Internet as an additional method of originating payday loans in the States in which they are licensed to do business. In addition, there are now a number of lenders offering what are referred to as “hybrid” payday loans, through the Internet. Hybrid payday loans are structured so that rollovers occur automatically unless the consumer takes affirmative action to pay off the loan, thus effectively creating a series of interest-only payments followed by a final balloon payment of the principal amount and an additional fee. Hybrid loans structured as single payment loans with automatic rollovers and longer-term loans with a final balloon payment are covered by the final rule's Ability-to-Repay requirements as discussed more fully below.

Industry size, structure, and products. The size of the online payday market is difficult to measure for a number of reasons. First, many online lenders offer a variety of products beyond single-payment loans (what the Bureau refers to as payday loans) and hybrid loans (which the Bureau views as a form of payday lending and falls within the final rule's definition of short-term loans), including longer-term installment loans; this poses challenges in sizing the portion of these firms' business that is attributable to payday and hybrid loans. Second, most online payday lenders are not publicly traded, which means that minimal financial information is available about this market segment. Third, many online payday lenders claim exemption from State lending laws and licensing requirements on the basis that they are located and operated from other jurisdictions. Consequently, these lenders report less information publicly, whether individually or in aggregate compilations, than lenders holding traditional State licenses. Finally, storefront payday lenders who are also using the online channel generally do not separately report their online originations. Bureau staff's reviews of the largest storefront lenders' Web sites indicate an increased focus in recent years on online loan origination.

With these caveats, a frequently cited industry analyst has estimated that by 2012, online payday loans had grown to generate nearly an equivalent amount of fee revenue as storefront payday loans on roughly 62 percent of the origination volume, about $19 billion, but originations had then declined somewhat to roughly $15.9 billion by 2015. This trend appears consistent with storefront payday loans, as discussed above, and is likely related at least in part to increasing lender migration from short-term into longer-term products. Online payday loan fee revenue has been estimated at $3.1 billion for 2015, or 19 percent of origination volume. However, these estimates may be both over- and under-inclusive; they may not differentiate precisely between online lenders' short-term and longer-term loans, and they may not account for the online lending activities by storefront payday lenders.

Whatever the precise size, the online industry can broadly be divided into two segments: online lenders licensed in the State in which the borrower resides and lenders that are not licensed in the borrower's State of residence.

The first segment consists largely of storefront lenders with an online channel to complement their storefronts as a means of originating loans, as well as a few online-only payday lenders who lend to borrowers in States where they have obtained State lending licenses. Because this segment of online lenders is State-licensed, State administrative payday lending reports include these data but generally do not differentiate loans originated online from those originated in storefronts. Accordingly, this portion of the market is included in the market estimates summarized above, and the lenders consider themselves to be subject to, or generally follow, the relevant State laws discussed above.

The second segment consists of lenders that claim exemption from State lending laws. Some of these lenders claim exemption because their loans are made from physical locations outside of the borrower's State of residence, including from off-shore locations outside of the United States. Other lenders claim exemption because they are lending from Tribal lands, with such lenders claiming that they are regulated by the sovereign laws of “federally recognized Indian tribes.” These lenders claim immunity from suit to enforce State or Federal consumer protection laws on the basis of their sovereign status. A Federal appellate court recently rejected claims of immunity from the Bureau's civil investigative demands by several Tribal-related lenders, finding that “Congress did not expressly exclude tribes from the Bureau's enforcement authority.”

A frequently cited source of data on this segment of the market is a series of reports using data from a specialty consumer reporting agency serving certain online lenders, most of whom are unlicensed. These data are not representative of the entire online industry, but nonetheless cover a large enough sample (2.5 million borrowers over a period of four years) to be significant. These reports indicate the following concerning this market segment:

• Although the mean and median loan size among the payday borrowers in this dataset are only slightly higher than the information reported above for storefront payday loans, the online payday lenders charge higher rates than storefront lenders. As noted above, most of the online lenders reporting this data claim exemption from State laws and do not comply with State rate caps. The median loan fee in this dataset is $23.53 per $100 borrowed, compared to $15 per $100 borrowed for storefront payday loans. The mean fee amount is even higher at $26.60 per $100 borrowed. Another study based on a similar dataset from three online payday lenders is generally consistent, putting the range of online payday loan fees at between $18 and $25 per $100 borrowed.

• More than half of the payday loans made by these online lenders are hybrid payday loans. As described above, a hybrid loan involves automatic rollovers with payment of the loan fee until a final balloon payment of the principal and fee. For the hybrid payday loans, the most frequently reported payment amount is 30 percent of principal, implying a finance charge during each pay period of $30 for each $100 borrowed.

• Unlike storefront payday loan borrowers who generally return to the same store to re-borrow, the credit reporting data may suggest that online borrowers tend to move from lender to lender. As discussed further below, however, it is difficult to evaluate whether some of this apparent effect is due to online lenders simply not consistently reporting lending activity.

Marketing, underwriting, and collection practices. As with most online lenders in other markets, online payday lenders have utilized direct marketing, lead generators, and other forms of advertising for customer acquisition. Lead generators, via Web sites advertising payday loans usually in the form of banner advertisements or paid search results (the advertisements that appear at the top of an Internet search on Google, Bing, or other search engines) operated by “publishers,” collect consumers' personal and financial information and electronically offer it to lenders that have expressed interest in consumers meeting certain criteria. In July 2016, Google banned ads for loans with APRs over 36 percent or with repayment due in 60 days or less. From the Bureau's market outreach activities it is aware that the payday lending industry's use of lead generators has decreased but that payday lenders may be using other forms of advertising for customer acquisition and retention.

Online lenders view fraud (i.e., consumers who mispresent their identity) as a significant risk and also express concerns about “bad faith” borrowing (i.e., consumers with verified identities who borrow without the intent to repay). Consequently, online payday and hybrid payday lenders attempt to verify the borrower's identity and the existence of a bank account in good standing. Several specialty consumer reporting agencies have evolved primarily to serve the online payday lending market. The Bureau is aware from market outreach that online lenders also generally report loan closure information on a real-time or daily basis to the specialty consumer reporting agencies. In addition, some online lenders report to the Bureau that they use nationwide credit report information to evaluate both credit and potential fraud risk associated with first-time borrowers, including recent bankruptcy filings. However, there is evidence that online lenders do not consistently utilize credit report data for every loan, and instead typically check and report data only for new borrowers or those returning after an extended absence from the lender's records.

Typically, proceeds from online payday loans are disbursed electronically into the consumer's bank account and the consumer authorizes the lender to electronically debit her account to repay the loan as payments are due. The Bureau is aware from market monitoring that lenders employ various practices to encourage consumers to agree to authorize electronic debits for repayment. Some lenders generally will not disburse electronically if consumers do not agree to ACH repayment, but instead will require the consumer to wait for a paper loan proceeds check to arrive in the mail. Some online payday lenders charge higher interest rates or fees to consumers who do not commit to electronic debits. In addition, some online payday lenders have adopted policies that may delay the crediting of non-ACH payments.

As noted above, online lenders typically collect payday loans via electronic debits. For a hybrid payday loan the lender seeks to collect the finance charges a pre-set number of times and then eventually collect the principal; for a true payday loan the lender will seek to collect the principal and finance charges when the loan is due. Online payday lenders, like their storefront counterparts, use various models and software, described above, to predict when an electronic debit is most likely to succeed in withdrawing funds from a borrower's bank account. As discussed further below, the Bureau has observed lenders seeking to collect multiple payments on the same day. This pattern may be driven by a practice of dividing the payment amount in half and presenting two debits at once, presumably to reduce the risk of a larger payment being returned for nonsufficient funds. Indeed, the Bureau found that about one-third of presentments by online payday lenders occur on the same day as another request by the same lender from the same account. The Bureau also found that split presentments almost always result in either payment of all presentments or return of all presentments (in which event the consumer will likely incur multiple nonsufficient funds (NSF) fees from the bank). The Bureau's study indicates that when an online payday lender's first attempt to obtain a payment from the consumer's account is unsuccessful, it will make a second attempt 75 percent of the time and if that attempt fails the lender will make a third attempt 66 percent of the time. As discussed further at part II.D, the success rate on these subsequent attempts is relatively low, and the cost to consumers may be correspondingly high.

There is limited information on the extent to which online payday lenders that are unable to collect payments through electronic debits resort to other collection tactics. The available evidence indicates, however, that online lenders sustain higher credit losses and risk of fraud than storefront lenders. One lender with publicly available financial information that originated both storefront and online single-payment loans reported in 2014, a 49 percent and 71 percent charge-off rate, respectively, for these loans. Online lenders generally classify as “fraud” both consumers who misrepresented their identity in order to obtain a loan and consumers whose identity is verified but default on the first payment due, which is viewed as reflecting the intent not to repay.

Business model. While online lenders tend to have fewer costs relating to operation of physical facilities than do storefront lenders, as discussed above, they face higher costs relating to lead acquisition and marketing, loan origination screening to verify applicant identity, and potentially larger losses due to what they classify as “fraud” than their storefront competitors.

Accordingly, it is not surprising that online lenders—like their storefront counterparts—are dependent upon repeated re-borrowing. Indeed, even at a cost of $25 or $30 per $100 borrowed, a typical single online payday loan would generate fee revenue of under $100, which is not sufficient to cover the typical origination costs. Consequently, as discussed above, hybrid loans that roll over automatically in the absence of affirmative action by the consumer account for a substantial percentage of online payday business. These products, while nominally structured as single-payment products, effectively build a number of rollovers into the loan. For example, the Bureau has observed online payday lenders whose loan documents suggest that they are offering a single-payment loan but whose business model is to collect only the finance charges due, roll over the principal, and require consumers to take affirmative steps to notify the lender if consumers want to repay their loans in full rather than allowing them to roll over. The Bureau recently initiated an action against an online lender alleging that it engaged in deceptive practices in connection with such products. In a recent survey conducted of online payday borrowers, 31 percent reported that they had experienced loans with automatic renewals.

As discussed above, a number of online payday lenders claim exemption from State laws and the regulations and limitations established under those laws. As reported by a specialty consumer reporting agency with data from that market, more than half of the payday loans for which information is furnished to it are hybrid payday loans with the most common fee being $30 per $100 borrowed, twice the median amount for storefront payday loans.

Similar to associations representing storefront lenders as discussed above, a national trade association representing online lenders includes loan repayment plans as one of its best practices, but does not provide many details in its public material. A trade association that represents Tribal online lenders has adopted a set of best practices, but the list does not address repayment plans.

Vehicle Title Loans, Including Short-Term Loans and Balloon-Payment Products

Vehicle title loans—also known as “automobile equity loans”—are another form of liquidity lending permitted in certain States. In a title loan transaction, the borrower must provide identification and usually the title to the vehicle as evidence that the borrower owns the vehicle “free and clear.” Unlike payday loans, there is generally no requirement that the borrowers have a bank account, and some lenders do not require a copy of a pay stub or other evidence of income. Rather than holding a check or ACH authorization for repayment as with a payday loan, the lender generally retains the vehicle title or some other form of security interest that provides it with the right to repossess the vehicle, which may then be sold with the proceeds used for repayment.

The lender retains the vehicle title or some other form of security interest during the duration of the loan, while the borrower retains physical possession of the vehicle. In some States either the lender files a lien with State officials to record and perfect its interest in the vehicle or charges a fee for non-filing insurance. In a few States, a clear vehicle title is not required, and vehicle title loans may be made as secondary liens against the title or against the borrower's automobile registration. In some States, such as Georgia, vehicle title loans are made under pawnbroker statutes that specifically permit borrowers to pawn vehicle certificates of title. Almost all vehicle title lending is conducted at storefront locations, although some title lending does occur online.

Product definition and regulatory environment. There are three types of vehicle title loans: Single-payment loans, installment loans, and in at least one State, balloon payment loans. Of the 24 States that permit some form of vehicle title lending, six States permit only single-payment title loans, 13 States allow the loans to be structured as single-payment or installment loans, and five permit only title installment loans. (The payment practices of installment title loans are discussed briefly below.) All but three of the States that permit some form of title lending (Arizona, Georgia, and New Hampshire) also permit payday lending.

Single-payment vehicle title loans are typically due in 30 days and operate much like payday loans: The consumer is charged a fixed price per $100 borrowed, and when the loan is due the consumer is obligated to repay the full amount of the loan plus the fee but is typically given the opportunity to roll over or re-borrow. The Bureau recently studied anonymized data from vehicle title lenders consisting of nearly 3.5 million loans made to over 400,000 borrowers in 20 States. For single-payment vehicle title loans with a typical duration of 30 days, the median loan amount was $694 with a median APR of 317 percent; the average loan amount was $959 and the average APR was 291 percent. Two other studies contain similar findings. Vehicle title loans are therefore for substantially larger amounts than typical payday loans, but carry similar APRs for similar terms. Some States that authorize vehicle title loans limit the rates lenders may charge to a percentage or dollar amount per $100 borrowed, similar to some State payday lending pricing structures. A common fee limit is 25 percent of the loan amount per month, but roughly half of the authorizing States have no restrictions on rates or fees. Some, but not all, States limit the maximum amount that may be borrowed to a fixed dollar amount, a percentage of the borrower's monthly income (50 percent of the borrower's gross monthly income in Illinois), or a percentage of the vehicle's value. Some States limit the initial loan term to one month but several States authorize rollovers (including, in Idaho and Tennessee, automatic rollovers arranged at the time of the original loan, resembling the hybrid payday structure described above), with a few States requiring mandatory amortization in amounts ranging from five to 20 percent on rollovers. Unlike payday loan regulation, few States require cooling-off periods between loans or optional extended repayment plans for borrowers who cannot repay vehicle title loans.

State vehicle title regulations also sometimes address default, repossession and related fees; any cure periods prior to and after repossession; whether the lender must refund any surplus after the repossession and sale or disposition of the vehicle; and whether the borrower is liable for any deficiency remaining after sale or disposition. Of the States that expressly authorize vehicle title lending, nine are “non-recourse” meaning that a lender's remedy upon the borrower's default is limited to repossession of the vehicle unless the borrower has impaired the vehicle by concealment, damage, or fraud. Other vehicle title lending statutes are silent and do not directly specify whether a lender has recourse against a borrower for any deficiency balance remaining after repossessing the vehicle. An industry trade association commenter stated that title lenders do not sue borrowers or garnish their wages for deficiency balances.

Some States have enacted general requirements that vehicle title lenders consider a borrower's ability to repay before making a title loan. For example, both South Carolina and Utah require lenders to consider borrower ability to repay, but this may be accomplished through a borrower affirmation that she has provided accurate financial information and has the ability to repay. Until July 1, 2017, Nevada required title lenders to generally consider a borrower's ability to repay and obtain an affirmation of this fact. Effective July 1st, an amendment to Nevada law requires vehicle title lenders (and payday lenders, as noted above) to assess borrowers' reasonable ability to repay by considering, to the extent available, their current or expected income; current employment status based on a pay stub, bank deposit, or other evidence; credit history; original loan amount due, or for installment loans or potential repayment plans, the monthly payment amount; and other evidence relevant to ability to repay including bank statements and borrowers' written representations. Missouri requires that lenders consider a borrower's financial ability to reasonably repay the loan under the loan's contract, but does not specify how lenders may satisfy this requirement.

Industry size and structure. Information about the vehicle title market is more limited than the storefront payday industry because there are currently no publicly traded monoline vehicle title loan companies, most payday lending companies that offer vehicle title loans are not publicly traded, and less information is generally available from State regulators and other sources. One national survey conducted in June 2015 found that 1.7 million households reported obtaining a vehicle title loan over the preceding 12 months. Another study extrapolating from State regulatory reports estimated that about two million Americans used vehicle title loans annually. In 2014, new vehicle title loan originations were estimated at roughly $2 billion with revenue estimates of $3 to $5.6 billion. These estimates may not include the full extent of rollovers, as well as vehicle title loan expansion by payday lenders.

There are approximately 8,000 title loan storefront locations in the United States, about half of which also offer payday loans. Of those locations that predominately offer vehicle title loans, three privately held firms dominate the market and together account for about 3,000 stores in about 20 States. These lenders are concentrated in the southeastern and southwestern regions of the country. In addition to the large title lenders, smaller vehicle title lenders are estimated to have about 800 storefront locations, and as noted above several companies offer both title loans and payday loans. The Bureau understands that for some firms whose core business had been payday loans, the volume of vehicle title loan originations now exceeds payday loan originations.

State loan data also show an overall trend of vehicle title loan growth. The number of borrowers in Illinois taking vehicle title loans increased 77 percent from 2009 to 2013, and then declined 14 percent from 2013 to 2015. The number of title loans taken out in California increased 183 percent between 2011 and 2016. In Virginia, from 2011 to 2013, the number of motor vehicle title loans made increased by 38 percent from 128,446 to a peak of 177,775, and the number of individual consumers taking title loans increased by 44 percent, from 105,542 to a peak of 152,002. By 2016, the number of title loans in Virginia decreased to 155,996 and the number of individual consumers taking title loans decreased to 114,042. The average number of loans per borrower remained constant at 1.2 from 2011 to 2015; in 2016 the number of loans per borrower increased to 1.4. In addition to loans made under Virginia's vehicle title law, a series of reports noted that some Virginia title lenders offered “consumer finance” installment loans without the corresponding consumer protections of the vehicle title lending law and, accounted for about “a quarter of the money loaned in Virginia using automobile titles as collateral.” In Tennessee, the number of licensed vehicle title (title pledge) locations at year-end has been measured yearly since 2006. The number of Tennessee locations peaked in 2014 at 1,071, 52 percent higher than the 2006 levels. In 2015, the number of locations declined to 965. However, in each year from 2013 to 2016, the State regulator has reported more licensed locations than existed prior to the State's title lending regulation, the Tennessee Title Pledge Act.

Vehicle title loan storefront locations serve a relatively small number of customers. One study estimated that the average vehicle title loan store made 218 loans per year, not including rollovers. Another study using data from four States and public filings from the largest vehicle title lender estimated that the average vehicle title loan store serves about 300 unique borrowers per year—or slightly more than one unique borrower per business day. The same report estimated that the largest vehicle title lender had 4.2 employees per store. But, as mentioned, a number of large payday firms offer both products from the same storefront and may use the same employees to do so. In addition, small vehicle title lenders are likely to have fewer employees per location than do larger title lenders.

Marketing, underwriting, and collections practices. Vehicle title loans are marketed to appeal to borrowers with impaired credit who seek immediate funds. The largest vehicle title lender described title loans as a “way for consumers to meet their liquidity needs” and described their customers as those who “often . . . have a sudden and unexpected need for cash due to common financial challenges.” Advertisements for vehicle title loans suggest that title loans can be used “to cover unforeseen costs this month . . . [if] utilities are a little higher than you expected,” if consumers are “in a bind,” for a “short term cash flow” problem, or for “fast cash to deal with an unexpected expense.” Vehicle title lenders advertise quick loan approval “in as little as 15 minutes.” Some lenders offer promotional discounts for the initial loan and bonuses for referrals, for example, a $100 prepaid card for referring friends for vehicle title loans.

The underwriting policies and practices that vehicle title lenders use vary and may depend on such factors as State law requirements and individual lender practices. As noted above, some vehicle title lenders do not require borrowers to provide information about their income and instead rely on the vehicle title and the underlying collateral that may be repossessed and sold in the event the borrower defaults—a practice known as asset-based lending. The largest vehicle title lender stated in 2011 that its underwriting decisions were based entirely on the wholesale value of the vehicle. Other title lenders' Web sites state that proof of income is required, although it is unclear whether employment information is verified or used for underwriting, whether it is used for collections and communication purposes upon default, or for both purposes. The Bureau is aware, from confidential information gathered in the course of its statutory functions, that one or more vehicle title lenders regularly exceed their maximum loan amount guidelines and instruct employees to consider a vehicle's sentimental or use value to the borrower when assessing the amount of funds they will lend.

As in the market for payday loans, there have been some studies about the extent of price competition in the vehicle title lending market. Vehicle title lending is almost exclusively a storefront market, as discussed above. The evidence of price competition is mixed. One large title lender stated that it competes on factors such as location, customer service, and convenience, and also highlights its pricing as a competitive factor. An academic study found evidence of price competition in the vehicle title market, citing the abundance of price-related advertising and evidence that in States with rate caps, such as Tennessee, approximately half of the lenders charged the maximum rate allowed by law, while the other half charged lower rates. However, another report found that like payday lenders, title lenders compete primarily on location, speed, and customer service, gaining customers by increasing the number of locations rather than underpricing their competition.

Loan amounts are typically for less than half the wholesale value of the consumer's vehicle. Low loan-to-value ratios reduce a lender's risk. A survey of title lenders in New Mexico found that the lenders typically lend between 25 and 40 percent of a vehicle's wholesale value. At one large title lender, the weighted average loan-to-value ratio was found to be 26 percent of Black Book retail value. The same lender has two principal operating divisions; one division requires that vehicles have a minimum appraised value greater than $500, but the lender will lend against vehicles with a lower appraised value through another brand.

When a borrower defaults on a vehicle title loan, the lender may repossess the vehicle. The Bureau believes, based on market outreach, that the decision whether to repossess a vehicle will depend on factors such as the amount due, the age and resale value of the vehicle, the costs to locate and repossess the vehicle, and State law requirements to refund any surplus amount remaining after the sale proceeds have been applied to the remaining loan balance. Available information indicates that lenders are unlikely to repossess vehicles they do not expect to sell. The largest vehicle title lender sold 83 percent of the vehicles it repossessed but did not report overall repossession rates. In 2012, its firm-wide gross charge-offs equaled 30 percent of its average outstanding title loan balances. The Bureau is aware of vehicle title lenders engaging in illegal debt collection activities in order to collect amounts claimed to be due under title loan agreements. These practices include altering caller ID information on outgoing calls to borrowers to make it appear that calls were from other businesses, falsely threatening to refer borrowers for criminal investigation or prosecution, and unlawfully disclosing debt information to borrowers' employers, friends, and family. In addition, approximately 16 percent of consumer complaints handled by the Bureau about vehicle title loans involved consumers reporting concerns about repossession issues.

Some vehicle title lenders have installed electronic devices on the vehicles, known as starter interrupt devices, automated collection technology, or more colloquially as “kill switches,” that can be programmed to transmit audible sounds in the vehicle before or at the payment due date. The devices may also be programmed to prevent the vehicle from starting when the borrower is in default on the loan, although they may allow a one-time re-start upon the borrower's call to obtain a code. One of the starter interrupt providers states that “[a]ssuming proper installation, the device will not shut off the vehicle while driving.” Due to concerns about consumer harm, a State Attorney General issued a consumer alert about the use of starter interrupt devices specific to vehicle title loans. The alert also noted that some title lenders require consumers to provide an extra key to their vehicles. In an attempt to avoid illegal repossessions, Wisconsin's vehicle title law prohibits lenders from requiring borrowers to provide the lender with an extra key to the vehicle. The Bureau has received several complaints about starter interrupt devices.

Business model. As noted above, short-term vehicle title lenders appear to have overhead costs relatively similar to those of storefront payday lenders. Default rates on vehicle title loans and lender reliance on re-borrowing activity appear to be even greater than that of storefront payday lenders.

Based on data analyzed by the Bureau, the default rate on single-payment vehicle title loans is six percent and the sequence-level default rate is 33 percent, compared with a 20 percent sequence-level default rate for storefront payday loans. One-in-five single-payment vehicle title loan borrowers have their vehicle repossessed by the lender. One industry trade association commenter stated that 15 to 25 percent of repossessed vehicles are subsequently redeemed by borrowers after paying off the deficiency balance owed (along with repossession costs).

Similarly, the rate of vehicle title re-borrowing appears high. In the Bureau's data analysis, more than half—56 percent—of single-payment vehicle title loan sequences stretched for at least four loans; over a third—36 percent—were seven or more loans; and 23 percent of loan sequences consisted of 10 or more loans. While other sources on vehicle title lending are more limited than for payday lending, the Tennessee Department of Financial Institutions publishes a biennial report on vehicle title lending. Like the single-payment vehicle title loans the Bureau has analyzed, the vehicle title loans in Tennessee are 30-day single-payment loans. The most recent report shows similar patterns to those the Bureau found in its research, with a substantial number of consumers rolling over their loans multiple times. According to the report, of the total number of loan agreements made in 2014, about 15 percent were paid in full after 30 days without rolling over. Of those loans that are rolled over, about 65 percent were at least in their fourth rollover, about 44 percent were at least in their seventh rollover, and about 29 percent were at least in their tenth, up to a maximum of 22 rollovers.

The impact of these outcomes for consumers who are unable to repay and either default or re-borrow is discussed in Market Concerns—Underwriting.

Short-Term Lending by Depository Institutions

As noted above, within the banking system, consumers with liquidity needs rely primarily on credit cards and overdraft services. Some depository institutions, particularly community banks and credit unions, provide occasional small loans on an accommodation basis to their customers. The Bureau's market monitoring indicates that a number of the banks and credit unions offering these accommodation loans are located in small towns and rural areas and that it is not uncommon for borrowers to be in non-traditional employment or have seasonal or variable income. In addition, some depository institutions have experimented with short-term payday-like products or partnered with payday lenders, but such experiments have had mixed results and in several cases have prompted prudential regulators to take action discouraging certain types of activity. For a period of time, a handful of banks also offered a deposit advance product as discussed below; that product also prompted prudential regulators to issue guidance that effectively discouraged the offering of the product.

National banks, most State-chartered banks, and State credit unions are permitted under existing Federal laws to charge interest on loans at the highest rate allowed by the laws of the State in which the lender is located (lender's home State). The bank or State-chartered credit union may then charge the interest rate of its home State on loans it makes to borrowers in other States without needing to comply with the usury limits of the States in which it makes the loans (borrower's home State). Federal credit unions generally must not charge more than an 18 percent interest rate. However, the National Credit Union Administration (NCUA) has taken some steps to encourage federally chartered credit unions to offer “payday alternative loans,” which generally have a longer term than traditional payday products. Federal credit unions are authorized to make these small-dollar loans at rates up to 28 percent interest plus an application fee. This program is discussed in more detail below.

Agreements between depository institutions and payday lenders. In 2000, the Office of the Comptroller of the Currency (OCC) issued an advisory letter alerting national banks that the OCC had significant safety and soundness, compliance, and consumer protection concerns with banks entering into contractual arrangements with vendors seeking to avoid certain State lending and consumer protection laws. The OCC noted it had learned of nonbank vendors approaching federally chartered banks urging them to enter into agreements to fund payday and title loans. The OCC also expressed concern about unlimited renewals (what the Bureau refers to as rollovers or re-borrowing), and multiple renewals without principal reduction. The agency subsequently took enforcement actions against two national banks for activities relating to payday lending partnerships.

The Federal Deposit Insurance Corporation (FDIC) has also expressed concerns with similar agreements between payday lenders and the depositories under its purview. In 2003, the FDIC issued Guidelines for Payday Lending applicable to State-chartered FDIC-insured banks and savings associations; the guidelines were revised in 2005 and most recently in 2015. The guidelines focus on third-party relationships between the chartered institutions and other parties, and specifically address rollover limitations. They also indicate that banks should ensure borrowers exhibit both a willingness and ability to repay when rolling over a loan. Among other things, the guidelines indicate that institutions should: (1) Ensure that payday loans are not provided to customers who had payday loans outstanding at any lender for a total of three months during the previous 12 months; (2) establish appropriate cooling-off periods between loans; and (3) provide that no more than one payday loan is outstanding with the bank at a time to any one borrower. In 2007, the FDIC issued guidelines encouraging banks to offer affordable small-dollar loan alternatives with APRs of 36 percent or less, reasonable and limited fees, amortizing payments, underwriting focused on a borrower's ability to repay but allowing flexible documentation, and to avoid excessive renewals.

Deposit advance product lending. As the payday lending industry grew, a handful of banks decided to offer their deposit customers a similar product termed a deposit advance product (DAP). While one bank started offering deposit advances in the mid-1990s, the product began to spread more rapidly in the late 2000s and early 2010s. DAP could be structured a number of ways but generally involved a line of credit offered by depository institutions as a feature of an existing consumer deposit account with repayment automatically deducted from the consumer's next qualifying deposit. Deposit advance products were available to consumers who received recurring electronic deposits if they had an account in good standing and, for some banks, several months of account tenure, such as six months. When an advance was requested, funds were deposited into the consumer's account. Advances were automatically repaid when the next qualifying electronic deposit, whether recurring or one-time, was made to the consumer's account rather than on a fixed repayment date. If an outstanding advance was not fully repaid by an incoming electronic deposit within about 35 days, the consumer's account was debited for the amount due and could result in a negative balance on the account.

The Bureau estimates that at the product's peak from mid-2013 to mid-2014, banks originated roughly $6.5 billion of advances, which represents about 22 percent of the volume of storefront payday loans issued in 2013. The Bureau estimates that at least 1.5 million unique borrowers took out one or more DAP loans during that same period.

DAP fees, like payday loan fees, did not vary with the amount of time that the advance was outstanding but rather were set as dollars per amount advanced. A typical fee was $2 per $20 borrowed, the equivalent of $10 per $100. Research undertaken by the Bureau using a supervisory dataset found that the median duration of an episode of DAP usage was 12 days, yielding an effective APR of 304 percent.

The Bureau further found that while the median draw on a DAP was $180, users typically took more than one draw before the advance was repaid. The multiple draws resulted in a median average daily DAP balance of $343, which is similar to the size of a typical payday loan. With the typical DAP fee of $2 per $20 advanced, the fees for $343 in advances equate to about $34.30. The median DAP user was indebted for 112 days over the course of a year and took advances in seven months. Fourteen percent of borrowers took advances totaling over $9,000 over the course of the year; these borrowers had a median number of days in debt of 254.

In 2010, the Office of Thrift Supervision (OTS) issued a supervisory directive ordering one bank to terminate its DAP program, which the bank offered in connection with prepaid accounts, after determining the bank engaged in unfair or deceptive acts or practices and violated the OTS' Advertising Regulation. Consequently, in 2011, pursuant to a cease and desist order, the bank agreed to remunerate its DAP consumers nearly $5 million and pay a civil monetary penalty of $400,000.

In November 2013, the FDIC and OCC issued final supervisory guidance on DAP. This guidance stated that banks offering DAP should adjust their programs in a number of ways, including applying more scrutiny in underwriting DAP loans and discouraging repetitive borrowing. Specifically, the OCC and FDIC stated that banks should ensure that the customer relationship is of sufficient duration to provide the bank with adequate information regarding the customer's recurring deposits and expenses, and that the agencies would consider sufficient duration to be no less than six months. In addition, the guidance said that banks should conduct a more stringent financial capacity assessment of a consumer's ability to repay the DAP advance according to its terms without repeated re-borrowing, while meeting typical recurring and other necessary expenses, as well as outstanding debt obligations. In particular, the guidance stated that banks should analyze a consumer's account for recurring inflows and outflows at the end, at least, of each of the preceding six months before determining the appropriateness of a DAP advance. Additionally, the guidance noted that in order to avoid re-borrowing, a cooling-off period of at least one monthly statement cycle after the repayment of a DAP advance should be completed before another advance could be extended. Finally, the guidance stated that banks should not increase DAP limits automatically and without a fully underwritten reassessment of a consumer's ability to repay, and banks should reevaluate a consumer's eligibility and capacity for DAP at least every six months.

Following the issuance of the FDIC and OCC guidance, banks supervised by the FDIC and OCC ceased offering DAP. Of two DAP-issuing banks supervised by the Federal Reserve Board and therefore not subject to either the FDIC or OCC guidance, one eliminated its DAP program while another continues to offer a modified version of DAP to its existing DAP borrowers. Today, with the exception of some short-term lending within the NCUA's Payday Alternative Loan (PAL) program, described in detail below, relatively few banks or credit unions offer large-scale formal loan programs of this type.

Federal credit union payday alternative loans. As noted above, Federal credit unions may not charge more than 18 percent interest. However, in 2010, the NCUA adopted an exception to the interest rate limit under the Federal Credit Union Act that permitted Federal credit unions to make PALs at an interest rate of up to 28 percent plus an application fee, “that reflects the actual costs associated with processing the application” up to $20. PALs may be made in amounts of $200 to $1,000 to borrowers who have been members of the credit union for at least one month. PAL terms range from one to six months, PALs may not be rolled over, and borrowers are limited to one PAL at a time and no more than three PALs from the same credit union in a rolling six-month period. PALs must fully amortize and the credit union must establish underwriting guidelines such as verifying borrowers' employment from at least two recent pay stubs.

In 2016, about 650 Federal credit unions (nearly 20 percent of all Federal credit unions) offered PALs, with originations at $134.7 million, representing a 9.7 percent increase from 2015. In 2015, the average PAL amount was about $700 and carried a median interest rate of 25 percent; in 2016, the average PAL loan amount increased to about $720 with a similar median interest rate of 25 percent.

C. Longer-Term, High-Cost Loans

In addition to short-term loans, certain longer-term, high-cost loans will be covered by the payments protections provisions of this rule. These are longer-term, high-cost loans with a leveraged payment mechanism, as described in more detail in part II.D and Markets Concerns—Payments. The category of longer-term high-cost loans most directly impacted by the payments protections in this rule are payday installment loans.

Payday Installment Loans

Product definition and regulatory environment. The term “payday installment loan” refers to a high-cost loan repaid in multiple installments, with each installment typically due at the consumer's payday and with the lender generally having the ability to collect the payment from the consumer's bank account as money is deposited or directly from the consumer's paycheck.

Two States, Colorado and Illinois, have authorized payday installment loans. Through 2010 amendments to its payday loan law, Colorado no longer permits short-term single-payment payday loans. Instead, in order to charge fees in excess of the 36 percent APR cap for most other consumer loans, the minimum loan term must be six months and lenders are permitted to take a series of post-dated checks or payment authorizations to cover each payment under the loan, providing lenders with the same access to borrower's accounts as a single-payment payday loan. In Illinois, lenders have been permitted to make payday installment loans since 2011. These loans must be fully-amortizing for terms of 112 to 180 days and the loan amounts are limited to the lesser of $1,000 or 22.5 percent of gross monthly income.

A number of other States have adopted usury laws that some payday lenders use to offer payday installment loans in lieu of, or in addition to, more traditional payday loans. Since July 2016, Mississippi lenders can make “credit availability loans”—closed-end fully-amortizing installment loans with loan terms of four to 12 months, whether secured by personal property or unsecured. The maximum loan amount on a credit availability loan is limited to $2,500, and lenders may charge a monthly handling fee of up to 25 percent of the outstanding principal balance plus an origination fee of the greater of 1 percent of the amount disbursed or $5.

As of 2015, Tennessee lenders may offer “flex loans”—open-end lines of credit that need not have a fixed maturity date and that may be secured by personal property or unsecured. The maximum outstanding balance on a flex loan may not exceed $4,000, with an interest rate of up to 24 percent per annum and “customary fees” for underwriting and other purposes not to exceed a daily rate of 0.7 percent of the average daily principal balance. At least one lender offering flex loans states that loan payments are “aligned with your payday.” Similar legislation has been unsuccessful in other States. For example, in May 2017 the Governor of Oklahoma vetoed legislation that would have authorized high-cost installment loans with interest rates of up to 17 percent per month, or 204 percent APR.

None of these laws authorizing payday installment loans, credit access loans, or flex loans appear to limit the use of electronic repayment or ACH options for repayment.

In addition to States that authorize a specific form of payday installment loan, credit access loan, or flex loan, several other States provide room within their usury laws for high-cost installment products. A recent report found that seven States have no rate or fee limits for closed-end loans of $500 and that 10 States have no rate or fee limits for closed-end loans of $2,000. The same report noted that for open-end credit, 13 States do not limit rates for a $500 advance and 15 States do not limit them for a $2,000 advance. Another recent study of the Web sites of five payday lenders that operate both online and at storefront locations found that these five lenders offered payday installment loans in at least 17 States.

In addition, as discussed above, a substantial segment of the online payday industry operates outside of the constraints of State law, and this segment, too, has migrated towards payday installment loans. For example, a study commissioned by a trade association for online lenders surveyed seven lenders and concluded that, while single-payment loans are still a significant portion of these lenders' volume, they are on the decline while installment loans are growing. Several of the lenders represented in the report had either eliminated single-payment products or were migrating to installment products while still offering single-payment loans. For the practical reasons associated with having no retail locations, online lenders prefer repayment by electronic methods and use various approaches to secure consumers' authorization for payments electronically through ACH debits.

As with payday loans, and as noted above, as authorized or permitted by some State laws, payday installment lenders often hold borrowers' checks or obtain their authorization for ACH repayment. Some borrowers may prefer ACH repayment methods for convenience. The Bureau is aware of certain practices used by payday installment lenders to secure repayment through consumers' accounts including longer waits for distribution of loan proceeds and higher fees for non-electronic payment methods, described above in the Online Payday Loans section, and discussed in more detail in part II.D and Markets Concerns—Payments. To the extent that longer-term payday installment loans meet the cost of credit threshold and include leveraged payment mechanisms, they are subject to this rule's payments protections.

Finance Company Installment Loans

Product definition and regulatory environment. Before the advent of single-payment payday loans or online lending, and before widespread availability of credit cards, “personal loans” or “personal installment loans” were offered by storefront nonbank installment lenders, often referred to as “finance companies.” Personal loans are typically unsecured loans used for any variety of purposes and distinguished from loans where the lender generally requires the funds be used for a specific intended purpose, such as automobile purchase loans, student loans, and mortgage loans. As discussed below, these finance companies (and their newer online counterparts) have a different business model than payday installment lenders. Some of these finance companies limit the APRs on their loans to 36 percent or less, whether required by State law or as a matter of company policy. However, there are other finance companies and installment lenders that offer loans that fall within the rule's definition of “covered longer-term loan,” as they carry a cost of credit that exceeds 36 percent APR and include repayment through a leveraged payment mechanism—access to the borrower's account.

According to a report from a consulting firm using data derived from a nationwide consumer reporting agency, in 2016 finance companies originated 8.6 million personal loans (unsecured installment loans) totaling $41.7 billion in originations; approximately 6.9 million of these loans worth $25.8 billion, with an average loan size of about $3,727, were made to nonprime consumers (categorized as near prime, subprime, and deep subprime, with VantageScores of 660 and below).

APRs at storefront locations in States that do not cap rates on installment loans can be 50 to 90 percent for subprime and deep subprime borrowers; APRs in States with rate caps are 24 to 36 percent APR for near prime and subprime borrowers. A survey of finance companies conducted in conjunction with a national trade association reported that 80 percent of loans were for $2,000 or less and 85 percent of loans had durations of 24 months or less (60 percent of loans had durations of one year or less). The survey did not report an average loan amount. Almost half of the loans had APRs between 49 and 99 percent; 9 percent of loans of $501 or less had APRs between 100 and 199 percent, but there was substantial rate variation among States. Except for loans subject to the Military Loan Act described above, APR calculations under Regulation Z include origination fees, but lenders generally are not required to include within the APR costs such as application fees and add-on services such as optional credit insurance and guaranteed automobile protection. A wider range and number of such up-front fees and add-on products and services appear to be charged by the storefront lenders than by their newer online counterparts.

Finance companies typically engage in underwriting that includes a monthly net income and expense budget, a review of the consumer's credit report, and an assessment of monthly cash flow. One trade association representing traditional finance companies has described the underwriting process as evaluating the borrower's “stability, ability, and willingness” to repay the loan. Many finance companies report loan payment history to one or more of the nationwide consumer reporting agencies, and the Bureau believes from market outreach that these lenders generally furnish payment information on a monthly basis.

With regard to newer online counterparts, the Bureau is aware from its market monitoring activities that some online installment lenders in this market offer products that resemble the types of loans made by finance companies. Many of these online installment lenders engage in highly-automated underwriting that involves substantial use of analytics and technology. The APRs on the loans are over 36 percent and can reach the triple digits.

Finance companies and online installment lenders offer various methods for consumers to repay their loans. Particularly for online loans, repayment through ACH is common. Some online installment lenders also allow other repayment methods, such as check, debit or credit card, MoneyGram, or Western Union, but may require advance notice for some of these payment methods. From its market monitoring functions, the Bureau is aware that finance companies with storefront locations tend to offer a wider array of repayment options. Some finance companies will accept ACH payments in person, set up either during the loan closing process or at a later date, or by phone. Finance companies also traditionally take payments in-store, generally by cash or check, or by mail. Some finance companies charge consumers a fee to use certain payment methods.

D. Initiating Payment From Consumers' Accounts

As discussed above, payday and payday installment lenders nearly universally obtain at origination one or more authorizations to initiate withdrawal of payment from the consumer's account. There are a variety of payment options or channels that they use to accomplish this goal, and lenders frequently obtain authorizations for multiple types. Different payment channels are subject to different laws and, in some cases, private network rules, leaving lenders with broad control over the parameters of how a particular payment will be pulled from a consumer's account, including the date, amount, and payment method.

Obtaining Payment Authorization

A variety of payment methods enable lenders to use a previously-obtained authorization to initiate a withdrawal from a consumer's account without further action from the consumer. These methods include paper signature checks, remotely created checks (RCCs) and remotely created payment orders (RCPOs), and electronic payments like ACH and debit and prepaid card transactions. Payday and payday installment lenders—both online and in storefronts—typically obtain a post-dated check or electronic payment authorization from consumers for repayments of loans. For storefront payday loans, lenders typically obtain a post-dated check (or, where payday installment products are authorized, a series of postdated checks) that they can use to initiate a check or ACH transaction from a consumer's account. For an online loan, a consumer often provides bank account information to receive the loan funds, and the lender often uses that bank account information to obtain payment from the consumer. This account information can be used to initiate an ACH payment from a consumer's account. Typically, online lenders require consumers to authorize payments from their account as part of their agreement to receive the loan proceeds electronically. Some traditional installment lenders also obtain an electronic payment authorization from their customers.

Payday and payday installment lenders often take authorization for multiple payment methods, such as taking a post-dated check along with the consumer's debit card information. Consumers usually provide the payment authorization as part of the loan origination process.

For storefront payday loans, providing a post-dated check is typically a requirement to obtain a loan. Under the Electronic Fund Transfer Act (EFTA) lenders cannot condition credit on obtaining an authorization from the consumer for “preauthorized” (recurring) electronic fund transfers, but in practice online payday and payday installment lenders are able to obtain such authorizations from consumers for almost all loans. The EFTA provision concerning compulsory use does not apply to paper checks and one-time electronic fund transfers. Moreover, even for loans subject to the EFTA compulsory use provision, lenders use various methods to obtain electronic authorizations. For example, although some payday and payday installment lenders provide consumers with alternative methods to repay loans, these options may be burdensome and may significantly change the terms of the loan. For example, one lender increases its APR by an additional 61 percent or 260 percent, depending on the length of the loan, if a consumer elects a cash-only payment option for its installment loan product, resulting in a total APR of 462 percent (210 day loan) to 780 percent (140 day loan). Other lenders change the origination process if consumers do not immediately provide account access. For example, some online payday lenders require prospective customers to contact them by phone if they do not want to provide a payment authorization and wish to pay by money order or check at a later time. Other lenders delay the disbursement of the loan proceeds if the consumer does not immediately provide a payment authorization.

Banks and credit unions have additional payment channel options when they lend to consumers who have a deposit account at the same institution. As a condition of certain types of loans, many financial institutions require consumers to have a deposit account at that same institution. The loan contract often authorizes the financial institution to pull payment directly from the consumer's account. Since these payments can be processed through an internal transfer within the bank or credit union, these institutions do not typically use external payment channels to complete an internal payment transfer.

Exercising Payment Authorizations

For different types of loans that will be covered under the rule, lenders use their authorizations to collect payment differently. As discussed above, most storefront lenders encourage or require consumers to return to their stores to pay in cash, roll over, or otherwise renew their loans. The lender often will deposit a post-dated check or initiate an electronic fund transfer only where the lender considers the consumer to be in “default” under the contract or where the consumer has not responded to the lender's communications. Bureau examiners have cited one or more payday lenders for threatening to initiate payments from consumer accounts that were contrary to the agreement, and that the lenders did not intend to initiate.

In contrast, online lenders typically use the authorization to collect all payments, not just those initiated after there has been some indication of distress from the consumer. Moreover, as discussed above, online lenders offering “hybrid” payday loan products structure them so that the lender is authorized to collect a series of interest-only payments—the functional equivalent of paying finance charges to roll over the loan—before full payment or amortizing payments are due. The Bureau also is aware that some online lenders, although structuring their product as nominally a two-week loan, automatically roll over the loan every two weeks unless the consumer takes affirmative action to make full payment. The payments processed in such cases are for the cost of the rollover rather than the full balance due.

As a result of these distinctions, storefront and online lenders have different success rates in exercising such payment authorizations. Some large storefront lenders report that they initiate payment attempts in less than 10 percent of cases, and that 60 to 80 percent of those attempts are returned for non-sufficient funds. Bureau analysis of ACH payments by online payday and payday installment lenders, which typically collect all payments by initiating a transfer from consumers' accounts, indicates that for any given payment only about 6 percent fail on the first try. However, over an eighteen-month observation period, 50% of online borrowers were found to experience at least one payment attempt that failed or caused an overdraft and one-third of the borrowers experienced more than one such incident.

Lenders typically charge fees for these returned payments, sometimes charging both a returned payment fee and a late fee. These fees are in addition to fees, such as NSF fees, that may be charged by the financial institution that holds the consumer's account.

The Bureau found that if an electronic payment attempt failed, online lenders try again three-quarters of the time. However, after an initial failure the lender's likelihood of failure jumps to 70 percent for the second attempt and 73 percent for the third. Of those that succeed, roughly one-third result in an overdraft.

Both storefront and online lenders also frequently change the ways in which they attempt to exercise authorizations after one attempt has failed. For example, many typically make additional attempts to collect initial payment due. Some lenders attempt to collect the entire payment amount once or twice within a few weeks of the initial failure. The Bureau, however, is aware of online and storefront lenders that use more aggressive and unpredictable payment collection practices, including breaking payments into multiple smaller payments and attempting to collect payment multiple times in one day or over a short period of time. The cost to lenders to repeatedly attempt payment depends on their contracts with payment processors and commercial banks, but is generally nominal; the Bureau estimates the cost is in a range of 5 to 15 cents for an ACH transaction. These practices are discussed in more detail in Market Concerns—Payments.

As noted above, banks and credit unions that lend to their account holders can use their internal system to transfer funds from the consumer accounts and do not need to utilize the payment networks. Deposit advance products and their payment structures are discussed further in part II.B. The Bureau believes that many small-dollar loans with depository institutions are paid through internal transfers.

Due to the fact that lenders obtain authorizations to use multiple payment channels and benefit from flexibility in the underlying payment systems, lenders generally enjoy broad discretion over the parameters of how a particular payment will be pulled from a consumer's account, including the date, amount, and payment method. For example, although a check specifies a date, lenders may not present the check on that date. Under UCC section 4-401, merchants can present checks for payment even if the check specifies a later date. Lenders sometimes attempt to collect payment on a different date from the one stated on a check or original authorization. They may shift the attempt date in order to maximize the likelihood that funds will be in the account; some use their own models to determine when to collect, while others use predictive payment products provided by third parties that estimate when funds are most likely to be in the account.

Moreover, the checks provided by consumers during origination often are not processed as checks. Rather than sending these payments through the check clearing network, lenders often process these payments through the ACH network. They are able to use the consumer account number and routing number on a check to initiate an ACH transaction. When lenders use the ACH network in a first attempt to collect payment, the lender has used the check as a source document and the payment is considered an electronic fund transfer under EFTA and Regulation E, which generally provide additional consumer protections—such as error resolution rights—beyond those applicable to checks. However, if a transaction is initially processed through the check system and then processed through the ACH network because the first attempt failed for insufficient funds, the subsequent ACH attempt is not considered an electronic fund transfer under current Regulation E. Similarly, consumers may provide their account and routing number to lenders for the purposes of an ACH payment, but the lender may use that information to initiate a remotely created check that is processed through the check system and thus may not receive Regulation E protections.

Payment System Regulation and Private Network Requirements

Different payment mechanisms are subject to different laws and, in some cases, private network rules that affect how lenders can exercise their rights to initiate withdrawals from consumers' accounts and how consumers may attempt to limit or stop certain withdrawal activity after granting an initial authorization. Because ACH payments and post-dated checks are the most common authorization mechanisms used by payday and payday installment lenders, this section briefly outlines applicable Federal laws and National Automated Clearinghouse Association (NACHA) rules concerning stop-payment rights, prohibitions on unauthorized payments, notices where payment amounts vary, and rules governing failed withdrawal attempts.

NACHA recently adopted several changes to the ACH network rules in response to complaints about problematic behavior by payday and payday installment lenders, including a rule that allows it to more closely scrutinize originators who have a high rate of returned payments. Issues around monitoring and enforcing those rules and their application to problems in the market for covered loans are discussed in more detail in Market Concerns—Payments. But it should be noted here at the outset that the NACHA rules only apply to payment attempts through ACH and are not enforceable by the Bureau.

Stop-payment rights. For preauthorized (recurring) electronic fund transfers, EFTA grants consumers a right to stop paym ent by issuing a stop-payment order through their depository institution. The NACHA private rules adopt this EFTA provision along with additional stop-payment rights. In contrast to EFTA, NACHA provides consumers with a stop-payment right for both one-time and preauthorized transfers. Specifically, for recurring transfers, NACHA Rules require financial institutions to honor a stop-payment order as long as the consumer notifies the bank at least 3 banking days before the scheduled debit. For one-time transfers, NACHA Rules require financial institutions to honor the stop-payment order as long as the notification provides them with a “reasonable opportunity to act upon the order.” Consumers may notify the bank or credit union verbally or in writing, but if the consumer does not provide written confirmation the oral stop-payment order may not be binding beyond 14 days. If a consumer wishes to stop all future payments from an originator, NACHA Rules allow a bank or credit union to require the consumer to confirm in writing that she has revoked authorization from the originator.

Checks are also subject to a stop-payment right under the Uniform Commercial Code (UCC). Consumers have a right to stop payment on any check by providing the bank with oral (valid for 14 days) or written (valid for 6 months) notice. To be effective, the stop-payment notice must describe the check “with reasonable certainty” and give the bank enough information to find the check under the technology then existing. The stop-payment notice also must be given at a time that affords the bank a reasonable opportunity to act on it before the bank becomes liable for the check under U.C.C. 4-303.

Although EFTA, the UCC, and NACHA Rules provide consumers with stop-payment rights, financial institutions typically charge a fee of approximately $32 for consumers to exercise those rights. Further, both lenders and financial institutions often impose a variety of requirements that make the process for stopping payments confusing and burdensome for consumers. See the discussion of these requirements in Market Concerns—Payments.

Protection from unauthorized payments. Regulation E and NACHA Rules both provide protections with respect to payments by a consumer's financial institution if the electronic transfer is unauthorized. Payments originally authorized by the consumer can become unauthorized under EFTA if the consumer notifies his or her financial institution that the originator's authorization has been revoked. NACHA has a specific threshold for unauthorized returns, which involve transactions that originally collected funds from a consumer's account but that the consumer is disputing as unauthorized. Under NACHA Rules, originators are required to operate with an unauthorized return rate below 0.5 percent or they risk fines and loss of access to the ACH network.

Notice of variable amounts. Regulation E and the NACHA Rules both provide that if the debit amount for a preauthorized transfer changes from the previous transfer or from the preauthorized amount, consumers must receive a notice 10 calendar days prior to the debit. However, both of these rules have an exception from this requirement if consumers have agreed to a range of debit amounts and the payment does not fall outside that range.

Based on outreach and market research, the Bureau does not believe that most payday and payday installment lenders making loans that will be covered under the rule are providing a notice of transfers varying in amount. However, the Bureau is aware that many of these lenders take authorizations for a range of amounts. As a result, lenders use these broad authorizations rather than fall under the Regulation E requirement to send a notice of transfers varying in amount even when collecting for an irregular amount (for example, by adding fees or a past due amount to a regularly scheduled payment). Some of these contracts provide that the consumer is authorizing the lender to initiate payment for any amount up to the full amount due on the loan.

Reinitiation Cap. After a payment attempt has failed, NACHA Rules allow an originator—in this case, the lender that is trying to collect payment—to attempt to collect that same payment no more than two additional times through the ACH network. NACHA Rules also require the ACH files for the two additional attempts to be labeled as “reinitiated” transactions. Because the rule applies on a per-payment basis, for lenders with recurring payment authorizations, the count resets to zero when the next scheduled payment comes due.

III. Summary of the Rulemaking Process

As described in more detail below, the Bureau has conducted broad outreach with a multitude of stakeholders on a consistent basis over more than five years to learn more about the market for small-dollar loans of various kinds. This outreach has comprised many public events, including field hearings, and hundreds of meetings with both consumer and industry stakeholders on the issues raised by small-dollar lending. In addition to meeting with lenders and other market participants, trade associations, consumer groups, community groups, and others, the Bureau has engaged with individual faith leaders and coalitions of faith leaders from around the country to gain their perspective on how these loans affect their communities and the people they serve. And the Bureau has met frequently with Federal, State, and Tribal officials to consult and share information about these kinds of loans and their consequences for consumers.

The Bureau's understanding of these loans, and how they affect consumers, has also been furthered by its ongoing supervisory activity, which involves exercising its legally mandated authority to conduct formal examinations of companies who make such loans and of debt collectors who collect on such loans. These examinations have canvassed the operations, marketing, underwriting, collections, and compliance management systems at such lenders and continue to do so on an ongoing basis. In addition, the Bureau has investigated and taken enforcement actions against a number of small-dollar lenders, which has provided further insight into various aspects of their operations and the practical effects of their business models on consumers.

The Bureau has also undertaken extensive research and analysis over several years to develop the factual foundation for issuance of this final rule. That research and analysis has included multiple white papers and data points on millions of such loans, as well as careful review of studies and reports prepared by others and the relevant academic literature. The Bureau has analyzed its own data on consumer complaints about the issues raised by small-dollar loans and the collections efforts made by lenders and debt collectors on such loans. And the Bureau has consistently engaged in market monitoring activities to gain insights into developing trends in the market for small-dollar loans.

All of the input and feedback the Bureau has received from its outreach over the years, its extensive experience of examining and investigating small-dollar lenders, and its research and analysis of the marketplace, have assisted the Bureau in developing and issuing this final rule. The material presented in this section summarizes the Bureau's work relating to the rule in three categories:

• The Bureau's background and processes in developing the rule;
• the key elements of the notice of proposed rulemaking; and
• the receipt and consideration of feedback prior to finalizing the rule.

A. Bureau Outreach to Stakeholders

Birmingham Field Hearing. The Bureau's formal outreach efforts on this subject began in January 2012, when it held its first public field hearing in Birmingham, Alabama, focused on small-dollar lending. At the field hearing, the Bureau heard testimony and received input from consumers, civil rights groups, consumer advocates, religious leaders, industry and trade association representatives, academics, and elected representatives and other governmental officials about consumers' experiences with small-dollar loan products. At the same time, the Bureau announced the launch of its program to conduct supervisory examinations of payday lenders pursuant to the Bureau's authority under section 1024 of the Dodd-Frank Act. As part of this initiative, the Bureau put in place a process to obtain loan-level records from a number of large payday lenders to assist in analyzing the nature and effects of such loans.

The Bureau transcribed the field hearing and posted the transcript on its Web site. Concurrently, the Bureau placed a notice in the Federal Register inviting public comment on the issues discussed in the field hearing. The Bureau received 664 public comments in response to that request, which were reviewed and analyzed.

Nashville Field Hearing. In March 2014, the Bureau held a field hearing in Nashville, Tennessee to gather further input from a broad range of stakeholders. The Bureau heard testimony from consumer groups, industry representatives, academics, and members of the public, including consumers of payday loans. The field hearing was held in conjunction with issuing the second of two research reports on findings by Bureau staff using the supervisory data that it had collected from a number of large payday lenders. In the Director's opening remarks, he noted three concerns associated with covered loans that had been identified in recent Bureau research: That a significant population of consumers were ending up in extended loan sequences; that some lenders use the electronic payments system in ways that pose risks to consumers; and that a troubling number of companies engage in collection activities that may be unfair or deceptive in one or more ways. While the Bureau was working on these reports and in the period following their release, the Bureau held numerous meetings with stakeholders on small-dollar lending in general and to hear their views on potential policy approaches.

Richmond Field Hearing. In March 2015, the Bureau held another field hearing in Richmond, Virginia to gather further input from a broad range of stakeholders. The focus of this field hearing was the announcement the Bureau simultaneously made of the rulemaking proposals it had under consideration that would require lenders to take steps to make sure consumers can repay their loans and would restrict certain methods of collecting payments from consumers' bank accounts in ways that lead to substantial penalty fees. The Bureau heard testimony from consumer groups, industry representatives, faith leaders, and members of the public, including consumers of payday loans. In addition to the field hearing, the Bureau held separate roundtable discussions with consumer advocates and with industry members and trade associations to hear feedback on the rulemaking proposals under consideration.

A summary of the rulemaking proposals under consideration was released at the time of the Richmond field hearing. This marked the first stage in the process the Bureau is required to follow under the Small Business Regulatory Enforcement and Fairness Act (SBREFA), which is discussed in more detail below. The summary was formally known as the Small Business Review Panel Outline. In addition to the discussions that occurred at the time of the Richmond field hearing, the Bureau has met on a number of other occasions with industry members and trade associations, including those representing storefront payday lenders, to discuss their feedback on the issues presented in the Outline.

Omaha Meeting and Other Events. At the Bureau's Consumer Advisory Board (CAB) meeting in June 2015 in Omaha, Nebraska, a number of meetings and field events were held about payday, vehicle title, and similar loans. The CAB advises and consults with the Bureau in the exercise of its functions under the Federal consumer financial laws, and provides information on emerging practices in the consumer financial products and services industry, including regional trends, concerns, and other relevant information. The CAB members over several years have included, among others, a payday lending executive and consumer advocates on payday lending. The Omaha events included a visit to a payday loan store to learn more about its operations first-hand and a day-long public session that focused on the Bureau's proposals in the Small Business Review Panel Outline and trends in payday and vehicle title lending. The CAB also held six subcommittee discussions on the Outline in the spring and summer of 2015, and three more subcommittee discussions on the proposed rule in the summer of 2016.

Kansas City Field Hearing. In June 2016, the Bureau held a field hearing in Kansas City, Missouri to gather further input on the issues surrounding potential new Federal regulations of small-dollar lending. The focus of this field hearing was the announcement that the Bureau simultaneously made of the release of its notice of proposed rulemaking on payday, vehicle title, and certain high-cost installment loans. The proposed rule would require lenders to take steps to make a reasonable determination that consumers can afford to repay their loans and would restrict certain methods of collecting payments from consumers' bank accounts in ways that can lead to substantial penalty fees. The Bureau heard testimony on the proposed rule from consumer groups, industry representatives, and members of the public, including consumers of payday loans.

The release of the notice of proposed rulemaking commenced the formal notice-and-comment process under the Administrative Procedure Act. In the notice of proposed rulemaking, the Bureau stated that comments on the proposed rule would have to be received on or before October 7, 2016 to be considered by the Bureau. The notice of proposed rulemaking further specified the details of the methods by which comments would be received, which included email, electronic, mail, and hand delivery/courier. The Bureau also noted that all comments submitted would become part of the public record and would be subject to public disclosure.

Little Rock Meeting and Other Events. In June 2016, just a week after the field hearing in Kansas City announcing the public release of the proposed rule, the CAB held another public meeting on this topic in Little Rock, Arkansas. Among other things, Bureau officials gave a public briefing on the proposed rule to the CAB members, and the Bureau heard testimony from the general public on the subject.

Two of the Bureau's other advisory bodies have also provided input and feedback on the Bureau's work to develop appropriate provisions to regulate small-dollar loans. The Community Bank Advisory Council (CBAC) held two subcommittee discussions of the proposals contained in the Small Business Review Panel Outline in March 2015 and November 2015, a Council discussion on the proposed rule in July 2016, and two more subcommittee discussions of the proposed rule in the summer of 2016. In addition, the Bureau's Credit Union Advisory Council (CUAC) held two subcommittee discussions of the proposals in April 2015 and October 2015, discussed the Outline in its full meeting in March 2016, and held two subcommittee discussions of the proposed rule during the summer of 2016.

Faith Leaders. The Bureau has taken part in a large number of meetings with faith leaders, and coalitions of faith leaders, of all denominations to hear their perspective on how small-dollar loans affect their communities and the people they serve. In April 2016, the White House convened a meeting of national faith leaders for this purpose, which included the Bureau's director. The Bureau has also engaged in outreach to local and national leaders from churches, synagogues, mosques, and temples—both in Washington, DC and in many locations around the country. In these sessions, the Bureau has heard from faith leaders about the challenges some of them have faced in seeking to develop alternatives to payday loans that would mitigate what they perceive to be the harms caused to consumers.

General Outreach. Various Bureau leaders, including its director, and Bureau staff have participated in and spoken at dozens of events and conferences throughout the country, which have provided further opportunities to gather insight and recommendations from both industry and consumer groups about how to approach the issue of whether and how to regulate small-dollar loans. In addition to gathering information from meetings with lenders and trade associations and through regular supervisory and enforcement activities, Bureau staff made fact-finding visits to at least 12 non-depository payday and vehicle title lenders.

Inter-Agency Consultation. As discussed in connection with section 1022 of the Dodd-Frank Act below, the Bureau has consulted with other Federal consumer protection and prudential regulators about these issues and the approaches that the other regulators have taken to small-dollar lending over the years. The Bureau has provided other regulators with information about the proposals under consideration, sought their input, and received feedback that has assisted the Bureau in preparing this final rule. In addition, the Bureau was involved, along with its fellow Federal regulatory agencies, in meetings and other efforts to assist the U.S. Department of Defense as it developed and adopted regulations to implement updates to the Military Lending Act. That statute governs small-dollar loans in addition to various other loan products, and the Bureau developed insights from this work that have been germane to this rulemaking, especially in how to address the potential for lenders to find ways to evade or circumvent its provisions.

Consultation with State and Local Officials. The Bureau's outreach also has included a large number of meetings and calls with State Attorneys General, State financial regulators, and municipal governments, along with the organizations representing the officials charged with enforcing applicable Federal, State, and local laws on small-dollar loans. These discussions have occurred with officials from States that effectively disallow such loans by imposing strict usury caps, as well as with officials from States that allow such loans and regulate them through various frameworks with different substantive approaches. The issues discussed have involved both storefront and online loans. In particular, as the Bureau has worked to develop the proposed registered information system requirements, it has consulted with State agencies from those States that require lenders to provide information about certain small-dollar loans to statewide databases. A group of State Attorneys General submitted a comment claiming that the extent to which the Bureau consulted State and local officials was insufficient. Some other State officials submitted similar comments. Although it is true that the Bureau did not meet with every attorney general or interested official from every State to discuss issues involving the regulation of small-dollar loans, it did meet with many of them, some on multiple occasions. In addition, the Bureau did receive public comments from groups of State Attorneys General and other officials, including both regulators and legislators, and has carefully considered the issues they discussed, which presented many conflicting points of view.

Several State Attorneys General requested that the Bureau commit to consulting with State officials before enforcing this regulation. The Bureau will coordinate and consult with State regulators and enforcement officials in the same manner that it does in other enforcement and supervisory matters.

Tribal Consultations. The Bureau has engaged in consultation with Indian tribes about this rulemaking. The Bureau's Policy for Consultation with Tribal Governments provides that the Bureau “is committed to regular and meaningful consultation and collaboration with tribal officials, leading to meaningful dialogue with Indian tribes on Bureau policies that would be expressly directed to tribal governments or tribal members or that would have direct implications for Indian tribes.” To date, the Bureau has held three formal consultation sessions related to this rulemaking. The first was held on October 27, 2014, at the National Congress of American Indians 71st Annual Convention and Marketplace in Atlanta, Georgia and before the release of the Bureau's small-dollar lending SBREFA materials. The timing of the consultation gave Tribal leaders an opportunity to speak directly with the small-dollar lending team about Tribal lender and/or consumer experiences prior to the drafting of proposals that would become the Small Business Review Panel Outline. A second consultation was held on June 15, 2015, at the Bureau's headquarters. At that consultation, Tribal leaders responded to the proposals under consideration set forth in the Outline that had recently been released. A third consultation was held on August 17, 2016, at the Sandra Day O'Connor College of Law in Phoenix, Arizona, after the release of the proposed rule. All Federally recognized Indian tribes were invited to attend these consultations, which generated frank and valuable input from Tribal leaders to Bureau senior leadership and staff about the effects such a rulemaking could have on Tribal nations and lenders. In addition, the Bureau has met individually with Tribal leaders, Tribal lenders, and Tribal lending associations in an effort to further inform its small-dollar lending work. A Tribal trade association dealing with financial services issues informed the Bureau that it believed these consultations were inadequate.

B. Supervisory and Enforcement Activity

In addition to these many channels of outreach, the Bureau has developed a broader understanding of small-dollar lending through its supervisory and enforcement work. This work is part of the foundation of the Bureau's expertise and experience with this market, which is informed by frequent contact with certain small-dollar lenders and the opportunity to scrutinize their operations and practices up close through supervisory examinations and enforcement investigations. Some illustrative details of this work are related below.

The Bureau's Supervisory Work. The Bureau has been performing supervisory examinations of small-dollar lenders for more than five years. During this time, the Bureau has written and published its guidelines on performing such examinations, which its exam teams have applied and refined further over time. All of this work has provided the Bureau with a quite comprehensive vantage point on the operations of payday and other small-dollar lenders and the nature and effects of their loan products for consumers.

In its regular published reports known as Supervisory Highlights, the Bureau has summarized, while maintaining confidentiality of supervised entities, the types of issues and concerns that arise in its examinations of non-bank financial companies in general, and of small-dollar lenders in particular. In its Summer 2013 edition, for example, the Bureau emphasized its general finding that “nonbanks are more likely to lack a robust [Compliance Management System] as their consumer compliance-related activities have not been subject to examinations at the federal level for compliance with the Federal consumer financial laws prior to the Bureau's existence.” The Bureau noted that it had identified “one or more instances of nonbanks that lack formal policies and procedures, have not developed a consumer compliance program, or do not conduct independent consumer compliance audits. Lack of an effective CMS has, in a number of instances, resulted in violations of Federal consumer financial laws.”

In the Spring 2014 edition, the Bureau addressed its supervisory approach to short-term, small-dollar lending in more detail. At that time, the Bureau noted that its exercise of supervisory authority marked the first time any of these lenders had been subject to Federal compliance examinations. The Bureau described a number of shortcomings it had found and addressed with the compliance management systems implemented by small-dollar lenders, including lack of oversight, inadequate complaint management, lack of written policies and procedures, failure to train staff adequately, lack of effective compliance audit programs, and more generally a pervasive lack of accountability within the compliance program. It also catalogued many different violations and abuses in the collection methods these lenders used with their customers. Finally, the report noted that Bureau examinations found deceptive practices in the use of preauthorized ACH withdrawals from borrower checking accounts.

The Summer 2016 edition included a discussion of debt collection issues, which are relevant to many payday lenders, and also included a section explicitly dedicated to small-dollar lending and issues associated with compliance with the Electronic Fund Transfer Act. The Bureau's examiners found that the “loan agreements of one or more entities failed to set out an acceptable range of amounts to be debited, in lieu of providing individual notice of transfers of varying amounts. These ranges could not be anticipated by the consumer because they contained ambiguous or undefined terms in their descriptions of the upper and lower limits of the range.” And the Spring 2017 edition expressed concerns about production incentives relevant to many providers of financial services, noting that “many supervised entities choose to implement incentive programs to achieve business objectives. These production incentives can lead to significant consumer harm if not properly managed.”

In the most recent Summer 2017 edition, the Bureau again described problems that it had addressed with short-term, small-dollar lending, including payday and vehicle title loans. Among them were a variety of collections issues, along with misrepresentations that several lenders had made in the marketing of such loans. Examiners reported that lenders had promised consumers that they could obtain such a loan without a credit check, yet this turned out to be untrue and, in some instances, to lead to loan denials based on the information obtained from the consumers' credit reports. They also found that certain lenders advertised products and services in their outdoor signage that they did not, in fact, offer. And some lenders advertised their products by making unsubstantiated claims about how they compared with those of competing lenders. These practices were found to be deceptive and changes were ordered to be made.

The Bureau further found that some lenders misrepresented their processes to apply for a loan online, and others misused references provided by loan applicants on applications for origination purposes by marketing products to the persons listed. Finally, examiners observed that one or more lenders mishandled the payment process by debiting accounts automatically for payments that had already been made, leading to unauthorized charges and overpayments. The entities also failed to implement adequate processes to accurately and promptly identify and refund borrowers who paid more than they owed, who were unable to avoid the injury.

The Bureau's Enforcement Work. The Bureau also has developed expertise and experience in this market over time by pursuing public enforcement actions against more than 20 small-dollar lenders, including brick-and-mortar storefront lenders, online lenders, and vehicle title lenders (as well as pawn lenders, which are not covered under the rule). A number of these actions have been resolved, but some remain pending in the courts at this time. In every instance, however, before the enforcement action was brought, it was preceded by a thorough investigation of the underlying facts in order to determine whether legal violations had occurred. The issues raised in these actions include engaging in misleading and deceptive marketing practices, making improper disclosures, training employees to hide or obfuscate fees, pushing customers into a cycle of debt by pressuring them to take out additional loans they could not afford, making false statements about whether and how transactions can be canceled or reversed, taking unauthorized and improper electronic withdrawals from customer accounts, and engaging in collections efforts that generate wide-ranging problems. The Bureau has determined many of these practices to be violations of the prohibition against unfair, deceptive, or abusive acts or practices. The information and insights that the Bureau has gleaned from these investigations and enforcement actions has further advanced its understanding of this market and of the factual foundations for the policy interventions contained in this final rule.

For example, in 2013 the Bureau resolved a public enforcement action against Cash America, Inc. that arose out of an examination of this large national payday lender. The Bureau cited Cash America for committing three distinct unfair and deceptive practices: Robo-signing court documents in debt collection lawsuits; violating the Military Lending Act by overcharging servicemembers and their families; and improperly destroying records in advance of the Bureau's examination. Cash America was ordered to pay $14 million in refunds to consumers and to pay a civil penalty of $5 million for these violations.

In 2014, the Bureau filed a public enforcement action against Ace Cash Express that developed out of the Bureau's prior exam work. The Bureau found through its examination and subsequent investigation that ACE had engaged in unfair, deceptive, and abusive practices by using illegal debt collection tactics to pressure overdue borrowers into taking out additional loans they could not afford. In fact, ACE's own training manual for its employees had a graphic illustrating this cycle of debt. According to the graphic, consumers begin by applying to ACE for a loan, which ACE approved. Next, if the consumer “exhausts the cash and does not have the ability to pay,” ACE “contacts the customer for payment or offers the option to refinance or extend the loan.” Then, when the consumer “does not make a payment and the account enters collections,” the cycle starts all over again—with the formerly overdue borrower applying for another payday loan.

The Bureau's examination of ACE was conducted in coordination with the Texas Office of Consumer Credit Commissioner and resulted in an order imposing $5 million in consumer refunds and a $5 million civil penalty. The enforcement action was partially based on ACE's creation of a false sense of urgency to get delinquent borrowers to take out more payday loans—all while charging new fees each time.

In September 2015, the Bureau took action against Westlake Services, an indirect auto finance company, and Wilshire Consumer Credit, its auto title lending subsidiary, which offered auto title loans directly to consumers, largely via the Internet, and serviced those loans; Wilshire also purchased and serviced auto title loans made by others. The Bureau concluded that Westlake and Wilshire had committed unfair and deceptive acts or practices by pressuring borrowers through the use of illegal debt collection tactics. The tactics included illegally deceiving consumers by using phony caller ID information (sometimes masquerading as pizza delivery services or flower shops), falsely threatening to refer borrowers for investigation or criminal prosecution, calling under false pretenses, and improperly disclosing information about debts to borrowers' employers, friends, and family. Wilshire also gave consumers incomplete information about the true cost of the loans it offered. The consent order resolving the matter required the companies to overhaul their debt collection practices and to cease advertising or marketing their products untruthfully. The companies were also ordered to provide consumers with $44.1 million in cash relief and balance reductions, and to pay a civil penalty of $4.25 million.

In December 2015, the Bureau resolved another enforcement action with EZCORP, Inc., a short-term, small-dollar lender. The action was initially generated from a supervisory exam that had exposed significant and illegal debt collection practices. These included in-person collection visits at consumers' homes or workplaces (which risked disclosing the consumer's debt to unauthorized third parties), falsely threatening consumers with litigation for not paying their debts, misrepresenting consumers' rights, and unfairly making multiple electronic withdrawal attempts from consumer accounts that caused mounting bank fees. These practices were found to be unfair and deceptive and to violate the Electronic Fund Transfer Act; as a result, the Bureau ordered EZCORP to refund $7.5 million to 93,000 consumers and pay a $3 million civil penalty, while halting collection of remaining payday and installment loan debts associated with roughly 130,000 consumers. That action also prompted the Bureau to issue an industry-wide warning about potentially unlawful conduct during in-person collections at homes or workplaces.

In September 2016, the Bureau took action against TitleMax's parent company TMX Finance, one of the country's largest auto title lenders, for luring consumers into costly loan renewals by presenting them with misleading information about the terms and costs of the deals. The Bureau's investigation found that store employees, as part of their sales pitch for the 30-day loans, offered consumers a “monthly option” for making loan payments using a written guide that did not explain the true cost of the loan if the consumer renewed it multiple times, though TMX personnel were well aware of these true costs. In fact, the guide and sales pitch distracted consumers from the fact that repeatedly renewing the loan, as encouraged by TMX Finance employees, would dramatically increase the loan's cost, while making it difficult, if not impossible, for a consumer to compare costs for renewing the loan over a given period. The company then followed up with those who failed to repay by making intrusive visits to homes and workplaces that put consumers' personal information at risk. TMX Finance was ordered to stop its unlawful practices and pay a $9 million penalty.

Likewise, in December 2016 the Bureau filed a public enforcement action against Moneytree, which offers payday loans and check-cashing services, for misleading consumers with deceptive online advertisements and collections letters. The company was ordered to cease its illegal conduct, refund $255,000 to consumers, and pay a civil penalty of $250,000. In addition to the deceptive advertising, the company was found to have deceptively told consumers that their vehicles could be repossessed when it had no right or ability to do so, and to have improperly withdrawn money from consumers' accounts without authorization to do so.

From the Bureau's experience of carrying out investigations of these kinds of illegal practices and halting them through its enforcement efforts, the Bureau has become much more aware of the nature and likelihood of unfair, deceptive, or abusive practices in this market. And though the Bureau generally has devoted less attention in its supervisory and enforcement programs to issues that it has long intended to address separately, as here, through its rulemaking authority, the Bureau nonetheless has gained valuable experience and expertise from all of this work that it now brings to this rulemaking process. Since the inception of its supervision and enforcement program, the Bureau has worked continually to maximize compliance with the Federal consumer financial laws as they apply to payday and other types of small-dollar lenders. Sustained attention to compliance through the Bureau's supervision and enforcement work is an important adjunct to this rulemaking, but is not a sufficient substitute for it.

C. Research and Analysis of Small-Dollar Loans

Bureau White Papers. In April 2013, the Bureau issued a white paper on payday loans and deposit advance products, including findings by Bureau staff. For each of these loan products, the Bureau examined loan characteristics, borrower characteristics, intensity of use, and sustained use of the product. These findings were based largely on the data the Bureau had collected from some of the larger payday lenders under its supervisory authority, and covered approximately 15 million loans generated in 33 States and on approximately 15,000 deposit advance product transactions. The report took a snapshot of borrowers at the beginning of the study period and traced their usage of these products over the course of the study period. The report demonstrated that though some consumers use payday loans and deposit advances at relatively low to moderate levels, a sizable share of users conduct transactions on a long-term basis, suggesting they are unable to fully repay the loan and pay other expenses without taking out a new loan shortly thereafter.

In March 2014, the Bureau issued another white paper on payday lending. This report was based on the supervisory data the Bureau had received from larger payday lenders, truncated somewhat to cover 12-month windows into borrowing patterns. These limitations yielded a dataset of over 12 million loans in 30 States. Responding to criticisms of the Bureau's white paper, this report focused on “fresh borrowers,” i.e., those who did not have a payday loan in the first month of the Bureau's data and whose usage began in the second month. After reviewing this data, the report yielded several key findings. First, of the loans taken out by these borrowers over a period of eleven months over 80 percent are rolled over or followed by another loan within 14 days. Half of all loans are made as part of a sequence that is at least ten loans long, and few borrowers amortize, meaning their principal amounts are not reduced between the first and last loan of a sequence. Monthly borrowers (the majority of whom are receiving government benefits) are disproportionately likely to stay in debt for eleven months or longer. And most borrowing involves multiple renewals following an initial loan, rather than multiple distinct borrowing episodes separated by more than fourteen days.

Both before and after the release of these white papers, the Bureau held numerous meetings with stakeholders to obtain their perspectives and comments on the methodology and contents of this research. As is also noted below, the Bureau also hosted individual scholars in the field for research presentations

Additional Research Reports. In April and May of 2016, the Bureau published two additional research reports on small-dollar loans. In conducting this research, the Bureau used not only the data obtained from the supervisory examinations previously described but also data obtained through orders the Bureau had issued pursuant to section 1022(c)(4) of the Dodd-Frank Act, data obtained through civil investigative demands made by the Bureau pursuant to section 1052 of the Dodd-Frank Act, and data voluntarily supplied to the Bureau by several lenders.

The first report addressed how online payday and payday installment lenders use access to consumers' bank accounts to collect loan payments. It found that after a failed ACH payment request made by an online lender, subsequent payment requests to the same account are unlikely to succeed, though lenders often continue to present them, with many online lenders submitting multiple payment requests on the same day. The resulting harm to consumers is shown by the fact that accounts of borrowers who use loans from online lenders and experience a payment that is returned for insufficient funds are more likely to be closed by the end of the sample period than accounts experiencing a returned payment for products other than payday or payday installment loans.

The other report addressed consumer usage and default patterns on short-term vehicle title loans. Similar to payday loans, the report determined that single-payment vehicle title lenders rely on borrowers who take out repeated loans, with borrowers stuck in debt for seven months or more supplying two-thirds of the title loan business. In over half the instances where the borrower takes out such a loan, they end up taking out four or more consecutive loans, which becomes an unaffordable, long-term debt load for borrowers who are already struggling with their financial situations. In addition to high rates of default, the Bureau found that these loans carried a further adverse consequence for many consumers, as one out of every five loan sequences ends up with the borrower having their vehicle seized by the lender in repossession for failure to repay.

In June 2016, the Bureau issued a supplemental report on payday, payday installment, vehicle title loan, and deposit advance products that addressed a wide range of subjects pertinent to the proposed rule. The report studied consumers' usage and default patterns for title and payday installment loans; analyzed whether deposit advance consumers overdrew accounts or took out payday loans more frequently after banks stopped offering deposit advance products; examined the impact of State laws on payday lending; compared payday re-borrowing rates across States with different renewal and cooling-off period laws; provided findings on payday borrowing and default patterns, using three different loan sequence definitions; and simulated effects of certain lending and collection restrictions on payday and vehicle title loan markets.

Consumer Complaint Information. The Bureau also has conducted analysis on its own consumer complaint information. Specifically, the Bureau had received, as of April 1, 2017, approximately 51,000 consumer complaints relating to payday and other small-dollar loan products. Of these complaints, about one-third were submitted by consumers as payday or other small-dollar loan complaints and two-thirds as debt collection complaints where the source of the debt was a payday loan.

Industry representatives have frequently expressed the view that consumers seem to be satisfied with payday and other covered short-term loan products, as shown by low numbers of complaints and the submission of positive stories about them to the “Tell Your Story” function on the Bureau's Web site. Yet, the Bureau has observed from its consumer complaint data that from November 2013 through December 2016, approximately 31,000 debt collection complaints cited payday loans as the underlying debt, and over 11 percent of the complaints the Bureau has handled about debt collection stemmed directly from payday loans.

In fact, when complaints about payday loans are normalized in comparison to other credit products, the numbers do not turn out to be low at all. For example, in 2016, the Bureau received about 4,400 complaints in which consumers reported “payday loan” as the complaint product and about 26,600 complaints about credit cards. Yet there are only about 12 million payday loan borrowers annually, and about 156 million consumers have one or more credit cards. Therefore, by way of comparison, for every 10,000 payday loan borrowers, the Bureau received about 3.7 complaints, while for every 10,000 credit cardholders, the Bureau received about 1.7 complaints. In addition, the substance of some of the consumer complaints about payday loans as catalogued by the Bureau mirrored many of the concerns that constitute the justification for this rule here.

Moreover, faith leaders and faith groups of many denominations from around the country collected and submitted comments indicating that many borrowers may direct their personal complaints or dissatisfactions with their experiences elsewhere than to government officials.

Market Monitoring. The Bureau has also continuously engaged in market monitoring for the small-dollar loan market, just as it does for the other markets within its jurisdiction. This work involves regular outreach to industry members and trade associations, as well as other stakeholders in this marketplace. It also involves constant attention to news, research, trends, and developments in the market for small-dollar loans, including regulatory changes that may be proposed and adopted by the States and localities around the country. The Bureau has also carefully reviewed the published academic literature on small-dollar liquidity loans, along with research conducted or sponsored by stakeholder groups. In addition, a number of outside researchers have presented their own research at seminars for Bureau staff.

D. Small Business Review Panel

Small Business Regulatory Enforcement Fairness Act (SBREFA) Process. In April 2015, in accordance with SBREFA, the Bureau convened a Small Business Review Panel with the Chief Counsel for Advocacy of the SBA and the Administrator of the Office of Information and Regulatory Affairs within the Office of Management and Budget (OMB). As part of this process, the Bureau prepared an outline of the proposals then under consideration and the alternatives considered (the Small Business Review Panel Outline), which it posted on its Web site for review and comment by the general public as well as the small entities participating in the panel process.

Before formally convening, the Panel took part in teleconferences with small groups of the small entity representatives (SERs) to introduce the Outline and get feedback on the Outline, as well as a series of questions about their business operations and other issues. The Panel gathered information from representatives of 27 small entities, including small payday lenders, vehicle title lenders, installment lenders, banks, and credit unions. The meeting participants represented storefront and online lenders, State-licensed lenders, and lenders affiliated with Indian tribes. The Panel held a full-day meeting on April 29, 2015, to discuss the Small Business Review Panel Outline. The 27 small entities also were invited to submit written feedback, and 24 of them did so. The Panel considered input from the small entities about the potential compliance costs and other impacts on those entities and about impacts on access to credit for small businesses and made recommendations about potential options for addressing those costs and impacts. These recommendations are set forth in the Small Business Review Panel Report, which is made part of the administrative record in this rulemaking. The Bureau carefully considered these findings and recommendations in preparing the proposed rule and completing this final rule, as detailed below in the section-by-section analysis of various provisions and in parts VII and VIII. The Bureau also continued its outreach and engagement with stakeholders on all sides since the SBREFA process concluded.

Comments Regarding the Bureau's SBREFA Process. Following the release of the proposed rule, a number of commenters criticized the SBREFA process. Some of these commenters were third parties such as trade associations who were familiar with the SBREFA process. Others were the SERs themselves. Some commenters argued that the Bureau failed to adequately consider the concerns raised and alternatives suggested by the SERs. Some commenters also expressed concerns about the SBREFA procedures.

Some commenters objected that in developing the proposed rule the Bureau did not consider policy suggestions made by SERs or recommendations made by the SBREFA Panel. For example, some commenters argued that the Bureau failed to consider whether, as some SERs contended, disclosures could prevent the consumer injury the Bureau is seeking to address in this rulemaking. Some commenters also suggested that the Bureau failed to adequately consider alternative approaches employed by various States. Some commenters criticized the Bureau for ignoring the Panel's recommendations in developing the proposal, including, for example, the recommendation that the Bureau consider whether the rule should permit loan sequences of more than three short-term loans. Other SER commenters argued that the Bureau should adopt the requirements imposed by certain States (like Illinois or Michigan or Utah) or should require lenders to offer off-ramps instead of the requirements herein. Some commenters indicated that they believed the Bureau ultimately ignored or underestimated the rule's potential impact on small businesses and inadequately considered the rule's potential impact on rural communities. Some commenters argued that the Bureau did not adequately address issues around the cost of credit to small entities. One commenter noted that some credit unions offer certain short-term loan products and that the Bureau did not consider the impact of the rule on credit union products and small credit unions.

The SBA Office of Advocacy submitted comments of its own on the proposed rule and on how it responded to the SBREFA process. Although Advocacy had no complaints about the procedures used or the input received in the process, it did present its views on whether the proposed rule sufficiently reflected the discussions and debates that had occurred during the Panel discussions and the SBREFA process as a whole. To begin with, Advocacy agreed with the Bureau that the proposed rule would have a significant economic impact on small entities, which it found to be a matter of concern and felt had been underestimated by the Bureau. It stated that the ability-to-repay requirements in the proposed rule would be burdensome, and the cooling-off periods in particular would harm small businesses. It encouraged the Bureau to exempt from the rule small businesses that operate in States that currently have payday lending laws and to mitigate its impact on credit unions, Indian tribes, and small communities. Advocacy also commented that the proposed rule would restrict access to credit for consumers and for certain small businesses, and suggested that an exception be made for situations where such a loan may be necessary to address an emergency.

The procedural objections to the SBREFA process raised by other commenters included concerns about the make-up of the SBREFA panel and whether it was representative of the small entities who would be most affected by the proposal; the timing of SBREFA meetings; the administration and management of SBREFA-related phone calls; the overall “sufficiency” of the process; and unheeded requests to convene additional Panel sessions or to conduct additional research on specific topics. One trade group commenter incorporated portions of a comment letter from a SER that was sent to the Bureau during the SBREFA process, which raised a number of procedural objections. Another stated the panel excluded open-end lenders. Some expressed concern that the process did not provide them adequate time to realize the full ramifications of the proposed rule and the effects it would have on their business activity. Others suggested that the process was flawed because the Bureau's analysis allegedly ignored the rule's potential costs. One commenter also suggested that the SBREFA process was tainted by the Bureau Director's public comments regarding small-dollar lending in the years preceding the rulemaking.

Some commenters noted that the SBREFA process had been effective in considering and responding to certain concerns, including input regarding PAL loans and checking customer borrowing history.

Responses to Comments. The Bureau disagrees with commenters arguing that the Bureau did not adequately consider the suggestions of SERs and the Panel. In the proposed rule, the Bureau modified certain aspects of the approach in the Small Business Review Panel Outline in response to feedback from SERs (and others). For example, the Outline included a 60-day cooling-off period after sequences of three short-term loans, but the proposed rule included a 30-day cooling-off period, and that change is retained in the final rule. In addition, the Bureau followed the Panel's recommendation to request comment on numerous specific issues. The feedback received by the Bureau also informed its decision to revise various aspects of the rule. For example, as discussed below, the Bureau revised the ability-to-repay requirements in a number of ways to provide greater flexibility and reduce the compliance burden, such as by not requiring income verification if evidence is not reasonably available. In addition, the rule no longer requires lenders to verify or develop estimates of rental housing expenses based on statistical data. And the Bureau considered all of the alternatives posited by the SERs, as noted where applicable throughout part V and in part VIII. More generally, the Bureau considered and made appropriate modifications to the rule based upon feedback received during the SBREFA process and in response to other feedback provided by the small business community. The Bureau obtained important input through the SBREFA process and all articulated viewpoints were understood—and considered—prior to the promulgation of the final rule.

The Bureau disagrees with commenters that it did not consider alternative approaches. For example, in the proposal, the Bureau explained why it believed that disclosures would not be sufficient to address the identified harms and why the approaches of various States also appeared to be insufficient to address those harms. The Bureau likewise explains in this final rule its conclusions about why those approaches would not be sufficient.

The Bureau both agrees and disagrees with various comments from Advocacy, and a fuller treatment of these issues is presented below in part VII, which addresses the potential benefits, costs, and impacts of the final rule, including reductions in access to financial products and services and impacts on rural issues, and in part VIII, which addresses among other things the economic impact of the final rule on small entities, including small businesses. But more briefly here, the Bureau would note that it has made many changes in the final rule to reduce the burdens of the specific underwriting criteria in the ability-to-repay requirements; that Advocacy has stated that it appreciates the modification of the 60-day cooling-off period presented in the SBREFA Panel Outline to the 30-day cooling-off period in the proposed rule and now in the final rule; that Advocacy thanked the Bureau for clarifying that the proposed rule (and now the final rule) will not apply to business loans; that adoption of the conditional exemption from the final rule for alternative loans mitigates its impact on credit unions; that the Bureau did engage in another formal Tribal consultation after release of the proposed rule as Advocacy had urged; that the Bureau had consulted further with a range of State officials prior to finalizing the rule; and that the Bureau has extended the implementation period of the final rule.

The Bureau also disagrees with commenters who criticized procedural aspects of the SBREFA process. With respect to the composition of the SERs that participated in the SBREFA process, the Bureau followed legal requirements for categorizing which entities qualified as small entities. The Bureau collaborated with the SBA Office of Advocacy so that the SERs included a variety of different types of lenders that could be affected by the rulemaking, ensuring that participants included a geographically diverse group of storefront payday lenders, online lenders, vehicle title lenders, installment lenders, and banks and credit unions. As noted above, to help ensure that the formal Panel meeting would allow for efficient and effective discussion of substantive issues, the Panel convened several telephone conferences before the formal meeting to provide information about the Outline and to obtain information from the SERs.

The Bureau disagrees, further, with the comments raising more specific procedural objections about the teleconferences and the Panel meeting. The Bureau provided agendas in advance of the calls and extended the length of the calls as needed to ensure that SERs were able to participate and provide feedback. While the Bureau appreciates that some SERs may have desired additional time to consider and provide feedback on the Outline, the Bureau notes that the Panel is required by law to report on the SERs' comments and advice within 60 days after the Panel is convened. The Bureau conducted the process diligently and in accordance with its obligations under the Regulatory Flexibility Act and consistent with prior SBREFA processes.

With respect to comments suggesting that the Bureau failed to adequately consider the costs and impact on small businesses and in rural areas, the Bureau notes that the costs and impacts were addressed in the notice of proposed rulemaking, and, for the final rule, are addressed in parts VII and VIII.

E. Consumer Testing

In developing the disclosures for this rule, the Bureau engaged a third-party vendor, Fors Marsh Group (FMG), to coordinate qualitative consumer testing for the disclosures that were being considered. The Bureau developed several prototype disclosure forms and tested them with participants in one-on-one interviews. Three categories of forms were developed and tested: (1) Origination disclosures that informed consumers about limitations on their ability to receive additional short-term loans; (2) upcoming payment notices that alerted consumers about lenders' future attempts to withdraw money from consumers' accounts; and (3) expired authorization notices that alerted consumers that lenders would no longer be able to attempt to withdraw money from the consumers' accounts. Observations and feedback from the testing were incorporated into the model forms developed by the Bureau.

Through this testing, the Bureau sought to observe how consumers would interact with and understand prototype forms developed by the Bureau. In late 2015, FMG facilitated two rounds of one-on-one interviews, each lasting 60 minutes. The first round was conducted in September 2015 in New Orleans, Louisiana, and the second round was conducted in October 2015 in Kansas City, Missouri. At the same time the Bureau released the proposed rule, it also made available a report that FMG had prepared on the consumer testing. The testing and focus groups were conducted in accordance with OMB Control Number 3170-0022. A total of 28 individuals participated in the interviews. Of these 28 participants, 20 self-identified as having used a small-dollar loan within the past two years.

Highlights from Interview Findings. FMG asked participants questions to assess how well they understood the information on the forms.

For the origination forms, the questions focused on whether participants understood that their ability to roll this loan over or take out additional loans may be limited. Each participant reviewed one of two different prototype forms: Either one for loans that would require an ability-to-repay determination (ATR Form) or one for loans that would be offered under the conditional exemption for covered short-term loans (Alternative Loan Form). During Round 1, many participants for both form types recognized and valued information about the loan amount and due date; accordingly, that information was moved to the beginning of all the origination forms for Round 2. For the ATR Forms, few participants in Round 1 understood that the “30 days” language was describing a period when future borrowing may be restricted. Instead, several read the language as describing the loan term. In contrast, nearly all participants reviewing the Alternative Loan Form understood that it was attempting to convey that each successive loan they took out after the first in this series had to be smaller than the previous loan, and that after taking out three loans they would not be able to take out another for 30 days. Some participants also reviewed a version of this Alternative Loan Form for when consumers are taking out their third loan in a sequence. The majority of participants who viewed this notice understood it, acknowledging that they would have to wait until 30 days after the third loan was paid off to be considered for another similar loan.

During Round 2, participants reviewed two new versions of the ATR Form. One adjusted the “30 days” phrasing and the other completely removed the “30 days” language, replacing it with the phrase “shortly after this one.” The Alternative Loan Form was updated with similar rephrasing of the “30 days” language. In order to simplify the table, the “loan date” column was removed.

The results in Round 2 were similar to Round 1. Participants reviewing the ATR forms focused on the language notifying them they should not take out this loan if they are unable to pay the full balance by the due date. Information about restrictions on future loans went largely unnoticed. The edits appeared to have a positive impact on comprehension since no participants interpreted either form as providing information on their loan term. There did not seem to be a difference in comprehension between the group with the “30 days” version and the group with the “shortly” version. As in Round 1, participants who reviewed the Alternative Loan Form noticed and understood the schedule detailing maximum borrowable amounts. These participants understood that the purpose of the Alternative Loan Form was to inform them that any subsequent loans must be smaller.

Questions for the payment notices focused on participants' ability to identify and understand information about the upcoming payment. Participants reviewed one of two payment notices: An Upcoming Withdrawal Notice or an Unusual Withdrawal Notice. Both forms provided details about the upcoming payment attempt and a payment breakdown table. The Unusual Withdrawal Notice also indicated that the withdrawal was unusual because the payment was higher than the previous withdrawal amount. To obtain feedback on participants' likelihood to open notices delivered in an electronic manner, these notices were presented as a sequence to simulate an email message.

In Round 1, all participants, based on seeing the subject line in the email inbox, said that they would open the Upcoming Withdrawal email and read it. Nearly all participants said they would consider the email legitimate. They reported having no concerns about the email because they would have recognized the company name, and because it included details specific to their account along with the lender contact information. When shown the full Upcoming Withdrawal Notice, participants understood that the lender would be withdrawing $40 from their account on a particular date. Several participants also pointed out that the notice described an interest-only payment. Round 1 results were similar for the Unusual Withdrawal Notice; all participants who viewed this notice said they would open the email, and all but one participant—who was deterred due to concerns with the appearance of the link's URL—would click on the link leading to additional details. The majority of participants indicated that they would want to read the email right away, because the words “alert” and “unusual” would catch their attention, and would make them want to determine what was going on and why a different amount was being withdrawn.

For Round 2, the payment amount was increased because some participants found it too low and would not directly answer questions about what they would do if they could not afford payment. The payment breakdown tables were also adjusted to address feedback about distinguishing between principal, finance charges, and loan balance. The results for both the Upcoming Payment and Unusual Payment Notices were similar to Round 1 in that the majority of participants would open the email, thought it was legitimate and from the lender, and understood the purpose.

For the consumer rights notice (referred to an “expired authorization notice” in the report), FMG asked questions about participant reactions to the notice, participant understanding of why the notice was being sent, and what participants might do in response to the notice information. As with the payment notices, these notices were presented as a sequence to simulate an email message.

In Round 1, participants generally understood that the lender had tried twice to withdraw money from their account and would not be able to make any additional attempts to withdraw payment. Most participants expressed disappointment with themselves for being in a position where they had two failed payments and interpreted the notice to be a reprimand from the lender.

For Round 2, the notice was edited to clarify that the lender was prohibited by Federal law from making additional withdrawals. For example, the email subject line was changed from “Willow Lending can no longer withdraw loan payments from your account” to “Willow Lending is no longer permitted to withdraw loan payments from your account.” Instead of simply saying “federal law prohibits us from trying to withdraw payment again,” language was added to both the email message and the full notice saying, “In order to protect your account, federal law prohibits us from trying to withdraw payment again.” More information about consumer rights and the CFPB was also added. Some participants in Round 2 still reacted negatively to this notice and viewed it as reflective of something they did wrong. However, several reacted more positively to this prototype and viewed the notice as protection.

To obtain feedback about consumer preferences on receiving notices through text message, participants were also presented with an image of a text of the consumer rights notice and asked how they would feel about getting this notice by text. Overall, the majority of participants in Round 1 (8 of 13) disliked the idea of receiving notices via text. One of the main concerns was privacy; many mentioned that they would be embarrassed if a text about their loan situation displayed on their phone screen while they were in a social setting. In Round 2, the text image was updated to match the new subject line of the consumer rights notice. The majority (10 of the 14) of participants had a negative reaction to the notification delivered via text message. Despite this, the majority of participants said that they would still open the text message and view the link.

Most participants (25 out of 28) also listened to a mock voice message of a lender contacting the participant to obtain renewed payment authorization after two payment attempts had failed. In Round 1, most participants reported feeling somewhat intimidated by the voicemail message and were inclined to reauthorize payments or call back based on what they heard. Participants had a similar reaction to the voicemail message in Round 2.

F. The Bureau's Proposal

Overview. In June 2016, the Bureau released for public comment a notice of proposed rulemaking on payday, vehicle title, and certain high-cost installment loans, which were referred to as “covered loans.” The proposal was published in the Federal Register in July 2016.

Pursuant to its authority under the Dodd-Frank Act, the Bureau proposed to establish new regulatory provisions to create consumer protections for certain consumer credit products. The proposed rule was primarily grounded on the Bureau's authority to identify and prevent unfair, deceptive, or abusive acts or practices, but also drew on the Bureau's authority to prescribe rules and make exemptions from such rules as is necessary or appropriate to carry out the purposes and objectives of the Federal consumer financial laws, its authority to facilitate supervision of certain non-bank financial service providers (including payday lenders), and its authority to require disclosures to convey the costs, benefits, and risks of particular consumer financial products or services.

In the proposal, the Bureau stated its concern that lenders that make covered loans have developed business models that deviate substantially from the practices in other credit markets by failing to assess consumers' ability to repay their loans and by engaging in harmful practices in the course of seeking to withdraw payments from consumers' accounts. The Bureau preliminarily concluded that there may be a high likelihood of consumer harm in connection with these covered loans because a substantial population of consumers struggles to repay their loans and find themselves ending up in extended loan sequences. In particular, these consumers who take out covered loans appear to lack the ability to repay them and face one of three options when an unaffordable loan payment is due: Take out additional covered loans, default on the covered loan, or make the payment on the covered loan and fail to meet other major financial obligations or basic living expenses. Many lenders may seek to obtain repayment of covered loans directly from consumers' accounts. The Bureau stated its concern that consumers may be subject to multiple fees and other harms when lenders make repeated unsuccessful attempts to withdraw funds from consumers' accounts.

Scope of the Proposed Rule. The Bureau's proposal would have applied to two types of covered loans. First, it would have applied to short-term loans that have terms of 45 days or less, including typical 14-day and 30-day payday loans, as well as single-payment vehicle title loans that are usually made for 30-day terms. Second, the proposal would have applied to longer-term loans with terms of more than 45 days that have (1) a total cost of credit that exceeds 36 percent; and (2) either a lien or other security interest in the consumer's vehicle or a form of “leveraged payment mechanism” that gives the lender a right to initiate transfers from the consumer's account or to obtain payment through a payroll deduction or other direct access to the consumer's paycheck. Included among covered longer-term loans was a subcategory of loans with a balloon payment, which require the consumer to pay all of the principal in a single payment or make at least one payment that is more than twice as large as any other payment.

The Bureau proposed to exclude several types of consumer credit from the scope of the proposal, including: (1) Loans extended solely to finance the purchase of a car or other consumer good in which the good secures the loan; (2) home mortgages and other loans secured by real property or a dwelling if recorded or perfected; (3) credit cards; (4) student loans; (5) non-recourse pawn loans; and (6) overdraft services and lines of credit.

Underwriting Requirements for Covered Short-Term Loans. The proposed rule preliminarily identified it as an unfair and abusive practice for a lender to make a covered short-term loan without reasonably determining that the consumer will have the ability to repay the loan, and would have prescribed requirements to prevent the practice. Before making a covered short-term loan, a lender would first be required to make a reasonable determination that the consumer would be able to make the payments on the loan and be able to meet the consumer's other major financial obligations and basic living expenses without needing to re-borrow over the ensuing 30 days. Specifically, a lender would have to:

• Verify the consumer's net income;
• verify the consumer's debt obligations using a national consumer report and, if available, a consumer report from a “registered information system” as described below;
• verify the consumer's housing costs or use a reliable method of estimating a consumer's housing expense based on the housing expenses of similarly situated consumers;
• estimate a reasonable amount of basic living expenses for the consumer—expenditures (other than debt obligations and housing costs) necessary for a consumer to maintain the consumer's health, welfare, and ability to produce income;
• project the amount and timing of the consumer's net income, debt obligations, and housing costs for a period of time based on the term of the loan; and
• determine the consumer's ability to repay the loan and continue paying other obligations and basic living expenses for a period of thirty days thereafter based on the lender's projections of the consumer's income, debt obligations, and housing costs and estimate of basic living expenses for the consumer.

Under certain circumstances, a lender would be required to make further assumptions or presumptions when evaluating a consumer's ability to repay a covered short-term loan. The proposal specified certain assumptions for determining the consumer's ability to repay a line of credit that is a covered short-term loan. In addition, if a consumer were to seek a covered short-term loan within 30 days of a covered short-term or longer-term balloon-payment loan, a lender generally would be required to presume that the consumer is not able to afford the new loan. A lender could overcome the presumption of unaffordability for a new covered short-term loan only if it could document a sufficient improvement in the consumer's financial capacity. Furthermore, a lender would have been prohibited for a period of 30 days from making a covered short-term loan to a consumer who has already taken out three covered short-term loans within 30 days of each other.

Under the proposal, a lender would also have been allowed to make a covered short-term loan without complying with all the underwriting criteria just specified, as long as the conditionally exempt loan satisfied certain prescribed terms to prevent and mitigate the risks and harms of unaffordable loans leading to extended loan sequences, and the lender confirmed that the consumer met specified borrowing history conditions and provided required disclosures to the consumer. Among other conditions, a lender would have been allowed to make up to three covered short-term loans in short succession, provided that the first loan had a principal amount no larger than $500, the second loan had a principal amount at least one-third smaller than the principal amount on the first loan, and the third loan had a principal amount at least two-thirds smaller than the principal amount on the first loan. In addition, a lender would not have been allowed to make a covered short-term loan under the alternative requirements if it would result in the consumer having more than six covered short-term loans during a consecutive 12-month period or being in debt for more than 90 days on covered short-term loans during a consecutive 12-month period. Under the proposal, a lender would not be permitted to take vehicle security in connection with these loans.

Underwriting Requirements for Covered Longer-Term Loans. The proposed rule would have identified it as an unfair and abusive practice for a lender to make certain covered longer-term loans without reasonably determining that the consumer will have the ability to repay the loan. The coverage would have been limited to high-cost loans of this type and for which the lender took a leveraged payment mechanism, including vehicle security. The proposed rule would have prescribed requirements to prevent the practice for these loans, subject to certain exemptions and conditions. Before making a covered longer-term loan, a lender would have had to make a reasonable determination that the consumer has the ability to make all required payments as scheduled. This determination was to be made by focusing on the month in which the payments under the loan would be the highest. The proposed ability-to-repay requirements for covered longer-term loans closely tracked the proposed requirements for covered short-term loans with an added requirement that the lender, in assessing the consumer's ability to repay a longer-term loan, must reasonably account for the possibility of volatility in the consumer's income, obligations, or basic living expenses during the term of the loan.

The Bureau has determined not to finalize this aspect of the proposal at this time (other than for covered longer-term balloon-payment loans), and will take any appropriate further action on this subject after the issuance of this final rule.

Payments Practices Related to Small-Dollar Loans. The proposed rule would have identified it as an unfair and abusive practice for a lender to attempt to withdraw payment from a consumer's account in connection with a covered loan after the lender's second consecutive attempt to withdraw payment from the account has failed due to a lack of sufficient funds, unless the lender obtains from the consumer a new and specific authorization to make further withdrawals from the account. This prohibition on further withdrawal attempts would have applied whether the two failed attempts are initiated through a single payment channel or different channels, such as the automated clearinghouse system and the check network. The proposed rule would have required that lenders provide notice to consumers when the prohibition has been triggered and follow certain procedures in obtaining new authorizations.

In addition to the requirements related to the prohibition on further payment withdrawal attempts, the proposed rule would require a lender to provide a written notice at least three business days before each attempt to withdraw payment for a covered loan from a consumer's checking, savings, or prepaid account. The notice would have contained key information about the upcoming payment attempt, and, if applicable, alerted the consumer to unusual payment attempts. A lender could provide electronic notices as long as the consumer consented to electronic communications.

Additional Requirements. The Bureau also proposed to require lenders to furnish to provisionally registered and registered information systems certain information concerning covered loans at loan consummation, any updates to that information over the life of the loan, and certain information when the loan ceases to be outstanding. To be eligible to become a provisionally registered or registered information system, an entity would have to satisfy the eligibility criteria prescribed in the proposed rule. The Bureau proposed a sequential process to allow information systems to be registered and lenders to be ready to furnish at the time the furnishing obligation in the proposed rule would take effect. For most covered loans, registered information systems would provide a reasonably comprehensive record of a consumer's recent and current borrowing. Before making most covered loans, a lender would have been required to obtain and consider a consumer report from a registered information system.

The proposal would require a lender to establish and follow a compliance program and retain certain records, which included developing and following written policies and procedures that are reasonably designed to ensure compliance with the proposed requirements. A lender would also be required to retain the loan agreement and documentation obtained for a covered loan, and electronic records in tabular format regarding origination calculations and determinations for a covered loan, for a consumer who qualifies for an exception to or overcomes a presumption of unaffordability for a covered loan, and regarding loan type, terms, payment history, and loan performance. The proposed rule also included an anti-evasion clause and a severability clause.

Effective Date. The Bureau proposed that, in general, the final rule would become effective 15 months after publication of the final rule in the Federal Register. It also proposed that certain provisions necessary to implement the consumer reporting components of the proposal would become effective 60 days after publication of the final rule in the Federal Register to facilitate an orderly implementation process.

G. Public Comments on the Proposed Rule

Overview. Reflecting the broad public interest in this subject, the Bureau received more than 1.4 million comments on the proposed rulemaking. This is the largest comment volume associated with any rulemaking in the Bureau's history. Comments were received from consumers and consumer advocacy groups, national and regional industry trade associations, industry participants, banks, credit unions, nonpartisan research and advocacy organizations, members of Congress, program managers, payment networks, payment processors, fintech companies, Tribal leaders, faith leaders and coalitions of faith leaders, and State and local government officials and agencies. The Bureau received well over 1 million comments from individuals regarding the proposed rule, often describing their own circumstances or those of others known to them in order to illustrate their views, including their perceptions of how the proposed rule might affect their personal financial situations. Some individuals submitted multiple separate comments.

The Bureau has not attempted to tabulate precise results for how to tally the comments on both sides of the rule. Nor would it be easy to do so in any practical way, and of course some of the comments did not appear to take a side in advocating for or against the rule, though only a small number would fall in this category. Nonetheless, it was possible to achieve a rough approximation that broke down the universe of comments in this manner and the Bureau made some effort to do so. As an approximation, of the total comments submitted, more than 300,000 comments generally approved of the Bureau's proposal or suggested that the Bureau should adopt a rule that is more restrictive of these kinds of loans in some way or other. Over one million comments generally opposed the proposed rule and took the view that its provisions would be too restrictive of these kinds of loans.

The Bureau received numerous submissions generated through mass mail campaigns and other organized efforts, including signatures on a petition or multiple letters, postcards, emails, or web comments. These campaigns were conducted by opponents and supporters of the proposed rule. The Bureau also received stand-alone comments submitted by a single commenter, individual, or organization.

Of the approximately 1.4 million comments submitted, a substantial majority were generated by mass-mail campaigns or other organized efforts. In many cases, these submissions contained the same or similar wording. Of those 1.4 million comments, approximately 300,000 were handwritten and often had either the same or similar content or advanced substantially similar themes and arguments. These comments were posted as attachments to the electronic docket at www.regulations.gov.

For many of the comments that were submitted as part of mass mail campaigns or other organized efforts, a sample comment was posted to the electronic docket at www.regulations.gov,, with the total number of such comments received reflected in the docket entries. Accordingly, these comments, whose content is represented on the electronic docket via the sample comment, were not individually posted to the electronic docket at www.regulations.gov.

In addition, the 1.4 million comments included more than 100,000 signatures or comments contained on petitions, with some petitions containing tens of thousands of signatures. These petitions were posted as attachments to the electronic docket at www.regulations.gov. Whenever relevant to the rulemaking, these submissions and comments were considered in the development of the final rule.

Form of Submission. As detailed in the proposed rule, the Bureau accepted comments through four methods: Email, electronic, regular mail, and hand delivery or courier (including delivery services like FedEx). Approximately 800,000 comments, or roughly 60% of the total, were paper comments received by mail or couriers, while approximately 600,000 (or about 40%) were submitted electronically, either directly to the electronic docket at www.regulations.gov or by email. The electronic submissions included approximately 100,000 scanned paper comments sent as PDF attachments to thousands of emails.

In addition, the Bureau also processed and considered comments that were received after the comment period had closed, as well as more than 50 ex parte submissions. The ex parte materials were generally presentations and summary memoranda relevant to the rulemaking that were provided to Bureau personnel in the normal course of their work, but outside the procedures for submitting written comments to the rulemaking docket referenced above. They were considered in accordance with the Bureau's established rulemaking procedures governing ex parte materials.

Materials on the record, including ex parte submissions and summaries of ex parte meetings and telephone conferences, are publicly available at www.regulations.gov. Other relevant information is discussed below as appropriate. In the end, the Bureau considered all of the comments it received about the proposed rule prior to finalizing the rule.

Stand-Alone Comments. Tens of thousands appear to have been “stand-alone” comments—comments that did not appear to have been submitted as part of a mass mail campaign or other organized effort. Nevertheless, many of these stand-alone comments contained language and phrasing that were highly similar to other comments. In addition, pre-printed postcards or other form comments with identical language submitted as part of an organized effort sometimes also included additional notations, such as “we need this product” or “don't take this away.” Some comment submissions also attached material, including copies of news articles, loan applications, loan advertisements, and even personal financial documents.

Many of the comments from lenders, trade associations, consumer advocacy groups, research and advocacy organizations, and government officials included specific discussion about particular provisions of the proposed rule, and the substantive issues raised in those comments are discussed in connection with those provisions. However, as noted above, a high volume of comments were received from individuals, rather than from such entities (or their official representatives). Many of these individual comments focused on personal experiences rather than legal or financial analysis of the details of the provisions of the proposed rule. The discussion below summarizes what the commenters—more than a million in total—had to say to the Bureau about the proposed rule. The comments can be broken into three general categories: (1) Individual comments made about the rule that were more factual in nature regarding the uses and benefits of covered short-term loans; (2) individual comments stating or explaining the grounds on which the commenters opposed the rule, both generally and in more specific respects; and (3) individual comments stating or explaining the grounds on which the commenters supported the rule, again both generally and in more specific respects. The individual comments as so categorized are set forth below, and they have helped inform the Bureau's consideration of the issues involved in deciding whether and how to finalize various aspects of the proposed rule.

Comments Not Specifically Supporting or Opposing the Rule. Many commenters noted, as a factual matter, the uses they make of covered short-term loans. These uses include: Rent, childcare, food, vacation, school supplies, car payments, power/utility bills, cell phone bills, credit card bills, groceries, medical bills, insurance premiums, student educational costs, daily living costs, gaps between paychecks, money to send back to a home country, necessary credit, to “make ends meet,” “hard times,” and “bills.” In considering these types of comments, the Bureau generally interpreted them as critical of the rule for going too far to regulate covered short-term loans.

Some individual commenters talked about how they would cover various costs and expenses if the rule caused previously available payday loans to become less available or unavailable. Among the alternatives they cited were credit cards, borrowing from family or friends, incurring NSF or overdraft charges, or seeking bank loans.

The comments included many suggestions about the consumer financial marketplace that reached beyond the scope of the proposed rule. Some of these comments suggested that the Bureau should regulate interest rates or limit the amounts that could be charged for such loans by imposing a nationwide usury cap.

Comments Opposing the Proposed Rule. The nature of criticism varied substantially. Some commenters were broadly opposed to the rule without further explanation, while others objected to the government's participation in regulating the activity affected by the rule. Some objected to the means by which the rule was being considered or enacted while others objected to various substantive aspects of the rule. Some commenters combined these various types of criticisms. Unexplained opposition included some very brief comments like “No” or “Are you crazy?”

Others based their opposition on general anti-government sentiments. Some objected simply to the fact of the rulemaking. These objections included comments like “I'm against Washington stopping me from getting a loan.” More specific comments stated that the government should not be in the business of limiting how much people can borrow and that consumers can manage their own funds. Others contended that similar regulatory efforts in other countries had been unsuccessful. Some were opposed on the ground that the proposed rule was too complicated, with a few objecting simply to its length and complexity or its reliance on dated evidence.

A considerable number of commenters, including some State and local governmental officials, opined that existing State laws and regulations adequately addressed any regulatory need in this area. Some suggested that any regulation of covered short-term loans should be left to the States or that the Bureau should “work with state governments.” Some suggested that the Bureau had not adequately consulted with State officials before proposing the rule. And though the specific intent of the comments was not always made clear, some suggested that, either in promulgating or implementing the rule, the Bureau should consult State law and compare different rates and requirements in different States. Some comments were implicitly critical of the proposal, even if not expressly so, when they proposed alternative approaches like the suggestion that the Bureau “should follow the Florida Model.”

Many comments were from individuals who indicated they were users of payday loans, were able to reliably pay them back, and objected to new restrictions. Some of those comments came with notations that they had been specifically asked by loan providers to submit such comments. Many opposed the rule in whole or in part. Some supported some parts of the rule and opposed other parts.

Hundreds of thousands of individuals submitted comments generally supporting the availability of small-dollar loans that would have been covered by the proposed rule. Many but not all were submitted by consumers of these loans, who mentioned their need for access to small loans to address financial issues they faced with paying bills or dealing with unexpected expenses. Certain consumers stated that they could not access other forms of credit and favored the convenience and simplicity of these loans. Many expressed their opposition to caps or limits on the number of times they would be able to borrow money on such loans.

As noted above, many commenters simply indicated that they like and use payday loans. The Bureau generally understood these comments as expressions of concerns that the proposed rule might or would restrict their access to covered loans. In contending for greater availability of such loans, commenters specifically noted their use of payday loans for a substantial range of financial needs and reasons. They explained that these loans are used to cover, among other financial needs, overdraft fees, the last piece of tuition rather than losing enrollment, a portion of rent so as not to incur a rent penalty, various bills so as to avoid incurring late fees, utilities so they would not be turned off, college student necessities not covered by student loans, and funds to cover a gap in available resources before the next paycheck. Several commenters specifically noted that payday loan costs were cheaper than bank overdraft fees that would otherwise be incurred. Some indicated they had no alternative to payday products because they lacked credit for credit cards and could not borrow from family or friends or relatives.

Some commenters focused on the favorable environment they experienced in using payday loans, often in juxtaposition to their less welcoming experience with banks. A number of loan providers commented that low-income, non-English speaking immigrants are treated well by those who make these loans to them. Various borrowers related that they have been treated well at payday storefronts and that employees are helpful with their loan applications.

Others indicated that local communities support local payday lenders and the loans they provide and these lenders in turn are leading small businesspersons in their communities. Others noted that payday lenders often provide other services like check cashing, bill paying, and loading of pre-paid cards, sometimes with no fees. Still others echoed that payday lenders do more than other lenders to help their individual customers, and are all about “finding a solution” for the customer. Some commented that payday lenders do not pressure customers to take out loans whereas banks do.

One commenter noted that even with substantial income, payday loans still provided convenience due to a favorable ongoing relationship with the lender. Others commented more generally that the loans are convenient because they require no application and no credit check, they are easy to get and easy to renew, and they are provided at locations where it is convenient to get a check cashed. One expressly noted that despite the recognized expense of such loans, their availability and convenience made them worth it.

Various commenters noted that small loans were difficult or impossible to obtain from banks. Others objected that banks require too much personal information when lending funds, like credit checks and references. Some noted that they had a poor credit history or insufficient credit history and therefore could not get loans from banks or credit cards. Some indicated that small-dollar loans may be necessary for assuring available cash flow at some small businesses. These commenters indicated that payday loans are often critical when bank loans have been denied, the business is awaiting customer payments, and funds are needed to make payroll. Some said that alternatives were unsafe or unable to meet their needs. Others claimed that pawn shops have a bad reputation, that loan sharks might be an available option but for the possible “outcome,” and foreign and “underground” lenders were not viable options.

Some merely signed their name to the contents of printed text. Others sometimes added related messages in filling out such forms. Other forms provided space for and encouraged individualized messages and explanations rather than simply presenting uniform prepared text. Some comments opposing the proposed rule were submitted by lender employees, and those comments also ranged fairly widely in the extent of their individualized content; some referred to their fears of losing their jobs if the proposed rule were to become effective in its current form.

Some of these commenters indicated that payday loan proceeds were used to pay bills for which non-payment would result in penalties or late fees or suspension of vital services; many of them expressed, or seemed implicitly to suggest, concern that the rule would restrict their access to funds for meeting these needs.

Some commenters discussed general or specific concerns about their understanding of the effect the rule would have without expressly indicating support for or opposition to the rule, though a fair reading of their comments showed them to be expressing concern that the proposed rule would, or might restrict their access to covered loans and thus appeared to be critical of the proposed rule. For example, specific concerns about the perceived negative effects of the rule included its potential effect on the cost of covered loans, including fees and interest rates, restrictions on product availability because of re-borrowing limits, and lack of clarity about what products would replace those made unavailable by the rule. A number of comments expressed concern or confusion about the alternative lending options they would have following the enactment of the rule, and whether these alternatives would be acceptable options.

Some had very specific concerns about the potential effects of the rule, including a potential lack of liquidity in the market, and expressed a general concern that the rule might lead to increased consumer fraud. Others were concerned about the security of the personal financial information they would have to provide to get a loan. Some expressed concern that the new requirements would lead to loan denials that would hurt their credit scores. Many employees of the lenders affected by the proposed rule were concerned about their continued employment status if the rule were to be adopted.

Some commenters proposed exclusions from the effects of the rule, either directly or indirectly, indicating, for example, the auto title or credit union loans should be unaffected by the final rule. It was also suggested that there should be a safe harbor if lenders do their own underwriting or engage in income verification. Others suggested that various types of lenders should be excluded from the rule. These included credit unions, on the ground that they make “responsible” loans that use the ability to repay as an eligibility screen already, and “flex loans” because they are like lines of credit. At least one commenter suggested that the Bureau should exempt FDIC-regulated banks from any coverage under the rule.

In addition to more general criticisms of the rule, individual commenters also offered objections and concerns about the substantive provisions of the proposed rule. Some were general, like the suggestion that repayment should be more flexible. Others were more focused on specific features of the rule, including claims that the proposed rule would violate existing laws in unspecified ways.

Many commenters were concerned about the burdens and length of the “30-day waiting period” or cooling-off period, noting that they would be unable to access such loans during those periods even if they had an urgent need for funds. Others similarly commented that the various requirements and restrictions would result in loan denials and impede their ability to access needed funds easily and quickly. Many specifically noted the need for funds for unexpected emergencies, like car repairs. Some simply declared these limits “unwarranted,” saying that they understood the risks associated with these loans and appreciated their availability nonetheless.

Some commenters focused on the procedural difficulties of obtaining covered loans under the rule. They objected to the length and detail of the loan application process when funds were needed quickly and easily to cope with emergencies, with car repairs cited frequently. They stated that the process for getting a small-dollar loan should be short and easy and that otherwise it was not worth the effort. Others felt that the proposed rule would require them to disclose too much information about their income and expenses, which would invade their privacy. Some stated that credit checks should not be required for small-dollar loans. Still others expressed concern that the government should not be able to demand such information or require that borrowers provide it.

A few commenters noted that it would be hard for lenders to comply with the rule, which would impose additional compliance costs. A few specifically suggested that the Bureau should consider having lenders use the State databases that lenders must currently use rather than the approach laid out in the proposed rule.

Finally, though the vast majority of critical comments opposed the proposed rule and the restrictions it would impose, a substantial number of individual commenters were critical because they did not believe the rule went far enough or imposed enough restrictions. These included views that allowing consumers to receive as many as six loans a year or more would sink them into further debt, that “big banks” would benefit from the rule, or that the rule should “go after big banks” rather than smaller payday lenders. Many critics of the proposed rule stated that it should more directly impose a cap on interest rates, as many States have done and as has proved effective in limiting the making of these kinds of loans. Others suggested that the proposed rule could have “unintended consequences,” though without clearly explaining what those consequences might be, and that more should be done to prevent them.

Comments Supporting the Proposed Rule. Many individuals submitted comments that either supported the thrust of the proposed rule or argued that it needed to be strengthened in particular ways to accomplish its purposes. Some were submitted by consumers of these loans, and others were submitted through groups such as nonprofit organizations or coalitions of faith leaders who organized the presentation of their individual stories. Many were submitted as part of campaigns organized by consumer advocacy groups and a variety of nonprofit organizations concerned about the dangers they perceived to flow from these types of loans. These comments tended to dwell on the risks and financial harms that many consumers incur from small-dollar loans. These accounts consistently centered on those borrowers who find themselves ending up in extended loan sequences and bearing the negative collateral consequences of re-borrowing, delinquency, and default, especially the inability to keep up with their other major financial obligations and the loss of control over their budgetary decisions. Many of these commenters cited the special risks posed by loans that are extended without a reasonable determination of the consumer's ability to repay the loan without re-borrowing. Some went further and urged that such loans be outlawed altogether based on their predatory nature and the extremely high costs to consumers of most of these loan products.

Some of these comments described their first-hand experiences with extended loan sequences and the financial harms that had resulted either to themselves or to friends or family members. Some colored their accounts with considerable anger and frustration about these experiences, how they were treated, and the effects that these loans had in undermining or ruining their financial situations.

Many comments were generated or collected by faith leaders and faith groups, with individuals often presenting their views in terms of moral considerations, as well as financial effects. Some of these comments cited scripture and offered religiously based objections to covered loan activity, with particular opposition to the high interest rates associated with covered loans. Others, without necessarily grounding their concerns in a specific religious orientation, noted that current covered loans harm certain financially vulnerable populations, including the elderly, low-income consumers, and single mothers. They also recounted efforts they and others had made to develop so-called “rescue” products to extricate members of their congregations from the cumulative harms of extended loan sequences. Some employees of lenders, especially credit unions, offered views in favor of the proposed rule based on what they had seen of the negative experiences that their customers had encountered with these types of loans.

Many commenters who favored the proposed rule dwelled on their concerns about the risks posed by the types of covered loans that are currently available to consumers. Overall, these comments tended to focus on the risks and financial harms that many consumers incur when using short-term small-dollar loans. They expressed concerns about borrowers who find themselves in extended loan sequences and bearing increasingly negative effects as a result. Commenters often stressed that these situations left consumers unable to keep up with other major financial obligations and that they lost control over their personal budgetary decisions.

Like the favorable comments regarding current payday loan activity—which the Bureau understood to be critical of the proposed rule—critics of current covered loan practices did not always specify their views about the proposed rule. Nonetheless, absent specific indications to the contrary, comments that were critical of current payday lending activity were understood to be supportive of the proposed rule as an effective potential response to those concerns.

Some comments simply indicated a general policy view that there was a need to “stop the debt trap” or that rollover loans were “out of hand.” Others objected to the perception that covered loans are “geared to people with fixed incomes.” Many opposed what they viewed as the common situation that these loans were unaffordable and put people in a position in which they are unable to pay off the principal and must roll over the loans to avoid default.

Some comments focused on the specific consumer protective nature of the proposed rule, indicating that the rule was needed because current lenders do not care about people's ability to repay the loans, knowing that they can profit from continuing re-borrowing. A handful of comments from current or former employees of such lenders said they supported the proposed rule because of the negative experiences they had seen their customers encounter with these types of loans. One commenter opined that even NSF fees were less damaging to consumers than the cumulative effects of these loans, with the fees they imposed and frequency with which they landed many consumers in continued debt traps.

Many others commenting on these types of loans indicated that their “debt trap” nature was reinforced in the context of vehicle loans, since repossession of a vehicle could dramatically deepen the downward debt spiral. Still, one commenter argued that even the repossession of the borrower's vehicle might not be as bad as the continuing predicament of self-perpetuating loan sequences with their escalating fees and loan balances.

Some indicated that other loans were better alternatives to payday loans, sometimes citing PAL loans in this regard. And some were concerned about the character of the lenders associated with covered loans, with one comment relating that a recent payday lender had been indicted for illegal conduct associated with payday lending.

Some individual commenters indicated that they were representatives of or otherwise affiliated with national consumer organizations, and other national organizations, and were supportive of the rule. Some commenters noted that they were current payday loan borrowers working to pay off their loans and were supportive of the rule. Others supported the rule based on their own generally negative personal experiences with covered loans, with some specifying that they only supported the rule as applied to lenders that made loans without determining whether borrowers had the ability to repay them.

Many individual commenters indicated support for time limits on these loans and the proposed “cooling-off period” because they believed it would ultimately help consumers better manage their funds. Some thought that the rule would have the effect of lowering interest rates.

Some individual commenters who identified themselves as State officials, including individual legislators, commented that the rule would favorably supplement existing statutes that dealt with covered loans in their respective States. Individuals affiliated with some industry groups indicated their general support for the rule, but expressed concern that, in unexplained ways, the rule may go “too far.” In contrast, others recommended that the standards in the proposed rule should be applied in the context of all consumer lending rather than just in this market.

The Bureau's Consideration of Individual Comments. Although the specific treatment of discrete issues is addressed more fully in part V below, which presents the section-by-section analysis explaining the components of the final rule, it may be useful here to provide some of the uses that the Bureau made of the individual comments. First, it is a notable and commendable fact that over a million individual commenters would take the time and effort to respond to the Bureau with their thoughts and reactions, both pro and con, to this proposed rule. Public comments are not just an obligatory part of the rulemaking process required by the Administrative Procedure Act, they are welcome as a means of providing insight and perspective in fashioning such rules. Perhaps needless to say, that inviting solicitation was put to the test here.

As noted earlier, many of the individual comments turned out to be duplicative and redundant of one another. In part, that was because both the industry groups, on the one side, and the consumer and community groups, on the other side, employed campaigns to solicit large numbers of individual comments. The Bureau does not view any of those efforts as improper or illegitimate, and it has not discounted any comments on their merits as a result of their apparent origins. It did create challenges, however, for figuring out how to manage this large volume of comments—how to receive and process them, how to handle and organize them, and how to review and consider them. In the end, the Bureau proceeded as laid out in its earlier discussion in this section, and though the process took many months and considerable effort, it was eventually completed in a satisfactory way.

The Bureau also does not view the repetition and redundancy among many of the comments as being immaterial. The Bureau considered not only what views the public has, but how intensely they are felt and maintained. The Bureau has frequently noted, in its handling of consumer complaints, that when the same concern arises more frequently, it may reflect an emerging pattern and be worthy of more attention than if the same concern arises only once or twice and thus appears to reflect a more isolated set of circumstances. The same may be true here, with the caveat that, depending on the circumstances, comments generated primarily through campaigns may or may not truly reflect any widespread or deeply felt convictions, depending on the level of the individual's actual involvement.

Having said that, the processes that Congress has created for Federal administrative rulemaking, both in the Administrative Procedure Act generally and here in the Dodd-Frank Act in particular, were not designed or intended to be governed by some rough assessment of majority vote or even majority sentiment. While rough estimates of pro and con submissions are provided above, the Bureau has simply sought to understand the consumer experiences reported in these comments and address the substance of these comments on their merits.

As a general matter, the individual comments have helped inform the Bureau's understanding of factual matters surrounding the circumstances and use of covered loans. In the sections on Market Concerns—Underwriting and Market Concerns—Payments, they helped add depth and content to the Bureau's description of issues such as borrower characteristics, the circumstances of borrowing, their expectations of and experience with extended loan sequences, including harms they have suffered as a consequence of delinquency, default, and loss of control over budgeting. Many of these concerns were already known at the outset of the rule-writing process, as a result of extensive outreach and feedback the Bureau has received on the subject, as well as through the research that the Bureau and others have performed on millions of covered loans, all of which is discussed above.

Nonetheless, the Bureau's review of large numbers of individual comments has reinforced certain points and prompted further consideration of others. For example, many individuals stated great concern that the proposed rule would make the underwriting process for small-dollar loans too burdensome and complex. They commented positively on the speed and convenience of obtaining such loans, and were concerned that the process described in the proposed rule would lead to fewer such loans being offered or made. This has influenced the Bureau's consideration of the details of the underwriting process addressed in § 1041.5 of the final rule and contributed to the Bureau's decision to modify various aspects of that process. At the same time, many other individual commenters had much to say about the perils of extended loan sequences and how they had harmed either themselves or others, which helped underscore the need for the Bureau to finalize a framework that would be sufficiently protective of consumers. In particular, many commenters supported the general requirement that lenders must reasonably assess the borrower's ability to repay before making a loan according to specific underwriting criteria, and that limited exceptions to those criteria would be made only where other conditions applied to ensure that lenders would not end up in extended loan sequences. There are also many other places in the Bureau's discussion and explanation of the final rule where individual comments played a role in the Bureau's analysis.

Further Inter-Agency Consultation. In addition to the inter-agency consultation that the Bureau engaged in prior to issuing the notice of proposed rulemaking, pursuant to section 1022(b)(2) of the Dodd-Frank Act, the Bureau has consulted further with the appropriate prudential regulators and the FTC during the comment process. As a result of these consultations, the Bureau has made a number of changes to the rule and has provided additional explanation for various determinations it has made about the provisions of the rule, which have been discussed with the other regulators and agencies during the consultation process.

Ex Parte Submissions. In addition, the Bureau considered the comments it received after the comment period had closed, as well as other input from more than 50 ex parte submissions, meetings, and telephone conferences. All such materials in the record are available to the public at http://www.regulations.gov. Relevant information received is discussed below in the section-by-section analysis and subsequent parts of this notice, as applicable. The Bureau considered all the comments it received about the proposal, made certain modifications, and is adopting the final rule as described more fully in part V below.

IV. Legal Authority

The Bureau is issuing this final rule pursuant to its authority under the Dodd-Frank Act. The rule relies on rulemaking and other authorities specifically granted to the Bureau by the Dodd-Frank Act, as discussed below.

A. Section 1031 of the Dodd-Frank Act

Section 1031(b)—The Bureau's Authority To Identify and Prevent UDAAPs

Section 1031(b) of the Dodd-Frank Act provides the Bureau with authority to prescribe rules to identify and prevent unfair, deceptive, or abusive acts or practices, or UDAAPs. Specifically, section 1031(b) of the Act authorizes the Bureau to prescribe rules “applicable to a covered person or service provider identifying as unlawful unfair, deceptive, or abusive acts or practices in connection with any transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service.” Section 1031(b) of the Act further provides that, “Rules under this section may include requirements for the purpose of preventing such acts or practice.”

There are notable similarities between the Dodd-Frank Act and the Federal Trade Commission Act (FTC Act) provisions relating to unfair and deceptive acts or practices. Accordingly, these FTC Act provisions, and case law and Federal agency rulemakings relying on them, inform the scope and meaning of the Bureau's rulemaking authority with respect to unfair and deceptive acts or practices under section 1031(b) of the Dodd-Frank Act.

Courts evaluating exercise of agency rulemaking authority under the unfairness and deception standards of the FTC Act have held that there must be a “reasonable relation” between the act or practice identified as unlawful and the remedy chosen by the agency. The Bureau agrees with this approach and therefore maintains it is reasonable to interpret section 1031(b) of the Dodd-Frank Act to permit the imposition of requirements to prevent acts or practices that are identified by the Bureau as unfair or deceptive, as long as the preventive requirements being imposed by the Bureau have a reasonable relation to the identified acts or practices.

The Bureau likewise maintains that it is reasonable to interpret section 1031(b) of the Dodd-Frank Act to provide that same degree of discretion to the Bureau with respect to the imposition of requirements to prevent acts or practices that are identified by the Bureau as abusive. Throughout this rulemaking process, the Bureau has relied on and applied this interpretation in formulating and designing requirements to prevent acts or practices identified as unfair or abusive.

Section 1031(c)—Unfair Acts or Practices

Section 1031(c)(1) of the Dodd-Frank Act provides that the Bureau shall have no authority under section 1031 to declare an act or practice in connection with a transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service, to be unlawful on the grounds that such act or practice is unfair, unless the Bureau “has a reasonable basis” to conclude that: The act or practice causes or is likely to cause substantial injury to consumers which is not reasonably avoidable by consumers; and such substantial injury is not outweighed by countervailing benefits to consumers or to competition. Section 1031(c)(2) of the Act provides that, “[i]n determining whether an act or practice is unfair, the Bureau may consider established public policies as evidence to be considered with all other evidence. Such public policy considerations may not serve as a primary basis for such determination.”

In sum, the unfairness standard under section 1031(c) of the Dodd-Frank Act requires primary consideration of three elements: The presence of a substantial injury, the absence of consumers' ability to reasonably avoid the injury, and the countervailing benefits to consumers or to competition associated with the act or practice. The Dodd-Frank Act also permits secondary consideration of public policy objectives.

As noted above, the unfairness provisions of the Dodd-Frank Act are similar to the unfairness standard under the FTC Act. That standard was developed, in part, when in 1994, Section 5(n) of the FTC Act was amended to incorporate the principles set forth in the FTC's December 17, 1980 “Commission Statement of Policy on the Scope of Consumer Unfairness Jurisdiction” (the FTC Policy Statement on Unfairness).

Due to the similarities between unfairness provisions in the Dodd-Frank and FTC Acts, the scope and meaning of the Bureau's authority under section 1031(b) of the Dodd-Frank Act to issue rules that identify and prevent acts or practices that the Bureau determines are unfair pursuant to section 1031(c) of the Dodd-Frank Act are naturally informed by the FTC Act unfairness standard, the FTC Policy Statement on Unfairness, FTC and other Federal agency rulemakings, and related case law. The Bureau believes it is reasonable to interpret section 1031 of the Dodd-Frank Act consistent with the specific positions discussed in this section on Legal Authority. The Bureau's interpretations are based on its expertise with consumer financial products, services, and markets, and its experience with implementing this provision in supervisory and enforcement actions. The Bureau also generally finds persuasive the reasons provided by the authorities supporting these positions as discussed in this section.

Substantial Injury

The first element required for a determination of unfairness under section 1031(c)(1) of the Dodd- Frank Act is that the act or practice causes, or is likely to cause, substantial consumer injury. As noted above, Bureau rulemaking regarding the meaning of the elements of this unfairness standard is informed by the FTC Act unfairness standard, the FTC Policy Statement on Unfairness, FTC and other Federal agency rulemakings, and related case law.

The FTC noted in the FTC Policy Statement on Unfairness that substantial injury ordinarily involves monetary harm, and that trivial or speculative harms are not cognizable under the test for substantial injury. The FTC also noted that an injury is “sufficiently substantial” if it consists of a small amount of harm to a large number of individuals or if it raises a significant risk of harm.

In addition, the FTC has also found that substantial injury may involve a large amount of harm experienced by a small number of individuals. And while the FTC has said that emotional impact and other more subjective types of harm ordinarily will not constitute substantial injury, the D.C. Circuit held that psychological harm can form part of the substantial injury along with financial harm.

Not Reasonably Avoidable

The second element required for a determination of unfairness under section 1031(c)(1) of the Dodd-Frank Act is that the substantial injury is not reasonably avoidable by consumers. Again, the FTC Act unfairness standard, the FTC Policy Statement on Unfairness, FTC and other Federal agency rulemakings, and related case law inform the meaning of this element of the unfairness standard.

The FTC has noted that knowing the steps for avoiding injury is not enough for the injury to be reasonably avoidable; rather, the consumer must also understand the necessity of taking those steps. As the FTC explained in its Policy Statement on Unfairness, most unfairness matters are brought to “halt some form of seller behavior that unreasonably creates or takes advantage of an obstacle to the free exercise of consumer decision making.” The D.C. Circuit held that such behavior can create a “market failure” and the agency “may be required to take corrective action.” Reasonable avoidability also takes into account the costs of making a choice other than the one made and the availability of alternatives in the marketplace.

Countervailing Benefits to Consumers or Competition

The third element required for a determination of unfairness under section 1031(c)(1) of the Dodd- Frank Act is that the act or practice's countervailing benefits to consumers or to competition do not outweigh the substantial consumer injury. Once again, the FTC Act unfairness standard, the FTC Policy Statement on Unfairness, FTC and other Federal agency rulemakings, and related case law inform the meaning of this element of the unfairness standard.

In applying the FTC Act's unfairness standard, the FTC has stated that it is important to consider both the costs of imposing a remedy and any benefits that consumers enjoy as a result of the practice. Authorities addressing the FTC Act's unfairness standard indicate that the countervailing benefits test does not require a precise quantitative analysis of benefits and costs, because such an analysis may be unnecessary or, in some cases, impossible. Rather, the agency is expected to gather and consider reasonably available evidence.

Public Policy

As noted above, section 1031(c)(2) of the Dodd-Frank Act provides that, “[i]n determining whether an act or practice is unfair, the Bureau may consider established public policies as evidence to be considered with all other evidence. Such public policy considerations may not serve as a primary basis for such determination.”

Section 1031(d)—Abusive Acts or Practices

The Dodd-Frank Act, in section 1031(b), authorizes the Bureau to identify and prevent abusive acts and practices. The Bureau believes that Congress intended for the statutory phrase “abusive acts or practices” to encompass conduct by covered persons that is beyond what would be prohibited as unfair or deceptive acts or practices, although such conduct could overlap and thus satisfy the elements for more than one of the standards.

Under section 1031(d) of the Dodd-Frank Act, the Bureau “shall have no authority . . . to declare an act or practice abusive in connection with the provision of a consumer financial product or service” unless the act or practice meets at least one of several enumerated conditions. For example, under section 1031(d)(2)(A) of the Act, an act or practice might “take[ ] unreasonable advantage of” a consumer's “lack of understanding . . . of the material risks, costs, or conditions of the [consumer financial] product or service” (i.e., the lack of understanding prong). Under section 1031(d)(2)(B) of the Act, an act or practice might “take[ ] unreasonable advantage of” the “inability of the consumer to protect the interests of the consumer in selecting or using a consumer financial product or service” (i.e., the inability to protect prong). The Dodd-Frank Act does not further elaborate on the meaning of these terms, leaving it to the Bureau to interpret and apply these standards.

Although the legislative history on the meaning of the Dodd-Frank Act's abusiveness standard is fairly limited, it suggests that Congress was particularly concerned about the widespread practice of lenders making unaffordable loans to consumers. A primary focus was on unaffordable home mortgages and mortgages made without adequate or responsible underwriting.

However, there is some indication that Congress also intended the Bureau to use the authority under section 1031(d) of the Dodd-Frank Act to address payday lending through the Bureau's rulemaking, supervisory, and enforcement authorities. For example, the Senate Committee on Banking, Housing, and Urban Affairs report on the Senate version of the legislation listed payday loans as one of several categories of consumer financial products and services, other than mortgages, where “consumers have long faced problems” because they lack “adequate Federal rules and enforcement,” noting further that “[a]busive lending, high and hidden fees, unfair and deceptive practices, confusing disclosures, and other anti-consumer practices have been a widespread feature in commonly available consumer financial products such as credit cards.” The same section of the Senate committee report included a description of the basic features of payday loans and the problems associated with them, specifically noting that many consumers are unable to repay the loans while meeting their other obligations and that many of these borrowers re-borrow, which results in a “perpetual debt treadmill.” These portions of the legislative history reinforce other indications in the Dodd-Frank Act that Congress consciously intended to confer direct authority upon the Bureau to address issues concerning payday loans.

B. Section 1032 of the Dodd-Frank Act

Section 1032(a) of the Dodd-Frank Act provides that the Bureau may prescribe rules to ensure that the features of any consumer financial product or service, “both initially and over the term of the product or service,” are “fully, accurately, and effectively disclosed to consumers in a manner that permits consumers to understand the costs, benefits, and risks associated with the product or service, in light of the facts and circumstances.” This authority is broad, and empowers the Bureau to prescribe rules regarding the disclosure of the “features” of consumer financial products and services generally.

Accordingly, the Bureau may prescribe rules containing disclosure requirements even if other Federal consumer financial laws do not specifically require disclosure of such features. Section 1032(c) of the Dodd-Frank Act provides that, in prescribing rules pursuant to section 1032 of the Act, the Bureau “shall consider available evidence about consumer awareness, understanding of, and responses to disclosures or communications about the risks, costs, and benefits of consumer financial products or services.”

Section 1032(b)(1) of the Dodd-Frank Act provides that “any final rule prescribed by the Bureau under this section requiring disclosures may include a model form that may be used at the option of the covered person for provision of the required disclosures.” Section 1032(b)(2) of the Act provides that such a model form “shall contain a clear and conspicuous disclosure that, at a minimum—(A) uses plain language comprehensible to consumers; (B) contains a clear format and design, such as an easily readable type font; and (C) succinctly explains the information that must be communicated to the consumer.”

Section 1032(b)(3) of the Dodd-Frank Act provides that any such model form “shall be validated through consumer testing.” And section 1032(d) of the Act provides that, “Any covered person that uses a model form included with a rule issued under this section shall be deemed to be in compliance with the disclosure requirements of this section with respect to such model form.”

C. Other Authorities Under the Dodd-Frank Act

Section 1022(b)(1) of the Dodd-Frank Act provides that the Bureau's director “may prescribe rules and issue orders and guidance, as may be necessary or appropriate to enable the Bureau to administer and carry out the purposes and objectives of the Federal consumer financial laws, and to prevent evasions thereof.” “Federal consumer financial law” includes rules prescribed under Title X of the Dodd-Frank Act, including sections 1031(b) to (d) and 1032.

Section 1022(b)(2) of the Dodd-Frank Act prescribes certain standards for rulemaking that the Bureau must follow in exercising its authority under section 1022(b)(1) of the Act. For a discussion of the Bureau's standards for rulemaking under section 1022(b)(2) of the Act, see part VII below.

Section 1022(b)(3)(A) of the Dodd-Frank Act authorizes the Bureau, by rule, to “conditionally or unconditionally exempt any class of covered persons, service providers, or consumer financial products or services” from any provision of Title X or from any rule issued under Title X as the Bureau determines “necessary or appropriate to carry out the purposes and objectives” of Title X. In doing so, the Bureau must, “tak[e] into consideration the factors” set forth in section 1022(b)(3)(B) of the Act, which specifies three factors that the Bureau shall, as appropriate, take into consideration in issuing such an exemption.

Furthermore, §§ 1041.10 and 1041.11 of the final rule are authorized by other Dodd-Frank Act authorities, such as sections 1021(c)(3), 1022(c)(7), 1024(b)(1), and 1024(b)(7) of the Act. A more complete description of the Dodd-Frank Act authorities on which the Bureau is relying for §§ 1041.10 and 1041.11 of the final rule is contained in the section-by-section analysis of those provisions.

D. Section 1041 of the Dodd-Frank Act and Preemption

Section 1041(a)(1) of the Dodd-Frank Act provides that Title X of the Act, other than sections 1044 through 1048, “may not be construed as annulling, altering, or affecting, or exempting any person subject to the provisions of [Title X] from complying with,” the statutes, regulations, orders, or interpretations in effect in any State (sometimes hereinafter, State laws), “except to the extent that any such provision of law is inconsistent with the provisions of [Title X], and then only to the extent of the inconsistency.” Section 1041(a)(2) of the Act provides that, for purposes of section 1041, “a statute, regulation, order, or interpretation in effect in any State is not inconsistent with” the Title X provisions “if the protection that such statute, regulation, order, or interpretation affords to consumers is greater than the protection provided” under Title X. This section further provides that a determination regarding whether a statute, regulation, order, or interpretation in effect in any State is inconsistent with the provisions of Title X may be made by the Bureau on its own motion or in response to a nonfrivolous petition initiated by any interested person.

The requirements of the final rule set minimum Federal standards for the regulation of covered loans. They thus accord with the common preemption principle that Federal law provides a floor and not a ceiling on consumer financial protection, as provided in section 1041(a)(2) of the Dodd-Frank Act. The requirements of this rule will thus coexist with State laws that pertain to the making of loans that the rule treats as covered loans (hereinafter, “applicable State laws”). Consequently, any person subject to the final rule will be required to comply with both the requirements of this rule and all applicable State laws, except to the extent that the applicable State laws are inconsistent with the requirements of the rule. This approach reflects the established framework of cooperative federalism between Federal and State laws in many other substantive areas. Accordingly, the arguments advanced by some commenters that the payday rule would “occupy the field” are incorrect. Where Federal law occupies an entire field, “even complementary State regulation is impermissible” because field preemption “foreclose[s] any State regulation in the area, even if it is parallel to Federal standards.” This rule would not have that effect.

As noted above, section 1041(a)(2) of the Dodd-Frank Act specifies that State laws which afford greater consumer protection than is provided under Title X are not inconsistent with the provisions of Title X. Specifically, as discussed in part II, different States have taken different approaches to regulating loans that are treated as covered loans under the final rule, with many States electing to permit the making of such loans according to varying conditions, and other States choosing not to do so by imposing usury caps that effectively render it impractical to make such loans in those States.

Particularly in the States where fixed usury caps effectively prohibit these types of loans, nothing in this rule is intended or should be construed to undermine or cast doubt on whether those provisions are sound public policy. Because Title X does not confer authority on the Bureau to establish usury limits, its policy interventions, as embodied in the final rule, are entirely distinct from such measures as are beyond its statutory authority. Therefore, nothing in this rule should be construed as annulling or even as inconsistent with a regulatory or policy approach to such loans based on usury caps, which are wholly within the prerogative of the States to lawfully impose. Indeed, as described in part II, South Dakota became the most recent State to impose a usury cap on payday loans after conducting a ballot initiative in 2016 in which the public voted to approve the measure by a substantial margin.

The requirements of the final rule will coexist with different approaches and frameworks for the regulation of such covered loans as reflected in applicable State laws. The Bureau is aware of certain applicable State laws that may afford greater protections to consumers than do the requirements of this rule. For example, as described in part II and just discussed above, certain States have fee or interest rate caps (i.e., usury limits) that payday lenders may find are set too low to sustain their business models. The Bureau regards the fee and interest rate caps in these States as providing greater consumer protections than, and thus as not inconsistent with, the requirements of the final rule.

Aside from those provisions of State law just discussed, the Bureau declines to determine definitively in this rulemaking whether any other individual statute, regulation, order, or interpretation in effect in any State is inconsistent with the rule. Comments on the proposal and internal analysis have led the Bureau to conclude that specific questions of preemption should be decided upon application, and the Bureau will respond to nonfrivolous petitions initiated by interested persons in accordance with section 1041(a)(2) of the Dodd-Frank Act. The Bureau believes that in most cases entities can apply the principles articulated above in a straightforward manner to determine their rights and obligations under both the rule and State law. Moreover, in light of the variety of relevant State law provisions and the range of practices that may be covered by those laws, it is impossible for the Bureau to provide a definitive description of all interactions or to anticipate all areas of potential concern.

Some commenters argued that because section 1041 of the Dodd-Frank Act includes only the term “this title,” and not “any rule or order prescribed by the Bureau under this title,” Congress contemplated only statutory and not regulatory preemption of State law. The Bureau disagrees and believes section 1041 is best interpreted to apply to Title X and rules prescribed by the Bureau under that Title. Section 1041 was modeled in large part on similar provisions from certain enumerated consumer laws. Consistent with longstanding case law holding that State laws can be pre-empted by Federal regulations promulgated in the exercise of delegated authority, those provisions were definitively interpreted to apply to requirements imposed by implementing regulations, even where the statutory provisions include explicit reference only to the statutes themselves. Congress is presumed to have been aware of those applications in enacting Title X, and section 1041 is best interpreted similarly. Moreover, the Bureau's interpretation furthers principles of consistency, uniformity, and manageability in interpreting Title X and legislative rules with the force and effect of law implementing that statute. Finally, while section 1041 of the Act instructs preemption analyses, any actual pre-emptive force derives from the substantive provisions of Title X and its implementing rules, not from section 1041 itself. A reading that section 1041 would apply only to Title X itself could lead to the conclusion that rules prescribed by the Bureau under Title X have broader preemptive effect than does Title X itself. The better interpretation is that the preemptive effect of regulations exercised under delegated authority should be guided by the provisions of section 1041.

Lastly, the Bureau intends this rule to interact in the same manner with laws or regulations at other government levels, like city or locality laws or regulations.

E. General Comments on the Bureau's Legal Authority

In addition to setting out the Bureau's legal authority for this rulemaking and responding to comments directed to specific sources of authority, it is necessary to address several more general comments that challenged or criticized certain aspects of the Bureau's ability to proceed to finalize this rule. They will be addressed here.

Some industry commenters and State Attorneys General have contended that the Bureau lacks the legal authority to adopt this rule because the Bureau itself or its statutory authority is unconstitutional on various grounds, including separation-of-powers, the non-delegation doctrine, and the 10th Amendment. No court has ever held that the Bureau is unable to issue regulations on the basis that it is unconstitutional, and in fact the Bureau has issued dozens of regulations to date, including many major rules that have profoundly affected key consumer markets such as mortgages, prepaid accounts, remittance transfers, and others—a number of which were mandated by Congress. In addition, longstanding precedent has established that a government agency lacks the authority to decide the constitutionality of congressional enactments.

One commenter argued that the timing of the proposed rule prevented the Bureau from using data gathered in Treasury Department Financial Empowerment Studies on small dollar loans conducted under Title XII of the Dodd-Frank Act, and that the combination of Title XII and section 1022 of the Dodd-Frank Act evidence Congress's intent to not grant the Bureau authority to issue a rule that reduces the availability of payday loans. There is nothing in either the plain language or structure of the Dodd-Frank Act to suggest that Congress intended the Bureau to postpone any regulation of unfair and abusive payday lending practices until after Treasury had established the multiyear grant program that Congress authorized Treasury to establish. Indeed, it is noteworthy that Title XII does not mandate that Treasury create such programs—it merely authorizes Treasury to do so. Moreover, contrary to the commenter's assertions, the final rule will not end payday lending and it will not undermine the rationale for the grants for which Congress provided in Title XII. There is no basis to conclude that the Bureau is under any obligation to wait for such grant programs to play out to prevent UDAAPs.

Some industry commenters have made the claim that the Bureau had impermissibly prejudged the evidence about whether and how to proceed with this rule and failed to comply with its own ex parte policy by engaging in improper communications with special interest groups prior to the publication of the notice of proposed rulemaking. The Bureau does not agree with these claims for several reasons. First, part III of the final rule, which summarizes in detail the Bureau's rulemaking process, shows that these claims are without basis. That discussion reflects the Bureau's considerable experience with these issues and with this market for over five years of steady work. It also includes a description of the Bureau's approach to handling the great volume of public comments received on the proposed rule, as well as a number of ex parte communications, which have been documented and incorporated into the administrative record and are available to the public at www.regulations.gov. Second, both the proposed rule and the final rule are based on the Bureau's careful review of the relevant evidence, including evidence generated by the Bureau's own studies, as well as evidence submitted by a broad range of stakeholders, including industry stakeholders. Finally, the numerous changes made in the final rule in response to stakeholder comments, including industry stakeholders, is further evidence that the Bureau has not prejudged any issues.

A number of industry commenters have argued that the rule conflicts with the Bureau's statutory purpose under section 1021(b)(4) of the Dodd-Frank Act, which is to enforce the law consistently for all persons, regardless of their status as depository institutions, because it addresses covered loans but does not address other types of financial products, such as overdraft services or credit card accounts. The Bureau notes in response that each of these products has its own features, characteristics, historical background, and prior regulatory treatment, as discussed further in the section-by-section analysis of § 1041.3(d). Just as it has not been judged to be impermissibly inconsistent for Federal and State authorities (including the Congress) to treat these distinct products differently as a matter of statutory law and regulation, despite certain similarities of product features and uses, even so it is not inconsistent for the Bureau to do so for the purposes of this rule. Further, while it may be true that more nonbanks will be impacted by this rule than banks by virtue of the products that banks and nonbanks are currently providing, that does not mean that this rule conflicts with section 1021(b)(4), but simply reflects the current makeup of this marketplace.

Finally, and more narrowly, some Tribal and industry commenters have averred that the Bureau lacks authority to adopt regulations pursuant to section 1031 of the Dodd-Frank Act that apply to Indian tribes or to any of the entities to which they have delegated Tribal authority. These arguments raised on behalf of Tribal lenders have also been raised in Tribal consultations that the Bureau has held with federally recognized Indian Tribes, as discussed in part III, and in various court cases to date. They rest on what the Bureau believes is a misreading of the Act and of Federal law and precedents governing the scope of Tribal immunity, positions that the Bureau has briefed extensively to the Federal courts in some key cases testing these issues.

V. Section-by-Section Analysis

Subpart A—General

Section 1041.1 Authority and Purpose

Proposed § 1041.1 provided that the rule is being issued pursuant to Title X of the Dodd-Frank Wall Street Reform and Consumer Protection Act. It also provided that the purpose of this part is to identify certain unfair and abusive acts or practices in connection with certain consumer credit transactions; to set forth requirements for preventing such acts or practices; and to prescribe requirements to ensure that the features of those consumer credit transactions are fully, accurately, and effectively disclosed to consumers. It also noted that this part prescribes processes and criteria for registration of information systems.

The Bureau did not receive any comments on proposed § 1041.1 and is finalizing this provision as proposed.

Section 1041.2 Definitions

Proposed § 1041.2 set forth definitions for certain terms relevant to the proposal. Additional definitions were set forth in proposed §§ 1041.3, 1041.5, 1041.9, 1041.14, and 1041.17 for further terms used in those respective sections. To the extent those definitions are used in the final rule and have not been moved into § 1041.2, as discussed below, they are addressed in the context of those particular sections (some of which have been renumbered in the final rule).

In general, the Bureau proposed to incorporate a number of defined terms under the Dodd-Frank Act and under other statutes or regulations and related commentary, particularly Regulation Z and Regulation E as they implement the Truth in Lending Act (TILA) and the Electronic Fund Transfer Act (EFTA), respectively. The Bureau believed that basing the proposal's definitions on previously defined terms may minimize regulatory uncertainty and facilitate compliance, especially where the other regulations are likely to apply to the same transactions in their own right. However, as discussed further below, the Bureau proposed, in certain definitions, to expand or modify the existing definitions or the concepts enshrined in such definitions for purposes of the proposal to ensure that the rule had its intended scope of effect, particularly as industry practices may evolve.

The Bureau received numerous comments about these proposed terms and their definitions, as well as some suggestions to define additional concepts left undefined in the proposal. The Bureau is finalizing § 1041.2 with some revisions and deletions from the proposal, as discussed further below, including the addition of a rule of construction as § 1041.2(b) to provide general guidance concerning the incorporation of terms from other statutes and regulations in the context of part 1041.

2(a) Definitions

2(a)(1) Account

Proposed § 1041.2(a)(1) would have defined account by cross-referencing to the definition of that same term in Regulation E, 12 CFR part 1005. Regulation E generally defines account to include demand deposit (checking), savings, or other consumer asset accounts (other than an occasional or incidental credit balance in a credit plan) held directly or indirectly by a financial institution and established primarily for personal, family, or household purposes. The term account was also used in proposed § 1041.3(c), which would provide that a loan is a covered loan if, among other requirements, the lender or service provider obtains repayment directly from a consumer's account. This term was also used in proposed § 1041.14, which would impose certain requirements when a lender seeks to obtain repayment for a covered loan directly from a consumer's account, and in proposed § 1041.15, which would require lenders to provide notices to consumers before attempting to withdraw payments from consumers' accounts. The Bureau stated that defining this term consistently with an existing regulation would reduce the risk of confusion among consumers, industry, and regulators. The Bureau considered the Regulation E definition to be appropriate because that definition is broad enough to capture the types of transactions that may implicate the concerns addressed by this part. Proposed comment 2(a)(1)-1 also made clear that institutions may rely on 12 CFR 1005.2(b) and its related commentary in determining the meaning of account.

One commenter stated that the definition of account should be expanded to include general-use prepaid cards, regardless of whether they are labeled and marketed as a gift card, as defined in 12 CFR 1005.20(a)(3). The Bureau recently finalized a separate rule creating comprehensive consumer protections for prepaid accounts, and in the process amended the definition of account in 12 CFR 1005.2(b) to include “a prepaid account,” so the thrust of the comment is already effectively addressed. The definition of “prepaid account” in that rulemaking only excludes gift cards that are both labeled and marketed as a gift card, which are subject to separate rules under Regulation E. The Bureau does not believe that such products are likely to be tendered as a form of leveraged payment mechanism, but will monitor the market for this issue and take appropriate action if it appears that lenders are using such products to evade coverage under the rule. The Bureau did not receive any other comments on this portion of the proposal and is finalizing this definition as proposed. Proposed comment 2(a)(1)-1 has now been incorporated into comment 2(b)(1)-1 to illustrate the broader rule of construction discussed in § 1041.2(b).

2(a)(2) Affiliate

Proposed § 1041.2(a)(2) would have defined affiliate by cross-referencing to the definition of that same term in the Dodd-Frank Act, 12 U.S.C. 5481(1). The Dodd-Frank Act defines affiliate as any person that controls, is controlled by, or is under common control with another person. Proposed §§ 1041.6 and 1041.10 would have imposed certain limitations on lenders making loans to consumers who have outstanding covered loans with an affiliate of the lender, and the Bureau's analyses of those proposed sections discussed in more detail the particular requirements related to affiliates. The Bureau stated that defining this term in the proposal consistently with the Dodd-Frank Act would reduce the risk of confusion among consumers, industry, and regulators. Although the limitations in proposed §§ 1041.6 and 1041.10 are not being finalized, the final rule includes a number of other provisions in which the term affiliate is used, including the conditional exemption in § 1041.3(f). The Bureau did not receive any comments on this portion of the proposal and is finalizing this definition as proposed.

2(a)(3) Closed-End Credit

Proposed § 1041.2(a)(3) would have defined closed-end credit as an extension of credit to a consumer that is not open-end credit under proposed § 1041.2(a)(14). This term is used in various parts of the rule where the Bureau proposed to tailor provisions specifically for closed-end and open-end credit in light of their different structures and durations. Most notably, proposed § 1041.2(a)(18) prescribed slightly different methods of calculating the total cost of credit for closed-end and open-end credit. Proposed § 1041.16(c) also required lenders to furnish information about whether a covered loan is closed-end or open-end credit to registered information systems. Proposed comment 2(a)(3)-1 also made clear that institutions may rely on 12 CFR 1026.2(a)(10) and its related commentary in determining the meaning of closed-end credit, but without regard to whether the credit is consumer credit or is extended to a consumer, as those terms are defined in 12 CFR 1026.2(a).

The Bureau did not receive any comments on the definition of closed-end credit contained in the proposal and is finalizing the definition and commentary as proposed. The Bureau did, however, receive a number of comments on the definition of open-end credit contained in the proposal and made some changes to that definition in light of the comments received, all as discussed below. Because the term closed-end credit is defined in contradistinction to the term open-end credit, the changes made to the latter definition will affect the parameters of this definition as well.

2(a)(4) Consumer

Proposed § 1041.2(a)(4) would have defined consumer by cross-referencing the definition of that term in the Dodd-Frank Act, which defines consumer as an individual or an agent, trustee, or representative acting on behalf of an individual. The term is used in numerous provisions across proposed part 1041 to refer to applicants for and borrowers of covered loans. The Bureau stated that this definition, rather than the arguably narrower Regulation Z definition of consumer—which defines consumer as “a cardholder or natural person to whom consumer credit is offered or extended”—is appropriate to capture the types of transactions that may implicate the concerns addressed by the proposed rule. In particular, the definition of this term found in the Dodd-Frank Act expressly includes agents and representatives of individuals, rather than just individuals themselves. The Bureau believed this definition might more comprehensively foreclose possible evasion of the specific consumer protections imposed by proposed part 1041 than would the definition found in Regulation Z. The Bureau did not receive any comments on this portion of the proposal and is finalizing this definition as proposed.

2(a)(5) Consummation

Proposed § 1041.2(a)(5) would have defined consummation as the time that a consumer becomes contractually obligated on a new loan, which is consistent with the definition of the term in Regulation Z § 1026.2(a)(13), or the time that a consumer becomes contractually obligated on a modification of an existing loan that increases the amount of the loan. The proposal used the term both in defining certain categories of covered loans and in defining the timing of certain proposed requirements. The time of consummation was important both in applying certain proposed definitions for purposes of coverage and in applying certain proposed substantive requirements. For example, under proposed § 1041.3(b)(1), whether a loan is a covered short-term loan would depend on whether the consumer is required to repay substantially all of the loan within 45 days of consummation. Under proposed § 1041.3(b)(2)(i), the determination of whether a loan is subject to a total cost of credit exceeding 36 percent per annum would be made at the time of consummation. Pursuant to proposed §§ 1041.6 and 1041.10, certain limitations would potentially apply to lenders making covered loans based on the consummation dates of those loans. Pursuant to proposed § 1041.15(b), lenders would have to furnish certain disclosures before a loan subject to the requirements of that section is consummated.

In the proposal, the Bureau stated that defining this term consistently with Regulation Z with respect to new loans would reduce the risk of confusion among consumers, industry, and regulators. Proposed comment 2(a)(5)-1 also made clear that the question of when a consumer would become contractually obligated with regard to a new loan is a matter to be determined under applicable law; for example, a contractual commitment agreement that binds the consumer to the loan would be a consummation. However, the comment stated that consummation does not occur merely because the consumer has made some financial investment in the transaction (for example, by paying a non-refundable fee), unless applicable law holds otherwise. The Bureau also provided guidance as to consummation with respect to particular loan modifications, so as to further the intent of proposed §§ 1041.3(b)(1) and (2), 1041.5(b), and 1041.9(b), all of which would impose requirements on lenders as of the time that the loan amount increases on an existing loan. The Bureau concluded that defining these increases in loan amounts as consummations would improve clarity for consumers, industry, and regulators. The above-referenced sections, as proposed, would impose no duties or limitations on lenders when a loan modification decreases the amount of the loan. Accordingly, in addition to incorporating Regulation Z commentary as to the general definition of consummation for new loans, proposed comment 2(a)(5)-2 explained the time at which certain modifications of existing loans would be considered to be a consummation for purposes of the rule. Proposed comment 2(a)(5)-2 explained that a modification would be considered a consummation if the modification increases the amount of the loan. Proposed comment 2(a)(5)-2 also explained that a cost-free repayment plan, or “off-ramp” as it is commonly known in the market, would not result in a consummation under proposed § 1041.2(a)(5).

In the proposal, the Bureau stated that it considered expressly defining a new loan in order to clarify when lenders would need to make the ability-to-repay determinations prescribed in proposed §§ 1041.5 and 1041.9. The definition that the Bureau considered would have defined a new loan as a consumer-purpose loan made to a consumer that (a) is made to a consumer who is not indebted on an outstanding loan, (b) replaces an outstanding loan, or (c) modifies an outstanding loan, except when a repayment plan, or “off-ramp” extends the term of the loan and imposes no additional fees.

Although some commenters requested more guidance to distinguish a loan modification from an instance of re-borrowing or a loan refinancing, the Bureau has concluded that the examples provided in the commentary sufficiently address all of the relevant scenarios where ambiguity could arise about whether consummation occurs. No other comments were received on any other aspect of this portion of the proposal. The Bureau has reworded parts of comment 2(a)(5)-2 for clarity in describing what types of loan modifications trigger substantive requirements under part 1041, but otherwise is finalizing this definition and the commentary as proposed.

2(a)(6) Cost of Credit

Proposed § 1041.2(a)(18) set forth the method for lenders to calculate the total cost of credit to determine whether a longer-term loan would be covered under proposed § 1041.3(b)(2). Proposed § 1041.2(a)(18) generally would have defined the total cost of credit as the total amount of charges associated with a loan expressed as a per annum rate, including various charges that do not meet the definition of finance charge under Regulation Z. The charges would be included even if they were paid to a party other than the lender. The Bureau proposed to adopt this approach to defining loan costs from the Military Lending Act, and also to have adopted the MLA's 36 percent threshold in defining what covered longer-term loans were subject to part 1041. The effect would have been that a loan with a term of longer than 45 days must have a total cost of credit exceeding a rate of 36 percent per annum in order to be a covered loan. The Bureau thus proposed using an all-in measure of the total cost of credit rather than the definition of annual percentage rate (APR) under Regulation Z because it was concerned that lenders might otherwise shift their fee structures to fall outside traditional Regulation Z concepts. This in turn would lead them to fall outside the proposed underwriting criteria for covered longer-term loans, which they could do, for example, by imposing charges in connection with a loan that are not included in the calculation of APR under Regulation Z.

The Bureau acknowledged that lenders were less familiar with the approach involving the MLA calculations than they are with the more traditional APR approach and calculations under Regulation Z. Therefore, the Bureau specifically sought comment on the compliance burdens of the proposed approach and whether to use the more traditional APR approach instead.

The Bureau received many comments on the definition of the total cost of credit, which reflected its functional position in the proposed rule as the trigger for the additional underwriting criteria applicable to covered longer-term loans. A number of comments addressed what kinds of fees and charges should be included or excluded from the total cost of credit and demanded more technical guidance, which reflected the increased complexity of using this method. One lender noted a specific loan program that would only be included in the rule because of the inclusion of participation fees in the proposed definition. Various commenters noted the greater simplicity of the APR calculation in Regulation Z, and contended that greater burdens would be imposed and less clarity achieved by applying the proposed definition of total cost of credit. The latter, they suggested, would confuse consumers who are accustomed to Regulation Z's APR definition, would be difficult to administer properly, and would be likely to have unintended consequences, such as causing many lenders to choose not to offer optional ancillary products like credit life and disability insurance, to the detriment of borrowers. Consumer groups, by contrast, generally preferred the proposed definition of total cost of credit, though they offered suggestions to tighten and clarify it in several respects.

As noted earlier, the Bureau is not finalizing the portions of the proposed rule governing underwriting criteria for covered longer-term loans at this time. Given that covered longer-term loans are only subject to the payment requirements in subpart C, and in view of the comments received, the Bureau concludes that the advantages of simplicity and consistency militate in favor of adopting an APR threshold as the measure of the cost of credit, which is widely accepted and built into many State laws, and which is the cost that will be disclosed to consumers under Regulation Z. Moreover, the Bureau believes that the other changes in the rule mean that the basis for concern that lenders would shift their fee structures to fall outside traditional Regulation Z definitions has been reduced. Instead, the cost-of-credit threshold is now relevant only to determine whether the portions of the final rule governing payments apply to longer-term loans, which the Bureau has concluded are much less likely to prompt lenders to seek to modify their fee structures simply to avoid the application of those provisions.

The Bureau notes that in determining here that the Regulation Z definition of cost of credit would be simpler and easier to use for the limited purpose of defining the application of the payment provisions of subpart C of this rule, the Bureau does not intend to decide or endorse this measure of the cost of credit—as contrasted with the total cost of credit adopted under the MLA—for any subsequent rule governing the underwriting of covered longer-term loans without balloons. The stricter and more encompassing measure used for the MLA rule may well be more protective of consumers, and the Bureau will consider the applicability of that measure as it considers how to address longer-term loans in a subsequent rule.

To effectuate this change, the Bureau has adopted as the final rule's defined term “cost of credit,” which is an APR threshold rather than a threshold based on the total cost of credit as defined in the proposed rule. The cost of credit is defined to be consistent with Regulation Z and thus includes finance charges associated with the credit as stated in Regulation Z, 12 CFR 1026.4. As discussed further below in connection with § 1041.3(b)(3), for closed-end credit, the total cost of credit must be calculated at consummation and according to the requirements of Regulation Z, 12 CFR 1026.22, but would not have to be recalculated at some future time, even if a leveraged payment mechanism is not obtained until later. For open-end credit, the total cost of credit must be calculated at consummation and, if it does not cross the 36 percent threshold at that time, at the end of each billing cycle thereafter according to the rules for calculating the effective annual percentage rate for a billing cycle as stated in Regulation Z, 12 CFR 1026.14(c) and (d). This is a change from the proposal in order to determine coverage in situations in which there may not be an immediate draw, which was not expressly addressed in the proposal.

The Bureau has concluded that defining the term cost of credit consistently with Regulation Z would reduce the risk of confusion among consumers, industry, and regulators. It also reduces burden and avoids undue complexities, especially now that the Bureau is not finalizing the underwriting criteria that were proposed for covered longer-term loans at this time. For these reasons, the Bureau is finalizing the definition of cost of credit in a manner consistent with the discussion above, as renumbered, and with some minor additional wording revisions from the proposed rule for clarity and consistency. The proposed commentary associated with the term total cost of credit is no longer relevant and has been omitted from the final rule.

2(a)(7) Covered Longer-Term Balloon-Payment Loan

Proposed § 1041.2(a)(7) would have defined a covered longer-term balloon-payment loan as a covered longer-term loan described in proposed § 1041.3(b)(2)—as further specified in the next definition below—where the consumer is required to repay the loan in a single payment or through at least one payment that is more than twice as large as any other payment(s) under the loan. Proposed § 1041.9(b)(2) contained certain rules that lenders would have to follow when determining whether a consumer has the ability to repay a covered longer-term balloon-payment loan. Moreover, some of the restrictions imposed in proposed § 1041.10 would apply to covered longer-term balloon-payment loans in certain situations.

The term covered longer-term balloon-payment loan would include loans that are repayable in a single payment notwithstanding the fact that a loan with a “balloon” payment is often understood in other contexts to mean a loan repayable in multiple payments with one payment substantially larger than the other payments. In the proposal, the Bureau found as a preliminary matter that both structures pose similar risks to consumers, and proposed to treat both types of loans the same way for the purposes of proposed §§ 1041.9 and 1041.10. Accordingly, the Bureau proposed to use a single defined term for both loan types to improve the proposal's readability.

Apart from including single-payment loans within the definition of covered longer-term balloon-payment loans, the proposed term substantially tracked the definition of balloon payment contained in Regulation Z § 1026.32(d)(1), with one additional modification. The Regulation Z definition requires the larger loan payment to be compared to other regular periodic payments, whereas proposed § 1041.2(a)(7) required the larger loan payment to be compared to any other payment(s) under the loan, regardless of whether the payment is a regular periodic payment. Proposed comments 2(a)(7)-2 and 2(a)(7)-3 explained that payment in this context means a payment of principal or interest, and excludes certain charges such as late fees and payments that are accelerated upon the consumer's default. Proposed comment 2(a)(7)-1 would have specified that a loan described in proposed § 1041.3(b)(2) is considered to be a covered longer-term balloon-payment loan if the consumer must repay the entire amount of the loan in a single payment.

A coalition of consumer advocacy groups commented that this proposed definition is under-inclusive because it fails to include other loans that create risk that consumers will need to re-borrow because larger payments inflict payment shock on the borrowers. The commenter suggested that a more appropriate definition would be the one found in the North Carolina Retail Installment Sales Act, which defines a balloon payment as a payment that is more than 10 percent greater than other payments, except for the final payment, which is a balloon payment if it is more than 25 percent greater than other payments. In light of this comparison, the commenter recommended that any payment that is 10 percent greater than any other payment should be considered a balloon payment.

The Bureau recognizes these concerns, but notes that the proposed definition is generally consistent with how balloon-payment loans are defined and treated under Regulation Z, and therefore believes that adopting that definition for purposes of this rule would promote consistency and reduce the risk of confusion among consumers, industry, and regulators. The Bureau will be alert to the risk that smaller irregular payments that are not as large as twice the amount of the other payments could still cause expense shock for some consumers and lead to the kinds of problems addressed here, and thus could trigger a finding of unfairness or abusiveness in particular circumstances. In addition, the Bureau has experience with the rules adopted to implement the Military Lending Act, where loan products and lending practices adopted by some lenders in this industry evolved to circumvent the provisions of those rules. In particular, as noted in the proposal, lenders began offering payday loans greater than 91 days in duration and vehicle title loans greater than 181 days in duration, along with open-end products, in a direct response intended to evade the MLA rules—a development that prompted further Congressional and regulatory intervention. If problems begin to appear in this market from practices that are intended to circumvent the provisions of this rule, the Bureau and other regulators would be able to address any unfair or abusive practices with respect to such loan products through supervision or enforcement authority, or by amending this rule to broaden the definition.

Some industry commenters contended that the Bureau's concerns about re-borrowing for covered longer-term loans were most applicable to loans with balloon-payment structures, and they therefore argued that any ability-to-repay restrictions and underwriting criteria should be limited to longer-term balloon-payment loans. The Bureau agrees that many of its concerns about covered longer-term balloon-payment loans are similar to its concerns about covered short-term loans. Yet the Bureau also has considerable concerns about certain lending practices with respect to other covered longer-term loans, and will continue to scrutinize those practices under its supervision and enforcement authority and in a future rulemaking. At this time, however, as described more fully below in the section on Market Concerns—Underwriting, the Bureau has observed longer-term loans involving balloon payments where the lender does not reasonably assess the borrower's ability to repay before making the loan, and in those circumstances it has observed many of the same types of consumer harms that it has observed when lenders fail to reasonably assess the borrower's ability to repay before making covered short-term loans.

As noted in part I, for a number of reasons the Bureau has decided not to address the underwriting of all covered longer-term loans at this time. Nonetheless, as just mentioned and as discussed more fully below in Market Concerns—Underwriting, the Bureau is concerned that if subpart B is not applied to covered longer-term balloon-payment loans, then lenders would simply extend the terms of their current short-term products beyond 45 days, without changing the payment structures of those loans or their current inadequate underwriting practices, as a way to circumvent the underwriting criteria for covered short-term loans. As stated above, the balloon-payment structure of these loans tend to pose very similar risks and harms to consumers as for covered short-term loans, including likely poses similar forecasting problems for consumers in repaying such loans. Therefore, in § 1041.5 of the final rule, the specific underwriting criteria that apply to covered short-term loans are made applicable to covered longer-term balloon-payment loans also. The Bureau has also modified the definition of covered longer-term balloon-payment loan so that it applies to all loans with the payment structures described in the proposal. This represents an expansion in scope as compared to the proposal, as longer-term balloon-payment loans are now being covered without regard to the cost of credit or whether the lender has taken a leveraged payment mechanism in connection with the loan. In the proposal, the Bureau specifically sought comment on this potential modification, and the reasons for it are set out more extensively below in Market Concerns—Underwriting. And along with other covered longer-term loans, these particular loans remain covered by the sections of the final rule on payments as well.

In light of the decision to treat covered longer-term balloon-payment loans differently from other covered longer-term loans, the Bureau decided to shift the primary description of the requirements for covered longer-term balloon-payment loans to § 1041.3(b)(2). Accordingly, the language of § 1041.2(a)(7) of the final rule has been revised to mirror the language of § 1041.2(a)(8) and (10), which simply cross-reference the descriptions of the various types of covered loans specified in proposed § 1041.3(b). As a housekeeping matter, therefore, the substantive definition for longer-term balloon-payment loans is now omitted from this definition and is addressed instead in a comprehensive manner in § 1041.3(b)(2) of this final rule, where it has been expanded to address in more detail various loan structures that constitute covered longer-term balloon-payment loans. For the same reason, proposed comments 2(a)(7)-1 to 2(a)(7)-3 are omitted from the final rule and those matters are addressed in comments 3(b)(2)-1 to 3(b)(2)-4 of the final rule, as discussed below.

The term covered longer-term balloon-payment loan is therefore defined in the final rule as a loan described in § 1041.3(b)(2).

2(a)(8) Covered Longer-Term Loan

Proposed § 1041.2(a)(8) would have defined a covered longer-term loan to be a loan described in proposed § 1041.3(b)(2). That proposed section, in turn, described a covered loan as one made to a consumer primarily for personal, family, or household purposes that is not subject to any exclusions or exemptions, and which can be either: (1) Closed-end credit that does not provide for multiple advances to consumers, where the consumer is not required to repay substantially the entire amount due under the loan within 45 days of consummation; or (2) all other loans (whether open-end credit or closed-end credit), where the consumer is not required to repay substantially the entire amount of the advance within 45 days of the advance under the loan and, in either case, two other conditions are satisfied—the total cost of credit for the loan exceeds an annual rate of 36 percent, as measured at specified times; and the lender or service provider obtains a leveraged payment mechanism, including but not limited to vehicle security, at specified times.

Some restrictions in proposed part 1041 would have applied only to covered longer-term loans described in proposed § 1041.3(b)(2). For example, proposed § 1041.9 would have prescribed the ability-to-repay determination that lenders are required to perform when making covered longer-term loans. Proposed § 1041.10 would have imposed limitations on lenders making covered longer-term loans to consumers in certain circumstances that may indicate the consumer lacks the ability to repay. The Bureau proposed to use a defined term for the loans described in proposed § 1041.3(b)(2) for clarity.

The Bureau received many comments on this definition that focused primarily on whether the definition was appropriate for purposes of the proposed underwriting requirements or for inclusion in the rulemaking generally, rather than with regard to the payment interventions in particular. A law firm representing a traditional installment lending client commented that the definition of covered longer-term loan in the proposed rule would include traditional installment loans to a greater extent than the Bureau anticipated, with a correspondingly larger impact on credit availability as installment lenders would be forced to replace their proven underwriting techniques with burdensome and untried approaches. Others contended that the Bureau had presented no evidence indicating that the practices associated with traditional installment loans are unfair or abusive.

Several commenters noted that a number of traditional installment loan products may exceed a total cost of credit of 36 percent, and some may even exceed a 36 percent annual percentage rate under TILA as well. A trade association said that such a stringent all-in annual percentage rate could encompass many bank loan products. More broadly, some commenters criticized the use of any form of interest rate threshold to determine the legal status of any loans as potentially violating the prohibition in section 1027(o) of the Dodd-Frank Act against imposing usury limits on extensions of consumer credit.

Many commenters offered their views on the prong of the definition that focused on the taking of a leveraged payment mechanism or vehicle security, again often in the context of application of the underwriting requirements rather than the payment requirements. Those concerns have largely been addressed or mooted by the Bureau's decisions to apply only the payment requirements to covered longer-term loans and to narrow the definition of such loans to focus only on those types of leveraged payment mechanisms that involve the ability to pull money from consumers' accounts, rather than vehicle security. Comments focusing on that narrower definition of leveraged payment mechanism are addressed in more depth in connection with § 1041.3(c) below.

Therefore, in light of these comments and the considerations discussed above and in connection with § 1041.3(b)(3) below, the Bureau is finalizing the definition of covered longer-term loan in § 1041.2(a)(8) as discussed, with the cross-reference to proposed § 1041.3(b)(2) now edited and renumbered as § 1041.3(b)(3). As for the latter section now referenced in this definition, it too has been edited to clarify that covered longer-term loans no longer encompass covered longer-term balloon-payment loans, which are now treated separately, as the former are no longer subject to specific underwriting criteria whereas the latter are subject to the same specific underwriting criteria as covered short-term loans, which are set out in § 1041.5 of the final rule.

The term covered longer-term loan is therefore defined in the final rule, as described in § 1041.3(b)(3), as one made to a consumer primarily for personal, family, or household purposes that is not subject to any exclusions or exemptions, and which can be neither a covered short-term loan nor a covered longer-term balloon-payment loan—and thus constitutes a covered longer-term loan without a balloon-payment structure—and which meets both of the following conditions: The cost of credit for the loan exceeds a rate of 36 percent per annum; and the lender or service provider obtains a leveraged payment mechanism as defined in § 1041.3(c) of the final rule.

The details of that description, and how it varies from the original proposed description of a covered longer-term loan, are provided and explained more fully in the section-by-section analysis of § 1041.3(b)(3) of the final rule.

2(a)(9) Covered Person

The Bureau has decided to include in the final rule a definition of the term covered person, which the final rule defines by cross-referencing the definition of that same term in the Dodd-Frank Act, 12 U.S.C. 5481(6). In general, the Dodd-Frank Act defines covered person as any person that engages in offering or providing a consumer financial product or service and any affiliate of such person if the affiliate acts as a service provider to such person. The Bureau concludes that defining the term covered person consistently with the Dodd-Frank Act is a mere clarification that reduces the risk of confusion among consumers, industry, and regulators, since this term is used throughout the final rule. The Bureau therefore is including this definition in the final rule as § 1041.2(a)(9).

2(a)(10) Covered Short-Term Loan

Proposed § 1041.2(a)(6) would have defined a covered short-term loan to be a loan described in proposed § 1041.3(b)(1). That proposed section, in turn, described a covered loan as one made to a consumer primarily for personal, family, or household purposes that is not subject to any exclusions or exemptions, and which can be either: Closed-end credit that does not provide for multiple advances to consumers, where the consumer is required to repay substantially the entire amount due under the loan within 45 days of consummation, or all other loans (whether open-end credit or closed-end credit), where the consumer is required to repay substantially the entire amount of the advance within 45 days of the advance under the loan. Some provisions in proposed part 1041 would apply only to covered short-term loans as described in proposed § 1041.3(b)(1). For example, proposed § 1041.5 would prescribe the ability-to-repay determination that lenders are required to perform when making covered short-term loans. Proposed § 1041.6 would impose limitations on lenders making sequential covered short-term loans to consumers. And proposed § 1041.16 would impose the payment provisions on covered short-term loans as well. The Bureau proposed to use a defined term for the loans described in § 1041.3(b)(1) for clarity.

Various commenters stated that this definition is extraordinarily broad and sweeps in many different types of short-term loans, and institutions and trade associations both argued for exempting the types of loans they or their members commonly make. For example, one credit union commenter argued that the Bureau should exclude loans with total cost of credit under 36 percent. Consumer advocates argued, to the contrary, that broad coverage under the proposed rule is necessary to capture the relevant market, which can differ legally and functionally from one State to another. The Bureau finds that covered short-term loans pose substantial risks and harms for consumers, as it has detailed more thoroughly below in Market Concerns—Underwriting and the section-by-section analysis for § 1041.4 of the final rule. At the same time, the Bureau is adopting various exclusions and exemptions from coverage under the rule in § 1041.3(d), (e), and (f) below, and has discussed commenters' requests for exclusions of various categories of loans and lenders in connection with those provisions. The Bureau has expanded the alternative loan exclusion, which now triggers off of cost of credit as defined under Regulation Z, and thus, it appears likely that the products of the credit union noted above are excluded. In light of the aggregate effect of this broad definition coupled with those exclusions and exemptions, the Bureau concludes that its definition of covered short-term loan is specific, yet necessarily broad in its coverage, in order to effectuate protections for consumers against practices that the Bureau has found to be unfair and abusive in the market for these loans. The Bureau is finalizing as proposed other than renumbering. Likewise, the provision referenced in this definition—proposed § 1041.3(b)(1)—is being finalized with only non-substantive language changes, though additional commentary on that provision has been added in the final rule and will be addressed below in the discussion of that portion of the rule.

2(a)(11) Credit

Proposed § 1041.2(a)(9) would have defined credit by cross-referencing the definition of credit in Regulation Z, 12 CFR part 1026. Regulation Z defines credit as the right to defer payment of debt or to incur debt and defer its payment. This term was used in numerous places throughout the proposal to refer generically to the types of consumer financial products that would be subject to the requirements of proposed part 1041. The Bureau stated that defining this term consistently with an existing regulation would reduce the risk of confusion among consumers, industry, and regulators. The Bureau also stated that the definition in Regulation Z is appropriately broad so as to capture the various types of transaction structures that implicate the concerns addressed by proposed part 1041. Proposed comment 2(a)(9) further made clear that institutions may rely on 12 CFR 1026.2(a)(14) and its related commentary in determining the meaning of credit.

One consumer group commented that the definition of credit did not include a definition of loan and that these commonly related terms should be clarified to avoid the potential for confusion—a point that is addressed in §§ 1041.2(a)(13) and 1041.3(a) of the final rule. The Bureau did not receive any other comments on this portion of the proposal and is finalizing this definition and the commentary as proposed.

2(a)(12) Electronic Fund Transfer

Proposed § 1041.2(a)(10) would have defined electronic fund transfer by cross-referencing the definition of that same term in Regulation E, 12 CFR part 1005. Proposed § 1041.3(c) would provide that a loan may be a covered longer-term loan if the lender or service provider obtains a leveraged payment mechanism, which can include the ability to withdraw payments from a consumer's account through an electronic fund transfer. Proposed § 1041.14 would impose limitations on how lenders use various payment methods, including electronic fund transfers. Proposed comment 2(a)(10)-1 also made clear that institutions may rely on 12 CFR 1005.3(b) and its related commentary in determining the meaning of electronic fund transfer. The Bureau stated that defining this term consistently with an existing regulation would reduce the risk of confusion among consumers, industry, and regulators. The Bureau did not receive any comments on this portion of the proposal and is finalizing this definition as renumbered and the commentary as proposed.

2(a)(13) Lender

Proposed § 1041.2(a)(11) would have defined lender as a person who regularly makes loans to consumers primarily for personal, family, or household purposes. This term was used throughout the proposal to refer to parties that are subject to the requirements of proposed part 1041. This proposed definition is broader than the general definition of creditor under Regulation Z in that, under this proposed definition, the credit that the lender extends need not be subject to a finance charge as that term is defined by Regulation Z, nor must it be payable by written agreement in more than four installments.

The Bureau proposed a broader definition than in Regulation Z for many of the same reasons that it proposed using the total cost of credit as a threshold for covering longer-term loans rather than the traditional definition of annual percentage rate as defined by Regulation Z, which was discussed in the analyses of §§ 1041.2(a)(11) and 1041.3(b)(2)(i) of the proposed rule. In both instances, the Bureau was concerned that lenders might otherwise shift their fee structures to fall outside of traditional Regulation Z concepts and thus outside the coverage of proposed part 1041. For example, the Bureau stated that some loans that otherwise would meet the requirements for coverage under proposed § 1041.3(b) could potentially be made without being subject to a finance charge as that term is defined by Regulation Z. If the Bureau adopted that particular Regulation Z requirement in the definition of lender, a person who regularly extended closed-end credit subject only to an application fee, or open-end credit subject only to a participation fee, would not be deemed to have imposed a finance charge. In addition, many of the loans that would be subject to coverage under proposed § 1041.3(b)(1) are repayable in a single payment, so those same lenders might also fall outside the Regulation Z trigger for loans payable in fewer than four installments. Thus, the Bureau proposed to use a definition that is broader than the one contained in Regulation Z to ensure that the provisions proposed in part 1041 would apply as intended.

The Bureau proposed to carry over from the Regulation Z definition of creditor the requirement that a person “regularly” makes loans to a consumer primarily for personal, family, or household purposes in order to be considered a lender under proposed part 1041. Proposed comment 2(a)(11)-1 explained that the test for determining whether a person regularly makes loans is the same as in Regulation Z, as explained in 12 CFR 1026.2(a)(17)(v), and depends on the overall number of loans made to a consumer for personal, family, or household purposes, not just covered loans. The Bureau stated in the proposal that it would be appropriate to exclude from the definition of lender those persons who make loans for personal, family, or household purposes on an infrequent basis so that persons who only occasionally make loans would not be subject to the requirements of proposed part 1041. Such persons could include charitable, religious, or other community institutions that make loans very infrequently or individuals who occasionally make loans to family members.

Consumer groups noted in commenting on the definition of lender that the proposed rule did not explicitly define what a loan is and urged the Bureau to include a definition of this term as well, as it is used frequently throughout the rule. They also commented that the definition of lender should be broadened to encompass service providers as well.

For the reasons explained above in the section-by-section analysis of § 1041.2(a)(6), with respect to the definition of the term cost of credit, the Bureau has now narrowed the coverage of longer-term loans by using a threshold that is based on finance charges under Regulation Z rather than the broader range of items included in the proposed definition of total cost of credit. At the same time, it has decided to maintain the broader definition of lender, which includes parties that extend credit even if it is not subject to a finance charge as defined in Regulation Z, nor payable by written agreement in more than four installments. With regard to covered short-term and longer-term balloon-payment loans, the Bureau has concluded that it is important to maintain broad coverage over such products, even if the companies that provide them may try to structure them so as to avoid qualifying as a “creditor” under Regulation Z. The reasons for revising the definition of cost of credit, again as explained further below, were driven in large part by the Bureau's decision not to address the underwriting of other covered longer-term loans in this rule at this time, given the benefits of alignment with Regulation Z and greater simplicity. The broader definition of lender remains germane, however, to the types of loans that are subject to the underwriting provisions of the final rule.

In addition, the Bureau does not find it necessary to supplement these definitions further by adding a new definition of loan in addition to the modified definitions of credit and lender. Instead, the Bureau is addressing the commenters' point by modifying the definition of lender in § 1041.2(a)(13) to refer to a person who regularly “extends credit” rather than making loans, and has revised § 1041.3(a) to refer to a lender who “extends credit by making covered loans.” The loans covered by the final rule are credit as defined in the rule and are made by lenders as defined in the rule. In addition, key subsets of the broader universe of loans—including covered short-term loans, covered longer-term loans, and covered longer-term balloon-payment loans—are also defined explicitly in the final rule. And these definitions are premised in turn on the explication of what is a covered loan in proposed § 1041.3(b). As for the relationship between the terms lender and service provider, the Bureau is satisfied that these relationships and their effects are addressed in a satisfactory manner by defining lender as set forth here and by including separate definitions of covered person and service provider in conformity to the Dodd-Frank Act, as discussed in § 1041.2(a)(9) and (18) of the final rule. The relationship between lender and service provider is discussed further below in the section-by-section analysis of § 1041.2(a)(18), which concerns the definition of service provider.

One other segment of commenters sought to be excluded or exempted from coverage under this rule, raising many of the same points that they had raised during Bureau outreach prior to release of the proposal.

As stated in the proposal, some stakeholders had suggested to the Bureau that the definition of lender should be narrowed so as to exempt financial institutions that predominantly make loans that would not be covered loans under the proposed rule. They stated that some financial institutions only make loans that would be covered loans as an accommodation to existing customers, and that providing such loans is such a small part of the overall business that it would not be practical for the institutions to develop the required procedures for making covered loans. The Bureau solicited comment on whether it should narrow the definition of lender based on the quantity of covered loans an entity offers, and, if so, how to define such a de minimis test. Similarly, during the comment period many commenters, including but not limited to smaller depository institutions, presented their views that this kind of accommodation lending is longstanding and widespread and so should not be subject to coverage under the rule.

At the same time, stakeholders had urged and the Bureau recognized at the time it issued the proposed rule that some newly formed companies are providing services that, in effect, allow consumers to draw on money they have earned but not yet been paid. Certain of these services do not require the consumer to pay any fees or finance charges, relying instead on voluntary “tips” to sustain the business, while others are compensated through electronic fund transfers from the consumer's account. Some current or future services may use other business models. The Bureau also noted the existence of some newly formed companies providing financial management services to low- and moderate-income consumers that include features to smooth income. The Bureau solicited comment on whether such entities should be considered lenders under the regulation.

During the public comment period, a coalition of consumer groups, some “fintech” firms, and others expressed concern about how the definition of lender would apply to new businesses that are creating services to consumers to access earned income for a fee—thereby jeopardizing certain promising innovations by making them subject to the constraining provisions of this rule—and others offered views on that set of issues as well. Commenters also offered their thoughts on other innovative income-smoothing and financial-management initiatives.

The Bureau has decided to address the issues raised by commenters that were seeking an exclusion or exemption from this rule not by altering the definition of lender but instead by fashioning specific exclusions and conditional exemptions as addressed below in § 1041.3(d), (e), and (f) of the final rule.

Therefore in light of the comments and responses, the Bureau is finalizing this definition as renumbered and the commentary as proposed, with the one modification—use of the phrase “extends credit”—as discussed above.

2(a)(14) Loan Sequence or Sequence

Proposed § 1041.2(a)(12) generally would have defined a loan sequence or sequence as a series of consecutive or concurrent covered short-term loans in which each of the loans (other than the first loan) is made while the consumer currently has an outstanding covered short-term loan or within 30 days thereafter. It would define both loan sequence and sequence the same way because the terms are used interchangeably in various places throughout the proposal. Furthermore, it also specified how to determine a given loan's place within a sequence (for example, whether a loan constitutes the first, second, or third loan in a sequence), which would implicate other provisions of the proposed rule.

The Bureau's rationale for proposing to define loan sequence in this manner was discussed in more detail in the section-by-section analysis of proposed §§ 1041.4 and 1041.6. The Bureau also sought comment on whether alternative definitions of loan sequence may better address its concerns about how a consumer's inability to repay a covered loan may cause the need for a successive covered loan.

Some consumer advocates commented that this definition would be clarified by including language from local ordinances or State laws that have the same effective meaning so as to avoid any confusion in compliance and enforcement. Consumer groups commented that the rule should treat a loan made within 60 days of another loan, rather than 30 days, as part of the same loan sequence in order to better effectuate its purpose of addressing the flipping of both short-term and longer-term loans and to include late fees as rollover fees. Some industry commenters argued for a shorter period.

The Bureau has considered a number of ways to specify and clarify the definition of loan sequences in order to minimize or avoid evasions of the final rule. Adopting local or State definitions would not appear to clarify the issues, as they are inconsistent from one jurisdiction to another. However, as discussed in greater detail below in Market Concerns—Underwriting and in §§ 1041.4 and 1041.5(d) of the final rule, the Bureau has decided to incorporate covered longer-term balloon-payment loans into this definition, reflecting concerns about the harms that can occur to consumers who take out a series of covered longer-term balloon-payment loans in quick succession as well as the Bureau's concerns about potential evasions of the underwriting criteria.

As discussed in the proposal, the Bureau also has considered various time frames for the definition of loan sequence, including 14 days as well as 30 days and 60 days, and decided in finalizing the rule to adhere to 30 days as a reasonable and appropriate frequency for use in this definition, to align with consumer expense cycles, which often involve recurring expenses that are typically a month in length. This is designed to account for the fact that where repaying a loan causes a shortfall, the consumer may seek to return during the same expense cycle to get funds to cover downstream expenses. In addition, a number of consumers receive income on a monthly basis. The various considerations involved in resolving these issues are discussed more fully in the section-by-section analysis of § 1041.5(d) of the final rule.

In light of the discussion above, the Bureau otherwise is finalizing this renumbered definition as modified. In addition, wherever the proposed definition had referred to a covered short-term loan, the definition in the final rule refers instead to a covered short-term loan or a covered longer-term balloon-payment loan—or, where pluralized, the definition in the final rule refers instead to covered short-term loans or covered longer-term balloon-payment loans, or a combination thereof.

2(a)(15) Motor Vehicle

In connection with proposing to subject certain longer-term loans with vehicle security to part 1041, in proposed § 1041.3(d) the Bureau would have defined vehicle security to refer to the term motor vehicle as defined in section 1029(f)(1) of the Dodd-Frank Act. That definition encompasses not only vehicles primarily used for on-road transportation, but also recreational boats, motor homes, and other categories. As described below, the Bureau has now decided to narrow the definition of covered-longer term loan to focus only on loans that meet a certain rate threshold and involve the taking of a leveraged payment mechanism as defined in § 1041.3(c) of the final rule, without regard to whether vehicle security is taken on the loan. However, the definitions of vehicle security and motor vehicle are still relevant to § 1041.6(b)(3), which prohibits lenders from making covered short-term loans under § 1041.6 if they take vehicle security in connection with such a loan, for the reasons explained in the section-by-section analysis of that provision.

Upon further consideration in light of this context and its experience from other related rulemakings, the Bureau has decided to narrow the definition of motor vehicle in the final rule to focus on any self-propelled vehicle primarily used for on-road transportation, but not including motor homes, recreational vehicles, golf carts, and motor scooters. Some commenters did suggest that vehicle title loans should encompass boats, motorcycles, and manufactured homes. Nonetheless, the Bureau has concluded that it is more appropriate to use a narrower definition because the term motor vehicle is germane to the vehicle title loans addressed in the final rule, which involve the prospect of repossession of the vehicle for failing to repay the loan. The impact to consumers from default or repossession likely operates differently for basic on-road transportation used to get to work or manage everyday affairs, thus creating different pressures to repay loans based on these kinds of vehicles as compared to loans based on other forms of transportation.

Moreover, from the Bureau's prior experience of writing rules with respect to vehicles, most notably in the Bureau's larger participant rule authorizing its supervision authority over certain entities in the market for auto loans, it is aware that treatment of this category of items requires clarification in light of what can be some difficult and unexpected boundary issues. The definition included here in § 1041.2(a)(15) of the final rule is thus similar to the language used in the Bureau's larger participant rule for the auto loan market, which generally encompasses the kinds of vehicles—specifically cars and trucks and motorcycles—that consumers primarily use for on-road transportation rather than for housing or recreation. The Bureau also notes that it had proposed to exclude loans secured by manufactured homes under § 1041.3(e)(2), and has finalized that provision in § 1041.3(d)(2) as discussed below.

2(a)(16) Open-End Credit

Proposed § 1041.2(a)(14) would have defined open-end credit by cross-referencing the definition of that same term in Regulation Z, 12 CFR part 1026, but without regard to whether the credit is consumer credit, as that term is defined in Regulation Z § 1026.2(a)(12), is extended by a creditor, as that term is defined in Regulation Z § 1026.2(a)(17), or is extended to a consumer, as that term is defined in Regulation Z § 1026.2(a)(11). In general, Regulation Z § 1026.2(a)(20) provides that open-end credit is consumer credit in which the creditor reasonably contemplates repeated transactions, the creditor may impose a finance charge from time to time on an outstanding unpaid balance, and the amount of credit that may be extended to the consumer during the term of the plan (up to any limit set by the creditor) is generally made available to the extent that any outstanding balance is repaid. For the purposes of defining open-end credit under proposed part 1041, the term credit, as defined in proposed § 1041.2(a)(9), was substituted for the term consumer credit in the Regulation Z definition of open-end credit; the term lender, as defined in proposed § 1041.2(a)(11), was substituted for the term creditor in the same Regulation Z definition; and the term consumer, as defined in proposed § 1041.2(a)(4), was substituted for the term consumer in the Regulation Z definition of open-end credit.

The term open-end credit was used in various parts of the proposal where the Bureau tailored requirements separately for closed-end and open-end credit in light of their different structures and durations. Most notably, proposed § 1041.2(a)(18) would require lenders to employ slightly different methods when calculating the total cost of credit of closed-end versus open-end loans. Proposed § 1041.16(c) also would require lenders to report whether a covered loan is a closed-end or open-end loan.

In the proposal, the Bureau stated that generally defining this term consistently across regulations would reduce the risk of confusion among consumers, industry, and regulators. With regard to the definition of consumer, however, the Bureau proposed that, for the reasons discussed in connection with proposed § 1041.2(a)(4), it would be more appropriate to incorporate the definition from the Dodd-Frank Act rather than the definition from Regulation Z, which is arguably narrower. Similarly, the Bureau indicated that it would be more appropriate to use the broader definition of lender contained in proposed § 1041.2(a)(11) than the Regulation Z definition of creditor.

One commenter recommended that the Bureau defer action on lines of credit entirely (not just overdraft lines of credit as would be excluded in proposed § 1041.3) and address these loan products in a future rulemaking. A number of commenters stated that the underwriting criteria for such products should be aligned with the provisions of the Credit CARD Act and the Bureau's rule on prepaid accounts, and raised questions about the timing calculations on line-of-credit payments.

In response, the Bureau continues to judge it to be important to address open-end lines of credit in this rule in order to achieve more comprehensive coverage, outside of those lines of credit that are excluded under final § 1041.3(d)(6) as discussed below. In response to many comments, including those urging closer alignment with other standards for assessing ability to repay under other statutory schemes, the Bureau has also modified the underwriting criteria in § 1041.5 of the final rule in a number of respects, as explained further below.

The Bureau is therefore finalizing § 1041.2(a)(16) largely as proposed, with one substantive clarification that credit products that otherwise meet the definition of open-end credit under Regulation Z should not be excluded from the definition of open-end credit under § 1041.2(a)(16) because they do not involve a finance charge. This change will assure that products are appropriately classified as open-end credit under part 1041, rather than as closed-end credit. The Bureau has also revised comment 2(a)(16)-1 to reflect this change and to streamline guidance clarifying that for the purposes of defining open-end credit under part 1041, the term credit, as defined in § 1041.2(a)(11), is substituted for the term consumer credit, as defined in 12 CFR 1026.2(a)(12); the term lender, as defined in § 1041.2(a)(13), is substituted for the term creditor, as defined in 12 CFR 1026.2(a)(17); and the term consumer, as defined in § 1041.2(a)(4), is substituted for the term consumer, as defined in 12 CFR 1026.2(a)(11).

For all the reasons discussed above, the Bureau is finalizing this definition and the commentary as renumbered and revised.

2(a)(17) Outstanding Loan

Proposed § 1041.2(a)(15) would have generally defined outstanding loan as a loan that the consumer is legally obligated to repay, except that a loan ceases to be outstanding if the consumer has not made any payments on the loan within the previous 180 days. Under this definition, a loan is an outstanding loan regardless of whether the loan is delinquent or subject to a repayment plan or other workout arrangement if the other elements of the definition are met. Under proposed § 1041.2(a)(12), a covered short-term loan would be considered to be within the same loan sequence as a previous such loan if it is made within 30 days of the consumer having the previous outstanding loan. Proposed §§ 1041.6 and 1041.7 would impose certain limitations on lenders making covered short-term loans within loan sequences, including a prohibition on making additional covered short-term loans for 30 days after the third loan in a sequence.

In the proposal, the Bureau stated that if the consumer has not made any payment on the loan for an extended period of time, it may be appropriate to stop considering the loan to be an outstanding loan for the purposes of various provisions of the proposed rule. Because outstanding loans are counted as major financial obligations for purposes of underwriting and because treating a loan as outstanding would trigger certain restrictions on further borrowing by the consumer under the proposed rule, the Bureau attempted to balance several considerations in crafting the proposed definition. One is whether it would be appropriate for very stale and effectively inactive debt to prevent the consumer from accessing credit, even if so much time has passed that it seems relatively unlikely that the new loan is a direct consequence of the unaffordability of the previous loan. Another is how to define such stale and inactive debt for purposes of any cut-off, and to account for the risk that collections might later be revived or that lenders would intentionally exploit a cut-off in an attempt to encourage new borrowing by consumers.

The Bureau proposed a 180-day threshold as striking an appropriate balance, and noted that this approach would generally align with the policy position taken by the Federal Financial Institutions Examination Council (FFIEC), which generally requires depository institutions to charge off open-end credit at 180 days of delinquency. Although that policy also requires that closed-end loans be charged off after 120 days, the Bureau found as a preliminary matter that a uniform 180-day rule for both closed-end and open-end loans may be more appropriate, given the underlying policy considerations discussed above, as well as for simplicity.

Proposed comment 2(a)(15)-1 would clarify that the status of a loan that otherwise meets the definition of outstanding loan does not change based on whether the consumer is required to pay a lender, affiliate, or service provider or whether the lender sells the loan or servicing rights to a third party. Proposed comment 2(a)(15)-2 would clarify that a loan ceases to be an outstanding loan as of the earliest of the date the consumer repays the loan in full, the date the consumer is released from the legal obligation to repay, the date the loan is otherwise legally discharged, or the date that is 180 days following the last payment that the consumer made on the loan. Additionally, proposed comment 2(a)(15)-2 would explain that any payment the consumer makes restarts the 180-day period, regardless of whether the payment is a scheduled payment or in a scheduled amount. Proposed comment 2(a)(15)-2 would further clarify that once a loan is no longer an outstanding loan, subsequent events cannot make the loan an outstanding loan. The Bureau proposed this one-way valve to ease compliance burden on lenders and to reduce the risk of consumer confusion.

One consumer group commented that, with respect to loans that could include more than one payment, it would be helpful for the definition to refer to an installment in order to ensure its alignment with terms used in State and local laws. Other consumer groups suggested various other changes to clarify details of timing addressed in this definition, as well as urging that the 180-day period should be changed to 365 days so that more loans would be considered as outstanding. Several commented that the definition should be changed so that the 180-day period should run from either the date of the last payment by the consumer or from the date of the last debt collection activity by the collector, in order to more accurately determine what is truly stale debt and to broaden the scope of what loans are outstanding to ensure that older loans are not being used by lenders to encourage consumers to re-borrow. To support compliance under the modified definition, they also urged that lenders be required to report collection activity to the registered information systems.

The Bureau has concluded that language in final comment 2(a)(17)-2 emphasizing that any payment restarts the 180-day clock is sufficient to address the commenter's concern without having to incorporate new terminology to align the term with its use in State and local laws. With respect to the comments about the time frame, and 365 days in particular, the Bureau was not persuaded of the reasoning or need to broaden the scope of outstanding loans to this extent. The Bureau's proposed 180-day period was already aligned to the longer end of the FFIEC treatment of these issues, by adopting the 180 days that the FFIEC has applied to open-end credit rather than the 120 days that it has applied to closed-end credit. In addition, the Bureau's experience with these markets suggests that these types of lenders typically write off their debts even sooner than 180 days.

The Bureau concludes that the various suggested changes that were offered to tighten the proposed standard are not necessary to be adopted at this time, though such matters could be revisited over time as supervision and enforcement of the final rule proceed in the future. In particular, the comment that lenders should be required to report collection activity to the registered information systems would have broadened the requirements of the rule and the burdens imposed in significant and unexpected ways that did not seem warranted at this juncture.

The Bureau also carefully considered the comments made about extending the period of an outstanding loan, which suggested that it should run not just 180 days from the date of the last payment made on the loan but also 180 days from the date of the last debt collection activity on the loan. The Bureau declines to adopt this proposed change, for several reasons. It would add a great deal of complexity that would encumber the rule, not only in terms of ensuring compliance but in terms of carrying out supervision and enforcement responsibilities as well. For example, this modification would appear not to be operational unless debt collection activities were reported to the registered information systems, which as noted above would add significant and unexpected burdens to the existing framework. Moreover, timing the cooling-off period to any debt collection activity could greatly extend how long a consumer would have to wait to re-borrow after walking away from a debt, thereby disrupting the balance the Bureau was seeking to strike in the proposal between these competing objectives. The Bureau also judged that if the comment was aimed at addressing and discouraging certain types of debt collection activities, it would be better addressed in the rulemaking process that the Bureau has initiated separately to govern debt collection issues. Finally, this suggestion seems inconsistent with the Bureau's experience, which indicates that lenders in this market typically cease their own collection efforts within 180 days.

For these reasons, the Bureau is finalizing this definition as renumbered and the commentary as proposed with minor changes for clarity. The Bureau has also added a sentence to comment 2(a)(17)-2 to expressly state that a loan is outstanding for 180 days after consummation if the consumer does not make any payments on it, the consumer is not otherwise released from the legal obligation to pay, and the loan is not otherwise legally discharged.

2(a)(18) Service Provider

Proposed § 1041.2(a)(17) would have defined service provider by cross-referencing the definition of that same term in the Dodd-Frank Act, 12 U.S.C. 5481(26). In general, the Dodd-Frank Act defines service provider as any person that provides a material service to a covered person in connection with the offering or provision of a consumer financial product or service, including one that participates in designing, operating, or maintaining the consumer financial product or service or one that processes transactions relating to the consumer financial product or service. Moreover, the Act specifies that the Bureau's authority to identify and prevent unfair, deceptive, or abusive acts or practices through its rulemaking authority applies not only to covered persons, but also to service providers. Proposed § 1041.3(c) and (d) would provide that a loan is covered under proposed part 1041 if a service provider obtains a leveraged payment mechanism or vehicle title and the other coverage criteria are otherwise met.

The definition of service provider and the provisions in proposed § 1041.3(c) and (d) were designed to reflect the fact that in some States, covered loans are extended to consumers through a multi-party transaction. In these transactions, one entity will fund the loan, while a separate entity, often called a credit access business or a credit services organization, will interact directly with, and obtain a fee or fees from, the consumer. This separate entity will often service the loan and guarantee the loan's performance to the party funding the loan. The credit access business or credit services organization, and not the party funding the loan, will in many cases obtain the leveraged payment mechanism or vehicle security. In these cases, the credit access business or credit services organization is performing the responsibilities normally performed by a party funding the loan in jurisdictions where this particular business arrangement is not used. Despite the formal division of functions between the nominal lender and the credit access business, the loans produced by such arrangement are functionally the same as those covered loans issued by a single entity and appear to present the same set of consumer protection concerns. Accordingly, the Bureau stated in the proposal that it is appropriate to bring loans made under these arrangements within the scope of coverage of proposed part 1041. Proposed comment 2(a)(17)-1 further made clear that persons who provide a material service to lenders in connection with the lenders' offering or provision of covered loans during the course of obtaining for consumers, or assisting consumers in obtaining, loans from lenders are service providers, subject to the specific limitations in section 1002(26) of the Dodd-Frank Act.

The Bureau stated that defining the term service provider consistently with the Dodd-Frank Act reduces the risk of confusion among consumers, industry, and regulators. Consumer groups commented that the rule should apply to service providers, including credit service organizations and their affiliates, whenever it applies to lenders and their affiliates. The Bureau concludes that the definitions of and references to lender and service provider, including incorporation of the statutory definitions of covered person and service provider into the regulatory definitions, throughout the regulation text and commentary are sufficiently well articulated to make these points clear as to the applicability and scope of coverage of part 1041. Both section 1031(a) and section 1036(a) of the Dodd-Frank Act specify that a service provider can be held liable on the same terms as a covered person—which includes a lender as defined by § 1041.2(13)—to the extent that a service provider engages in conduct that violates this rule on behalf of a lender, or entities such as credit access businesses and credit service organizations that provide a material service to a lender in making these kinds of covered loans. The Bureau did not receive any other comments on this portion of the proposal and is finalizing this definition and the commentary as just discussed and as renumbered.

2(a)(19) Vehicle Security

The Bureau has decided to make “vehicle security” a defined term, incorporating language that described the practice of taking vehicle security from proposed § 1041.3(d). Its role is now more limited, however, due to other changes in the rule, which no longer governs the underwriting of covered longer-term loans (other than balloon-payment loans), which instead are now subject only to the payment provisions. Nonetheless, the Bureau is preserving the language explaining vehicle security and moving it here for purposes of defining the exclusion of vehicle title loans from coverage under § 1041.6 of the final rule, which provides for conditionally exempted loans.

As to the definition itself, the proposal would have stated that for purposes of defining a covered loan, a lender or service provider obtains vehicle security if it obtains an interest in a consumer's motor vehicle (as defined in section 1029(f)(1) of the Dodd-Frank Act) as a condition of the credit, regardless of how the transaction is characterized by State law, including: (1) Any security interest in the motor vehicle, motor vehicle title, or motor vehicle registration whether or not the security interest is perfected or recorded; or (2) a pawn transaction in which the consumer's motor vehicle is the pledged good and the consumer retains use of the motor vehicle during the period of the pawn agreement. Under the proposal, the lender or service provider would obtain vehicle security if the consumer is required, under the terms of an agreement with the lender or service provider, to grant an interest in the consumer's vehicle to the lender in the event that the consumer does not repay the loan.

As noted in the proposal, because of exclusions contained in proposed § 1041.3(e)(1) and (5), the term vehicle security would have excluded loans made solely and expressly for the purpose of financing a consumer's initial purchase of a motor vehicle in which the lender takes a security interest as a condition of the credit, as well as non-recourse pawn loans in which the lender has sole physical possession and use of the property for the entire term of the loan. Proposed comment 3(d)(1)-1 also would have clarified that mechanic liens and other situations in which a party obtains a security interest in a consumer's motor vehicle for a reason that is unrelated to an extension of credit do not trigger coverage.

The Bureau proposed that the security interest would not need to be perfected or recorded in order to trigger coverage under proposed § 1041.3(d)(1). The Bureau reasoned that consumers may not be aware that the security interest is not perfected or recorded, nor would it matter in many cases. Perfection or recordation protects the lender's interest in the vehicle against claims asserted by other creditors, but does not necessarily affect whether the consumer's interest in the vehicle is at risk if the consumer does not have the ability to repay the loan. Even if the lender or service provider does not perfect or record its security interest, the security interest can still change a lender's incentives to determine the consumer's ability to repay the loan and exacerbate the harms the consumer experiences if the consumer does not have the ability to repay the loan.

The Bureau received many comments on the prong of the definition that focused on the taking of a leveraged payment mechanism or vehicle security, again often in the context of application of the underwriting requirements rather than the payment requirements. Those concerns have largely been addressed or mooted by the Bureau's decisions to apply only the payment requirements to covered longer-term loans and to narrow the definition of such loans to focus only on those types of leveraged payment mechanisms that involve the ability to pull money from consumers' accounts, rather than vehicle security. Comments focusing on that narrower definition of leveraged payment mechanism are addressed in more depth in connection with § 1041.3(c) below.

Importantly, the term vehicle security as defined in proposed § 1041.3(d) was further limited in its effect by the provisions of proposed § 1041.3(b)(3)(ii), which had stated that a lender or service provider did not become subject to the proposed underwriting criteria merely by obtaining vehicle security at any time, but instead had to obtain vehicle security before, at the same time as, or within 72 hours after the consumer receives the entire amount of funds that the consumer is entitled to receive under the loan. Many commenters criticized the 72-hour requirement as undermining consumer protections and fostering evasion of the rule. Because of various changes that have occurred in revising the coverage of the underwriting criteria and reordering certain provisions in the final rule, this limitation is no longer necessary to effectuate any of those purposes of the rule. The definition of vehicle security remains relevant to the provisions of § 1041.6 of the final rule, but it is unclear how a 72-hour limitation is germane to establishing the scope of coverage under that section, and so it has been eliminated from the final rule.

One consumer group suggested that a vehicle title loan should be covered under the rule regardless of whether the title was a condition of the loan. The Bureau does not find it necessary to alter the definition in this manner in order to accomplish the purpose of covering vehicle title loans, particularly in light of the language in comment 2(a)(19)-1, which indicates that vehicle security will attach to the vehicle for reasons that are related to the extension of credit.

With respect to comments on the details of the definition of vehicle security, one commenter had suggested that the final rule should make clear that the proposed restrictions on this form of security interest do not interfere with or prohibit any statutory liens that have been authorized by Congress. Because nothing in the language of the final rule purports to create any such interference or prohibition, the Bureau does not find it necessary to modify its definition of vehicle security in this regard. Other commenters made various points about the meaning and coverage of the term motor vehicle in the Bureau's treatment of the term vehicle security. Those comments are addressed separately in the discussion of the definition of motor vehicle in § 1041.2(a)(15) of the final rule.

The Bureau has moved the discussion of vehicle security from proposed § 1041.3(d) to § 1041.2(a)(19) in the general definitions section, and has narrowed the definition of motor vehicle contained in section 1029(f)(1) of the Dodd-Frank Act, replacing it with the somewhat narrower definition of motor vehicle contained in § 1041.2(a)(15) of the final rule as described above. The definition of vehicle security still includes the other elements of the proposal, as slightly rewritten for clarity to focus on this term itself rather than on the actions of a lender or service provider.

Accordingly, the term vehicle security is defined in the final rule as an interest in a consumer's motor vehicle obtained by the lender or service provider as a condition of the credit, regardless of how the transaction is characterized by State law, including: (1) Any security interest in the motor vehicle, motor vehicle title, or motor vehicle registration whether or not the security interest is perfected or recorded; or (2) a pawn transaction in which the consumer's motor vehicle is the pledged good and the consumer retains use of the motor vehicle during the period of the pawn agreement. This definition also carries with it proposed comment 3(d)(1)-1, now finalized as comment 2(a)(19)-1, which explains that an interest in a consumer's motor vehicle is a condition of credit only to the extent the security interest is obtained in connection with the credit, and not for a reason that is unrelated to an extension of credit, such as the attachment of a mechanic's lien. This comment is finalized with the language unchanged.

2(b) Rule of Construction

After reserving this provision in the proposal, the Bureau has determined to add a rule of construction for purposes of part 1041, which states that where definitions are incorporated from other statutes or regulations, the terms have the meaning and incorporate the embedded definitions, appendices, and commentary from those other laws except to the extent that part 1041 provides a different definition for a parallel term. The Bureau had included versions of this basic principle in the regulation text and commentary for certain individual provisions of the proposed rule, but has concluded that it would be helpful to memorialize it as a general rule of construction. Accordingly, the Bureau moved certain proposed commentary for individual definitions to comment 2(b)-1 of the final rule in order to provide examples of the rule of construction, and streamlined certain other proposed commentary as described above.

Section 1041.3 Scope of Coverage; Exclusions; Exemptions

The primary purpose of proposed part 1041 was to identify and adopt rules to prevent unfair and abusive practices as defined in section 1031 of the Dodd-Frank Act in connection with certain consumer credit transactions. Based upon its research, outreach, and analysis of available data, the Bureau proposed to identify such practices with respect to two categories of loans to which it proposed to apply this rule: (1) Consumer loans with a duration of 45 days or less; and (2) consumer loans with a duration of more than 45 days that have a total cost of credit above a certain threshold and that are either repayable directly from the consumer's income stream, as set forth in proposed § 1041.3(c), or are secured by the consumer's motor vehicle, as set forth in proposed § 1041.3(d).

In the proposal, the Bureau tentatively concluded that it is an unfair and abusive practice for a lender to make a covered short-term loan without determining that the consumer has the ability to repay the loan. The Bureau likewise tentatively concluded that it is an unfair and abusive practice for a lender to make a covered longer-term loan without determining the consumer's ability to repay the loan. Accordingly, the Bureau proposed to apply the protections of proposed part 1041 to both categories of loans.

In particular, proposed §§ 1041.5 and 1041.9 would have required that, before making a covered loan, a lender must determine that the consumer has the ability to repay the loan. Proposed §§ 1041.6 and 1041.10 would have imposed certain limitations on repeat borrowing, depending on the type of covered loan. Proposed §§ 1041.7, 1041.11, and 1041.12 would have provided for alternative requirements that would allow lenders to make covered loans, in certain limited situations, without first determining that the consumer has the ability to repay the loan. Proposed § 1041.14 would have imposed consumer protections related to repeated lender-initiated attempts to withdraw payments from consumers' accounts in connection with covered loans. Proposed § 1041.15 would have required lenders to provide notices to consumers before attempting to withdraw payments on covered loans from consumers' accounts. Proposed §§ 1041.16 and 1041.17 would have required lenders to check and report borrowing history and loan information to certain information systems with respect to most covered loans. Proposed § 1041.18 would have required lenders to keep certain records on the covered loans that they make. And proposed § 1041.19 would have prohibited actions taken to evade the requirements of proposed part 1041.

The Bureau did not propose to extend coverage to several other types of loans and specifically proposed excluding, to the extent they would otherwise be covered under proposed § 1041.3, certain purchase money security interest loans, certain loans secured by real estate, credit cards, student loans, non-recourse pawn loans, and overdraft services and lines of credit. The Bureau likewise proposed not to cover loans that have a term of longer than 45 days if they are not secured by a leveraged payment mechanism or vehicle security or if they have a total cost of credit below a rate of 36 percent per annum.

By finalizing application of the underwriting requirements with respect to certain categories of loans as described above, and excluding certain other types of loans from the reach of the rule, the Bureau does not mean to signal any definitive conclusion that it could not be an unfair or abusive practice to make any other types of loans, such as loans that are not covered by part 1041, without reasonably assessing a consumer's ability to repay. Moreover, this rule does not supersede or limit any protections imposed by other laws, such as the Military Lending Act and implementing regulations. The coverage limits in the rule simply reflect the fact that these are the types of loans the Bureau has studied in depth to date and has chosen to address within the scope of the proposal. Indeed, the Bureau issued, concurrently with the proposal, a Request for Information (RFI), which solicited information and evidence to help assess whether there are other categories of loans for which lenders do not determine the consumer's ability to repay that may pose risks to consumers. The Bureau also sought comment in response to the RFI as to whether other lender practices associated with covered loans may warrant further action by the Bureau.

The Bureau thus is reinforcing the point that all covered persons within the meaning of the Dodd-Frank Act have a legal duty not to engage in unfair, deceptive, or abusive acts or practices. The Bureau is explicitly authorized to consider, on a case-by-case basis, through its supervisory or enforcement activities, whether practices akin to those addressed here are unfair, deceptive, or abusive in connection with loans not covered by the rule. The Bureau also is emphasizing that it may decide to engage in future rulemaking with respect to other types of loans or other types of practices associated with covered loans at a later date.

3(a) General

In proposed § 1041.3(a), the Bureau provided that proposed part 1041 would apply to a lender that makes covered loans. The Bureau received no specific comments on proposed § 1041.3(a), and is finalizing this provision as proposed except that it has adopted language as discussed above in connection with the definition of lender in § 1041.2(a)(13) to refer to a person who “extends credit by making covered loans.”

3(b) Covered Loan

In the proposal, the Bureau noted that section 1031(b) of the Dodd-Frank Act empowers it to prescribe rules to identify and prevent unfair, deceptive, or abusive acts or practices associated with consumer financial products or services. Section 1002(5) of the Dodd-Frank Act defines such products or services as those offered or provided for use by consumers primarily for personal, family, or household purposes or, in certain circumstances, those delivered, offered, or provided in connection with another such consumer financial product or service. Proposed § 1041.3(b) would have provided, generally, that a covered loan means closed-end or open-end credit that is extended to a consumer primarily for personal, family, or household purposes that is not excluded by § 1041.3(e).

By proposing to apply the rule only to loans that are extended to consumers primarily for personal, family, or household purposes, the Bureau intended it not to apply to loans that are made primarily for a business, commercial, or agricultural purpose. But the proposal explained that a lender would violate proposed part 1041 if it extended a loan ostensibly for a business purpose and failed to comply with the requirements of proposed part 1041 for a loan that is, in fact, primarily for personal, family, or household purposes. In this regard, the Bureau referenced the section-by-section analysis of proposed § 1041.19, which provided further discussion of evasion issues.

Proposed comment 3(b)-1 would have clarified that whether a loan is covered is generally based on the loan terms at the time of consummation. Proposed comment 3(b)-2 would have clarified that a loan could be a covered loan regardless of whether it is structured as open-end or closed-end credit. Proposed comment 3(b)-3 would have explained that the test for determining the primary purpose of a loan is the same as the test prescribed by Regulation Z § 1026.3(a) and clarified by the related commentary in supplement I to part 1026. The Bureau stated that lenders are already familiar with the Regulation Z test and that it would be appropriate to apply that same test here to maintain consistency in interpretation across credit markets, though the Bureau also requested comment on whether more tailored guidance would be useful here as the related commentary in supplement I to part 1026, on which lenders would be permitted to rely in interpreting proposed § 1041.3(b), did not discuss particular situations that may arise in the markets that would be covered by proposed part 1041.

One commenter noted that while business loans are outside the scope of the rule, many small business owners use their personal vehicles to secure title loans for their businesses, and asserted that it will be difficult for lenders to differentiate the purposes of a loan in such instances. Another commenter suggested that provisions should be added to ensure that loans are made for personal use only. More generally, one commenter stated that the breadth of the definition of covered loan would enhance the burden that the proposed rule would impose on credit unions.

In response, the Bureau notes that its experience with these markets has made it aware that the distinction between business and household purposes is necessarily fact-specific, yet the basic distinction is embedded as a jurisdictional matter in many consumer financial laws and has long been regarded as a sensible line to draw. Further, the concern about the breadth of this definition as affecting credit unions is addressed substantially by the measures adopted in the final rule to reduce burdens for lenders, along with the exclusions and exemptions that have been adopted, including the conditional exemption for alternative loans.

The Bureau is finalizing § 1041.3(b) as proposed. The commentary is finalized as proposed, except proposed comment 3(b)-1, which the Bureau is not finalizing. That comment had proposed that whether a loan is covered is generally determined based on the loan terms at the time of consummation. As noted below, final comment 3(b)(3)-3 makes clear that a loan may become a covered longer-term loan at any such time as both requirements of § 1041.3(b)(3)(i) and (ii) are met, even if they were not met when the loan was initially made.

3(b)(1)

Proposed § 1041.3(b)(1) would have brought within the scope of proposed part 1041 those loans in which the consumer is required to repay substantially the entire amount due under the loan within 45 days of either consummation or the advance of loan proceeds. Loans of this type, as they exist in the market today, typically take the form of single-payment loans, including payday loans, vehicle title loans, and deposit advance products. However, coverage under proposed § 1041.3(b)(1) was not limited to single-payment products, but rather included any single-advance loan with a term of 45 days or less and any multi-advance loan where repayment is required within 45 days of a credit draw. Under proposed § 1041.2(a)(6), this type of covered loan was defined as a covered short-term loan.

Specifically, proposed § 1041.3(b)(1) prescribed different tests for determining whether a loan is a covered short-term loan based on whether or not the loan is closed-end credit that does not provide for multiple advances to consumers. For this type of credit, a loan would be a covered short-term loan if the consumer is required to repay substantially the entire amount of the loan within 45 days of consummation. For all other types of loans, a loan would be a covered short-term loan if the consumer is required to repay substantially the entire amount of an advance within 45 days of the advance.

As proposed comment 3(b)(1)-1 explained, a loan does not provide for multiple advances to a consumer if the loan provides for full disbursement of the loan proceeds only through disbursement on a single specific date. The Bureau stated that a different test to determine whether a loan is a covered short-term loan is appropriate for loans that provide for multiple advances to consumers, because open-end credit and closed-end credit providing for multiple advances may be consummated long before the consumer incurs debt that must be repaid. If, for example, the consumer waited more than 45 days after consummation to draw on an open-end line, but the loan agreement required the consumer to repay the full amount of the draw within 45 days of the draw, the loan would not be practically different than a closed-end loan repayable within 45 days of consummation. The Bureau preliminarily found that it is appropriate to treat the loans the same for the purposes of proposed § 1041.3(b)(1).

As the Bureau described in part II of the proposal, the terms of short-term loans are often tied to the date the consumer receives his or her paycheck or benefits payment. While pay periods typically vary from one week to one month, and expense cycles are typically one month, the Bureau proposed 45 days as the upper bound for covered short-term loans in order to accommodate loans that are made shortly before a consumer's monthly income is received and that extend beyond the immediate income payment to the next income payment. These circumstances could result in loans that are somewhat longer than a month in duration, but the Bureau believed that they nonetheless pose similar risks of harm to consumers as loans with durations of a month or less.

The Bureau also considered proposing to define covered short-term loans as loans that are substantially repayable within either 30 days of consummation or advance, 60 days of consummation or advance, or 90 days of consummation or advance. The Bureau, nonetheless, did not propose the 30-day period because, as described above, some loans for some consumers who are paid on a monthly basis can be slightly longer than 30 days, yet still would essentially constitute a one-pay-cycle, one-expense-cycle loan. The Bureau stated that it did not propose either the 60-day or 90-day period because loans with those terms encompass multiple income and expense cycles, and thus may present somewhat different risks to consumers, though such loans would have been covered longer-term loans if they met the criteria set forth in proposed § 1041.3(b)(2).

As discussed in the proposal, the Bureau proposed to treat longer-term loans, as defined in proposed § 1041.3(b)(2), as covered loans only if the total cost of credit exceeds a rate of 36 percent per annum and if the lender or service provider obtains a leveraged payment mechanism or vehicle security as defined in proposed § 1041.3(c) and (d). The Bureau did not propose similar limitations with respect to the definition of covered short-term loans because the evidence available to the Bureau seemed to suggest that the structure and short-term nature of these loans give rise to consumer harm even in the absence of costs above the 36 percent threshold or particular means of repayment.

Proposed comment 3(b)(1)-2 noted that both open-end credit and closed-end credit may provide for multiple advances to consumers. The comment explained that open-end credit is self-replenishing even though the plan itself has a fixed expiration date, as long as during the plan's existence the consumer may use the line, repay, and reuse the credit. Likewise, closed-end credit may consist of a series of advances. For example, under a closed-end commitment, the lender might agree to lend a fixed total amount in a series of advances as needed by the consumer, and once the consumer has borrowed the maximum, no more is advanced under that particular agreement, even if there has been repayment of a portion of the debt.

Proposed comment 3(b)(1)-3 explained that a determination of whether a loan is substantially repayable within 45 days requires assessment of the specific facts and circumstances of the loan. Proposed comment 3(b)(1)-4 provided guidance on determining whether loans that have alternative, ambiguous, or unusual payment schedules would fall within the definition. The comment explained that the key principle in determining whether a loan would be a covered short-term loan or a covered longer-term loan is whether, under applicable law, the consumer would be considered to be in breach of the terms of the loan agreement if the consumer failed to repay substantially the entire amount of the loan within 45 days of consummation.

As noted above, § 1041.3(b)(1) provides the substance of the definition of covered short-term loan as referenced in § 1041.2(a)(10) of the final rule. The limited comments on this provision are presented and addressed in the section-by-section analysis of that definition. For the reasons stated there, the Bureau is finalizing § 1041.3(b)(1) as proposed, with only non-substantive language changes. One modification has been made in the commentary, however, to address comments received about deposit advance products. New comment 3(b)(1)-4 in the final rule states that a loan or advance is substantially repayable within 45 days of consummation or advance if the lender has the right to be repaid through a sweep or withdrawal of any qualifying electronic deposit made into the consumer's account within 45 days of consummation or advance. A loan or advance described in this paragraph is substantially repayable within 45 days of consummation or advance even if no qualifying electronic deposit is actually made into or withdrawn by the lender from the consumer's account. This comment was added to address more explicitly a deposit advance product in which the lender can claim all the income coming in to the account, as it comes in, for the purpose of repaying the loan, regardless of whether income in fact comes in during the first 45 days after a particular advance. Proposed comment 3(b)(1)-4 thus has been renumbered as comment 3(b)(1)-5 of the final rule.

3(b)(2)

Proposed § 1041.3(b)(2) would have brought within the scope of proposed part 1041 several types of loans for which, in contrast to loans covered under proposed § 1041.3(b)(1), the consumer is not required to repay substantially the entire amount of the loan or advance within 45 days of consummation or advance. Specifically, proposed § 1041.3(b)(2) extended coverage to longer-term loans with a total cost of credit exceeding a rate of 36 percent per annum if the lender or service provider also obtains a leveraged payment mechanism as defined in proposed § 1041.3(c) or vehicle security as defined in proposed § 1041.3(d) in connection with the loan before, at the same time, or within 72 hours after the consumer receives the entire amount of funds that the consumer is entitled to receive. Under proposed § 1041.2(a)(8), this type of covered loan would be defined as a covered longer-term loan.

As discussed above in connection with § 1041.2(a)(7), the Bureau defined a sub-category of covered longer-term loans that would be subject to certain tailored provisions in proposed §§ 1041.6, 1041.9, and 1041.10 because they involved balloon-payment structures that the Bureau believed posed particular risks to consumers. The Bureau proposed to cover such longer-term balloon-payment loans only if they exceeded the general rate threshold and involved leveraged payment mechanisms or vehicle security, but specifically sought comment on whether such products should be subject to the rule more generally in light of the particular concerns about balloon payment structures.

In light of the Bureau's decision to differentiate which parts of the rule apply to longer-term balloon-payment loans and more generally to longer-term loans, the Bureau has decided to make the two categories mutually exclusive and to describe them separately in § 1041.3(b)(2) and (3) of the final rule, respectively. Accordingly, the Bureau is finalizing § 1041.3(b)(2) to define longer-term balloon-payment loans, incorporating the language of proposed § 1041.2(a)(7) as further revised in various respects.

First, for purposes of greater clarity in ordering § 1041.3(b) of the final rule, the Bureau is separating out its treatment of covered longer-term balloon-payment loans (in § 1041.3(b)(2)) from its treatment of all other covered longer-term loans (in § 1041.3(b)(3)). As described in greater detail below in Market Concerns—Underwriting and in the section-by-section analysis of § 1041.4, the Bureau has decided to restructure these provisions in this way because it has decided in the final rule to subject covered longer-term balloon-payment loans both to the underwriting criteria and the payment requirements of the final rule, but to apply only the payment requirements to other types of covered longer-term loans.

This organization reflects in part the comments received from industry and trade groups who contended that the Bureau's concerns about re-borrowing for covered longer-term loans were most applicable to loans with balloon-payment structures. They therefore argued that any ability-to-repay restrictions and underwriting criteria should be limited to longer-term balloon-payment loans. These comments reinforced the Bureau's preliminary view that concerns about the re-borrowing of covered longer-term balloon-payment loans were most similar to the concerns it had about the re-borrowing of covered short-term loans. As described more fully below in the section on Market Concerns—Underwriting, the Bureau has observed longer-term loans involving balloon payments where the lender does not reasonably assess the borrower's ability to repay before making the loan, and has observed in these circumstances the same types of consumer harms that it has observed when lenders fail to make a reasonable assessment of the borrower's ability to repay before making covered short-term loans. Nonetheless, the Bureau also maintains its concerns about lender practices in the market for other covered longer-term loans, and emphasizes that it retains supervision and enforcement authority to oversee such lenders for unfair, deceptive, or abusive acts or practices.

As discussed further below, for a number of reasons the Bureau has decided not to address the underwriting of all covered longer-term loans at this time. Nonetheless, as discussed above in the section-by-section analysis of § 1041.2(a)(7) of the final rule, the Bureau is concerned that covered longer-term balloon-payment loans have a loan structure that poses many of the same risks and harms to consumers as with covered short-term loans, and could be adapted in some manner as a loan product intended to circumvent the underwriting criteria for covered short-term loans. Therefore, in § 1041.5 of the final rule, the specific underwriting criteria that apply to covered short-term loans are, with certain modifications, made applicable to covered longer-term balloon-payment loans also (without regard to interest rate or the taking of a leveraged payment mechanism). And along with other covered longer-term loans, these loans remain covered by the sections of the final rule on payment practices as well.

Given this resolution of the considerations raised by the comments and based on the Bureau's further consideration and analysis of the market, the Bureau is finalizing § 1041.3(b)(2) in parallel with § 1041.3(b)(1), since both types of loans—covered short-term loans and covered longer-term balloon loans—are subject to the same underwriting criteria and payment requirements as prescribed in the final rule.

As noted above in the discussion of § 1041.2(a)(7), in conjunction with making the definition of covered longer-term balloon-payment loan into a separate category in its own right rather than a subcategory of the general definition of covered longer-term loan, the Bureau has decided to subject such loans to an expansion in scope as compared to the proposal, since longer-term balloon-payment loans are now being covered by both the underwriting and payment provisions of the final rule without regard to whether the loans exceed a particular threshold for the cost of credit or involve the taking of a leveraged payment mechanism or vehicle security. The Bureau had specifically sought comment as to whether to cover longer-term balloon-payment loans regardless of these two conditions, and has concluded that it is appropriate to do so in light of concerns about the risks and harms that balloon-payment structures pose to consumers and of potential industry evolution to circumvent the rule, as set out more extensively below in Market Concerns—Underwriting.

The Bureau has also revised the definition of covered longer-term balloon-payment loan to address different types of loan structures in more detail. As discussed above in connection with § 1041.2(a)(7), the proposal would generally have defined the term to include loans that require repayment in a single payment or that require at least one payment that is more than twice as large as any other payment(s) under the loan. The Bureau based the twice-as-large threshold on the definition of balloon payment under Regulation Z, but with some modification in details. However, the Bureau did not expressly address whether covered longer-term balloon-payment loans could be both closed-end and open-end credit.

After further consideration of the policy concerns that prompted the Bureau to apply the underwriting requirements in subpart B to covered longer-term balloon-payment loans, the Bureau has concluded that it is appropriate to define that term to include both closed-end and open-end loans that involve the kinds of large irregular payments that were described in the proposed definition. In light of the fact that such loans could be structured a number of ways, the Bureau finds it helpful for purposes of implementation and compliance to build out the definition to more expressly address different types of structures. The Bureau has done this by structuring § 1041.3(b)(2) to be similar to the covered-short-term definition in § 1041.3(b)(1), but with longer time frames and descriptions of additional potential payment structures.

Specifically, the revised definition for covered longer-term balloon-payment loans separately addresses closed-end loans that do not provide for multiple advances from other loans (both closed-end and open-end) that do involve multiple advances. With regard to the former set of loans, § 1041.3(b)(2)(i) defines a covered longer-term balloon-payment loan to include those where the consumer is required to repay the entire balance of the loan more than 45 days after consummation in a single payment or to repay such loan through at least one payment that is more than twice as large as any other payment(s). With regard to multiple-advance loans, the revised definition focuses on either of two types of payment structures. Under the first structure, the consumer is required to repay substantially the entire amount of an advance more than 45 days after the advance is made or is required to make at least one payment on the advance that is more than twice as large as any other payment(s). Under the second structure, the consumer is paying the required minimum payments but may not fully amortize the outstanding balance by a specified date or time, and the amount of the final payment to repay the outstanding balance at such time could be more than twice the amount of other minimum payments under the plan.

The contours of this definition are thus very similar to those for covered short-term loans, which pose the same kinds of risks and harms for consumers, and its focus on payments that are more than twice as large as other payments is generally consistent with how balloon-payment loans are defined and treated under Regulation Z. The Bureau believes retaining that payment size threshold will promote consistency and reduce the risk of confusion among consumers, industry, and regulators.

Along with finalizing § 1041.3(b)(2) as just stated, the Bureau has also built out the related commentary to incorporate the original commentary to proposed § 1041.2(a)(7) and concepts that were already used in the definition of covered short-term loan, as well as to elaborate further on language that has been added to the final rule. As now adopted, comment 3(b)(2)-1 specifies that a closed-end loan is considered to be a covered longer-term balloon-payment loan if the consumer must repay the entire amount of the loan in a single payment which is due more than 45 days after the loan was consummated, or to repay substantially the entire amount of any advance in a single payment more than 45 days after the funds on the loan were advanced, or is required to pay at least one payment that is more than twice as large as any other payment(s). Comment 3(b)(2)-2 states that for purposes of § 1041.3(b)(2)(i) and (ii), all required payments of principal and any charges (or charges only, depending on the loan features) due under the loan are used to determine whether a particular payment is more than twice as large as another payment, regardless of whether the payments have changed during the loan term due to rate adjustments or other payment changes permitted or required under the loan. Comment 3(b)(2)-3 discusses charges for actual unanticipated late payments, for exceeding a credit limit, or for delinquency, default, or a similar occurrence that may be added to a payment, and notes that they are excluded from the determination of whether the loan is repayable in a single payment or a particular payment is more than twice as large as another payment. Likewise, sums that are accelerated and due upon default are excluded from the determination of whether the loan is repayable in a single payment or a particular payment is more than twice as large as another payment. These three comments are based on prior comments to proposed § 1041.2(a)(7), with certain revisions made for consistency and form.

Comment 3(b)(2)-4 is new and provides that open-end loans are considered to be covered longer-term balloon-payment loans under § 1041.3(b)(2)(ii) if: either the loan has a billing cycle with more than 45 days and the full balance is due in each billing period, or the credit plan is structured such that paying the required minimum payment may not fully amortize the outstanding balance by a specified date or time, and the amount of the final payment to repay the outstanding balance at such time could be more than twice the amount of other minimum payments under the plan. An example is provided to show how this works for an open-end loan, in light of particular credit limits, monthly billing cycles, minimum payments due, fees or interest, and payments made, to determine whether the credit plan is a covered loan and why.

3(b)(3)

As noted above, proposed § 1041.3(b)(2) encompassed both covered longer-term balloon-payment loans and certain other covered longer-term loans. Because the Bureau is finalizing a separate definition of covered longer-term balloon-payment loans in § 1041.3(b)(2), new § 1041.3(b)(3) of the final rule addresses covered loans that are neither covered short-term loans nor covered longer-term balloon-payment loans, but rather are covered longer-term loans that are only subject to provisions of the rule relating to payment practices.

Specifically, proposed § 1041.3(b)(2) would have extended coverage to longer-term loans with a total cost of credit exceeding a rate of 36 percent per annum if the lender or service provider also obtains a leveraged payment mechanism as defined in proposed § 1041.3(c) or vehicle security as defined in proposed § 1041.3(d) in connection with the loan before, at the same time, or within 72 hours after the consumer receives the entire amount of funds that the consumer is entitled to receive. Under proposed § 1041.2(a)(8), this type of covered loan would have been defined as a covered longer-term loan.

The Bureau received extensive comments on covered longer-term loans, but key changes in the final rule mitigate most of the points made in those comments. As discussed above in connection with § 1041.2(a)(8), many commenters offered views on the prongs of the definition of covered longer-term loan as triggers for whether such loans should be subject not only to the payment requirements of part 1041 but also its underwriting requirements. As just discussed above and discussed more fully in part I and in Market Concerns—Underwriting, the Bureau has decided not to apply these underwriting requirements to longer-term loans unless they involve balloon payments as defined in §§ 1041.2(a)(7) and 1041.3(b)(2). However, the Bureau believes that such longer-term loans may still pose substantial risk to consumers with regard to certain lender payment practices, and therefore is finalizing subpart C of the rule to apply to covered longer-term loans. It thus remains relevant to describe the parameters of such loans in § 1041.3(b)(3) of the final rule, which continues to provide the substantive content for the parallel definition of covered longer-term loans in § 1041.2(a)(8) of the final rule.

In light of this decision about the policy interventions, the Bureau has also decided to narrow the definition of covered longer-term loans relative to the proposal both by relaxing the rate threshold and narrowing the focus to only loans involving the taking of a leveraged payment mechanism. Thus, § 1041.3(b)(3) of the final rule defines covered longer-term loans as loans that do not meet the definition of covered short-term loans under § 1041.3(b)(1) or of covered longer-term balloon-payment loans under § 1401.3(b)(2); for all remaining covered loans, two further limitations that were contained in the proposed rule apply, so that a loan only becomes a covered longer-term loan if both of the following conditions are also satisfied: The cost of credit for the loan exceeds a rate of 36 percent per annum, as measured in specified ways; and the lender or service provider obtains a leveraged payment mechanism as defined in § 1041.3(c) of the final rule.

As described above in connection with the definition of cost of credit in § 1041.2(a)(6), the Bureau has decided to relax the rate threshold in the final rule by basing the threshold on the annual percentage rate as defined in Regulation Z rather than the total cost of credit concept used in the Military Lending Act. The final rule retains the numeric threshold of 36 percent, however, since, as the proposal explained more fully, that annual rate is grounded in many established precedents of Federal and State law.

With regard to the taking of leveraged payment mechanisms or vehicle security as part of the definition of covered longer-term loan, as discussed in more detail below in connection with § 1041.3(c), the Bureau has narrowed the definition to focus solely on loans that involve types of leveraged payment mechanisms that enable a lender to pull funds directly from a consumer's account. Accordingly, a loan that involves vehicle security may be a covered longer-term loan if it involves a leveraged payment mechanism under § 1041.3(c), but not because it involves vehicle security in its own right.

The final rule also modifies and clarifies certain details of timing about when status as a covered longer-term loan is determined, in light of the fact that such loans are only subject to the payment requirements under the final rule. With regard to the rate threshold, it is measured at the time of consummation for closed-end credit. For open-end credit, it is measured at consummation and, if the cost of credit at consummation is not more than 36 percent per annum, again at the end of each billing cycle for open-end credit. Once open-end credit meets the threshold, it is treated as doing so for the duration of the plan. The rule also provides a rule for calculating the cost of credit in any billing cycle in which a lender imposes a charge included in the cost of credit where the principal balance is $0. The definition of leveraged payment mechanisms is also truncated, as mechanisms based on access to employer payments or payroll deduction repayments are no longer germane to a policy intervention that is limited solely to the payment practices in § 1041.8 of the final rule. Also, vehicle security is no longer relevant to determining coverage of longer-term loans. The Bureau has also omitted language providing a 72-hour window for determining coverage as a longer-term loan from the final rule, as that was driven largely by the need for certainty on underwriting. In short, the two major modifications to this provision as it had been set forth in the proposal are further clarification of how the 36 percent rate is measured for open-end credit and the removal of any references to vehicle security and other employment-based sources of repayment.

The commentary to proposed § 1041.3(b)(2) has been extensively revised in light of the other restructuring that has occurred in § 1041.3(b) of the final rule. To summarize briefly, comments 3(b)(3)-1 to 3(b)(3)-3 and 3(b)(3)(ii)-1 to 3(b)(3)(ii)-2 largely recapitulate the provisions of § 1041.3(b)(3) of the final rule in greater detail, as well as clarifying their practical application through a series of examples. Two key points of clarification, however, concern timing. First, comment 3(b)(3)-3 makes clear that a loan may become a covered longer-term loan at any such time as both requirements of § 1041.3(b)(3)(i) and (ii) are met, even if they were not met when the loan was initially made. Second, comment 3(b)(3)(ii)-1 states that the condition in § 1041.3(b)(3)(ii) is satisfied if a lender or service provider obtains a leveraged payment mechanism before, at the same time as, or after the consumer receives the entire amount of funds that the consumer is entitled to receive under the loan, regardless of the means by which the lender or service provider obtains a leveraged payment mechanism.

For the reasons stated in view of the comments, the Bureau is finalizing § 1041.3(b)(3) and the commentary as described above.

3(c) Leveraged Payment Mechanism

Proposed § 1041.3(c) would have set forth three ways that a lender or a service provider could obtain a leveraged payment mechanism that, if other conditions were met under proposed § 1041.3(b)(2), would bring a longer-term loan within the proposed coverage of proposed part 1041. Specifically, the proposal would have treated a lender as having obtained a leveraged payment mechanism if the lender or service provider had the right to initiate a transfer of money from the consumer's account to repay the loan, the contractual right to obtain payment from the consumer's employer or other payor of expected income, or required the consumer to repay the loan through payroll deduction or deduction from another source of income. In all three cases, the consumer would be required, under the terms of an agreement with the lender or service provider, to cede autonomy over the consumer's account or income stream in a way that the Bureau believed, as stated in the proposal, would change incentives to determine the consumer's ability to repay the loan and can exacerbate the harms the consumer experiences if the consumer does not have the ability to repay the loan and still meet the consumer's basic living expenses and major financial obligations. As explained in the section-by-section analysis of proposed §§ 1041.8 and 1041.9, the Bureau preliminarily found that it is an unfair and abusive practice for a lender to make such a loan without determining that the consumer has the ability to repay.

Proposed § 1041.3(c)(1) generally would have provided that a lender or a service provider obtains a leveraged payment mechanism if it has the right to initiate a transfer of money, through any means, from a consumer's account (as defined in proposed § 1041.2(a)(1)) to satisfy an obligation on a loan. For example, this would occur with a post-dated check or preauthorization for recurring electronic fund transfers. However, the proposed regulation did not define leveraged payment mechanism to include situations in which the lender or service provider initiates a one-time electronic fund transfer immediately after the consumer authorizes such transfer.

In the proposal, the functionality of this determination was that it served as one of three preconditions to the underwriting of such covered longer-term loans, along with the provisions of proposed § 1041.3(c)(2) and (3). In light of other changes to the proposed rule, however, the final rule is no longer covering the underwriting of covered longer-term loans (other than balloon-payment loans), but simply determining whether they are subject to the intervention for payment practices in § 1041.8 of the final rule. As described above, as a result of the decision to apply only the rule's payment requirements to covered-longer term loans, the Bureau is not finalizing the provisions of proposed § 1041.3(c)(2) and (3), which covered payment directly from the employer and repayment through payroll deduction, respectively, as they are no longer germane to the purpose of this policy intervention. With the elimination of those two provisions, § 1041.3(c)(1) is being reorganized more simply as just part of § 1041.3(c) of the final rule to focus on forms of leveraged payment mechanism that involve direct access to consumers' transaction accounts.

Proposed § 1041.3(c)(1) generally would have provided that a lender or a service provider obtains a leveraged payment mechanism if it has the right to initiate a transfer of money, through any means, from a consumer's account (as defined in proposed § 1041.2(a)(1)) to satisfy an obligation on a loan. For example, this would occur with a post-dated check or preauthorization for recurring electronic fund transfers. However, the proposed regulation did not define leveraged payment mechanism to include situations in which the lender or service provider initiates a one-time electronic fund transfer immediately after the consumer authorizes such transfer.

As proposed comment 3(c)(1)-1 explained, the key principle that makes a payment mechanism leveraged is whether the lender has the ability to “pull” funds from a consumer's account without any intervening action or further assent by the consumer. In those cases, the lender's ability to pull payments from the consumer's account gives the lender the ability to time and initiate is to coincide with expected income flows into the consumer's account. This means that the lender may be able to continue to obtain payment (as long as the consumer receives income and maintains the account) even if the consumer does not have the ability to repay the loan while meeting his or her major financial obligations and basic living expenses. In contrast, the Bureau stated in the section-by-section analysis of proposed § 1041.3(c)(1) that a payment mechanism in which the consumer “pushes” funds from his or her account to the lender does not provide the lender leverage over the account in a way that changes the lender's incentives to determine the consumer's ability to repay the loan or exacerbates the harms the consumer experiences if the consumer does not have the ability to repay the loan.

Proposed comment 3(c)(1)-2 provided examples of the types of authorizations for lender-initiated transfers that constitute leveraged payment mechanisms. These include checks written by the consumer, authorizations for electronic fund transfers (other than immediate one-time transfers as discussed further below), authorizations to create or present remotely created checks, and authorizations for certain transfers by account-holding institutions (including a right of set-off). Proposed comment 3(c)(1)-4 explained that a lender does not obtain a leveraged payment mechanism if a consumer authorizes a third party to transfer money from the consumer's account to a lender as long as the transfer is not made pursuant to an incentive or instruction from, or duty to, a lender or service provider. Proposed comment 3(c)(1)-3 contained similar language.

As noted above, proposed § 1041.3(c)(1) provided that a lender or service provider does not obtain a leveraged payment mechanism by initiating a one-time electronic fund transfer immediately after the consumer authorizes the transfer. This provision is similar to what the Bureau proposed in § 1041.15(b), which exempts lenders from providing the payment notice when initiating a single immediate payment transfer at the consumer's request, as that term is defined in proposed § 1041.14(a)(2), and is also similar to what the Bureau proposed in § 1041.14(d), which permits lenders to initiate a single immediate payment transfer at the consumer's request even after the prohibition in proposed § 1041.14(b) on initiating further payment transfers has been triggered.

Accordingly, proposed comment 3(c)(1)-3 clarified that if the loan agreement between the parties does not otherwise provide for the lender or service provider to initiate a transfer without further consumer action, the consumer may authorize a one-time transfer without causing the loan to be a covered loan. Proposed comment 3(c)(1)-3 further clarified that the term “immediately” means that the lender initiates the transfer after the authorization with as little delay as possible, which in most circumstances will be within a few minutes. Proposed comment 3(c)(1)-4 took the opposite perspective, noting that a lender or service provider does not initiate a transfer of money from a consumer's account if the consumer authorizes a third party, such as a bank's automatic bill pay service, to initiate a transfer of money from the consumer's account to a lender or service provider as long as the third party does not transfer the money pursuant to an incentive or instruction from, or duty to, a lender or service provider.

In the proposal, the Bureau noted that it anticipated that scenarios involving authorizations for immediate one-time transfers would only arise in certain discrete situations. For closed-end loans, a lender would be permitted to obtain a leveraged payment mechanism more than 72 hours after the consumer has received the entirety of the loan proceeds without the loan becoming a covered loan. Thus, in the closed-end context, this exception would only be relevant if the consumer was required to make a payment within 72 hours of receiving the loan proceeds—a situation which is unlikely to occur. However, the Bureau acknowledged that the situation may be more likely to occur with open-end credit. According to the proposal, longer-term open-end loans could be covered loans if the lender obtained a leveraged payment mechanism within 72 hours of the consumer receiving the full amount of the funds which the consumer is entitled to receive under the loan. Thus, if a consumer only partially drew down the credit plan, but the consumer was required to make a payment, a one-time electronic fund transfer could trigger coverage without the one-time immediate transfer exception.

The Bureau received a few comments on § 1041.3(c)(1) of the proposed rule and the related commentary. One commenter contended that the definition of leveraged payment mechanism is overly broad as between different types of push and pull transactions. Another commenter claimed that the Bureau was improperly attributing motive to the practices of different types of lenders that were using the same leveraged payment mechanisms, that its treatment of leveraged payment mechanisms would have more than a minimal effect on lenders that were already engaged in substantial underwriting, and that the proposed rule and commentary were misaligned with respect to transactions that push or pull money from the consumer's account.

In response to these comments, the Bureau concludes that, in general, its definition is reasonably calibrated to address the core practice at issue here, which is a lender or service provider establishing a right to initiate payment directly from the consumer without any intervening action or further assent from the consumer, subject to certain narrow limitations. The definition of leveraged payment mechanism thus is not overbroad for the purposes served by the rule. As for the final set of comments, the Bureau did not undertake any inquiry or determine any of these issues based on speculation about the motivations of particular lenders; rather, it presumed that lenders that secure leveraged payment mechanisms do so for a mix of reasons. The Bureau also acknowledges at least some tension between the proposed rule and the related commentary in their treatment of push and pull transactions from a consumer's account. On further consideration, however, the Bureau has concluded that with the focus now solely on payment practices, push transactions are no longer germane to the analysis and thus has revised proposed comments 3(c)(1)-1 and 3(c)(1)-4 accordingly.

In light of these comments received and the responses, the Bureau is finalizing proposed § 1041.3(c)(1) as part of § 1041.3(c), and is revising the definition of leveraged payment mechanism to align more closely with the rule's payment provisions. Specifically, the Bureau is revising the proposed language that would have excluded a one-time immediate transfer from the definition. Under the definition as finalized, the exception applies if the lender initiates a single immediate payment transfer at the consumer's request, as defined in § 1041.8(a)(2). As discussed in the section-by-section analysis of §§ 1041.8 and 1041.9, transfers meeting the definition of a single immediate payment transfer at the consumer's request are excluded from the cap on failed payment attempts and the payment notice requirements. The Bureau has concluded that using the same definition for purposes of excluding certain transfers from the definition of leveraged payment mechanism is important for the consistency of the rule.

One practical result of this revision is that, whereas the proposed exclusion from the definition of leveraged payment mechanism would have applied only to a one-time electronic fund transfer, the exclusion as finalized permits the lender to initiate an electronic fund transfer or process a signature check without triggering coverage under § 1041.3(b)(3), provided that the lender initiates the transfer or processes the signature check in accordance with the timing and other conditions in § 1041.8(a)(2). The Bureau notes, however, that the definition of single immediate payment transfer at the consumer's request applies only to the first time that a lender initiates the electronic fund transfer or processes the signature check pursuant to the exception. It does not apply to the re-presentment or re-submission of a transfer or signature check that is returned for nonsufficient funds. If a transfer or signature check is returned, the lender could still work with the consumer to obtain payment in cash or to set up another transfer meeting the definition of single immediate payment transfer at the consumer's request.

The Bureau is finalizing the remainder of the commentary to this provision, which is reordered as comments 3(c)-1 to 3(c)-4 of the final rule, with revisions to the language consistent with the revisions made to the definition of leverage payment mechanism in § 1041.3(c).

3(d) Exclusions for Certain Credit Transactions

As discussed above, the Bureau decided to narrow how part 1041 applies to covered longer-term loans to focus only on payment practices. Accordingly, the detailed discussion of vehicle security that appeared in proposed § 1041.3(d) in connection with the definition of covered longer-term loan under proposed § 1041.3(b)(2) is no longer germane to the final rule. As noted in the section-by-section analysis of § 1041.2(a)(19) of the final rule, the Bureau has now moved certain language from proposed § 1041.3(d) describing vehicle security to § 1041.2(a)(19) of the final rule, since vehicle security is relevant to application to § 1041.6 of the final rule. Thus the remainder of § 1041.3 is being renumbered, and all references to the provisions of proposed § 1041.3(e) have now been finalized as § 1041.3(d), with further revisions and additions as described below.

Proposed § 1041.3(e) would have excluded specific types of credit from part 1041, specifically purchase money security interest loans extended solely for the purchase of a good, real estate secured loans, certain credit cards, student loans, non-recourse pawn loans in which the consumer does not possess the pledged collateral, and overdraft services and overdraft lines of credit. The Bureau found as a preliminary matter that notwithstanding the potential term, cost of credit, repayment structure, or security of these loans, they arise in distinct markets that may pose a somewhat different set of concerns for consumers. At the same time, the Bureau was concerned about the risk that these exclusions could create avenues for evasion of the proposed rule. In the Accompanying RFI, the Bureau also solicited information and additional evidence to support further assessment of whether other categories of loans may pose risks to consumers where lenders do not determine the consumer's ability to repay. The Bureau also emphasized that it may determine in a particular supervisory or enforcement matter or in a later rulemaking, in light of evidence available at the time, that the failure to assess ability to repay when making a loan excluded from coverage here may nonetheless be an unfair or abusive act or practice.

The Bureau did not receive any comments on the brief opening language in § 1041.3(e) of the proposed rule, and is finalizing the language which notes that the exclusions listed in § 1041.3(d) of the final rule apply to certain transactions, with slight modifications for clarity.

The Bureau did, however, receive some general comments about the topic of exclusions from the scope of coverage of the proposed rule. First, various consumer groups argued that there should be no exclusions or exemptions from coverage under the rule, which would weaken its effectiveness.

A “fintech” company urged the Bureau to develop a “sandbox” type of model to allow innovation and to encourage the development of alternative loan models. Another such company offered a more complicated and prescriptive regulatory scheme establishing a safe harbor, lifting income verification requirements for loans with low loss rates and loans with amortizing payment plans, and full relief from cooling-off periods if borrowers repay their loans on time with their own money. One commenter during the SBREFA process argued for a broad exemption from the rule for payday lenders in States that permit such loans pursuant to existing regulatory frameworks governing payday lending. Another sought an exemption for Tribal lenders, asserting that the Bureau lacked statutory authority to treat them as covered by the rule. Many finance companies, and others commenting on their behalf, offered reasons why the Bureau should omit traditional installment loans from coverage under the rule; they also presented different formulations of how this result could be achieved.

The Bureau does not agree that the exclusions listed in the proposal should be eliminated, for all the reasons set out in the discussion of those specific exclusions below (and notes that a further exclusion and two conditional exemptions have been added to or revised from the proposed rule). As for the notion of a “sandbox” approach to financial innovation, the Bureau has developed its own approach to these issues, having created and operated its Project Catalyst for several years now as a means of carrying out the Bureau's statutory objective to ensure that “markets for consumer financial products and services operate transparently and efficiently to facilitate access and innovation.” The suggestion that a distinct and highly prescriptive regulatory approach should be adopted in preference to the framework actually set out in the proposal is not supported by any data or analysis of this market.

The arguments for an exemption of payday lender in those States where they are permitted to make such loans are directly contrary to all of the data and analysis contained in the extended discussions above in part II and below in Market Concerns—Underwriting. All of the risks and harms that the Bureau has identified from covered loans occur, by definition, in those States that authorize such lending, rather than in the 15 States and the District of Columbia that have effectively banned such lending under their State laws. The arguments raised on behalf of Tribal lenders have also been raised in Tribal consultations that the Bureau has held with federally recognized Indian tribes, as discussed in part III, and rest on what the Bureau believes is a misreading of the statutes and of governing Federal law and precedents governing the scope of Tribal immunity.

As for the points raised by finance companies and others about traditional installment loans, they are largely being addressed by various modifications to the proposed rule, including by not imposing underwriting requirements for covered longer-term loans (other than covered longer-term balloon-payment loans), by adopting the exclusions and conditional exemptions, and, as some commenters suggested, by adopting the definition of cost of credit under TILA in place of the definition of total cost of credit in the proposed rule.

3(d)(1) Certain Purchase Money Security Interest Loans

Proposed § 1041.3(e)(1) would have excluded from coverage under proposed part 1041 loans extended for the sole and express purpose of financing a consumer's initial purchase of a good when the good being purchased secures the loan. Accordingly, loans made solely to finance the purchase of, for example, motor vehicles, televisions, household appliances, or furniture would not be subject to the consumer protections imposed by proposed part 1041 to the extent the loans are secured by the good being purchased. Proposed comment 3(e)(1)-1 explained the test for determining whether a loan is made solely for the purpose of financing a consumer's initial purchase of a good. If the item financed is not a good or if the amount financed is greater than the cost of acquiring the good, the loan is not solely for the purpose of financing the initial purchase of the good. Proposed comment 3(e)(1)-1 further explained that refinances of credit extended for the purchase of a good do not fall within this exclusion and may be subject to the requirements of proposed part 1041.

Purchase money loans are typically treated differently than non-purchase money loans under the law. The FTC's Credit Practices Rule generally prohibits consumer credit in which a lender takes a nonpossessory security interest in household goods but makes an exception for purchase money security interests. The Federal Bankruptcy Code, the UCC, and some other State laws also apply different standards to purchase money security interests. This differential treatment facilitates the financing of the initial purchase of relatively expensive goods, which many consumers would not be able to afford without a purchase money loan. In the proposal, the Bureau stated that it had not yet determined whether purchase money loans pose similar risks to consumers as the loans covered by proposed part 1041. Accordingly, the Bureau proposed not to cover such loans at this time.

A number of commenters expressed concern about the proposal's use of a sole purpose test for determining when a loan made to finance the consumer's initial purchase of a good gives rise to a purchase money security interest. Other alternatives were suggested, including a primary purpose test or perhaps the definition used in the UCC adopted in many States. Some commenters expressed concerns about motor vehicle purchases, in particular, noting that where the amount financed includes not simply the vehicle itself, but also the costs of ancillary products such as an extended service contract or a warranty, or other related costs such as taxes, tags, and title, it may be unclear whether the loan would lose its status as a purchase money security interest loan and become a covered loan instead. Others contended that covering the refinancing of credit that was extended for the purchase of a good could seem inconsistent with the terms of the exclusion itself, and could also bring back within the proposed rule's scope of coverage many motor vehicle loans where the total cost of credit would exceed a rate of 36 percent per annum. These commenters again were particularly concerned about motor vehicle loans, which they noted often exceed a 100 percent lien-to-value ratio because additional products, such as add-on products like extended warranties, are often financed along with the price of the vehicle.

In response to these comments, the Bureau streamlined and added language to proposed comment 3(e)(1)-1 to specify that a loan qualifies for this exclusion even if the amount financed under the loan includes Federal, State, or local taxes or amounts required to be paid under applicable State and Federal licensing and registration requirements. The Bureau recognized that these mandatory and largely unavoidable items should not cause a loan to lose its excluded status. Yet the same considerations do not apply to ancillary products that are being sold along with a vehicle or other household good, but are not themselves the good in which the lender takes a security interest as a condition of the credit. As to the concern about refinances of credit extended for the purchase of a good, and especially the concern that this provision could bring back within the proposed rule's scope of coverage many motor vehicle loans where the total cost of credit would exceed a rate of 36 percent per annum, the Bureau concluded that other changes made elsewhere in the final rule largely mitigate these concerns. In particular, the Bureau notes that the definition of total cost of credit in § 1041.2(a)(18) of the proposed rule has now been replaced with the definition of cost of credit in § 1041.2(a)(6) of the final rule, which aligns this term with Regulation Z. The Bureau also notes that these concerns about refinancing are most applicable to covered longer-term loans, which are no longer subject to underwriting criteria in the final rule (with the exception of covered longer-term balloon-payment loans). And though they are subject to the payment provisions, other changes in the coverage and the scope of the exceptions for certain payment transfers mitigate the effects for credit unions, in particular, that were the source of many of the comments on this issue.

For these reasons, the Bureau is finalizing the regulation text as proposed, and the revised commentary as explained above as § 1041.3(d)(1) in the final rule.

3(d)(2) Real Estate Secured Credit

Proposed § 1041.3(e)(2) would have excluded from coverage under proposed part 1041 loans that are secured by real property, or by personal property used as a dwelling, and in which the lender records or perfects the security interest. The Bureau stated that even without this exclusion, very few real estate secured loans would meet the coverage criteria set forth in proposed § 1041.3(b). Nonetheless, the Bureau preliminarily found that a categorical exclusion would be appropriate. For the most part, these loans are already subject to Federal consumer protection laws, including, for most closed-end loans, ability-to-repay requirements under Regulation Z § 1026.43. The proposed requirement that the security interest in the real estate be recorded or perfected also strongly discourages attempts to use this exclusion for sham or evasive purposes. Recording or perfecting a security interest in real estate is not a cursory exercise for a lender—recording fees are often charged and documentation is required. As proposed comment 3(e)(2)-1 explained, if the lender does not record or otherwise perfect the security interest in the property during the term of the loan, the loan does not fall under this exclusion and may be subject to the requirements of proposed part 1041. The Bureau did not receive any comments on this portion of the proposed rule, and is finalizing this exclusion and the commentary as proposed, with formatting changes only.

3(d)(3) Credit Cards

Proposed § 1041.3(e)(3) would have excluded from coverage under proposed part 1041 credit card accounts meeting the definition of credit card account under an open-end (not home-secured) consumer credit plan in Regulation Z § 1026.2(a)(15)(ii), rather than products meeting the more general definition of credit card accounts under Regulation Z § 1026.2(a)(15). By focusing on the narrower category, the exclusion would apply only to credit card accounts that are subject to the Credit CARD Act of 2009, which provides various heightened safeguards for consumers. These protections include a limitation that card issuers cannot open a credit card account or increase a credit line on a card account unless the card issuer first considers the consumer's ability to repay the required payments under the terms of the account, as well as other protections such as limitations on fees during the first year after account opening, late fee restrictions, and a requirement that card issuers give consumers a reasonable amount of time to pay their bill.

The Bureau preliminarily found that potential consumer harms related to credit card accounts are more appropriately addressed by the CARD Act, its implementing regulations, and other applicable law. At the same time, if the Bureau were to craft a broad exclusion for all credit cards as generally defined under Regulation Z, the Bureau would be concerned that a lender seeking to evade the requirements of the rule might seek to structure a product in a way that is designed to take advantage of this exclusion. The Bureau therefore proposed a narrower definition, focusing only on those credit card accounts that are subject to the full range of protections under the CARD Act and its implementing regulations. Among other requirements, the regulations imposing the CARD Act prescribe a different ability-to-repay standard that lenders must follow, and the Bureau found as a preliminary matter that the combined consumer protections governing credit card accounts subject to the CARD Act are sufficient for that type of credit.

One commenter stated that all credit cards should be excluded from coverage under the rule, not just those subject to the CARD Act. Another industry commenter found it noteworthy that credit cards are not covered under the rule even though they can result in a cycle of debt. Consumer groups argued that this exclusion should be narrowed to lower-cost mainstream credit cards in harmony with the provisions of the Military Lending Act and implementing regulations. Other narrowing categories were also suggested in that comment.

For all the reasons stated in the proposal, the Bureau does not find it sensible to expand coverage in this exclusion beyond those credit cards that are subject to the various heightened safeguards and protections for consumers in the CARD Act. At the same time, the reasons for drawing the boundaries of this exclusion around that particular universe of credit cards also militate against narrowing the scope of the exclusion further. Accordingly, the Bureau is finalizing this exclusion as proposed, with formatting changes only. The Bureau notes that “hybrid prepaid-credit card” products, which are treated as open-end (not home-secured) consumer credit plans under the final prepaid accounts rule, will be excluded from the scope of this final rule under § 1041.3(d)(3).

3(d)(4) Student Loans

Proposed § 1041.3(e)(4) would have excluded from coverage under proposed part 1041 loans made, insured, or guaranteed pursuant to a Federal student loan program, and private education loans. The Bureau stated that even without this exclusion, very few student loans would meet the coverage criteria set forth in proposed § 1041.3(b). Nonetheless, the Bureau preliminarily determined that a categorical exclusion is appropriate. Federal student loans are provided to students or parents meeting eligibility criteria established by Federal law and regulations, such that the protections afforded by this proposed rule would be unnecessary. Private student loans are sometimes made to students based on their future potential ability to repay (as distinguished from their current ability), but they are typically co-signed by a party with financial capacity. These loans raise discrete issues that may warrant further attention in the future, but the Bureau found as a preliminary matter that they were not appropriately considered along with the types of loans at issue in this rulemaking. The Bureau stated in the proposal that it would continue to monitor the student loan servicing market for trends and developments; for unfair, deceptive, or abusive practices; and to evaluate possible policy responses, including potential rulemaking.

Consumer groups contended that student loans should not be excluded from coverage under the rule. They noted that the effect of deleting this exclusion would likely be limited to private education loans, since the total cost of credit for Federal student loans in the proposed rule would likely not exceed a rate of 36 percent per annum. The Bureau continues to judge that student loans are specialized in nature, are subject to certain other regulatory constraints more specifically contoured to the loan product, and are generally not appropriately considered among the types of loans at issue here. The Bureau did not receive any other comments on this portion of the proposed rule, and is finalizing this exclusion as proposed, with formatting changes only.

3(d)(5) Non-Recourse Pawn Loans

Proposed § 1041.3(e)(5) generally would have excluded from coverage, under proposed part 1041, loans secured by pawned property in which the lender has sole physical possession and use of the pawned property for the entire term of loan, and for which the lender's sole recourse if the consumer does not redeem the pawned property is the retention and disposal of the property. Proposed comment 3(e)(5)-1 explained that if any consumer, including a co-signor or guarantor, is personally liable for the difference between the outstanding loan balance and the value of the pawned property, then the loan does not fall under this exclusion and may be subject to the requirements of proposed part 1041.

The Bureau preliminarily found that bona fide, non-recourse pawn loans generally pose somewhat different risks to consumers than loans covered under proposed part 1041. As described in part II, non-recourse pawn loans involve the consumer physically relinquishing control of the item that secures the loan during the term of the loan. The Bureau stated that consumers may be more likely to understand and appreciate the risks associated with physically turning over an item to the lender when they are required to do so at consummation. Moreover, in most situations, the loss of a non-recourse pawned item over which the lender has sole physical possession during the term of the loan is less likely to affect the rest of the consumer's finances than is either a leveraged payment mechanism or vehicle security. For instance, a pawned item of this nature may be valuable to the consumer, but the consumer most likely does not rely on the pawned item for transportation to work or to pay basic living expenses or major financial obligations. Otherwise, the consumer likely would not have pawned the item under those terms. Finally, because the loans are non-recourse, in the event that a consumer is unable to repay the loan, the lender must accept the pawned item as fully satisfying the debt, without further collection activity on any remaining debt obligations. In all of these ways, the Bureau stated in the proposal that pawn transactions appear to differ significantly from the secured loans that would be covered under proposed part 1041.

One commenter claimed that the same reasons for excluding non-recourse pawn loans applies to vehicle title loans, and that vehicle title loans may even be preferred by consumers as the consumer retains the use of the vehicle and they can be less costly. Another similarly argued that the Bureau ignored the principle of a level playing field among different financial products by excluding high-cost alternatives like pawn loans, which can be even more costly at times than payday loans. Consumer groups suggested that the exclusion should be narrowed only to pawn loans where the loan does not exceed the fair market value of the good.

Another commenter representing pawnbrokers argued that the exclusion for pawn loans is justified because pawn transactions function as marketed, they are less likely than other loan products to affect the rest of the consumer's finances, consumers do not experience very high default rates or aggressive collection efforts, certain other harms identified in the proposal do not occur in the pawn market, State and local government regulation is working well, consumers are given clear disclosures on their pawn ticket, and loan terms are longer than the typical 14-day payday loan.

The Bureau does not find that these comments justify any modifications to this provision, and therefore finalizes the exclusion and the commentary as proposed, with formatting changes only. The first two comments do not provide any tangible support for eliminating the rationale for the exclusion of non-recourse pawn loans, and issues involving vehicle title loans are addressed elsewhere, as in Market Concerns—Underwriting, which describes the special risks and harms to consumers of repossession of their vehicle, which would potentially cause them to lose their basic transportation to work and to manage their everyday affairs. The suggestion that certain pawn loans should be covered loans depending on the relationship between the amount of the loan and the fair market value of the good would introduce needless complexity into the rule without discernible benefits. The Bureau notes that non-recourse pawn loans had previously been referenced in the definition of non-covered bridge loan in proposed § 1041.2(a)(13), which has now been omitted from the final rule. To the extent that provision would have restricted the making of such loans in connection with the underwriting criteria for covered longer-term loans, those provisions are not being included in the final rule. To the extent that provision would have restricted the making of such loans in connection with the requirements in the rule for making covered short-term or longer-term balloon-payment loans, the Bureau concludes that various other changes made in §§ 1041.5 and 1041.6 address the subject of those restrictions in ways that obviate the need for defining the term non-covered bridge loan. However, note that any type of loan, including pawn loans, if used to bridge between multiple covered short-term loans or covered longer-term balloon-payment loans, are factors which could indicate that a lender's ability-to-repay determinations are unreasonable. See comment 5(b)-2.

3(d)(6) Overdraft Services and Lines of Credit

Proposed § 1041.3(e)(6) would have excluded from coverage under proposed part 1041 overdraft services on deposit accounts as defined in 12 CFR 1005.17(a), as well as payments of overdrafts pursuant to a line of credit subject to Regulation Z, 12 CFR part 1026. Proposed comment 3(e)(6)-1 noted that institutions could rely on the commentary to 12 CFR 1005.17(a) in determining whether credit is an overdraft service or an overdraft line of credit that is excluded from the requirements of part 1041. Overdraft services generally operate on a consumer's deposit account as a negative balance, where the consumer's bank processes and pays certain payment transactions for which the consumer lacks sufficient funds in the account and imposes a fee for the service as an alternative to either refusing to authorize the payment (in the case of most debit and ATM transactions and ACH payments initiated from the consumer's account) or rejecting the payment and charging a non-sufficient funds fee (in the case of other ACH payments as well as paper checks). Overdraft services have been treated separately from the provisions of Regulation Z in certain circumstances, and are subject to specific rules under EFTA and the Truth in Savings Act (TISA) and their respective implementing regulations. In contrast, overdraft lines of credit are separate open-end lines of credit under Regulation Z that have been linked to a consumer's deposit account to provide automatic credit draws to cover the processing of payments for which the funds in the deposit account are insufficient.

As discussed above in part II, the Bureau is engaged in research and other activity in anticipation of a separate rulemaking on overdraft products and practices. Given that overdraft services and overdraft lines of credit involve complex overlays with rules about payment processing, deposit accounts, set-off rights, and other forms of depository account access, the Bureau preliminarily found that any discussion of whether additional regulatory protections are warranted for those two products should be reserved for that rulemaking. Accordingly, the Bureau proposed excluding both types of overdraft products from the scope of this rule, using definitional language from Regulation E to distinguish both overdraft services and overdraft lines of credit from other types of depository credit products.

One industry commenter argued that the Bureau ignored the principle of a level playing field among different financial products by excluding high-cost alternatives like overdraft, which can be even more costly at times than payday loans. Consumer groups argued that the Bureau should eliminate this exclusion or limit it in various ways. The Bureau maintains the analysis presented in the proposed rule to conclude that overdraft services and lines of credit are unique products with a distinct regulatory history and treatment, which should be excluded from this rule and addressed on their own as a matter of supervision, enforcement, and regulation. The Bureau also did not find persuasive the suggestion that overdraft services and lines of credit should be covered in some partial manner, which would introduce needless complexity into the rule without discernible benefits. Having received no other comments on this portion of the proposed rule, the Bureau is finalizing this exclusion and the commentary as proposed, with formatting changes only.

3(d)(7) Wage Advance Programs

Based on prior discussions with various stakeholders, the Bureau solicited and received comments in the proposal in connection with the definition of lender under proposed § 1041.2(a)(11) about some newly formed companies that are seeking to develop programs that provide innovative access to consumers' wages in ways that do not seem to pose the kinds of risks and harms presented by covered loans. Certain of these companies, but by no means all of them, are part of the “fintech” wave. Some are developing new products as an outgrowth of businesses focusing mainly on payroll processing, for example, whereas others are not associated with consumers' employers but rather are focused primarily on devising new means of advising consumers about how to improve their approach to cash management. The Bureau has consistently expressed interest in encouraging more experimentation in this space.

In particular, a number of these innovative financial products are seeking to assist consumers in finding ways to draw on the accrued cash value of wages they have earned but not yet been paid. Some of these products are doing so without imposing any fees or finance charges, other than a charge for participating in the program that is designed to cover processing costs. Others are developing different models that may involve fees or advances on wages not yet earned.

The Bureau notes that some efforts to give consumers access to accrued wages may not be credit at all. For instance, when an employer allows an employee to draw accrued wages ahead of a scheduled payday and then later reduces the employee's paycheck by the amount drawn, there is a quite plausible argument that the transaction does not involve “credit” because the employee may not be incurring a debt at all. This is especially likely where the employer does not reserve any recourse upon the payment made to the employee other than the corresponding reduction in the employee's paycheck.

Other initiatives are structured in more complicated ways that are more likely to constitute “credit” under the definition set forth in § 1041.2(a)(11) and Regulation Z. For example, if an employer cannot simply reduce the amount of an employee's paycheck because payroll processing has already begun, there may be a need for a mechanism for the consumer to repay the funds after they are deposited in the consumer's account.

The Bureau has decided in new § 1041.3(d)(7) to exclude such wage advance programs—to the extent they constitute credit—from coverage under the rule if they meet certain additional conditions. The Bureau notes that the payment of accrued wages on a periodic basis, such as bi-weekly or monthly, appears to be largely driven by efficiency concerns with payroll processing and employers' cash management. In addition, the Bureau believes that the kinds of risks and harms that the Bureau has identified with making covered loans, which are often unaffordable as a result of the identified unfair and abusive practice, may not be present where these types of innovative financial products are subject to appropriate safeguards. Accordingly, where advances of wages constitute credit, the Bureau is adopting § 1041.3(d)(7) to exclude them from part 1041 if the advances are made by an employer, as defined in the Fair Labor Standards Act, 29 U.S.C. 203(d), or by the employer's business partner, to the employer's employees, provided that the following conditions apply:

• The employee is not required to pay any charges or fees in connection with such an advance from the employer or the employer's business partner, other than a charge for participating in the program; and
• The entity advancing the funds warrants that it has no legal or contractual claim or remedy against the employee based on the employee's failure to repay in the event the amount advanced is not repaid in full; will not engage in any debt collection activities if the advance is not deducted directly from wages or otherwise repaid on the scheduled date; will not place the amount advanced as a debt with or sell the debt to a third party; and will not report the debt to a consumer reporting agency concerning the amount advanced.

The Bureau has considered the comments as well as its own analysis of this evolving marketplace and has concluded that new and innovative financial products that meet these conditions will tend not to produce the kinds of risks and harms that the Bureau's final rule is seeking to address with respect to covered loans. At the same time, nothing prevents the Bureau from reconsidering these assumptions in a future rulemaking if there is evidence that such products are harming consumers.

The Bureau has also adopted new commentary. Comment 3(d)(7)-1 notes that wage advance programs must be offered by the employee's employer or the employer's business partner, and examples are provided of such business partners, which could include companies that are involved in providing payroll processing, accounting services, or benefits programs to the employer. Comment 3(d)(7)(i)-1 specifies that the advance must be made only against accrued wages and must not exceed the amount of the employee's accrued wages, and provides further definition around the meaning of accrued wages. Comment 3(d)(7)(ii)(B)-1 clarifies that though the entity advancing the funds is required to warrant that it has no legal or contractual claim or remedy against the consumer based on the consumer's failure to repay in the event the amount advanced is not repaid in full, this provision does not prevent the entity from obtaining a one-time authorization to seek repayment from the consumer's transaction account.

For these reasons, the Bureau is adopting the exclusion for wage advance programs as described in § 1041.3(d)(7) of the final rule and the related commentary.

3(d)(8) No-Cost Advances

As discussed above in connection with § 1041.3(d)(7), the Bureau noted in the proposal, in connection with its discussion of the definition of lender in proposed § 1041.2(a)(11), that some newly formed companies are providing products or services that allow consumers to draw on wages they have earned but not yet been paid. Some of these companies are providing advances of funds and are doing so without charging any fees or finance charges, for instance by relying on voluntary tips. The proposal noted that others were seeking repayment and compensation through electronic transfers from the consumer's account. The Bureau sought comment on whether to exclude such entities and similar products from coverage under the rule.

The Bureau received limited comments on this issue, perhaps reflecting that it represents a fairly new business model in the marketplace, with some championing the potential benefits for consumers and others maintaining that no exclusions—or at least no additional exclusions—should be created to the rule as it was proposed. Some comments described in more detail how the evolution of these products was unfolding, how they operate, and how they may affect the marketplace and consumers. The Bureau has also had discussions with stakeholders in connection with its other functions, such as market monitoring, supervision, and general outreach, that have informed its views and understanding of these new products and methods of providing access to funds for more consumers. As discussed above in connection with § 1041.3(d)(7), the Bureau is aware that some of these products provide access to the consumer's own funds in the form of earned wages already accrued but not yet paid out because of administrative and payroll processes historically developed by employers, whereas other products rely on estimates of wages likely to be accrued, or accrued on average, and may make advances against expected wages that are not already earned and accrued.

The Bureau has carefully considered the comments it has received on these issues, as well as other information about the market that it has gleaned from the course of its regular activities. The Bureau has addressed certain wage advance programs offered by employers or their business partners in § 1041.3(d)(7), as discussed above. In addition, after further weighing the potential benefits to consumers of this relatively new approach, the Bureau has decided to create a specific exclusion in § 1041.3(d)(8) of the final rule to apply to no-cost advances, regardless of whether they are offered by an employer or its business partner. The exclusion contains similar conditions to § 1041.3(d)(7), except that it applies to advances of funds where the consumer is not required to pay any charge or fee (even a fee for participating in the program), and it is not limited to the accrued cash value of the employee's wages. Like § 1041.3(d)(7), the exclusion is further limited to situations in which the entity advancing the funds warrants to the consumer as part of the contract between the parties (i) that it has no legal or contractual claim or remedy against the consumer based on the consumer's failure to repay in the event the amount advanced is not repaid in full; and (ii) that with respect to the amount advanced to the consumer, the entity advancing the funds will not engage in any debt collection activities, place the debt with or sell the debt to a third party, or report the debt to a consumer reporting agency if the advance is not repaid on the scheduled date.

The exclusion in § 1041.3(d)(8) is thus designed to apply to programs relying solely on a “tips” model or otherwise providing emergency assistance at no cost to consumers. The Bureau estimates, based on its experience with the marketplace for different types of small-dollar loans, that products meeting the conditions of § 1041.3(d)(8) are likely to benefit consumers and unlikely to lead to the risks and harms described below in Market Concerns—Underwriting. Unlike the proposal, the Bureau has decided not to confine such no-fee advances solely to the employer-employee context, as the very specific features of their product structure makes an exclusion from the rule for them likely to be beneficial for consumers across the spectrum. At the same time, nothing prevents the Bureau from reconsidering these assumptions in a future rulemaking if there is evidence that such products are harming consumers.

New comment 3(d)(8)-1 further provides that though an entity advancing the funds is required to warrant that it has no legal or contractual claim or remedy against the consumer based on the consumer's failure to repay in the event the amount advanced is not repaid in full, this provision does not prevent the entity from obtaining a one-time authorization to seek repayment from the consumer's transaction account.

For these reasons, the Bureau is adopting the exclusion for no-cost advances as described in § 1041.3(d)(8) of the final rule and the related commentary.

3(e) Conditional Exemption for Alternative Loans

In § 1041.11 of the proposed rule, the Bureau set forth a conditional exemption for loans with a term of between 46 days and 180 days, if they satisfied a set of conditions that generally followed those established by the NCUA under the Payday Alternative Loan (PAL) Program as described above in part II. The proposal did not, however, contain a comparable exemption for PAL loans with durations between 30 and 45 days, with 30 days being the minimum duration permitted for a PAL loan. Loans that met the conditions of the proposed conditional exemption would have been exempted from the proposed underwriting criteria applicable to covered longer-term loans, but still would have been subject to the requirements on payment practices and the notice requirements.

The Bureau received many general comments on the proposed exemption for PAL loans offered by credit unions and for comparable loan products if offered by other lenders. Some commenters argued that credit unions, as a class of entity, should be entirely exempted from all coverage under the rule. Others asked for more tailored exemptions for certain credit unions, such as for those with assets totaling less than $10 billion. Still others requested that credit unions be relieved of specific obligations under the rule, such as from compliance and record retention provisions (because their prudential regulators already address those matters); or from payment regulations for internal collections that do not incur fees; or from underwriting requirements for Community Development Financial Institutions (CDFIs) that provide beneficial credit and financial services to underserved markets and populations. By contrast, other commenters did not think the Bureau could or should create any special provisions for credit unions in particular. But some consumer and legal aid groups were supportive of the PAL program, which they viewed as beneficial to consumers and not easily subject to manipulation.

Some asserted that the PAL program was too constrained to support any broad provision of such loans, which were unlikely to yield a reasonable rate of return and thus not likely to generate a substantial volume of loans or to be sustainable for other lenders that are not depository institutions. Others argued that the proposed rule contained provisions that would go beyond the terms of the PAL program and increase complexity, and these additional provisions should be scaled back to mirror the PAL program more closely. Some commenters contended that the PAL program itself imposed a usury limit, which would be improper if adopted by the Bureau.

As discussed earlier, the Bureau has decided not to finalize the specific underwriting criteria with respect to covered longer-term loans (other than covered longer-term balloon-payment loans) at this time. However, the Bureau has decided, for the reasons explained below, to create a conditional exemption to the rule that applies to any alternative loan, which is a term that is defined more specifically below. In brief, an alternative loan is a covered loan that meets certain conditions and requirements that are generally consistent with the provisions of the PAL program as authorized and administered by the NCUA, including any such loan made by a Federal credit union that is in compliance with that program. The conditions and requirements of the exemption are modified in certain respects relative to the proposal to reflect that the conditional exemption now also encompasses loans of less than 45 days in duration to create a more comprehensive lending framework, unlike the coverage initially described in the proposed rule. In creating this exception, the Bureau agrees with the commenters that concluded, after observing the PAL program over time, that program is generally beneficial to consumers and not easily subject to manipulation in ways that would create risks and harms to consumers.

At the same time, the Bureau recognizes that one of the objectives set forth in the Dodd-Frank Act is for Federal consumer financial law to be enforced consistently without regard to the status of a person as a depository institution. Consistent with that objective, the Bureau has set forth the elements of alternative loans in general form, so that lenders other than Federal credit unions—including both banks and other types of financial institutions—can offer comparable loans in accordance with essentially the same conditions and requirements. By doing so, the Bureau is making it possible for more lenders to offer this product, which will offer the opportunity to test the prediction made by some commenters that these loans would not scale if offered by lenders that are not depository institutions—a point on which the Bureau is not yet convinced either way.

The conditional exemption for alternative loans contained in § 1041.3(e) of the final rule is adopted pursuant to the Bureau's exemption authority in section 1022(b)(3) of the Dodd-Frank Act to “conditionally or unconditionally exempt any class of covered persons, service providers, or consumer financial products or services, from any . . . rule issued under this title.” In this respect, Congress gave the Bureau broad latitude, simply stating that it should do so “as [it] deems necessary or appropriate to carry out the purposes and objectives of this title.” The statutory language thus indicates that the Bureau should evaluate the case for creating such an exemption in light of its general purposes and objectives as Congress articulated them in section 1021 of the Dodd-Frank Act. In addition, when the Bureau exercises its exemption authority under section 1022(b)(3) of the Dodd-Frank Act, it is further required to take into consideration, as appropriate, three additional statutory factors: (i) The total assets of the class of covered persons; (ii) the volume of transactions involving consumer financial products or services in which the class of covered persons engages; and (iii) existing provisions of law which are applicable to the consumer financial product or service and the extent to which such provisions provide consumers with adequate protections.

Here, the Bureau perceives tangible benefit for consumers and for lenders by preserving the framework of the PAL program, which as discussed in part II has had some success in generating approximately $134.7 million in originations in 2016—up 9.7 percent from the 2015 levels—with relatively low costs of credit and relatively low levels of charge-offs for this particular market. In particular, the Bureau agrees with those commenters that noted the distinct elements of the PAL program, including the specified product features, are not configured to give rise to the kinds of risks and harms that are more evident with covered short-term loans or covered longer-term balloon-payment loans. In short, the PAL product thus far seems to be beneficial for consumers, and a conditional exemption to make such loans more broadly available to the public appears consistent with the Bureau's purpose “of ensuring that all consumers have access to markets for consumer financial products and services.” Likewise, it seems consistent also with the Bureau's objective of ensuring that “markets for consumer financial products and services operate transparently and efficiently to facilitate access and innovation,” and the competition that alternative loans could provide to other types of covered loans may be helpful in protecting consumers “from unfair . . . or abusive acts and practices.”

Turning to the statutory factors set out in section 1022(b)(3), the assets of the expected class of lenders is likely to remain relatively small in light of the thousands of smaller credit unions, as also is the volume of transactions, which many commenters did not seem to expect would scale into much larger loan programs, though the Bureau is not yet convinced on this point either way. In addition, the PAL program itself is regulated and overseen by NCUA with respect to the credit unions who offer it, which means that “existing provisions of law . . . are applicable to [it]” and it is reasonable at this time to judge that “such provisions provide consumers with adequate protection” in using this loan product, as Congress indicated was germane to determining the justifications for an exemption. Moreover, under the general terms of § 1041.3(e), which allows all lenders to make alternative loans regardless of whether they are credit unions, the Bureau and other regulators, including State regulators, stand well-positioned to monitor the development of this loan product over time, and to make adjustments if the current experience of these loans as generally beneficial for consumers were perceived to be changing in ways that created greater consumer risks and harms.

The Bureau decided to create this conditional exemption in order to recognize that the NCUA is currently operating and supervising this established loan program for credit unions and to avoid duplicative overlap of requirements that could foster confusion and create undue burdens for certain lenders, in light of the Bureau's conclusion that loans made on terms that are generally consistent with the PAL program do not pose the same kinds of risks and harms for consumers as the types of covered loans addressed by this rule. It also judges this approach to be superior to the broader scope of exemptions urged by various commenters, such as a complete exemption from the rule for all loans of all types made by credit unions (rather than just PAL loans), or even a conditional exemption from certain portions of the rule for all loans of all types made by credit unions. As for the comment that these loans impose a usury cap, the Bureau has explained elsewhere that an actual usury cap would flatly prohibit certain loans from being made based directly on the interest rate being charged, whereas the exemption provided here would merely allow such loans to avoid triggering certain conditions of making such loans—most notably, the requirement that the lender reasonably assess the borrower's ability to repay the loan according to its terms but also the provisions concerning payment practices.

For all of these reasons, the Bureau is finalizing this provision and the related commentary with several modifications. First, in response to comments suggesting that various conditions for alternative loans as stated in the proposed rule would render this loan product too burdensome and complex, the Bureau has eliminated certain conditions for such loans in the final rule. In particular, among the conditions added in the proposal that now are dropped are: required monthly payments; rules on charging fees; required checking of affiliate records; certain additional requirements, such as prohibitions on prepayment penalties and sweeping of accounts in certain circumstances, as well as required information furnishing. Second, certain changes have been made to take account of the fact that proposed § 1041.11 had applied only to covered longer-term loans, whereas § 1041.3(e) of the final rule applies to covered loans more generally. The language of each prong of § 1041.3(e)(1) through (4) of the final rule is set out below, and immediately thereafter any changes made from the proposed language to the text of the final rule are specified and explained. Again, as a prefatory matter, an alternative loan is a covered loan that meets all four of these sets of conditions and requirements.

3(e)(1) Loan Term Conditions

• Loan term conditions. An alternative loan must satisfy the following conditions:

○ The loan is not structured as open-end credit, as defined in § 1041.2(a)(16);

○ The loan has a term of not less than one month and not more than six months;

○ The principal of the loan is not less than $200 and not more than $1,000;

○ The loan is repayable in two or more payments, all of which payments are substantially equal in amount and fall due in substantially equal intervals, and the loan amortizes completely during the term of the loan; and

○ The loan carries a cost of credit (excluding any application fees) of not more than the interest rate permissible for Federal credit unions to charge under regulations issued by the National Credit Union Administration at 12 CFR 701.21(c)(7)(iii), and any application fees charged to the consumer reflect the actual costs associated with processing the application and do not exceed the application fees permissible for Federal credit unions to charge under regulations issued by the National Credit Union Administration at 12 CFR 701.21(c)(7)(iii).

The language of the final rule originated in § 1041.11(a) of the proposed rule. The name of the exemption has been revised from a conditional exemption for certain covered longer-term loans up to six months in duration to a conditional exemption for alternative loans. The term of the loan is modified from “not more than six months” to “not less than one month and no more than six months,” again to reflect the change made in this exemption to encompass the broader set of all covered loans, rather than just covered longer-term loans. The other conditions, including the $200 floor and the $1,000 cap, are maintained because they are consistent with the requirements of the PAL program. The prior condition that the loan be repayable in two or more payments “due no less frequently than monthly” is now changed to omit the quoted language because the term of these loans may now be shorter than was the case in the proposal. The amortization provision is broken out and simplified to provide more flexibility around the payment schedule and allocation, which again reflects the fact that many of these loans may now be covered short-term loans. Finally, the prior language around total cost of credit is now replaced with cost of credit, which is consistent with TILA and Regulation Z and is responsive to suggestions made by several commenters; the permissible interest rate on such products is that set by the NCUA for the PAL program; any application fees charged to the consumer must reflect the actual associated costs and comply with the provisions of any NCUA regulations; and the lender does not impose any charges other than the rate and application fees permitted by the NCUA for the PAL program.

3(e)(2) Borrowing History Condition

Section 1041.3(e)(2) provides that prior to making an alternative loan under § 1041.3(e), the lender must determine from its records that the loan would not result in the consumer being indebted on more than three outstanding loans made under this section from the lender within a period of 180 days. Section 1041.3(e)(2) also provides that the lender must also make no more than one alternative loan under § 1041.3(e) at a time to a consumer.

Aside from conforming language changes, the only substantive revision here is to excise references to affiliates of the lenders, consistent with the NCUA's practice in administering the PAL program.

3(e)(3) Income Documentation Condition

Section 1041.3(e)(3) provides that in making an alternative loan under § 1041.3(e), the lender must maintain and comply with policies and procedures for documenting proof of recurring income.

This prong contains minor conforming language changes only.

3(e)(4) Safe Harbor

Section 1041.3(e)(4) provides that loans made by Federal credit unions in compliance with the conditions set forth by the National Credit Union Administration at 12 CFR 701.21(c)(7)(iii) for a Payday Alternative Loan are deemed to be in compliance with the requirements and conditions of § 1041.3(e)(1), (2), and (3).

This prong contains entirely new language, replacing what had been “additional requirements” in § 1041.11(e) of the proposed rule. Those additional requirements tailored by the NCUA for credit unions and included in the original proposal would be cumbersome in various respects for all lenders to adopt, including provisions on additional information furnishing, restrictions on sweeps and set-offs as means of a depository institution collecting on the loan, and prepayment penalties. The safe harbor provided for Federal credit unions in compliance with NCUA's requirements for the PAL program, however, reflects the fact that to qualify for the safe harbor, a credit union would be obligated to comply with all of the additional requirements of the PAL program.

Having considered the comments received, the Bureau concludes that it is appropriate to finalize § 1041.3(e) for all the reasons discussed above. The Bureau also is finalizing proposed comment 3(d)(8)-1 as comment 3(e)-1 of the final rule, which notes that this provision does not confer on the lenders of such loans any exemption from the requirements of other applicable laws, including State laws. This comment also clarifies that all lenders, including Federal credit unions and persons that are not Federal credit unions, are permitted to make loans under the specific terms in § 1041.3(e), provided that such loans are permissible under other applicable laws, including State laws. The remainder of the commentary is being carried forward from the proposed rule with revisions, all made to align them with the modified language in § 1041.3(e) of the final rule. The proposed comments previously designated as 11(a)-1 to (11)(e)(1)(ii)-2 are now renumbered as comments 3(e)(1)-1 to 3(e)(3)-1 in the final rule.

3(f) Conditional Exemption for Accommodation Loans

In the proposal, in connection with the discussion of the proposed definition of lender in § 1041.2(a)(11), the Bureau noted that some stakeholders had suggested narrowing the definition of lender to avoid covering lenders that are primarily focused on other types of lending or other types of financial services, but on occasion make covered loans as a means of accommodating their existing customers. The stakeholders posited that such loans would be likely to operate differently from loans made as a primary line of business, for instance because the lenders who make them have information about consumers' financial situations from their primary lines of business and because their incentives in making the loans is to preserve their customer relationships, and thus may not pose the same risks and harms as other types of covered loans. The Bureau solicited comments on this suggestion.

The Bureau had also proposed a more detailed provision, in proposed § 1041.12, in order to provide a conditional exemption for certain covered longer-term loans that would be made through accommodation lending programs and would be underwritten to achieve an annual portfolio default rate of not more than five percent. The proposal would have allowed a lender to make such loans without meeting the specific underwriting criteria contained in the proposed rule, though proposed § 1041.12 laid out its own detailed provisions applicable to the making of such loans. Notably, the Bureau found that the feedback it received on this provision overlapped considerably with the comments submitted in response to the question the Bureau had asked with respect to the definition of lender about providing an exception based on de minimis lending.

Many commenters expressed their views favoring a de minimis exemption. Several of them urged that the Bureau should set parameters for the exemption based both on loan volume and the percentage of revenue derived from such loans. More specific suggestions ranged from caps of 100 to several thousand loans per year; one commenter suggested 2,000 loans per year that yield no more than five percent of revenue; others urged a cap of 2,500 loans per year that yield no more than 10 percent of revenue.

The Bureau also received a number of comments on proposed § 1041.12 and proposed comments 12(a)-1 to (12)(f)(1)(ii)-2. Banking organizations argued that the Bureau should exempt types of institutions rather than types of loans, and that because community banks are responsible providers of small loans, they should be conditionally exempted from coverage.

Many commenters were also critical of the provisions of proposed § 1041.12, which they viewed as so cumbersome as to discourage many institutions from engaging in this type of lending. These comments focused particularly on the back-end requirements and calculations included in the proposal. Some commenters noted the guidance already in place from other banking regulators that had suppressed such lending at the banks, and predicted that the proposal would exacerbate those difficulties. State bank regulators, in particular, advocated in favor of a de minimis threshold to preserve such lending by smaller community banks as beneficial to consumers, especially in rural areas and as a way to provide alternatives if the effect of the rule would be to cause consolidation in the small-dollar lending market. Consumer groups generally opposed exemptions to the rule but acknowledged that a properly structured de minimis provision would be unlikely to create much if any harm to consumers.

As stated earlier, the Bureau has decided not to finalize the ability-to-repay requirements with respect to covered longer-term loans (other than covered longer-term balloon-payment loans) at this time. However, as a result of reviewing and analyzing the public input on the issue of accommodation lending more generally, the Bureau has determined to create a conditional exemption that is applicable to accommodation loans that have been traditionally made primarily by community banks and credit unions. At the same time, in line with the Dodd-Frank Act's goal of enforcing Federal consumer financial law without regard to a financial company's status as a depository institution, the Bureau has set forth the elements of accommodation loans in general form such that any lender whose covered loan originations fall below the thresholds set in final § 1041.3(f) can qualify for the conditional exemption. In part, the Bureau is reaching this conclusion based on its review of the comments received, which indicated that lenders would find the approach taken in proposed § 1041.12 to be cumbersome or even unworkable for lenders. Whether or not this was objectively demonstrable for most lenders, it was clear that the proposed approach would have been taken as a discouraging factor for those deciding whether or not to make such loans. Moreover, the Bureau concluded that loans made as an occasional accommodation to existing customers were not likely to pose the same risks and harms as other types of covered loans, because such loans would be likely to operate differently and carry different incentives for the lender as compared to loans made as a primary line of business.

As discussed in the preceding section on alternative loans, when the Bureau exercises its exemption authority under section 1022(b)(3) of the Dodd-Frank Act to create an exemption for “any class of covered persons, service providers, or consumer financial products or services, from any * * * rule issued under this title,” it has broad latitude that Congress conferred upon it to do so. Again, Congress simply said that the Bureau should exercise this authority “as [it] deems necessary or appropriate to carry out the purposes and objectives of this title,” and the Bureau's general purposes and objectives are stated in section 1021 of the Dodd-Frank Act. In addition, when the Bureau exercises its exemption authority under section 1022(b)(3) of the Dodd-Frank Act, it is further required, as appropriate, to take into consideration three statutory factors: The total assets of the class of covered persons; the volume of transactions involving consumer financial products or services in which the class of covered persons engages; and existing provisions of law which are applicable to the consumer financial product or service and the extent to which such provisions provide consumers with adequate protections. Here, too, it appears that Congress intended the Bureau to do so in view of its purposes and objectives as set forth in the Dodd-Frank Act.

Here, the Bureau perceives tangible benefit for consumers and for lenders to be able to maintain access to individualized loans of the kind permitted by this provision and in line with the traditions and experience of community banks over many years, which have generally underwritten these loans as an accommodation on an individualized basis in light of their existing customer relationships. In this manner, the conditional exemption would help ensure “that all consumers have access to markets for consumer financial products and services,” which is a principal purpose of the Dodd-Frank Act, and would not be restricted in their existing access to such traditional loan products. At the same time, this conditional exemption would enable the Bureau “to reduce unwarranted regulatory burdens” on these longstanding loan products made to existing bank customers on an individualized basis in light of their existing customer relationships, without posing any of the kinds of risks and harms to consumers that exist with the types of covered loans addressed by this rule.

And though the provisions of § 1041.3(f) are written in general terms to be applicable to lenders that are not themselves depository institutions, it does not appear likely that these provisions would be open to wide-scale abuse, precisely because the loan and revenue restrictions are set at a de minimis level that would tend to limit the scope of any predatory behavior. Assessing the matter against the three additional statutory factors as well, then, the assets of these lenders availing themselves of this provision would likely be limited; the volume of transactions would be small, by definition and design; and Federal consumer financial law, as implemented through the Bureau's continuing supervisory and enforcement authorities and by other means as provided in the statute, would maintain consumer protections in the broader market despite this slight restriction on coverage under the rule.

Therefore, as stated in § 1041.3(f), this provision will conditionally exempt any accommodation loan from coverage under the final rule. That category is defined to apply to a covered loan made by any lender where the lender and its affiliates collectively have made 2,500 or fewer covered loans in the current calendar year and also made 2,500 or fewer covered loans in the preceding calendar year; and during the most recent completed tax year in which the lender was in operation, if applicable, the lender and any affiliates that were in operation and used the same tax year derived no more than 10 percent of their receipts from covered short-term and longer-term balloon-payment loans, or if the lender was not in operation in a prior tax year, the lender reasonably anticipates that the lender and any of its affiliates that use the same tax year will, during the current tax year, derive no more than 10 percent of their receipts from covered short-term loans and covered longer-term balloon-payment loans. Comment 3(f)-1 of the final rule provides an example of the application of this provision to a sample lender.

Although, in general, all covered loans and the receipts from those loans would count toward the thresholds in § 1041.3(f) for the number of loans per year and for receipts, § 1041.3(f) allows lenders not to count toward either threshold covered longer-term loans for which the conditional exclusion for transfers in § 1041.8(a)(1)(ii) applies to all transfers for payments made under the loan. As explained in the section-by-section discussion of § 1041.8(a)(1)(ii), when the lender is the account-holder, that provision excludes certain transfers from the definition of payment transfer if, pursuant to the terms of the loan agreement or account agreement, the lender (1) does not charge the consumer any fee, other than a late fee under the loan agreement, in the event that the lender initiates a transfer of funds from the consumer's account in connection with the covered loan for an amount that the account lacks sufficient funds to cover; and (2) does not close the consumer's account in response to a negative balance that results from a transfer of funds initiated in connection with the covered loan. These conditions provide substantial protection against the harms targeted by the provisions in §§ 1041.8 and 1041.9. As a result, loans for which all payment transfers are excluded under § 1041.8(a)(1)(ii) from the definition of payment transfer are not subject to either the prohibition in § 1041.8(b) on initiating more than two consecutive failed payment transfers or the requirement in § 1041.9(b) to provide payment notices prior to initiating certain payment withdrawals. Since those loans carry with them substantial protection against the harms targeted in subpart C and would not be subject to those provisions, the Bureau believes that it is simpler not to count them for purposes of § 1041.3(f) either.

The Bureau had sought comment about the appropriate parameters of this conditional exemption, which is designed to be a de minimis provision to allow only a certain amount of lending of this kind to accommodate customers as a distinct sidelight to the institution's main lines of business. Once again, the purpose of this provision is to accommodate existing customers through what traditionally have been loans that were underwritten on an individualized basis for existing customers. It was not proposed, and is not being adopted, to stimulate the development of a model for loans that are offered in high volumes. As for the parameters that the Bureau decided on, they closely reflect the submissions received in the comment process, with both the overall loan limit (2,500 per year) and the revenue limit (no more than 10 percent of receipts) intended to keep loans made pursuant to this exemption to a very limited part of the lender's overall business. Each of the two provisions operates together to achieve that joint objective, which would not necessarily be achieved by either component operating in isolation.

The Bureau decided to create this conditional exemption in order to respond to the persuasive points made by the commenters about the benefits that would flow from preserving this modest amount of latitude to be able to contour specialized loans as an accommodation to individual customers. That is especially so in view of the unlikelihood that this practice would pose the same kinds of risks and harms that the Bureau recognized with covered short-term loans and covered longer-term balloon-payment loans as described below in Market Concerns—Underwriting. The adoption of this conditional exemption also evinces the Bureau's recognition of the input it has heard from many stakeholders over the years, particularly from depository institutions, who have regularly supplied the Bureau with details about their perspective that smaller depository lenders such as community banks and credit unions have a long history and tradition of making loans to accommodate their existing customers for various personal reasons, such as minor expenses related to some type of family event. These loans are typically underwritten, customized, made for small amounts and at reasonable cost, and generate low levels of defaults. Although this type of accommodation lending is often quite specialized and individualized, it could be construed to overlap in certain ways with the covered loans encompassed by the rule. The conditional exemption that is now finalized in § 1041.3(f) provides an effective method of addressing legitimate concerns about the potentially detrimental consequences of that overlap for consumers.

3(g) Receipts

The Bureau has added a new definition of the term receipts, which § 1041.3(g) of the final rule defines to mean total income (or, in the case of a sole proprietorship, gross income) plus cost of goods sold as these terms are defined and reported on Internal Revenue Service (IRS) tax return forms (such as Form 1120 for corporations; Form 1120S and Schedule K for S corporations; Form 1120, Form 1065, or Form 1040 for LLCs; Form 1065 and Schedule K for partnerships; and Form 1040, Schedule C for sole proprietorships). Receipts do not include net capital gains or losses; taxes collected for and remitted to a taxing authority if included in gross or total income, such as sales or other taxes collected from customers but excluding taxes levied on the entity or its employees; or amounts collected for another (but fees earned in connection with such collections are receipts). Items such as subcontractor costs, reimbursements for purchases a contractor makes at a customer's request, and employee-based costs such as payroll taxes are included in receipts. This definition of receipts is modeled on the definitions of the same term in the Bureau's larger participant rulemakings for the consumer reporting and debt collection markets, which in turn were based in part on the Small Business Administration's definition of receipts at 13 CFR 121.104.

The Bureau is adding this definition to clarify how the term is used in § 1041.3(f) in the course of describing accommodation loans, and to reduce the risk of confusion among consumers, industry, and regulators.

3(h) Tax Year

The Bureau has added a new definition of the term tax year, which § 1041.3(h) of the final rule defines to have the same meaning attributed to this term by the IRS as set forth in IRS Publication 538, which provides that a tax year is an annual accounting period for keeping records and reporting income and expenses. The Bureau is adding this definition to clarify how the term is used in § 1041.3(f) in the course of describing accommodation loans, and to reduce the risk of confusion among consumers, industry, and regulators.

Subpart B—Underwriting

Overview of the Bureau's Approach in the Proposal and in the Final Rule

The Bureau proposed to identify an unfair and abusive practice with respect to the making of covered short-term loans pursuant to its authority to “prescribe rules * * * identifying as unlawful unfair, deceptive, or abusive acts or practices.” The proposal explained the Bureau's preliminary view that it is both an unfair and abusive practice for a lender to make such a loan without reasonably determining that the consumer will have the ability to repay the loan. To avoid committing this unfair and abusive practice, the Bureau stated that a lender would have to make a reasonable assessment that the consumer has the ability to repay the loan. The proposal would have established a set of requirements to prevent the unlawful practice by requiring lenders to follow certain specified underwriting practices in assessing whether the consumer has the ability to repay the loan, as well as imposing certain limitations on rapid re-borrowing. The Bureau proposed the ability-to-repay requirements under its authority to prescribe rules for “the purpose of preventing unfair and abusive acts or practices.”

The proposal would have further relied on section 1022(b)(3) of the Dodd-Frank Act to exempt certain covered short-term loans from the ability-to-repay requirements if the loans satisfied a set of conditions designed to avoid the harms that can result from unaffordable loans, including the harms that can flow from extended sequences of multiple loans in rapid succession. Accordingly, lenders seeking to make covered short-term loans would have the choice, on a case-by-case basis, either to comply with the ability-to-repay requirements according to the specified underwriting criteria or to make loans that meet the conditions set forth in the proposed exemption—conditions that are specifically designed as an alternative means to protect consumers against the harms that can result from unaffordable loans.

As detailed further below, the Bureau has carefully considered its own research, analysis performed by others, and the public comments received with respect to this rulemaking and is now finalizing its finding that failing to reasonably determine whether consumers have the ability to repay covered short-term loans according to their terms is an unfair and abusive practice. These sources establish that unaffordable covered short-term loans generate severe harms for a substantial population of consumers. The Bureau has made the judgment that the harms and risks of such loans can be addressed most effectively by requiring lenders to underwrite such loans in accordance with specific criteria and thus not to make such a loan without reasonably determining that the consumer has the ability to repay the loan according to its terms. The Bureau has also retained the conditional exemption, while noting that the conditions on such loans, which are specifically designed as an alternative means to protect consumers against the harms that can result from unaffordable loans, will likely prompt lenders to consider more carefully their criteria for making such loans as well, given that defaults and delinquencies can no longer be offset by the revenues from repeated re-borrowing. The Bureau has modified various details of the proposed rule with respect to the underwriting criteria for the ability-to-repay requirement and the conditional exemption to strike a better balance among compliance burdens and other concerns, but has maintained the basic framework that was initially set forth in the proposed rule.

The Bureau also proposed to identify the same unfair and abusive practice with respect to the failure to assess consumers' ability to repay certain longer-term loans, including both installment and balloon-payment structures, as long as the loans exceeded certain price thresholds and involved the taking of either a leveraged payment mechanism or vehicle security. The Bureau proposed to subject these covered longer-term loans to underwriting requirements similar to those for covered short-term loans, as well as proposing two exemptions for loans that satisfied different sets of conditions designed to avoid the risks and harms that can result from unaffordable loans.

As detailed further below, the Bureau has carefully considered its own research, analysis performed by others, and the public comments received with respect to the proposed treatment of covered longer-term loans, and has decided to take a bifurcated approach at this time to concerns about unfair or abusive underwriting of longer-term loans. With regard to balloon payment structures, the Bureau finds that failing to reasonably assess whether consumers have the ability to repay covered longer-term balloon-payment loans according to specific underwriting criteria is an unfair and abusive practice. Because they require large lump-sum or irregular payments, these loans impose financial hardships and payment shocks on consumers that are similar to those posed by short-term loans over just one or two income cycles. Indeed, the Bureau's analysis of longer-term balloon-payment loans in the market for vehicle title loans found that borrowers experienced high default rates—notably higher than for similar loans with amortizing installment payments. The Bureau also has concluded that the outcomes between a single-payment loan with a term of 46 or more days is unlikely to be much different for consumers than an identical loan with a term of 45 days, and is concerned that failing to cover longer-term balloon-payment loans would induce lenders to slightly extend the terms of their existing short-term lump-sum loans in an effort to evade coverage under the final rule, as occurred in this market in response to regulations adopted under the Military Lending Act.

For these reasons, the Bureau is finalizing its finding that failing to reasonably assess whether consumers have the ability to repay covered longer-term balloon-payment loans is an unfair and abusive practice. The Bureau has made the judgment that these risks and harms can be addressed most effectively—as with covered short-term loans—by requiring lenders to underwrite such loans in accordance with specified criteria and thus not to make such a loan without reasonably determining that the consumer has the ability to repay the loan according to its terms. After having sought comment on the issue of whether longer-term balloon-payment loans should be covered regardless of price or the taking of a leveraged payment mechanism or vehicle security, the Bureau has decided, in light of the risks to consumers, to apply the rule to all such loans, aside from certain exclusions and exemptions described above in § 1041.3 of the final rule.

The Bureau has decided, however, not to move forward with its primary finding that it is an unfair and abusive practice to make certain higher-cost longer-term installment loans without making a reasonable determination that the consumer will have the ability to repay the loan, and, accordingly, its prescription of underwriting requirements designed to prevent that practice. The Bureau has decided to defer this aspect of the proposal for further consideration in a later rulemaking. After consideration of the research and the public comments, the Bureau has concluded that further analysis and outreach are warranted with respect to such loans, as well as other types of credit products on which the Bureau sought comment as part of the Request for Information. While such loans differ in certain ways from the loans covered in this final rule, the Bureau remains concerned that failing to underwrite such products may nonetheless pose substantial risk for consumers. The Bureau will continue to gather evidence about the risks and harms of such products for consideration as a general matter in a later rulemaking, and will continue in the meantime to scrutinize such lending for potential unfair, deceptive, or abusive acts or practices pursuant to its supervisory and enforcement authority.

And, as detailed in subpart C below, the Bureau has concluded that it is appropriate to apply certain limitations and disclosure requirements concerning payment practices (and related recordkeeping requirements) to longer-term installment loans with a cost of credit above 36 percent that involve the taking of a leveraged payment mechanism.

The predicate for the identification of an unfair and abusive practice in the Bureau's proposal—and thus for the preventive ability-to-repay requirements—was a set of preliminary findings about the consumers who use storefront and online payday loans, single-payment vehicle title loans, and other covered short-term loans, and the impact on those consumers of the practice of making such loans without assessing the consumers' ability to repay. The preliminary findings as set forth in the proposal, the comments that the Bureau received on them, and the Bureau's responses to those comments as the foundation of its final rule are all discussed below in the following section referred to as Market Concerns—Underwriting. Further in the discussion below, the Bureau also addresses the same issues with respect to covered longer-term balloon-payment loans.

Market Concerns—Underwriting

Short-Term Loans

In the proposal, the Bureau stated its concern that lending practices in the markets for storefront and online payday lending, single-payment vehicle title loans, and other covered short-term loans are causing harm to many consumers who use these products. Those harms include default, delinquency, and re-borrowing, as well as various collateral harms from making unaffordable payments. This section reviews the available evidence with respect to the consumers who use covered short-term loans, their reasons for doing so, and the outcomes they experience. It also reviews the lender practices that contribute to these outcomes. The discussion begins with the main points presented in this section of the proposal, stated in summary form, and provides a high-level overview of the general responses offered by the commenters. More specific issues and comments are then treated in more detail in the succeeding subsections. In the proposal, the Bureau's preliminary views were stated in summary form as follows:

• Lower-income, lower-savings consumers. Consumers who use these products tend to come from lower- or moderate-income households. They generally do not have any savings to fall back on, and they have very limited access to other sources of credit; indeed, typically they have sought unsuccessfully to obtain other, lower cost, credit before turning to a short-term loan. The commenters generally validated these factual points, though many disputed the inferences and conclusions to be drawn from these points, whereas others agreed with them. Individual commenters generally validated the factual descriptions of these characteristics of borrowers as well.
• Consumers in financial difficulty. Some consumers turn to these products because they have experienced a sudden drop in income (“income shock”) or a large unexpected expense (“expense shock”). Other borrowers are in circumstances in which their expenses consistently outstrip their income. A sizable percentage of users report that they would have taken a loan on almost any terms offered. Again, the commenters generally validated these points as a factual matter, but disputed the inferences and conclusions to be drawn therefrom.
• Loans do not function as marketed. Lenders market single-payment products as short-term loans designed to provide a bridge to the consumer's next payday or other income receipt. In practice, however, the amounts due on these loans consume such a large portion of the consumer's paycheck or other periodic income source as to be unaffordable for most consumers seeking to recover from an income or expense shock, and even more so for consumers with a chronic income shortfall. Lenders actively encourage consumers either simply to pay the finance charges due and roll over the loan instead of repaying the loan in full (or effectively roll over the loan by engaging in back-to-back transactions or returning to re-borrow in no more than a few days after repaying the loan). Indeed, lenders are dependent upon such re-borrowing for a substantial portion of their revenue and would lose money if each borrower repaid the loan when it was due without re-borrowing. The commenters tended to recharacterize these points rather than disputing them as a factual matter, though many industry commenters disagreed that these loans should be considered “unaffordable” for “most” consumers if many consumers manage to repay them after borrowing once or twice. Others contended that these loans should not be considered “unaffordable” if they are repaid eventually, even after re-borrowing multiple times in extended loan sequences. The commenters on all sides generally did not dispute the nature of the underlying business model as resting on repeat re-borrowing that lenders actively encourage, though they sharply disputed whether this model benefited or harmed consumers.
• Very high re-borrowing rates. Most borrowers find it necessary to re-borrow when their loan comes due or shortly after repaying their loan, as other expenses come due. This re-borrowing occurs both with payday loans and with single-payment vehicle title loans. The Bureau found that 56 percent of payday loans are borrowed on the same day and 85 percent of these loans are re-borrowed within a month. Fifty percent of all new storefront payday loans are followed by at least three more loans and 33 percent are followed by six more loans. While single-payment vehicle title loans are often for somewhat longer durations than payday loans, typically with terms of one month, re-borrowing tends to occur sooner and longer sequences of loans are more common. The Bureau found that 83 percent of single-payment vehicle title loans are re-borrowed on the same day and 85 percent of them are re-borrowed within a month. Over half (56 percent) of all new single-payment vehicle title loans are followed by at least three more loans, and more than a third (36 percent) are followed by six or more loans. Of the payday loans made to borrowers paid weekly, bi-weekly, or semi-monthly, over 20 percent are in loan sequences of 20 loans or more and over 40 percent of loans made to borrowers paid monthly are in loan sequences of comparable durations (i.e., 10 or more monthly loans). The commenters did not challenge the thrust of these points as demonstrating a high incidence of re-borrowing, which is a point that was reinforced by consumer groups and was illustrated by many individual commenters as well.
• Consumers do not expect lengthy loan sequences. Many consumers who take out a payday loan do not expect to re-borrow to the extent that they do. This is especially true of those consumers who end up in extended cycles of indebtedness. Research shows that many consumers who take out loans are able to accurately predict how long it will take them to get out of debt, especially if they repay immediately or re-borrow only once, but a substantial population of consumers is not able to do so, and for those consumers who end up in extended loan sequences, there is little correlation between predictions and behavior. A study on this topic found that as many as 43 percent of borrowers may have underestimated the length of time to repayment by two weeks or more. The study found that consumers who have borrowed heavily in the recent past are even more likely to underestimate how long it will take to repay the loan. Consumers' difficulty in this regard may be exacerbated by the fact that such loans involve a basic mismatch between how they are marketed as short-term credit and appear designed to function as long sequences of re-borrowing, which regularly occurs for a number of consumers. This disparity can create difficulties for consumers in being able to estimate accurately how long they will remain in debt and how much they will ultimately pay for the initial extension of credit. Research into consumer decision-making also helps explain why consumers may re-borrow more than they expect. For example, people under stress, including consumers in financial crisis, tend to become very focused on their immediate problems and think less about the future. Consumers also tend to underestimate their future expenses, and may be overly optimistic about their ability to recover from the shock they have experienced or to bring their expenses in line with their incomes. These points were sharply disputed by the commenters, and will be discussed further below.

• Very high default rates and collateral harms. Some consumers do succeed in repaying short-term loans without re-borrowing, and others eventually repay the loan after re-borrowing multiple times. But research shows that approximately 20 percent of payday loan sequences and 33 percent of single-payment vehicle title loan sequences end up with the consumer defaulting. Consumers who default can become subject to often aggressive and psychologically harmful debt collection efforts. While delinquent, they may also seek to avoid default in ways that lead to a loss of control over budgeting for their other needs and expenses. In addition, 20 percent of single-payment vehicle title loan sequences end with borrowers losing their cars or trucks to repossession. Even borrowers who have not yet defaulted may incur penalty fees, late fees, or overdraft fees along the way and may find themselves struggling to pay other bills or meet their basic living expenses. Commenters generally did not dispute that consumers may feel the effects of these negative collateral consequences of such loans and of delinquency and default, though industry commenters tended to downplay them and some argued that any such harms were outweighed by the economic benefits of such loans. Individual commenters validated this account of the negative collateral consequences of such loans as reflecting their own experiences. Many others countered that they had successful experiences with these loans and that they were benefited more than they were harmed by these experiences.
• Harms occur despite existing regulation. The research indicates that in the States that have authorized payday and other short-term loans, these harms persist despite existing regulatory frameworks. Indeed, payday loans do not legally exist in many States, so by definition the harms identified by the Bureau's research flow from such loans in those States where they are offered pursuant to existing regulatory frameworks. Even in those States where such loans are offered pursuant to somewhat different conditions, these distinctions do not appear to eliminate the harms that flow from the structure of such loans. In particular, the Bureau is concerned that existing caps on the amount that a consumer can borrow, rollover limitations, and short cooling-off periods still appear to leave many consumers vulnerable to the specific harms discussed above relating to default, delinquency, re-borrowing, and other collateral harms from attempting to avoid the other injuries by making unaffordable payments. Industry commenters took issue with these concerns and disputed this characterization of the effects of such loans.

In the proposal, the Bureau also reviewed the available evidence underlying each of these preliminary views. The Bureau sought and received comments on its review of the evidence, and those comments are reviewed and addressed in the discussion below. Based on the reasons set forth in each of the segments in this part, which respond to the comments and present further analysis that the Bureau has engaged in to consider these matters further, the Bureau now adopts as its findings underlying the final rule its views as stated in this initial summary overview, with certain modifications as set forth below.

a. Borrower Characteristics and Circumstances of Borrowing

As the Bureau laid out in the proposal, borrowers who take out payday, single-payment vehicle title, and other covered short-term loans are typically low-to-moderate income consumers who are looking for quick access to cash, who have little to no savings, who often have poor credit histories, and who have limited access to other forms of credit. Comments received from industry participants, trade associations, and individual users of these loans noted that this description of the borrower population does not describe all of the people who use these loans. That is so, of course, but the Bureau's discussion in the proposal was not intended as an exhaustive account of the entire universe of borrowers. Instead, it merely represented many of the recurring borrower characteristics that the Bureau found based on its experience with such loans over the past several years and based on data from a number of studies as discussed further below.

In the proposal, the Bureau had found preliminarily that the desire borrowers have for immediate cash may be the result of an emergency expense or an unanticipated drop in income. The comments received from industry participants, trade associations, and individual users of these loans strongly reinforce the basis for this finding. Many comments describe the function that these loans perform as coping with income and expense shocks—that is, with unexpected, temporary expenses or shortfalls in income. These comments cited surveys and studies to bolster this point, including one survey that noted 86 percent of borrowers strongly or somewhat agreed that their use of a payday loan was to cope with an unexpected expense. Many other comments, including comments from individual users of these loans, offered anecdotal accounts of the personal reasons many borrowers have for taking out these loans, including a wide variety of circumstances that can create such income or expense shocks. Comments received from consumer groups were also in agreement on these points and further underscored a shared understanding that this impetus drives much of the demand for such loans.

The comments received from industry participants, trade associations, and individual users of these loans made a different point as well. One trade association, for example, noted that many consumers use such loans for “income smoothing” or to create a better match between income and expenses in the face of income and expense volatility—that is, where the consumer's income or expenses fluctuate over the course of the year, such that credit is needed during times of lower income or higher expenses to tide the consumer over until times of higher income or lower expenses. Many reasons were given by commenters, including a high volume of individual commenters, for such income and expense volatility, and the following examples are merely illustrative of the broader and more widespread phenomenon: People who work on commission; people scheduled to receive one-time or intermittent income supplements, such as holiday bonuses; people who work irregular hours, including many contractor or part-time workers; people who have seasonal opportunities to earn extra income by working additional hours; or circumstances that may arise that create the need or the opportunity to satisfy in full some other outstanding debt that is pressing. Comments from consumer groups echoed these accounts of how these economic situations drive a certain amount of the demand for such loans. The nature and weight of these comments thus lend further support to the preliminary findings that the Bureau had made on these issues.

In the proposal, the Bureau also noted that many borrowers who take out payday or single-payment vehicle title loans are consumers whose living expenses routinely exceed their income. This category of borrowers may consistently experience negative residual income, or to use a common phrase, find that they routinely have “too much month at the end of the money” and take out such loans in an effort to bolster their income—an effort that often proves to be unsuccessful when they are later unable to repay the loan according to its terms. Various commenters agreed with this account of some borrowers, and some of the individual commenters likewise described their own experiences in this vein.

In addition, some commenters noted that certain borrowers may use these kinds of loans to manage accumulated debt, preferring to use the proceeds of the loan to pay down other debt for which nonpayment or default would be more costly alternatives. This was not frequently cited as a reason why many borrowers decide to take out such loans, but it may explain occasional instances.

1. Borrower Characteristics

In the proposal, the Bureau noted that a number of studies have focused on the characteristics of payday borrowers. For instance, the FDIC and the U.S. Census Bureau have undertaken several special supplements to the Current Population Survey (CPS Supplement); the proposal cited the most recent available data from 2013, which found that 46 percent of payday borrowers (including storefront and online borrowers) have a family income of under $30,000. The latest edition of the Survey has more recent data from 2015, which finds that the updated figure is 49 percent. A study covering a mix of storefront and online payday borrowers similarly found that 49 percent had income of $25,000 or less. Other analyses of administrative data that include the income borrowers reported to lenders show similar results.

A 2012 survey administered by the Center for Financial Services Innovation (CFSI) to learn more about users of small-dollar credit products including payday loans, pawn loans, direct deposit advances, installment loans, and auto title loans found that 43 percent of small-dollar credit consumers had a household income between $0 and $25,000, compared to 26 percent of non-small-dollar credit consumers. The mean annual household income for those making use of such products was $32,000, compared to $40,000 for those not using such products. Other studies and survey evidence presented by commenters were broadly consistent with the data and analysis contained in the studies that the Bureau had cited on this point.

Additionally, the Bureau found in its analysis of confidential supervisory data that 18 percent of storefront borrowers relied on Social Security or some other form of government benefits or public assistance. The FDIC study further found that payday borrowers are disproportionately Hispanic or African-American (with borrowing rates two to three times higher respectively than for non-Hispanic whites) and that unmarried female-headed families are more than twice as likely as married couples to be payday borrowers. The CFSI study discussed above upheld this general assessment with regard to race, with African-American and Hispanic borrowers over-represented among such borrowers. The commenters did not take issue with these points, and various submissions across the broad spectrum of stakeholders, including both industry participants and consumer groups, consistently reinforced the point that these loans disproportionately go to minority borrowers.

The demographic profiles of single-payment vehicle title borrowers appear to be roughly comparable to the demographics of payday borrowers. Calculations from the CPS Supplement indicate that 44 percent of title borrowers have annual family incomes under $30,000. Another survey likewise found that 54 percent of title borrowers reported incomes below $30,000, compared with 60 percent for payday borrowers. Commenters presented some data to suggest that various borrowers are more educated and that many are middle-aged, but these results did not alter the great weight of the overall survey data on this point.

And as with payday borrowers, data from the CPS Supplement show vehicle title borrowers to be disproportionately African-American or Hispanic, and more likely to live in unmarried female-headed families. Similarly, a survey of borrowers in three States conducted by academic researchers found that title borrowers were disproportionately female and minority. Over 58 percent of title borrowers were female. African-Americans were over-represented among borrowers compared to their share of their States' population at large. Hispanic borrowers were over-represented in two of the three States; however, these borrowers were under-represented in Texas, the State with the highest proportion of Hispanic residents in the study. Commenters generally did not take issue with these points, and various submissions from both industry participants and consumer groups support the view that they are an accurate reflection of the borrower population. One commenter contended that the data did not show vehicle title borrowers to be disproportionately minority consumers, though this view did not seem to take into account the composition of the total population in the States that were surveyed.

As noted in the proposal, studies of payday borrowers' credit histories show both poor credit histories and recent credit-seeking activity. One academic paper that matched administrative data from one storefront payday lender to credit bureau data found that the median credit score for a payday applicant was in the bottom 15 percent of credit scores overall. The median applicant had one open credit card, but 80 percent of applicants had either no credit card or no credit available on a card. The average borrower had 5.2 credit inquiries on her credit report over the preceding 12 months before her initial application for a payday loan (three times the number for the general population), but obtained only 1.4 accounts on average. This suggests that borrowers made repeated but generally unsuccessful efforts to obtain additional other forms of credit prior to initiating a payday loan. While typical payday borrowers may have one or more credit cards, they are unlikely to have unused credit; in fact, they are often delinquent on one or more cards, and have often experienced multiple overdrafts and/or NSFs on their checking accounts. A recent report analyzing credit scores of borrowers from five large storefront payday lenders provides corroborative support, finding that the average borrower had a VantageScore 3.0 score of 532 and that over 85 percent of borrowers had a score below 600, indicating high credit risk. By way of comparison, the national average VantageScore is 669 and only 30 percent of consumers have a VantageScore below 600.

The proposal also cited reports using data from a specialty consumer reporting agency, which indicate that online borrowers have comparable credit scores to storefront borrowers (a mean VantageScore 3.0 score of 525 versus 532 for storefront). Another study based on the data from the same specialty consumer reporting agency and an accompanying survey of online small-dollar credit borrowers reported that 79 percent of those surveyed had been denied traditional credit in the past year due to having a low or no credit score, 62 percent had already sought assistance from family and friends, and 24 percent reported having negotiated with a creditor to whom they owed money. Moreover, heavy use of online payday loans seems to be correlated with more strenuous credit-seeking: compared to light (bottom quartile) users of online loans, heavy (top quartile) users were more likely to have been denied credit in the past year (87 percent of heavy users compared to 68 percent of light users).

In the proposal, the Bureau also noted that other surveys of payday borrowers added to the picture of consumers in financial distress. For example, in a survey of payday borrowers published in 2009, fewer than half reported having any savings or reserve funds. Almost a third of borrowers (31.8 percent) reported monthly debt-to-income payments of 30 percent or higher, and more than a third (36.4 percent) of borrowers reported that they regularly spend all the income they receive. Similarly, a 2010 survey found that over 80 percent of payday borrowers reported making at least one late payment on a bill in the preceding three months, and approximately one quarter reported frequently paying bills late. Approximately half reported bouncing at least one check in the previous three months, and 30 percent reported doing so more than once. Furthermore, a 2012 survey found that 58 percent of payday borrowers report that they struggled to pay their bills on time. More than a third (37 percent) said they would have taken out a loan on almost any terms offered. This figure rises to 46 percent when the respondent rated his or her financial situation as particularly poor.

A large number of comments received from industry participants, trade associations, consumer groups, academics, and individual users of these loans extensively reinforced this picture of the financial situation for many storefront and online borrowers. Industry participants and trade associations presented their understanding of the characteristics of the borrower population as being marked by poor credit histories, an acute need for credit, aggressive efforts to seek credit, and general unavailability of other means of credit for many of these borrowers. In many of the comments, these characteristics were described in particular detail and emphasized as making the case to show the need for the availability of such loans. Many individual users of these loans also related their own personal stories and situations, which were typically marked by these same features of their financial histories that demonstrated their need for credit products.

Despite these points of general agreement, many industry participants, trade associations, individual users of such loans, and some academics submitted comments that vigorously disagreed with what they regarded as assumptions the Bureau had made in the proposal about payday and vehicle title borrowers. In their view, the Bureau was wrongly portraying these consumers as financially unsophisticated and incapable of acting in their own best interests. On the contrary, many of these commenters stated, such borrowers are often very knowledgeable about the costs and terms of such loans. Their decision to take out a payday or vehicle title loan was represented, in many instances, as being based on a rational judgment that access to this form of credit is far more valuable than reducing the risks and costs associated with their indebtedness.

The Bureau recognizes that the characteristics of individual users of payday and single-payment vehicle title loans are differentiated in many and various ways. Much of the debate here represents different characterizations and opinions about potential conclusions drawn from the facts, rather than direct disagreements about the facts themselves. These issues are important and they are considered further in the discussions of unfairness and abusiveness under final § 1041.4.

2. Circumstances of Borrowing

The proposal discussed several surveys that have asked borrowers why they took out their loans or for what purpose they used the loan proceeds, and noted that these are challenging questions to study. Any survey that asks about past behavior or events runs some risk of recall errors. In addition, the fact that money is fungible makes this question more complicated. For example, a consumer who has an unexpected expense may not feel the effect fully until weeks later, depending on the timing of the unexpected expense relative to other expenses and to the receipt of income. In that circumstance, a borrower may say either that she took out the loan because of the unexpected expense, or that she took out the loan to cover regular expenses. Perhaps because of this difficulty, results across surveys are somewhat inconsistent, with one finding high levels of unexpected expenses, while others find that payday loans are used primarily to pay for regular expenses.

In the first survey discussed in the proposal, a 2007 survey of payday borrowers, the most common reason cited for taking out a loan was “an unexpected expense that could not be postponed,” with 71 percent of respondents strongly agreeing with this reason and 16 percent somewhat agreeing. A 2012 survey of payday loan borrowers, by contrast, found that 69 percent of respondents took their first payday loan to cover a recurring expense, such as utilities, rent, or credit card bills, and only 16 percent took their first loan for an unexpected expense.

The 2012 CFSI survey of alternative small-dollar credit products, discussed earlier in this section asked separate questions about what borrowers used the loan proceeds for and what precipitated the loan. Responses were reported for “very short term” and “short term” credit; “very short term” referred to payday, pawn, and deposit advance products. Respondents could report up to three reasons for what precipitated the loan; the most common reason given for very-short-term borrowing (approximately 37 percent of respondents) was “I had a bill or payment due before my paycheck arrived,” which the authors of the report on the survey results interpreted as a mismatch in the timing of income and expenses. Unexpected expenses were cited by 30 percent of very-short-term borrowers, and approximately 27 percent reported unexpected drops in income. Approximately 34 percent reported that their general living expenses were consistently more than their income. Respondents could also report up to three uses for the funds; the most common answers related to paying for routine expenses, with about 40 percent reporting the funds were used to “pay utility bills,” about 40 percent reporting the funds were used to pay “general living expenses,” and about 20 percent saying the funds were used to pay rent. Of all the reasons for borrowing, consistent shortfalls in income relative to expenses was the response most highly correlated with consumers who reported repeated usage or rollovers.

A survey of 768 online payday users conducted in 2015 and drawn from a large administrative database of payday borrowers looked at similar questions, and compared the answers of heavy and light users of online loans. Based on consumers' self-reported borrowing history, they were segmented into heavy users (users with borrowing frequency in the top quartile of the dataset) and light users (bottom quartile). Heavy users were much more likely to report that they “[i]n past three months, often or always ran out of money before the end of the month” (60 percent versus 34 percent). In addition, heavy users were nearly twice as likely as light users to state their primary reason for seeking their most recent payday loan as being to pay for “regular expenses such as utilities, car payment, credit card bill, or prescriptions” (49 percent versus 28 percent). Heavy users were less than half as likely as light users to state their reason as being to pay for an “unexpected expense or emergency” (21 percent versus 43 percent). Notably, 18 percent of heavy users stated that their primary reason for seeking a payday loan online was that they “had a storefront loan, needed another [loan]” as compared to just over one percent of light users.

One industry commenter asserted that a significant share of vehicle title loan borrowers were small business owners who use these loans for business, rather than personal uses. The commenter pointed to one study that cited anonymous “industry sources” who claimed that 25-30 percent of title borrowers were small businesses and another study that cited an unpublished lender survey which found that about 20 percent of borrowers were self-employed. Evidence was not provided by the commenter to document the share of vehicle title loan borrowers who are either self-employed or small business owners; however, the Bureau notes that it is important to distinguish between borrowers who may be small business owners but may not necessarily use a title loan for a business purpose. For example, one survey of title loan borrowers found that while 16 percent of title loan borrowers were self-employed, only 6 percent of title loan borrowers state that they took the loan for a business expense. The study's authors concluded that “. . . it seems like business credit is not a significant portion of the loans.” Another survey found that 20 percent of title loan borrowers are self-employed, and an additional 3 percent were both self-employed and worked for an employer. In that survey, 3 percent of title loan borrowers reported the loan was for a business expense and 2 percent reported the loan was for a mix of personal and business use.

Some commenters agreed with the Bureau that the results across surveys are somewhat inconsistent, perhaps because of methodological issues. Industry commenters predictably chose to place more emphasis on the results that accorded with their arguments that these loans help consumers cope with financial shocks or allow smoothing of income. By contrast, consumer groups predictably took the opposite perspective. They contended that these loans do present special risks and harms for consumers that outweigh the benefits of access to such loans without being subject to any underwriting, especially for those consumers who experience chronic shortfalls of income. Both groups of commenters chose to downplay the results that tended to undermine their arguments. On the whole, these comments do not call into question the Bureau's treatment of the factual issues here, but go more to the potential characterization of those facts or the inferences to be drawn from them. Those issues are discussed further in the section-by-section analysis for § 1041.4 below.

A number of comments from industry participants and trade associations faulted the Bureau for not undertaking to conduct its own surveys of borrowers to gauge the circumstances that lead them to use payday, title, or other covered short-term loans. Although the Bureau had reviewed and analyzed at least four different surveys of such borrowers conducted over the past decade, as discussed above, these commenters stated that the Bureau would have furthered its understanding by speaking with and hearing directly from such borrowers. Nonetheless, many of these commenters offered further non-survey information of this kind by referencing the consumer narratives in thousands of individual consumer complaints about payday, title, and other covered loans that have been filed with the Bureau (which also include a substantial number of debt collection complaints stemming from such loans). They also pointed to individual responses that have been filed about such loans on the Bureau's online “Tell Your Story” function, where some number of individual borrowers have explained how they use such loans, often describing the benefits and challenges they have experienced as a result.

In addition, a large volume of comments—totaling well over a million comments about the proposal, both pro and con—were filed with the Bureau by individual users of payday and vehicle title loans. Many of these commenters described their own personal experiences with these loans, and others offered their perspectives. The Bureau has reviewed these comments and has carefully considered the stories they told. These comments include a large number of positive accounts of how people successfully used such loans to address shortfalls or cope with emergencies and concerns about the possibility of access to such loans being removed. The comments included fewer but still a very sizable number of other accounts, much more negative in tone, of how consumers who took out such loans became trapped in long cycles of repeated re-borrowing that led to financial distress, marked by problems such as budgetary distortions, high collateral costs, the loss of depository accounts and other services, ultimate default on the loans, and the loss of other assets such as people's homes and their vehicles. Some of these comments came from the individual consumers themselves, while many came from friends, family members, clergy, legal aid attorneys, neighbors, or others who were concerned about the impact the loans had on consumers whom they knew, and in some cases whom they had helped to mitigate the negative experience through financial assistance, counseling, or legal assistance. The enormous volume of such individual comments itself helps to provide considerably more information about borrowers that helps to supplement the prior survey data discussed in the proposal. It appears that various parties on both sides of these issues went to great lengths to solicit such a large number of comment submissions by and about individual users of such loans.

The substantial volume and variation of individual comments have further added to the Bureau's understanding of the wide variety of circumstances in which such borrowing occurs. They underscore the Bureau's recognition that not only the personal characteristics, but also the particularized circumstances, of individual users of payday and single-payment vehicle title loans can be quite differentiated from one another across the market. Nonetheless, the focus of this rule is on how the identified lender practice of making such loans without reasonably assessing the borrower's ability to repay the loan according to its terms affects this broad and diverse universe of consumers.

b. Lender Practices

As described in the proposal, the business model of lenders who make payday and single-payment vehicle title loans is predicated on the lenders' ability to secure extensive re-borrowing. As recounted in the Background section, the typical storefront payday loan has a principal amount of $350, and the consumer pays a typical fee of 15 percent of the principal amount. For a consumer who takes out such a loan and repays it when it is due without re-borrowing, this means the typical loan would produce roughly $50 in revenue to the lender. Lenders would thus require a large number of “one-and-done” consumers to cover their overhead and acquisition costs and generate profits. However, because lenders are able to induce a large percentage of borrowers to repeatedly re-borrow, lenders have built a model in which the typical storefront lender, as discussed in part II above, has two or three employees serving around 500 customers per year. Online lenders do not have the same overhead costs, but they have been willing to pay substantial acquisition costs to lead generators and to incur substantial fraud losses, all of which can only be sufficiently offset by their ability to secure more than a single fee—and often many repeated fees—from their borrowers.

In the proposal, the Bureau used the term “re-borrow” to refer to situations in which consumers either roll over a loan (which means they pay a fee to defer payment of the principal for an additional period of time), or take out a new loan within a short period time following a previous loan. Re-borrowing can occur concurrently with repayment in back-to-back transactions or can occur shortly thereafter. In the proposal, the Bureau stated its reasons for concluding that re-borrowing often indicates that the previous loan was beyond the consumer's ability to repay while meeting the consumer's other major financial obligations and basic living expenses. As discussed in more detail in the section-by-section analysis of § 1041.6, the Bureau proposed and now concludes that it is appropriate to consider loans to be re-borrowings when the second loan is taken out within 30 days of the consumer being indebted on a previous loan. While the Bureau's 2014 Data Point used a 14-day period and the Small Business Review Panel Outline used a 60-day period, the Bureau used a 30-day period in its proposal to align the time frame with consumer expense cycles, which are typically a month in length. This duration was designed to account for the fact that where repaying a loan causes a shortfall, the effect is most likely to be experienced within a 30-day period in which monthly expenses for matters such as housing and other debts come due. The Bureau recognizes that some re-borrowing that occurs after a 30-day period may be attributable to the spillover effects of an unaffordable loan and that some re-borrowing that occurs within the 30-day period may be attributable to a new need that arises unrelated to the impact of repaying the short-term loan. Thus, while other periods could plausibly be used to determine when a follow-on loan constitutes re-borrowing, the Bureau believes that the 30-day period provides the most appropriate period for these purposes. In fact, the evidence presented below suggests that for any of these three potential time frames, though the percentage varies somewhat, the number of loans that occur as part of extended loan sequences of 10 loans or more is around half of all payday loans. Accordingly, this section, Market Concerns—Underwriting, uses a 30-day period to determine whether a loan is part of a loan sequence.

The proposal noted that the majority of lending revenue earned by storefront payday lenders and lenders that make single-payment vehicle title loans comes from borrowers who re-borrow multiple times and become enmeshed in long loan sequences. Based on the Bureau's data analysis, approximately half of all payday loans are in sequences that contain 10 loans or more, depending on the time frame that is used to define the sequence. Looking just at loans made to borrowers who are paid weekly, bi-weekly, or semi-monthly, more than 20 percent of loans are in sequences that are 20 loans or longer. Similarly, the Bureau found that about half of all single-payment vehicle title loans are in sequences of 10 loans or more, and over two-thirds of them are in sequences of at least seven loans. The commenters did not take serious issue with this data analysis, and the Bureau finds these particular facts to be of great significance in assessing the justifications for regulatory measures that would address the consequent harms experienced by consumers.

Commenters on all sides of the proposal did not seriously take issue with the account presented in the proposal of the basic business model in the marketplace for payday and single-payment vehicle title loans. They did have widely divergent views about whether they would characterize these facts as beneficial or pernicious, or what consequences they perceive as resulting from this business model. One credit union trade association stated its view that such lending takes advantage of consumers and exacerbates bad financial situations and thus it favored curbs on payday lending. Consumer groups and numerous individual borrowers echoed this view. Industry participants, other trade associations, and many other individual borrowers took the position, explicitly or implicitly, that the benefits experienced by successful users of these loans outweighed the costs incurred by those who engaged in repeat re-borrowing with consequent negative outcomes and collateral consequences.

As discussed below, the Bureau has considered the comments submitted on the proposal and continues to believe that both the short term and the single-payment structure of these loans contributes to the long loan sequences that borrowers take out. Various lender practices exacerbate the problem by marketing to borrowers who are particularly likely to wind up in long sequences of loans, by failing to screen out borrowers who are likely to wind up in long-term debt or to establish guardrails to avoid long-term indebtedness, and by actively encouraging borrowers to continue to re-borrow when their single-payment loans come due.

1. Loan Structure

The proposal described how the single-payment structure and short duration of these loans makes them difficult to repay. Within the space of a single income or expense cycle, a consumer with little to no savings cushion and who has borrowed to meet an unexpected expense or income shortfall, or who chronically runs short of funds, is unlikely to have the available cash needed to repay the full amount borrowed plus the finance charge on the loan when it is due and to cover other ongoing expenses. This is true for loans of a very short duration regardless of how the loan may be categorized. Loans of this type, as they exist in the market today, typically take the form of single-payment loans, including payday loans and vehicle title loans, though other types of credit products are possible. Because the focus of the Bureau's research has been on payday and vehicle title loans, the discussion in Market Concerns—Underwriting centers on those types of products.

The size of single-payment loan repayment amounts (measured as loan principal plus finance charges owed) relative to the borrower's next paycheck gives some sense of how difficult repayment may be. The Bureau's storefront payday loan data shows that the average borrower being paid on a bi-weekly basis would need to devote 37 percent of her bi-weekly paycheck to repaying the loan. Single-payment vehicle title borrowers face an even greater challenge. In the data analyzed by the Bureau, the median borrower's payment on a 30-day loan is equal to 49 percent of monthly income, and the Bureau finds it especially significant as indicating the severe challenges and potential for negative outcomes associated with these loans.

The commenters did not offer any data that disagreed with this analysis of how the loan structure works in practice. Industry commenters did assert, however, that the structure of these loans is not intended or designed as a means of exploiting consumers, but rather has evolved as needed to comply with the directives of State law and State regulation of this lending market. As a historical matter, this appears to be incorrect; indeed, another commenter is the founder of the company who helped to initiate the payday lending industry, W. Allan Jones. The comment notes that the “traditional `payday loan' product” was first developed by his company in 1993 in Tennessee and then became the basis for legislation and regulation that has spread to a majority of States, with various modifications and refinements. As noted above in part II.A, however, another large payday lender—QC Financial—began making payday loans in Kansas in 1992 under an existing provision of that state's existing consumer lending structure and that same year at least one State regulator formally held that deferred presentment activities constituted consumer lending subject to the State's consumer credit laws. Other accounts of the history of payday lending generally tend to reinforce these historical accounts that modern payday lending began emerging in the early 1990s as a variant of check-cashing stores whereby the check casher would cash and hold consumers' personal checks for a fee for several days—until payday—before cashing them. The laws of States, particularly those that had adopted the Uniform Consumer Credit Code (UCCC) including Kansas and Colorado, permitted lenders to retain a minimum finance charge on loans ranging in the 1990's from about $15 to $25 per loan regardless of State rate caps, and payday lenders used those provisions to make payday loans. In other States, and later in UCCC States, more specific statutes were enacted to authorize and regulate what had become payday lending. No doubt the structure of such loan products over time is affected by and tends to conform to State laws and regulations, but the point here is that the key features of the loan structure, which tend to make these loans difficult to repay for a significant population of borrowers, are core to this financial product and are fairly consistent across time and geography.

Regardless of the historical background, however, one implication of the suggestion put forward by these commenters appears to be that the intended consequence of this loan product is to produce cycles of re-borrowing or extended loan sequences for many consumers that exceed the permissible short-term loan periods adopted under State law. The explanation seems to be that the actual borrowing needs of consumers extend beyond the permissible loan periods permitted by State law. If that is so, then the inherent nature of this mismatched product imposes large forecasting risks on the consumer, which may often lead to unexpected harms. And even if the claim instead is that the loan structure manages to co-exist with the formal constraints imposed by State law, this justification does little to minimize the risks and harms to the substantial population of consumers who find themselves trapped in extended loan sequences.

2. Marketing

The proposal also noted that the general positioning of short-term products in marketing and advertising materials as a solution to an immediate liquidity challenge attracts consumers facing these problems, encouraging them to focus on short-term relief rather than the likelihood that they are taking on a new longer-term debt. Lenders position the purpose of the loan as being for use “until next payday” or to “tide over” the consumer until she receives her next paycheck. These types of product characterizations can encourage consumers to think of these loans as easy to repay, a fast solution to a temporary cash shortfall, and a short-term obligation, all of which lessen the risk in the consumer's mind that the loan will become a long-term debt cycle. Indeed, one study reporting consumer focus group feedback noted that some participants reported that the marketing made it seem like payday loans were “a way to get a cash infusion without creating an additional bill.”

As discussed in the proposal, in addition to presenting loans as short-term solutions, rather than potentially long-term obligations, lender advertising often focuses on how quickly and easily consumers can obtain a loan. An academic paper reviewing the advertisements of Texas storefront and online payday and vehicle title lenders found that the speed of getting a loan is the most frequently advertised feature in both online (100 percent) and storefront (50 percent) payday and title loans. Advertising that is focused on immediacy and speed capitalizes on the sense of urgency borrowers feel when facing a cash shortfall. Indeed, the names of many payday and vehicle title lenders include the words (in different spellings) “speedy,” “cash,” “easy,” and “quick,” thus emphasizing their rapid and simple loan funding.

All of the commenters generally agreed as a factual matter that the marketing and offering of such loans is typically marked by ease, speed, and convenience, which are touted as positive attributes of such loans that make them desirable credit products from the standpoint of potential borrowers. Yet industry participants and trade associations broadly disputed what they viewed as the Bureau's perspective on the potential implications of this marketing analysis, as suggesting that many borrowers lack knowledge or awareness about the nature, costs, and overall effects of these loans. Consumer advocates, on the other hand, contended that the manner in which these loans are being marketed affects the likelihood that borrowers will tend to view them as short-term obligations that will not have long-term effects on their overall financial position, which often leads consumers to experience the negative outcomes associated with unexpectedly ending up in extended loan sequences.

3. Failure To Assess Ability To Repay

As discussed in the proposal, the typical loan process for storefront payday, online payday, and single-payment vehicle title lenders generally involves gathering some basic information about borrowers before making a loan. Lenders normally do collect income information, although the information they collect may just be self-reported or “stated” income. Payday lenders collect information to ensure the borrower has a checking account, and title lenders need information about the vehicle that will provide the security for the loan. Some lenders access consumer reports prepared by specialty consumer reporting agencies and engage in sophisticated screening of applicants, and at least some lenders turn down the majority of applicants to whom they have not previously made loans.

One of the primary purposes of this screening, however, is to avoid fraud and other “first payment defaults,” not to make any kind of determination that borrowers will be able to repay the loan without re-borrowing. These lenders generally do not obtain any information about the borrower's existing obligations or living expenses, which means that they cannot and do not prevent those with expenses chronically exceeding income, or those who have suffered from an income or expense shock from which they need substantially more time to recover than the term of the loan, from taking on additional obligations in the form of payday or similar loans. Thus, lenders' failure to assess the borrower's ability to repay the loan permits those consumers who are least able to repay the loans, and consequently are most likely to re-borrow, to obtain them.

Lending to borrowers who cannot repay their loans would generally not be profitable in a traditional lending market, but as described elsewhere in this section, the factors that funnel consumers into cycles of repeat re-borrowing turn the traditional model on its head by creating incentives for lenders to actually want to make loans to borrowers who cannot afford to repay them when due if instead the consequence is that these borrowers are likely to find themselves re-borrowing repeatedly. Although industry stakeholders have argued that lenders making short-term loans already take steps to assess “ability to repay” and will always do so out of economic self-interest, the Bureau believes that this refers narrowly to whether the consumer will default up front on the loan, rather than whether the consumer has the capacity to repay the loan without having to re-borrow and while meeting other financial obligations and basic living expenses. The fact that lenders often do not perform additional underwriting when borrowers are rolling over a loan, or are returning to borrow again soon after repaying a prior loan, further shows that lenders do not see re-borrowing as a sign of borrowers' financial distress or as an outcome to be avoided. Rather, repeated re-borrowing may be perceived as a preferred outcome for the lender or even as an outcome that is a crucial underpinning to the business model in this loan market.

For the most part, commenters did not take issue with the tenets of this factual description of the typical underwriting process for such loans, though some lenders contended that they do not intentionally seek out potential customers who are likely to have to re-borrow multiple times. As noted, however, this approach is consistent with the basic business model for such loans as described above. Industry participants and trade associations did dispute one perceived implication of this discussion by asserting that long loan sequences, at least standing alone, cannot simply be assumed to be harmful or to demonstrate a consumer's inability to repay these loans, as many factors may bear on those outcomes. This point is discussed further below.

4. Encouraging Long Loan Sequences

In the proposal, the Bureau recounted its assessment of the market by noting that lenders attract borrowers in financial crisis, encourage them to think of the loans as a short-term solution, and fail to screen out those for whom the loans are likely to become a long-term debt cycle. After that, lenders then actively encourage borrowers to re-borrow and continue to be indebted rather than pay down or pay off their loans. Although storefront payday lenders typically take a post-dated check, which could be presented in a manner timed to coincide with deposit of the borrower's paycheck or government benefits, lenders usually encourage or even require borrowers to come back to the store to redeem the check and pay in cash. When the borrowers return, they are typically presented by lender employees with two salient options: Repay the loan in full, or simply pay a fee to roll over the loan (where permitted under State law). If the consumer does not return, some lenders may reach out to the customer but ultimately the lender will proceed to attempt to collect by cashing the check. On a $300 loan at a typical charge of $15 per $100 borrowed, the cost to defer the due date for another 14 days until the next payday is $45, while repaying in full would cost $345, which may leave the borrower with insufficient remaining income to cover expenses over the ensuing month and therefore tends to prompt re-borrowing. Requiring repayment in person gives staff at the stores the opportunity to frame for borrowers a choice between repaying in full or just paying the finance charge, which may be coupled with encouragement guiding them to choose the less immediately painful option of paying just the finance charge and rolling the loan over for another term. Based on its experience from supervising payday lenders over the past several years, the Bureau has observed that storefront employees are generally incentivized to maximize the store's loan volume and the data suggest that re-borrowing is a crucial means of achieving this goal.

As laid out in the proposal, the Bureau's research shows that payday borrowers rarely re-borrow a smaller amount than the initial loan. Doing so would effectively amortize their loans by reducing the principal amount owed over time, thereby reducing their costs and the expected length of their loan sequences. Rather than encouraging borrowers to make amortizing payments that would reduce their financial exposure over time, lenders encourage borrowers to pay the minimum amount and re-borrow the full amount of the earlier loan, thereby contributing to this outcome. In fact, as discussed in the proposal, some online payday loans automatically roll the loan over at the end of its term unless the consumer takes affirmative action in advance of the due date, such as notifying the lender in writing at least three days before the due date. As some industry commenters noted, single-payment vehicle title borrowers who take out multiple loans in a sequence are more likely than payday borrowers who taken out multiple loans in a sequence to reduce the loan amount from the beginning to end of that sequence. After excluding for single loan sequences for which this analysis is not applicable, 37 percent of single-payment vehicle title loan sequences have declining loan amounts compared to just 15 percent of payday loan sequences. This greater likelihood of declining loan amounts for single-payment vehicle title loans compared to payday loans may also be influenced by the larger median size of title loans, which is $694, as compared to the median size of payday loans, which is $350. However, this still indicates that a large majority of single payment vehicle title loan borrowers have constant or increasing loan amounts over the course of a sequence. In addition, the Bureau's analysis shows that those single payment vehicle title loan borrowers who do reduce their loan amounts during a sequence only do so for a median of about $200, which is less than a third of the median loan amount of about $700. This may reflect the effects of certain State laws regulating vehicle title loans that require some reduction in loan size across a loan sequence.

Lenders also actively encourage borrowers who they know are struggling to repay their loans to roll over and continue to borrow. In the Bureau's work over the past several years to monitor the operations and compliance of such lenders, including supervisory examinations and enforcement actions, the Bureau has found evidence that lenders maintain training materials that promote borrowing by struggling borrowers. In one enforcement action, the Bureau found that if a borrower did not repay in full or pay to roll over the loan on time, personnel would initiate collections. Store personnel or collectors would then offer new loans as a source of relief from the collections activities. This approach, which was understood to create a “cycle of debt,” was depicted graphically as part of the standard “loan process” in the company's new hire training manual. The Bureau is aware of similar practices in the single-payment vehicle title lending market, where store employees offer borrowers additional cash during courtesy calls and when calling about past-due accounts, and company training materials instruct employees to “turn collections calls into sales calls” and encourage delinquent borrowers to refinance to avoid default and repossession of their vehicles.

It also appears that lenders do little to affirmatively promote the use of “off ramps” or other alternative repayment options, even when those are required by law to be made available to borrowers. Such alternative repayment plans could help at least some borrowers avoid lengthy cycles of re-borrowing. Lenders that belong to one of the two national trade associations for storefront payday lenders have agreed to offer an extended payment plan to borrowers, but only if the borrower makes a request at least one day prior to the date on which the loan is due. (The second national trade association reports that its members provide an extended payment plan option, but details on that option are not available.) In addition, about 18 States require payday lenders to offer repayment plans to borrowers who encounter difficulty in repaying payday loans. The usage rate of these repayment plans varies widely, but in all cases it is relatively low. One explanation for the low take-up rate on these repayment plans may be that certain lenders disparage the plans or fail to promote their availability. By discouraging the use of repayment plans, lenders make it more likely that such consumers will instead re-borrow. The Bureau's supervisory examinations uncovered evidence that one or more payday lenders train their employees not to mention repayment plans until after the employees have offered renewals, and then only to mention repayment plans if borrowers specifically ask about them.

In general, most of the commenters did not take issue with this factual account of the mechanics or incentives that lead to a high incidence of rolling over such loans, and much of what they said tended to confirm it. In particular, industry commenters acknowledged that incentive programs for their employees based on net revenue are widespread in the industry. Such programs are not illegal, of course, but given the structure of these loans as described above, this suggests that employees are being incentivized to encourage re-borrowing and extended loan sequences by having borrowers roll their loans over repeatedly.

Industry participants, trade associations, and some individual users of such loans did argue, however, about the implications of this analysis. One of their claims is that many consumers have an actual borrowing need that extends beyond the loan period permitted under State law, and thus repeated re-borrowing may be a means of synchronizing the consumer's borrowing needs to the specific contours of the loan product. In particular, they contended that re-borrowing may be beneficial to consumers as part of longer-term strategies around income smoothing or debt management, a point that is discussed further below.

5. Payment Mechanisms and Vehicle Title

The proposal noted that where lenders can collect payments through post-dated checks or ACH authorizations, or obtain security interests in borrowers' vehicles, these mechanisms also can be used to encourage borrowers to re-borrow, as a way to avoid what otherwise could be negative consequences if the lender were to cash the check or repossess the vehicle. For example, consumers may feel significantly increased pressure to return to a storefront to roll over a payday or vehicle title loan that includes such features. They may do so rather than risk incurring new fees in connection with an attempt to deposit the consumer's post-dated check, such as an overdraft or NSF fee from the bank and a returned-item fee from the lender if the check were to bounce or risk suffering the repossession of their vehicle. The pressure can be especially acute when the lender obtains security in the borrower's vehicle.

The proposal also noted that in cases where consumers do ultimately default on their loans, and these mechanisms are at last effectuated, they often magnify the total harm that consumers suffer from losing their access to essential transportation. Consumers often will have additional account and lender fees assessed against them, and some will end up having their bank accounts closed. When this occurs, they will have to bear the many attendant costs of becoming stranded outside the banking system, which include greater inconvenience, higher costs, reduced safety of their funds, and the loss of the other advantages of a standard banking relationship.

These harms are very real for many consumers. For example, as discussed in more detail below in Market Concerns—Payments, the Bureau's research has found that 36 percent of borrowers who took out online payday or payday installment loans and had at least one failed payment during an eighteen-month period had their checking accounts closed by the bank by the end of that period, a rate that is four times greater than the closure rate for accounts that only had NSFs from non-payday transactions. For accounts with failed online payday loan transactions, account closures typically occur within 90 days of the last observed online payday loan transaction; in fact, 74 percent of account closures in these situations occur within 90 days of the first NSF return triggered by an online payday or payday installment lender. This suggests that the online loan played a role in the closure of the account, or that payment attempts failed because the account was already headed towards closure, or both.

In general, the commenters did not challenge the Bureau's factual account of how these payment mechanisms can lead to these collateral consequences that harm consumers. Industry commenters did disagree, however, with the premise that these harms were caused by the use of covered short-term loans. Some disagreed about the overall magnitude of these harms, stating that there is no evidence that covered short-term loans actually cause account closures or NSF fees, as stated in the proposal, and arguing that the Bureau overstated the extent to which consumers who default are subjected to NSF fees or fees resulting from bounced checks. But they did not present any convincing data to refute what the Bureau had observed from its own research and experience, and the assertion that online loans may have performed more poorly than storefront loans in these respects was not persuasive. Although the Bureau did not purport to find that the evidence in its data was determinative as to causation, the relationship between the consumer experience on such loans and the borrower outcomes was strongly reinforced by the data and logical as to the connection between them.

c. Patterns of Lending and Extended Loan Sequences

The Bureau's proposal described how borrower characteristics, the circumstances of borrowing, the structure of the short-term loans, and the practices of the lenders together lead to dramatic negative outcomes for many payday and single-payment vehicle title borrowers. There is strong evidence that a meaningful share of borrowers who take out payday and single-payment vehicle title loans end up with very long sequences of loans, and the loans made to borrowers with these negative outcomes make up a majority of all the loans made by these lenders.

Long loan sequences lead to very high total costs of borrowing. Each single-payment loan carries the same cost as the initial loan that the borrower took out. For a storefront borrower who takes out the average-sized payday loan of $350 with a typical fee of $15 per $100, each re-borrowing by rolling over the loan means paying additional fees of $52.50. After just three re-borrowings, the borrower will have paid more than $150 simply to defer payment of the original principal amount by an additional period ranging from six weeks to three months.

As noted in the proposal, the cost of re-borrowing for title borrowers is even more dramatic, given the higher price and larger size of those loans. The Bureau's data indicates that the median loan size for single-payment vehicle title loans is $694. One study found that the most common rate charged on the typical 30-day title loan is $25 per $100 borrowed, which is a common State limit and equates to an APR of 300 percent. A typical instance of re-borrowing thus means that the consumer pays a fee of around $175. After just three re-borrowings, a consumer will typically have paid about $525 simply to defer payment of the original principal amount by three months.

The proposal cited evidence for the prevalence of long sequences of payday and title loans, which comes from the Bureau's own work, from analysis by independent researchers and analysts commissioned by industry, and from statements by industry stakeholders. The Bureau has published several analyses of storefront payday loan borrowing. Two of these have focused on the length of loan sequences that borrowers take out. In these publications, the Bureau defined a loan sequence as a series of loans where each loan was taken out either on the day the prior loan was repaid or within some number of days from when the loan was repaid. The Bureau's 2014 Data Point used a 14-day window to define a sequence of loans. Those data have been further refined in the CFPB Report on Supplemental Findings and shows that when a borrower who is not currently in a loan sequence takes out a payday loan, borrowers wind up taking out at least four loans in a row before repaying 43 percent of the time, take out at least seven loans in a row before repaying 27 percent of the time, and take out at least 10 loans in a row before repaying 19 percent of the time. In the CFPB Report on Supplemental Findings, the Bureau re-analyzed the data using 30-day and 60-day definitions of sequences. The results are similar, although using longer windows leads to longer sequences of more loans. Using the 30-day definition of a sequence, 50 percent of new loan sequences contain at least four loans, 33 percent of sequences contain at least seven loans, and 24 percent of sequences contain at least 10 loans. Borrowers who take out a fourth loan in a sequence have a 66 percent likelihood of taking out at least three more loans, for a total sequence length of seven loans. And such borrowers have a 48 percent likelihood of taking out at least six more loans, for a total sequence length of 10 loans.

These findings are mirrored in other analyses. During the SBREFA process, one participant submitted an analysis prepared by Charles River Associates (CRA) of loan data from several small storefront payday lenders. Using a 60-day sequence as its definition, CRA found patterns of borrowing very similar to those that the Bureau had found. Compared to the Bureau's results using a 60-day sequence definition, in the CRA analysis there were more loans where the borrower defaulted on the first loan or repaid without re-borrowing (roughly 44 percent versus 25 percent), and fewer loans that had 11 or more loans in the sequence, but otherwise the patterns were nearly identical.

Similarly, in an analysis funded by an industry research organization, researchers found a mean sequence length, using a 30-day sequence definition, of nearly seven loans. This is slightly higher than the mean 30-day sequence length in the Bureau's analysis (5.9 loans).

Analysis of a multi-lender, multi-year dataset by a research group affiliated with a specialty consumer reporting agency found that over a period of approximately four years the average borrower had at least one sequence of nine loans; that 25 percent of borrowers had at least one loan sequence of 11 loans; and that 10 percent of borrowers had at least one loan sequence of 22 loans. Looking at these same borrowers for a period of 11 months—one month longer than the duration analyzed by the Bureau—the researchers found that on average the longest sequence these borrowers experienced over the 11 months was 5.3 loans, that 25 percent of borrowers had a sequence of at least seven loans, and that 10 percent of borrowers had a sequence of at least 12 loans. This research group also identified a core of users with extremely persistent borrowing, and found that 30 percent of borrowers who took out a loan in the first month of the four-year period also took out a loan in the last month. The median time in debt for this group of extremely persistent borrowers was over 1,000 days, which is more than half of the four-year period. The median borrower in this group of extremely persistent borrowers had at least one loan sequence of 23 loans long or longer (which was nearly two years for borrowers who were paid monthly). Perhaps most notable, almost one out of ten members of this research group (nine percent) borrowed continuously for the entire four-year period.

In the proposal, the Bureau also presented its analysis of single-payment vehicle title loans according to the same basic methodology. Using a 30-day definition of loan sequences, the Bureau found that short-term single-payment vehicle title loans had loan sequences that were similar to payday loans. More than half (56 percent) of these sequences contained at least four loans; 36 percent contained seven or more loans; and 23 percent had 10 or more loans. The Bureau's analysis found that title borrowers were less likely than those using payday loans to repay a loan without re-borrowing or defaulting. Only 12 percent of single-payment vehicle title loan sequences consisted of a single loan that was repaid without subsequent re-borrowing, compared to 22 percent of payday loan sequences. Other sources on title lending are more limited than for payday lending, but are generally consistent. For instance, the Tennessee Department of Financial Institutions publishes a biennial report on 30-day single-payment vehicle title loans. The most recent report shows very similar results to those the Bureau found in its research, with 66 percent of borrowers taking out four or more loans in row, 40 percent taking out more than seven loans in a row, and 24 percent taking out more than 10 loans in a row.

Some commenters noted data showing that vehicle title borrowers use re-borrowing to self-amortize their principal balance to a greater extent than payday borrowers do, which they suggested is evidence that title re-borrowing is not injurious. As noted previously, while it is true that more title borrowers in multi-loan sequences have declining loan balances than do payday borrowers in multi-loan sequences, this is likely the result of title loans starting out at much larger amounts. More salient is the fact that 63 percent of multi-loan sequences of title loans are for principal amounts that either remain unchanged or actually increase during the sequence, and that even those title loan sequences that do have a decline in loan amount over time only have a median decline of about $200 from beginning to end of the sequence, which is less than one-third of the average total amount of these loans. And the default rate remains high even for amortizing multi-loan sequences of title loans, at 22 percent, which is slightly higher than the default rate for payday loans (20 percent), even though the latter amortize less often. All of this suggests that even if title borrowers can somewhat reduce the larger principal amount of their loans over time, it remains difficult to succeed in digging themselves out of the debts they have incurred with these loans.

In addition to direct measures of the length of loan sequences, the cumulative number of loans that borrowers take out provides ample indirect evidence that they are often getting stuck in a long-term debt cycle. The Bureau has measured total borrowing by payday borrowers in two ways. In one study, the Bureau took a snapshot of borrowers in lenders' portfolios at a point in time (measured as borrowing in a particular month) and tracked them for an additional 11 months (for a total of 12 months) to assess overall loan use. This study found that the median borrowing level was 10 loans over the course of a year, and more than half of the borrowers had loans outstanding for more than half of the year. In another study, the Bureau measured the total number of loans taken out by borrowers beginning new loan sequences. It found that these borrowers had lower total borrowing than borrowers who may have been mid-sequence at the beginning of the period, but the median number of loans for the new borrowers was six loans over a slightly shorter (11-month) period. Research by others finds similar results, with average or median borrowing, using various data sources and various samples, of six to 13 loans per year.

One commenter provided further data on the length of time consumers use payday loans, which gave more particulars about multi-year indebtedness in States with payday lending, such as South Carolina and Florida. The Florida data showed that over 40 percent of all consumers who took out one or more payday loans in 2012 continued to use the product three years later, and about a third of all consumers who took one or more payday loans in 2012 continued to use the product five years later. The South Carolina data provided similar information, but reported findings for consumers by borrowing intensity. It tended to show that those with the greatest intensity of borrowing were the least likely to end the borrowing relationship over a three-year period. Separately, a report on payday lending market trends by a specialty consumer reporting agency finds that over half of all loans are made to existing customers rather than consumers who have not used payday loans before. This report concludes that “even though new customers are critical, existing customers are the most productive.”

The proposal also noted that, given differences in the regulatory context and the overall nature of the market, less information is available about online lending than storefront lending. Borrowers who take out payday loans online are likely to change lenders more frequently than storefront borrowers, so that absent comprehensive data that allows borrowing patterns to be tracked across all lenders, measuring the duration of loan sequences becomes much more challenging. The limited information that is available suggests that online borrowers take out fewer loans than storefront borrowers, but that borrowing is highly likely to be under-counted. A report commissioned by an online lender trade association, using data from three online lenders making single-payment payday loans, reported an average loan length of 20 days and an average of 73 days in debt per year. The report averages the medians of the three lenders' data, which makes interpretation of these values difficult; still, these findings indicate that borrowers take out three to four loans per year at these lenders.

Additional analysis is available based on the records of a specialty consumer reporting agency. The records show similar loans per borrower, 2.9, but over a multi-year period. These loans, however, are not primarily single-payment payday loans. A small number are installment loans, while most are “hybrid” loans with a typical duration of roughly four pay cycles. In addition, this statistic likely understates usage because online lenders may not report all of the loans they make, and some may only report the first loan they make to a borrower. Borrowers may also be more likely to change lenders online and, as many lenders do not report to the specialty consumer reporting agency that provided the data for the analysis, when borrowers change lenders their subsequent loans often may not be in the data analyzed.

Although many industry commenters disputed the significance of these findings, they offered little evidence that was inconsistent with the data presented by the Bureau. One commenter disputed the accuracy of the Bureau's statement that 69 percent of payday loan sequences which end in default are multi-loan sequences and offered its own analysis based on its own customer data, which presented somewhat lower numbers but was largely consistent with the data presented by the Bureau. Still other commenters cited a petition that purported to show data errors relating to the Bureau's White Paper on payday loans and deposit advance products that was used to draw conclusions about the prevalence of re-borrowing, which they argued was based on an unrepresentative sample weighted heavily toward repeat users. The Bureau has addressed this criticism previously, and explained that the methodology used in the White Paper, which took a snapshot of borrowers at the beginning of a twelve-month observation period and followed those borrowers over the ensuing eleven months, is an appropriate method of assessing borrowing intensity even though it is true that any such snapshot will be disproportionately composed of repeat borrowers because they comprise the bulk of payday lenders' business. At the same time, the Bureau has conducted an alternative analysis which tracks the borrowing experience of fresh borrowers and it is that analysis on which the Bureau is principally relying here for covered short-term loans.

Another study was cited to suggest that cost does not drive the cycle of debt because it found that borrowers who were given no-fee loans had re-borrowing rates that were comparable to those who were given loans with normal fees. The upshot of this study, however, tended to show that the single-payment loan structure was instead a sufficient driver of the debt cycle, even without regard to the size of the fees that were charged. In fact, this study actually tends to refute the claim made elsewhere by industry commenters that the Bureau is trying to evade the statutory prohibition on imposing a usury cap by addressing price, since price alone does not seem to drive the cycle of debt that is a primary source of the harms resulting from these loans—rather, it is the single-payment loan structure that does so.

Many industry participants and trade associations contended that, standing alone, multiple loan sequences cannot be presumed to be harmful to consumers. In particular, one trade association stated that where an income or expense shock cannot be resolved at once, re-borrowing in extended loan sequences can be an effective longer-term strategy of income smoothing or debt management until the consumer's financial situation improves. Thus re-borrowing cannot be presumed to be necessarily irrational or harmful, depending on the circumstances. This commenter also cited studies that examined the credit scores of payday borrowers and reported finding better outcomes for longer-term borrowers than for those who are limited to shorter loan durations, and also that reported finding better outcomes for consumers in States with less restrictive payday lending laws than for those in States with more restrictive laws. These issues are important and they are discussed further in § 1041.4 below.

A coalition of consumer groups was in agreement as a factual matter that many consumers of payday and single-payment vehicle title loans end up in extended loan sequences, and many individual commenters described their own personal experiences and perspectives on this point. They observed that borrowers in these situations do in fact suffer many if not all of the harmful collateral consequences described in the proposal, which merely compound their existing financial difficulties and leave them worse off than they were before they took out such loans. Once again, however, putting aside the starkly different conclusions that commenters were drawing from the data, the basic accuracy of the data presented in the proposal on the patterns of lending and extended loan sequences was generally acknowledged. The arguments for and against the validity of their respective conclusions are considered further in the section-by-section analysis for § 1041.4 below.

d. Consumer Expectations and Understanding of Loan Sequences

As discussed in the proposal, extended sequences of loans raise tangible concerns about the market for short-term loans. These concerns are exacerbated by the empirical evidence on consumer understanding of such loans. The available evidence indicates that many of the borrowers who take out long sequences of payday loans and single-payment vehicle title loans do not anticipate at the outset that they will end up experiencing those long sequences.

Measuring consumers' expectations about re-borrowing is inherently challenging. When answering survey questions about loan repayment, there is the risk that borrowers may conflate repaying an individual loan with completing an extended sequence of borrowing. Asking borrowers retrospective questions about their expectations at the time they started borrowing is likely to suffer from recall problems, as people have difficulty remembering what they expected at some time in the past. The recall problem is likely to be compounded by respondents tending to want to avoid admitting that they have made a mistake. Asking about expectations for future borrowing may also be imperfect, as some consumers may not be thinking explicitly about how many times they will roll a loan over when taking out their first loan. Merely asking the question may cause people to think about it and focus on it more than they otherwise would have.

Two studies discussed in the proposal have asked payday and vehicle title borrowers at the time they took out their loans about their expectations about re-borrowing, either the behavior of the average borrower or their own borrowing, and compared their responses with actual repayment behavior of the overall borrower population. One 2009 survey of payday borrowers found that over 40 percent of borrowers thought that the average borrower would have a loan outstanding for only two weeks, and another 25 percent said four weeks. Translating weeks into loans, the four-week response likely reflects borrowers who believe the average number of loans that a borrower will take out before repaying is either one loan or two loans, depending on how many respondents were paid bi-weekly as opposed to monthly. The report did not provide data on actual re-borrowing, but based on analysis performed by the Bureau and others, these results suggest that respondents were, on average, somewhat optimistic about re-borrowing behavior. However, it is difficult to be certain that some survey respondents did not conflate the time during which the loans are outstanding with the contract term of individual loans. This may be so because the researchers asked borrowers, “What's your best guess of how long it takes the average person to pay back in full a $300 payday loan?” Some borrowers may have interpreted this question to refer to the specific loan being taken out, rather than subsequent rollovers. People's beliefs about their own re-borrowing behavior could also vary from their beliefs about average borrowing behavior by others. This study also did not specifically distinguish other borrowers from the subset of borrowers who end up in extended loan sequences.

Another study discussed in the proposal was a study of single-payment vehicle title borrowers, where researchers surveyed borrowers about their expectations about how long it would take to repay the loan. The report did not have data on borrowing, but compared the responses with the distribution of repayment times reported by the Tennessee Department of Financial Institutions. The report found that the entire population of borrowers was slightly optimistic, on average, in their predictions.

The two studies just described compared borrowers' predictions of average borrowing with overall average borrowing levels, which is only informative about how accurate borrowers' predictions are about the average. By contrast, a 2014 study by Professor Ronald Mann, which was discussed in the proposal, did attempt to survey borrowers at the point at which they were borrowing. This survey asked them about their expectations for repaying their loans and compared their responses with their subsequent actual borrowing behavior, using loan records to measure how accurate their predictions were. The results described in the report, combined with subsequent analysis that Professor Mann shared with Bureau staff, show the following:

First, and most significant, many fewer borrowers expected to experience long sequences of loans than actually did experience long sequences. Focusing on the borrowers who ended up borrowing for more than 150 days, it is notable that none predicted they would be in debt for even 100 days. And of those who ended up borrowing for more than 100 days, only a very small fraction predicted that outcome. Indeed, the vast majority of those who borrowed for more than 100 days actually expected to borrow for less than 50 days. Borrowers who experienced long sequences of loans do not appear to have expected those long sequences when they made their initial borrowing decision; in fact they had not predicted that their sequences would be longer than the average predicted by borrowers overall. And while some borrowers did expect long sequences, those borrowers were more likely to err in their predictions; as Mann noted, “both the likelihood of unexpectedly late payment and the proportionate size of the error increase substantially with the length of the borrower's prediction.”

Second, Mann's analysis suggests that past borrowing experience is not indicative of increased understanding of product use. In fact, those who had borrowed the most in the past did not do a better job of predicting their future use; they were actually more likely to underestimate how long it would take them to repay fully. As Mann noted in his paper, “heavy users of the product tend to be those that understand least what is likely to happen to them.”

Finally, Mann's research also indicated that about as many consumers underestimated how long they would need to re-borrow as those who overestimated it, which suggested they have difficulty predicting the extent to which they will need to re-borrow. In particular, the Bureau's analysis of the data underlying Mann's paper determined that there was not a correlation between borrowers' predicted length of re-borrowing and their actual length of re-borrowing. Professor Mann, in an email to the Bureau, confirmed that his data showed no significant relationship between the predicted number of days and the days to clearance. This point was reinforced in his survey results by the fact that fully 20 percent of the borrowers who responded were not even able to offer any prediction at all about their expected duration of indebtedness.

Professor Mann submitted a comment about his paper, which took issue with the Bureau's analysis of its findings. He contended his research shows instead that most payday borrowers expected some repeated sequences of loans, most of them accurately predicted the length of the sequence that they would borrow, and they did not systematically err on the optimistic side. The Bureau acknowledges these findings, and does not believe they are inconsistent with the interpretation provided here. Mann also noted that the Bureau placed its main emphasis not on the entire universe of borrowers, but on the group of borrowers who continued borrowing over the period for which he had access to the loan data, where his research showed that many of those borrowers did not anticipate that they would end up in such extended loan sequences. He further acknowledged that “the absolute size of the errors is largest for those with the longest sequences.” He went on to state that this finding suggests “that the borrowers who have borrowed the most are those who are in the most dire financial distress, and consequently least able to predict their future liquidity.” He also noted that the errors of estimation these borrowers tend to make are unsystematic and do not consist either of regular underestimation or regular overestimation of their subsequent duration of borrowing.

The discussion of these survey findings thus seems to reflect more of a difference in emphasis than a disagreement over the facts. Professor Mann's interpretation appears most applicable to those borrowers who remain in debt for a relatively short period, who constitute a majority of all borrowers, and who do not appear to systematically fail to appreciate what will happen to them when they re-borrow. The Bureau does not disagree with this point. Instead, it emphasizes the subset of borrowers who are its principal concern, which consists of those longer-term borrowers who find themselves in extended loan sequences and thereby experience the various harms that are associated with a longer cycle of indebtedness. For those borrowers, the picture is quite different, and their ability to estimate accurately what will happen to them when they take out a payday loan is more limited, as Mann noted in his paper and in the comment he submitted. For example, of the borrowers who remained in debt at least 140 days (10 biweekly loans), it appears that all (100 percent) underestimated their times in debt, with the average borrower in this group spending 119 more days in debt than anticipated (equivalent to 8.5 unanticipated rollovers). Of those borrowers who spent 90 or more days in debt (i.e., those most directly affected by the rule's limits on re-borrowing under the § 1041.6), it appears that more than 95 percent underestimated their time in debt, spending an average of 92 more days in debt than anticipated (equivalent to 6.5 unanticipated rollovers). Additionally, a line of “best fit” provided by Professor Mann describing the relationship between a borrower's expected time in debt and the actual time in debt experienced by that borrower shows effectively zero slope (indicating no correlation between a borrower's expectations and outcomes). In other words, while many individuals appear to have anticipated short durations of use with reasonable accuracy (highlighted by Mann's interpretation), virtually none properly anticipated long durations (which is the market failure described here). For further discussion on the Mann data, see the Section 1022(b)(2) Analysis in part VII below.

Professor Mann's comment also referred to two other surveys of payday borrowers that the Bureau discussed in its proposal. A trade association commissioned the two surveys, which suggest that consumers are able to predict their borrowing patterns. Both studies, as the Bureau had noted and as Professor Mann acknowledged, are less reliable in their design than the original Mann study because they focus only on borrowers who had successfully repaid a recent loan, which clearly would have biased the results of those surveys, because that approach would tend to under-sample borrowers who are in extended loan sequences. In addition, by entirely omitting borrowers whose loan sequences ended in default, these studies would have skewed the sample in other respects as well. At a minimum, the majority of borrowers who are light users of payday loans are likely to experience such loans very differently from the significant subset of borrowers (who are a minority of all borrowers, though the loans made to them constitute an overall majority of these loans) who find that they end up in extended loan sequences and suffer the various negative consequences of that predicament.

These surveys, which were very similar to each other, were conducted in 2013 and 2016 of storefront payday borrowers who had recently repaid a loan and had not taken another loan within a specified period of time. Of these borrowers, 94 to 96 percent reported that when they took out the loan they understood well or very well “how long it would take to completely repay the loan” and a similar percentage reported that they, in fact, were able to repay their loan in the amount of time they expected. These surveys suffer from the challenge of asking people to describe their expectations about borrowing at some time in the past, which may lead to recall problems, as described earlier. In light of the sampling bias discussed above and the challenge inherent in the survey design, the Bureau concludes that these studies do not undermine the evidence above indicating that especially those consumers who engage in long-term re-borrowing through extended loan sequences are generally not able to predict accurately the number of times that they will need to re-borrow.

As discussed in the proposal, several factors may contribute to consumers' lack of understanding of the risk of re-borrowing that will result from loans that prove unaffordable. As explained above in the section on lender practices, there is a mismatch between how these products are marketed and described by industry and how they actually operate in practice. Although lenders present the loans as a temporary bridge option, only a minority of payday loans are repaid without any re-borrowing. These loans often produce lengthy cycles of rollovers or new loans taken out shortly after the prior loans are repaid. Not surprisingly, many borrowers (especially those who end up in extended loan sequences) are not able to tell when they take out the first loan how long their cycles will last and how much they will ultimately pay for the initial disbursement of cash. Even borrowers who believe they will be unable to repay the loan immediately—and therefore expect some amount of re-borrowing—are generally unable to predict accurately how many times they will re-borrow and at what cost, unless they manage to repay the loan fairly quickly. And, as noted above, borrowers who end up re-borrowing many times are especially susceptible to inaccurate predictions.

Moreover, as noted in the proposal, research suggests that financial distress can be one of the factors in borrowers' decision-making. As discussed above, payday and single-payment vehicle title loan borrowers are often in financial distress at the time they take out the loans. Their long-term financial condition is typically very poor. For example, as described above, studies find that both storefront and online payday borrowers have little to no savings and very low credit scores, which is a sign of overall distressed financial condition. They may have credit cards but likely do not have unused credit, are often delinquent on one or more cards, and have often experienced multiple overdrafts and/or NSFs on their checking accounts. They typically have tried and failed to obtain other forms of credit before turning to a payday lender, or they otherwise may perceive that such other options would not be available to them and there is no time to comparison shop when facing an imminent liquidity crisis.

Research has shown that when people are under pressure they tend to focus on the immediate problem they are confronting and discount other considerations, including the longer- term implications of their actions. Researchers sometimes refer to this phenomenon as “tunneling,” evoking the tunnel-vision decision-making that people may tend to engage in as they confront such situations. Consumers experiencing a financial crisis, as they often are when they are deciding whether or not to take out these kinds of loans, can be prime examples of this behavior. Even when consumers are not facing a crisis, research shows that they tend to underestimate their near-term expenditures and, when estimating how much financial “slack” they will have in the future, tend to discount even the expenditures they do expect to incur. Finally, regardless of their financial situation, research suggests that consumers may generally have unrealistic expectations about their future earnings, their future expenses, and their ability to save money to repay future obligations. Much research has documented that consumers in many contexts demonstrate optimism bias about future events and their own future performance. Without attempting to specify how frequently these considerations may affect individual borrower behavior, it is enough here to note that they are supported in the academic literature and are consistent with the observed behavior of those who use covered short-term loans.

As discussed in the proposal, each of these behavioral biases is exacerbated when facing a financial crisis, and taken together they can contribute to affecting the decision-making of consumers who are considering taking out a payday loan, a single-payment vehicle title loan, or some other covered short-term loan. The effect of these behavioral biases may cause consumers to fail to make an accurate assessment of the likely duration of indebtedness, and, consequently, the total costs they will pay as a result of taking out the loan. Tunneling also may cause consumers not to focus sufficiently on the future implications of taking out a loan. To the extent consumers do comprehend what will happen when the loan comes due—or when future loans come due in extended loan sequences—underestimation of future expenditures and optimism bias can cause them to misunderstand the likelihood of repeated re-borrowing. These effects could be attributable to their belief that they are more likely to be able to repay the loan without defaulting or re-borrowing than they actually are. And consumers who recognize at origination that they will have difficulty paying back the loan and that they may need to roll the loan over or re-borrow once or twice may still underestimate the likelihood that they will wind up rolling over or re-borrowing multiple times and the increasingly high costs of doing so.

Regardless of the underlying explanation, the empirical evidence indicates that many borrowers who find themselves ending up in extended loan sequences did not expect that outcome—with their predictive abilities diminishing as the loan sequences become more extended. In this regard, it is notable that one survey found that payday and vehicle title borrowers were more likely to underestimate the cost and amount of time in debt than borrowers of other products examined in the survey, including pawn loans, deposit advance products, and installment loans.

The commenters on this discussion in the proposal expressed sharply divergent views. Some industry commenters stated their belief that consumers make rational decisions and many of them do expect to re-borrow when they take out covered short-term loans. Others noted that this argument fails to come to grips with the key problem that the Bureau has focused on in its analysis—known to economists as a “right tail” problem—which rests on the fact that a subset constituting a substantial population of payday borrowers are the ones who do not seem to expect but yet experience the most extreme negative outcomes with these loans.

Other industry participants and trade associations criticized the Bureau for not conducting its own surveys of payday and title borrowers, and contended that such surveys would have shown that borrowers are generally well informed about their decisions to obtain such loans. And a large number of comments from individual users of these loans were in accord with these views, presenting their own experiences with such loans as positive and as having benefited their financial situations.

Other industry commenters pointed out what they regarded as a low volume of consumer complaints about this product, which they viewed as inconsistent with the notion that many borrowers are surprised by experiencing unexpected negative outcomes with these loans. Yet it is equally plausible that those borrowers who find themselves in extended loan sequences may be embarrassed and therefore may be less likely to submit complaints about their situation. This is consistent with survey results that show many confirmed borrowers nonetheless deny having taken out a payday loan. Borrowers may also blame themselves for having gotten themselves caught up in a cycle of debt authorized by State law, which may also explain why they would be unlikely to file a complaint with a government agency or a government official.

In addition, the Bureau has noted previously that a relatively high proportion of debt collection complaints it receives are about payday loans—a much higher proportion, for example, than for mortgages or auto loans or student loans. From its consumer complaint data, the Bureau observed that from November 2013 through December 2016 more than 31,000 debt collection complaints cited payday loans as the underlying debt. More than 11 percent of the complaints that the Bureau has handled about debt collection stem directly from payday loans. And in any event, it is not at all clear that the Bureau receives a low number of consumer complaints about payday loans once they are normalized in comparison to other credit products. For example, in 2016, the Bureau received approximately 4,400 complaints in which consumers reported “payday loan” as the complaint product and about 26,600 complaints about credit cards. Yet there are only about 12 million payday loan borrowers annually, and approximately 156 million consumers have one or more credit cards. Therefore, by way of comparison, for every 10,000 payday loan borrowers, the Bureau received about 3.7 complaints, while for every 10,000 credit cardholders, the Bureau received about 1.7 complaints.

In addition, some faith leaders and faith groups of many denominations from around the country collected and submitted comments, which underscored the point that many borrowers may direct their personal complaints or dissatisfactions with their experiences elsewhere than to government officials. Indeed, some of the faith leaders who commented on the proposal mentioned their intentions or efforts to develop their own safer loan products in response to the crises related to them by such borrowers.

Various commenters, including some academics such as Professor Mann whose views are discussed above, also cited research that they viewed as showing that such borrowers understand the nature of the product, including the fact that they may remain indebted beyond the initial term of the loan, with many able to predict accurately (within two weeks) how long it will take to repay their loan or loans. They cited various studies to make the point that consumers are in a better position to understand and act in their own interests than are policymakers who are more removed from the conditions of their daily lives. Some of these commenters were particularly critical of what they viewed as the erroneous assumptions and, even more broadly, the misguided general approach taken by behavioral economists. They argued that any such approach to policymaking is not well grounded and runs counter to their preferred view that consumer behavior instead is marked by rational expectations and clear insight into decision-making about financial choices.

By contrast, many consumer groups and some researchers took a very different view. They tended to agree with the points presented in the proposal about how behavioral characteristics can undermine decision-making for borrowers of these loans, especially for those in financial distress. In their view, these factors can and often do lead to misjudgments by many consumers of the likelihood that they may find themselves caught up in extended loan sequences and experiencing many of the harmful collateral consequences that were described in the proposal. They suggested that both the research and the personal experiences of many borrowers suggest that this picture of a substantial number of consumers is generally accurate, especially for those consumers who find that they have ended up in extended loan sequences.

As the Bureau had noted in the proposal, the patterns of behavior and outcomes in this market are broadly consistent with a number of cognitive biases that are described and documented in the academic literature on behavioral economics. Yet it is important to note that the Bureau's intervention is motivated by the observed pattern of outcomes in the market, and not by any settled viewpoint on the varying theories about the underlying rationality of the decisions that may lead to them. That is, the Bureau does not and need not take a position here on the types of behavioral motivations that may drive the observed outcomes, for it is the outcomes themselves that are problematic, regardless of how economists may attempt to explain them. In fact, both the rational agent models generally favored by industry comments and the more behavioral models favored by consumer groups and some researchers could very well lead to these same observed outcomes.

The Bureau has weighed these conflicting comments and concludes that the discussion of these issues in the proposal remains generally accurate and is supported by considerable research and data on how payday and title loans operate in actual practice and how these loans are experienced by consumers. The data do seem to indicate that a significant group of consumers do not accurately predict the duration of their borrowing. This is particularly true, notably, for the subset of consumers who do in fact end up in extended loan sequences. These findings, and not any definitive judgment about the validity of behavioral economics or other theories of consumer behavior, provide the foundation on which this rule is based. Finally, though certain commenters have expressed concern that the Bureau had not heard sufficiently from individual users of these loans, the Bureau has now received and reviewed a high volume of individual comments that were submitted as part of this rulemaking process.

e. Delinquency and Default

The proposal also addressed the specific topics of delinquency and default on payday and single-payment vehicle title loans. In addition to the various harms caused by unanticipated loan sequences, the Bureau was concerned that many borrowers suffer other harms from unaffordable loans in the form of the collateral costs that come from being delinquent or defaulting on the loans. Many borrowers, when faced with unaffordable payments, will be late in making loan payments, and may ultimately cease making payments altogether and default on their loans. They may take out multiple loans before defaulting, either because they are simply delaying the inevitable or because their financial situation deteriorates over time to the point where they become delinquent and eventually default rather than continuing to pay additional re-borrowing fees. For example, the evidence from the CFPB Report on Supplemental Findings shows that approximately two-thirds of payday loan sequences ending in default are multi-loan sequences in which the borrower has rolled over or re-borrowed at least once before defaulting. And nearly half of the consumers who experienced either a default or a 30-day delinquency already had monthly fees exceeding $60 before their first default or 30-day delinquency occurred.

While the Bureau noted in the proposal that it is not aware of any data directly measuring the number of late payments across the industry, studies of what happens when payments are so late that the lenders deposit the consumers' original post-dated checks suggest that late payment rates are relatively high. For example, one study of payday borrowers in Texas found that in 10 percent of all loans, the post-dated checks were deposited and bounced. Looking at the borrower level, the study found that half of all borrowers had a check that was deposited and bounced over the course of the year following their first payday loan. An analysis of data collected in North Dakota showed a lower, but still high, rate of lenders depositing checks that later bounced or trying to collect loan payment via an ACH payment request that failed. It showed that 39 percent of new borrowers experienced a failed loan payment of this type within a year after their first payday loan, and 44 percent did so within the first two years after their first payday loan. In a public filing, one large storefront payday lender reported a lower rate (6.5 percent) of depositing checks, of which nearly two-thirds were returned for insufficient funds. In the Bureau's analysis of ACH payments initiated by online payday and payday installment lenders, half of online borrowers had at least one overdraft or NSF transaction related to their loans over 18 months. These borrowers' depository accounts incurred an average total of $185 in fees.

As the Bureau noted in the proposal, bounced checks and failed ACH payments can be quite costly for borrowers. The median bank fee for an NSF transaction is $34.00, which is equivalent to the cost of a rollover on a $300 storefront loan. If the lender makes repeated attempts to collect using these methods, this leads to repeated fees being incurred by the borrower. The Bureau's research indicates that when one attempt fails, online payday lenders make a second attempt to collect 75 percent of the time but are unsuccessful in 70 percent of those cases. The failure rate increases with each subsequent attempt.

In addition to incurring NSF fees from a bank, in many cases when a check bounces the consumer can be charged a returned check fee by the lender. This means the borrower would be incurring duplicative and additional fees for the same failed transaction. In this connection, it should be noted that lender-imposed late fees are subject to certain restrictions in some but not all States.

The proposal also noted that default can also be quite costly for borrowers. These costs vary with the type of loan and the channel through which the borrower took out the loan. As discussed above, default may come after a lender has already made repeated and expensive attempts to collect from the borrower's deposit account, such that a borrower may ultimately find it necessary to close the account. In other instances, the borrower's bank or credit union may close the account if the balance is driven negative and the borrower is unable for an extended period of time to return the balance to positive. And borrowers of single-payment vehicle title loans stand to suffer even greater harms from default, as it may lead to the repossession of their vehicle. In addition to the direct costs of the loss of an asset, the deprivation of their vehicle can seriously disrupt people's lives and put at risk their ability to remain employed or to manage their ordinary affairs as a practical matter. Yet another consequence of these setbacks could be personal bankruptcy in some cases.

Default rates on individual payday loans appear at first glance to be fairly low. This figure is three percent in the data the Bureau has analyzed, and the commenters are in accord about this figure. But because so many borrowers respond to the unaffordability of these loans by re-borrowing in sequences of loans rather than by defaulting immediately, a more meaningful measure of default is the share of loan sequences that end in default. The Bureau's data show that, using a 30-day definition of a loan sequence, fully 20 percent of loan sequences end in default. A recent report based on a multi-lender dataset showed similar results, with a three percent loan-level default rate and a 16 percent sequence-level default rate.

Other researchers have found similarly high levels of default. One study of Texas borrowers found that 4.7 percent of loans were charged off, while 30 percent of borrowers had a loan charged off in their first year of borrowing. Default rates on single-payment vehicle title loans are higher than those on storefront payday loans; in addition, initial single-payment vehicle title loans are more likely than storefront payday loans to result in a default. In the data analyzed by the Bureau, the default rate on all title loans is six percent, and the sequence-level default rate is 33 percent. Over half of all defaults occur in single-payment vehicle title loan sequences that consist of three or fewer loans. Nine percent of single-payment vehicle title loan sequences consist of single loans that end in default, compared to six percent of payday loan sequences. The Bureau's research suggests that title lenders repossess a vehicle slightly more than half the time when a borrower defaults on a loan. In the data the Bureau has analyzed, three percent of all single-payment vehicle title loans lead to repossession, which represents approximately 50 percent of loans on which the borrower defaulted. At the sequence level, 20 percent of sequences end up with the borrower's vehicle being repossessed. In other words, one in five borrowers is unable to escape their debt on these loans without losing their car or truck.

Some industry and trade association commenters posited that the Bureau had overstated the default and repossession rates on vehicle title loans. Companies argued that the Bureau had erroneously stated a higher repossession rate than their own data showed, with one commenter estimating its own short-term title loan sequence repossession rate at 8.4 percent. Others contended that the Bureau's repossession rates were much higher than those reported through other sources, such as regulator reports in States like Idaho and Texas. In arguing that the Bureau had overstated the default and repossession rates, one trade group also cited a study which had concluded that the rates were lower. The study relied on a handful of State regulator reports in addition to “industry sources.” Yet the difference seems to trace to the fact that default and repossession rates are typically reported at the loan level rather than the sequence level. The Bureau's loan-level data is actually fairly similar to the figures cited by these commenters. But the Bureau believes that sequence level is a more appropriate indicator, since it captures experience at the level of the borrower. Put differently, sequence level more appropriately indicates outcomes for particular consumers, rather than for particular lenders; from this standpoint, a loan that is rolled over three times before defaulting should not be miscounted as three “successfully” repaid loans and one default. As noted previously, over 80 percent of single-payment vehicle title loans were re-borrowed on the same day as a previous loan was repaid. Regardless, to the extent any one company has lower repossession rates than the average, that fact does not put in question the averages that the Bureau used, because inevitably there will be companies that are both above and below the average. The Bureau also notes that the study discussed above cited by a trade group, which relies on undefined “industry sources” and a handful of State regulator reports to criticize the Bureau's data on default and repossession rates, relied on far less robust loan level data than the Bureau used to arrive at the figures it cited in the Bureau's supplemental research report and in the proposal.

One commenter noted that because the vehicles put up for collateral on these loans are usually old and heavily used, lenders often do not repossess the vehicle because it is not worth the trouble. This commenter also argued that the impact of repossession is not significant, based on a study indicating that less than 15 percent of consumers whose vehicles are repossessed would not find alternative means of transportation, which again is at odds with the information presented in other studies that have been cited. Another commenter asserted that the stress created by the threat of vehicle repossession is no worse than other stresses felt by consumers in financial difficulties, though it is difficult to know how much to credit this claim.

The proposal further noted that borrowers of all types of covered loans are also likely to be subject to collection efforts, which can take aggressive forms. From its consumer complaint data, the Bureau observed that from November 2013 through December 2016 more than 31,000 debt collection complaints cited payday loans as the underlying debt. More than 11 percent of the complaints that the Bureau has handled about debt collection stem directly from payday loans. These collections efforts can include harmful and harassing conduct, such as repeated phone calls from collectors to the borrower's home or place of work, the harassment of family and friends, and in-person visits to consumers' homes and worksites. Some of this conduct, depending on the facts and circumstances, may be illegal. Aggressive calling to the borrower's workplace can put at risk the borrower's employment and jeopardize future earnings. Many of these practices can cause psychological distress and anxiety for borrowers who are already under the strain of financial pressure.

In fact, the Bureau's enforcement and supervisory examination processes have uncovered evidence of numerous illegal collection practices by payday lenders, including practices of the kinds just described. These have included: Illegal third-party calls, illegal home visits for collection purposes, false threats to add new fees, false threats of legal action or referral to a non-existent in-house “collections department,” and deceptive messages regarding non-existent “special promotions” to induce borrowers to return calls.

In addition, lenders and trade associations contended that the Bureau had overstated the extent of harm, noting that they do not typically report nonpayment of these kinds of loans to consumer reporting agencies, which can interfere with the consumer's access to credit, and that this lack of reporting would obviate any harm that the borrower would suffer on that front. Nonetheless, debt collectors can and do report unpaid debts to the consumer reporting companies even when the original creditors do not, and the aggressive collection tactics that the Bureau has identified with respect to unpaid payday loans through its investigations and numerous enforcement actions suggest that this may be a common collateral consequence of default on these loans as well.

The potential consequences of the loss of a vehicle depend on the transportation needs of the borrower's household and the available transportation alternatives. According to two surveys of title loan borrowers, 15 percent of all borrowers report that they would have no way to get to work or school if they lost their vehicle to repossession. Using an 8 percent repossession rate, one industry commenter asserted that only about one percent of title loan borrowers would thus lose critical transportation, by multiplying 15 percent times 8 percent. However, the survey author specifically warns against doing this, noting that “a borrower whose car is repossessed probably has lower wealth and income than a borrower whose car is not repossessed, and is therefore probably more likely to lack another way of getting to work.” More than one-third (35 percent) of borrowers pledge the title to the only working vehicle in the household. Even those with a second vehicle or the ability to get rides from friends or take public transportation would presumably experience significant inconvenience or even hardship from the loss of a vehicle. This hardship goes beyond simply getting to work or school, and would as a practical matter also adversely affect the borrower's ability to conduct their ordinary household affairs, such as obtaining food or medicine or other necessary services.

In the proposal, the Bureau noted that it analyzed online payday and payday installment lenders' attempts to withdraw payments from borrowers' deposit accounts, and found that six percent of payment attempts that were not preceded by a failed payment attempt themselves fail, incurring NSF fees. Another six percent avoid failure, despite a lack of sufficient available funds in the borrower's account, but only because the borrower's depository institution makes the payment as an overdraft, in which case the borrower was likely to be charged a fee that is generally similar in magnitude to an NSF fee. The Bureau could not determine default rates from these data.

As noted in the proposal, when borrowers obtain a payday or title loan, they may fail to appreciate the extent of the risk that they will default and the costs associated with default. Although consumers may well understand the concept and possibility of default, in general, they are unlikely, when they are deciding whether to take out a loan, to be fully aware of the extent of the risk and severity of the harms that would occur if they were to default or what it would take to avoid default. They may be overly focused on their immediate needs relative to the longer-term picture. The lender's marketing materials may have succeeded in convincing the consumer of the value of a loan to bridge financial shortfalls until their next paycheck. Some of the remedies a lender might invoke to address situations of nonpayment, such as repeatedly attempting to collect from a borrower's checking account or using remotely created checks, may be unknown or quite unfamiliar to many borrowers. Realizing that these measures are even a possibility would depend on the borrower investigating what would happen in the case of an event they typically do not expect to occur, such as a default.

Industry commenters contended that consumers tend to be highly knowledgeable about the nature, costs, and overall effects of payday and single-payment vehicle title loans. Yet they generally did not address the points raised here about the level of awareness and familiarity that these consumers would tend to have about the risks and costs of these other, more collateral consequences of delinquency and default. Consumer groups, by contrast, supported the view that these collateral consequences are part of the true overall cost of payday and title loans and that they are largely unforeseen by most consumers.

f. Collateral Harms From Making Unaffordable Payments

The proposal further elucidated other harms associated with payday and title loans, in addition to the harms associated with delinquency and default, by describing how borrowers who take out these loans may experience other financial hardships as a result of making payments on unaffordable loans. These harms may occur whether or not the borrower also experiences delinquency or default somewhere along the way, which means they could in many cases be experienced in addition to the harms otherwise experienced from these situations.

These further harms can arise where the borrower feels compelled to prioritize payment on the loan and does not wish to re-borrow. This course of action may result in defaulting on other obligations or forgoing basic living expenses. If a lender has taken a security interest in the borrower's vehicle, for example, and the borrower does not wish to re-borrow, then the borrower is likely to feel compelled to prioritize payments on the title loan over other bills or crucial expenditures, because of the substantial leverage that the threat of repossession gives to the lender.

The repayment mechanisms for other short-term loans can also cause borrowers to lose control over their own finances. If a lender has the ability to withdraw payment directly from a borrower's checking account, the borrower may lose control over the order in which she would prefer her payments to be made and thus may be unable to choose to make essential expenditures before repaying the covered loan. This is especially likely to happen when the lender is able to time the withdrawal to align with the borrower's payday or with the specific day when the borrower is scheduled to receive periodic income. Moreover, even if a title borrower does not have her vehicle repossessed, the threat of repossession in itself may cause tangible harm to borrowers. It may cause them to forgo other essential expenditures in order to make a payment they cannot afford in order to avoid repossession. And there may be psychological harm in addition to the stress associated with the possible loss of a vehicle. Lenders recognize that consumers often have a “pride of ownership” in their vehicle and, as discussed above, one or more lenders are willing to exceed their maximum loan amount guidelines by considering the vehicle's sentimental or use value to the consumer when they are assessing the amount of funds they will lend.

The Bureau noted in the proposal that it is not able to directly observe the harms that borrowers suffer from making unaffordable payments. But it stands to reason that when loans are made without regard to the consumer's ability to repay and the lender secures the ability to debit a consumer's account or repossess a vehicle, many borrowers are suffering harms from making unaffordable payments at certain times, and perhaps frequently.

The commenters had vigorous reactions to this discussion in the proposal. On the effects that vehicle title borrowers feel based on their concern about losing their transportation, industry commenters argued that the Bureau had overstated its points. They emphasized that these loans are typically non-recourse loans in many States, which puts some specific limits on the harm experienced by borrowers. In the proposal, the Bureau had observed that this result would still expose the borrower to consider threat of harm if they end up losing their primary (and in many instances their sole) means of transportation to work and to manage their everyday affairs. Moreover, the Bureau notes these comments omit the issue of what harms exist in States where vehicle title loans are recourse. The Bureau notes the receipt of a comment letter from two consumer advocacy groups that discussed in detail the laws and lender practices in Arizona, where a robust vehicle title loan market exists. They wrote that in Arizona lenders are permitted to sue for deficiency balances after repossession; lenders can collect a “reasonable amount” for the cost of collection and court and attorneys' fees related to repossession; and that as of 2015, nine of out of 10 largest title lenders still required borrowers to provide bank account access to get loans secured by vehicles. Furthermore, these commenters countered that borrowers often can find other means of transportation, citing what they present as a supportive survey. Their interpretation of the data is not convincing, however, as even the authors of the survey cautioned against making simplistic calculations about factors and probabilities that are intertwined in the analysis, and which thus may considerably understate the incidence of hardship. One industry commenter pointed to a survey which showed that though a majority of title loan borrowers would prioritize their title loan payment over that of a credit card, very few of these borrowers would prioritize a title loan payment over rent, utilities, groceries, or other expenses. However, the author of this survey clearly states that because of an extremely small sample size, his findings are anecdotal and are not representative of borrowers either in the local area surveyed or nationally.

The industry commenters further noted that as many as half of the title borrowers who default do so on their first payment, and they construed this occurrence as a strategic default which demonstrates that these borrowers did not confront any particular hardship by facing unaffordable payments that could cause them to lose their vehicle. Yet the notion that a borrower would make the conscious decision to employ this approach as a means of “selling” their vehicle, where they likely will receive a sharply reduced price for it and expose themselves to the other related risks discussed here, seems strained and implausible. That is especially the case insofar as doing so would needlessly incur the risks and costs of various potential penalty fees, late fees, towing fees, and the like that could occur (depending on the provisions of State law) when lenders carry out a repossession of the vehicle.

Industry and trade association commenters also suggested that the proposal is improperly paternalistic by attempting to substitute the judgment of the Bureau for the judgments made by individual consumers about how best to address the risks of collateral harms from making unaffordable payments. Difficult choices that consumers have to make about how to meet their obligations may be temporarily eased by the ability to access these loans and utilize the proceeds, at least for those consumers who do not end up experiencing the kinds of negative collateral consequences described above from delinquencies and defaults, and perhaps for some other borrowers as well. It also can substitute a new creditor with more limited recourse for an existing creditor with greater leverage, such as a landlord or a utility company. Although the addition of a payday or title loan obligation to the already-constrained mix of obligations can lead to the kind of budgeting distortions described by the proposal, it might instead lead to more immediate financial latitude to navigate those choices and avoid the impending harms of delinquency or default on other pre-existing obligations. This narrative was echoed by comments from a large number of individual users of such loans, who described the benefits they experienced by having access to the loan proceeds for immediate use while finding various ways to avert the negative collateral consequences described in the proposal.

Consumer groups, on the other hand, strongly urged the view that payday and title loans often lead to harms similar to those described in the proposal for a significant set of borrowers. This position was buttressed by submissions from and about a sizeable number of individual borrowers as well, which included narratives describing extreme financial dislocations flowing directly from harms cause by unaffordable payments. Although the proceeds of such loans do offer a temporary infusion of flexibility into the borrower's financial situation, that brief breathing spell is generally followed almost immediately thereafter by having to confront similar financial conditions as before but now with the looming or actual threat of these harmful collateral consequences being felt as well. Again, in contrast to the viewpoint that repeated re-borrowing may be consciously intended as a means of addressing financial shortfalls over a longer period of time, the consumer groups contended that extended loan sequences often reflect the inherent pressures of the initial financial need, now exacerbated by having to confront unaffordable payments on the new loan. And many individual users of such loans described their own negative experiences in ways that were consistent with the difficult situations and outcomes that can result from having to deal with unaffordable payments.

Once again, the factual observations presented in the proposal on the kinds of collateral harms that can arise for payday and title borrowers who struggle to pursue potential alternatives to making unaffordable payments, as opposed to defaulting on these loans, were not seriously contested. The disagreement among the commenters was instead over the inferences to be drawn from these facts in context of other facts and potential benefits that they presented as bearing on their views of overall consumer welfare, and thus the broader conclusions to be drawn for purposes of deciding whether or not to support the proposed rule. Those contextual matters are important and will be discussed further in § 1041.4 below.

g. Harms Remain Under Existing Regulatory Approaches

As stated in the proposal, based on the Bureau's analysis and outreach, the harms that it has observed from payday loans, single-payment vehicle title loans, and other covered short-term loans persist in these markets despite existing regulatory frameworks. This formulation, of course, is something of a tautology, since if the harms the Bureau perceives to exist do in fact exist, they clearly do so despite the impact of existing regulatory frameworks that fail to prevent or mitigate them. Nonetheless, in the proposal the Bureau stated that existing regulatory frameworks in those States that have authorized payday and/or title lending still leave many consumers vulnerable to the specific harms discussed above relating to default, delinquency, re-borrowing, and the collateral harms that result from attempting to avoid these other injuries by making unaffordable payments.

Several different factors have complicated State efforts to effectively apply their regulatory frameworks to payday and title loans. For example, lenders may adjust their product offerings or their licensing status to avoid State law restrictions, such as by shifting from payday loans to vehicle title or installment loans or open-end credit or by obtaining licenses under State mortgage lending laws. As noted earlier, the State regulatory frameworks grew up around the pre-existing models of single-payment payday loans, but have evolved in certain respects over the past two decades. States also have faced challenges in applying their laws to certain online lenders, including lenders claiming Tribal affiliation or offshore lenders.

As discussed above in part II, States have adopted a variety of different approaches for regulating short-term loans. For example, 15 States and the District of Columbia have interest rate caps or other restrictions that, in effect, prohibit payday lending and thereby limit access to this form of credit. Although consumers in these States may still be exposed to potential harms from short-term lending, such as online loans made by lenders that claim immunity from these State laws or from loans obtained in neighboring States, these provisions provide strong protections for consumers by substantially reducing their exposure to the harms they can incur from these loans. Again, as discussed above, these harms flow from the term and the single-payment structure of these loans, which along with certain lender practices expose a substantial population of consumers to the risks and harms they experience, such as ending up in extended loan sequences.

As explained in greater detail in part II above and in the section-by-section analysis for § 1041.5, the 35 States that permit payday loans in some form have taken a variety of different approaches to regulating such loans. Some States have restrictions on rollovers or other re-borrowing. Among other things, these restrictions may include caps on the total number of permissible loans in a given period, or cooling-off periods between loans. Some States prohibit a lender from making a payday loan to a borrower who already has an outstanding payday loan.

Some States have adopted provisions with minimum income requirements. For example, some States provide that a payday loan cannot exceed a percentage (most commonly 25 percent) of a consumer's gross monthly income. Some State payday or title lending statutes require that the lender consider a consumer's ability to repay the loan before making a loan, though none of them specifies what steps lenders must take to determine whether the consumer has the ability to repay a loan. Some States require that consumers have the opportunity to repay a short-term loan through an extended payment plan over the course of a longer period of time. And some jurisdictions require lenders to provide specific disclosures in order to alert borrowers of potential risks.

While the proposal noted that these provisions may have been designed to target some of the same or similar potential harms identified above, these provisions do not appear to have had a significant impact on reducing the incidences of re-borrowing and other harms that confront consumers of these loans. In particular, as discussed above, the Bureau's primary concern about payday and title loans is that many consumers end up re-borrowing over and over again, turning what was ostensibly a short-term loan into a long-term cycle of debt with many negative collateral consequences. The Bureau's analysis of borrowing patterns in different States that permit payday loans indicates that most States have very similar rates of re-borrowing, with about 80 percent of loans followed by another loan within 30 days, regardless of the terms of the specific restrictions that are in place.

In particular, laws that prevent direct rollovers of payday loans, as well as laws that impose very short cooling-off periods between loans, such as Florida's prohibition on same-day re-borrowing, have had very little impact on re-borrowing rates measured over periods longer than one day. The 30-day re-borrowing rate in all States that prohibit rollovers is 80 percent, and in Florida the rate is 89 percent. Some States, however, do stand out as having substantially lower re-borrowing rates than other States. These include Washington, which limits borrowers to no more than eight payday loans in a rolling 12-month period and has a 30-day re-borrowing rate of 63 percent, and Virginia, which imposes a minimum loan length of two pay periods and imposes a 45-day cooling-off period once a borrower has had five loans in a rolling six-month period, and has a 30-day re-borrowing rate of 61 percent (though title loans have claimed much greater market share in the wake of these restrictions on payday loans).

Likewise, the Bureau explained in the proposal the basis for its view that disclosures would be insufficient to adequately reduce the harm that consumers suffer when lenders do not reasonably determine consumers' ability to repay the loan according to its terms, which rested on two primary reasons. First, the Bureau noted that it is difficult for disclosures to address the underlying incentives in this market for lenders to encourage borrowers to re-borrow and take out extended loan sequences. As the Bureau discussed in the proposal, the prevailing business model in the short-term loan market involves lenders deriving a very high percentage of their revenues from extended loan sequences. The Bureau noted that while enhanced disclosures would provide more information to consumers, the Bureau believed that the single-payment structure of these loans, along with their high cost, would cause them to remain unaffordable for most consumers. The Bureau believed that, as a result, lenders would have no greater incentive to underwrite them more rigorously, and lenders would remain dependent on long-term loan sequences for revenues.

Second, the Bureau noted in the proposal that empirical evidence suggests that disclosures may have only modest impacts on consumer borrowing patterns for short-term loans generally and negligible impacts on whether consumers re-borrow. The Bureau stated that evidence from a field trial of several disclosures designed specifically to warn of the risks and costs of re-borrowing showed that these disclosures had a marginal effect on the total volume of payday borrowing. The Bureau observed that its analysis of similar disclosures implemented by the State of Texas showed a reduction in loan volume of 13 percent after the disclosure requirement went into effect, relative to the loan volume changes for the study period in comparison States, but further showed that the probability of re-borrowing on a payday loan declined by only approximately two percent once the disclosure was put in place. The Bureau noted that the analysis thus tended to confirm the fairly limited magnitude of the effects from the field trial.

For these reasons, the Bureau stated in the proposal that evidence indicates the core harms to consumers in this credit market remain even after a disclosure regime is put in place. The Bureau also repeated its observation that consumers have a very high probability of winding up in a very long loan sequence once they have taken out only a few loans in a row. The Bureau noted that the contrast of the very high likelihood that a consumer will wind up in a long-term debt cycle after taking out only a few loans, with the nearly negligible impact of a disclosure on consumer re-borrowing patterns, provides further evidence of the insufficiency of disclosures to address what the Bureau perceives to be one of the core harms to consumers here. The issues around the sufficiency of disclosures, and whether it is likely that further disclosures would adequately address the harms that the Bureau has identified with payday and single-payment vehicle-title loans, are discussed further in the section-by-section analysis for § 1041.5.

The proposal also discussed the SBREFA process, and noted that many participants urged the Bureau to reconsider the proposals under consideration and to consider deferring to existing regulation of these credit markets by the States or to adopt Federal regulations that are modeled on the laws or regulations of certain States. In the Small Business Review Panel Report, the Panel recommended that the Bureau continue to consider whether regulations in place at the State level are sufficient to address concerns about unaffordable loan payments. The Panel also recommended that the Bureau consider whether existing State laws and regulations could provide a model for elements of the Federal regulation. The SBA Office of Advocacy raised similar issues and suggested that the Bureau should defer to State payday lending laws.

The Bureau has examined State laws closely in connection with its work on the final rule, as discussed in part II above, and the Bureau has taken guidance from what it has learned from its consideration of those differing frameworks. The Bureau has also consulted with various State regulators and State Attorneys General on these issues over the course of its original research on these topics, its formulation of the SBREFA framework, its conduct of the SBREFA process, its formulation of the proposal, and its work since to finalize the rule. The Bureau has also considered the comments that it has received from all parties, including State regulators and State Attorneys General and the SBA Office of Advocacy, which conflict with one another in a great many respects on the topics and arguments that have already been addressed in this discussion. All of this consideration of the State legal and regulatory frameworks has been applicable to the Bureau's consideration of how it should approach its formulation of underwriting processes, restrictions on rollovers, and the use of cooling-off periods.

For those States with strong usury caps, of course, it bears repeating that the Bureau is not authorized to mirror those provisions because it is expressly barred by statute from imposing any usury cap on these loans. The Bureau has recognized this explicit restriction and carefully followed it in promulgating this rule, which does not prohibit any loan from being made based on the interest rate charged on the loan. Some of the industry commenters and trade associations have disputed this point in connection with certain provisions of the proposal, but have not explained how any loans are being prohibited on that basis.

Industry participants and trade associations commented extensively on the fact that payday and single-payment vehicle title loans are subject to significant regulation already in the remaining States, even without any new regulation being proposed by the Bureau. They pointed to specific State frameworks as examples of how these products are regulated adequately and as providing access to credit without posing undue problems for borrowers. One trade association, for example, specifically cited Florida's regulatory framework as allowing consumers in that State to use such products productively and successfully, while generating few complaints. Florida Congressional representatives made the same point. Other commenters, including some of the State Attorneys General, pointed to regulatory models in other States and drew similar conclusions. The Bureau has carefully assessed these State frameworks in considering how to respond to the comments received on the proposal and whether and how to modify the proposal in formulating the provisions of the final rule.

For example, despite Colorado's 2010 payday lending reforms that set a six-month minimum loan term for payday loans and reduced the annual percentage rates, concerns remain about sustained use and ability to repay the loans. A recent report based on State regulator data noted that in 2015, the average borrower “took out 3.3 loans from the same lender over the course of the year, with a growing percentage of consumers (14.7 percent) being in debt every day for 12 consecutive months. Also one in four payday loans show signs of distress by delinquency or default.”

In 2010, the State of Washington amended its payday lending law to limit borrowers to no more than eight loans in a rolling 12-month period, add an extended repayment plan that borrowers could take any time before default, and add a database that all lenders must use to report loans and check before new loans are made. The State regulator has issued yearly reports; with the most recent report being from calendar year 2015. There is no specific ability-to-repay requirement other than the loan amount cannot exceed 30 percent of the borrower's gross monthly income or a maximum of $700 with no review of expenses. The 2015 report contains three highlights in particular. First, borrowing patterns continue to reflect a small number of borrowers responsible for most of the State's payday loans. For payday loans originated in calendar year 2015, about one-quarter (25.38 percent) of borrowers took out about half (49.59 percent) of the total loans. Second, about a quarter of borrowers—26.62 percent—reached the eight-loan cap during 2015. Note that the cap is based on a rolling 12-month period rather than a calendar year and some of these loans may have been originated in 2014. Also, note that some borrowers may be seeking loans online through unlicensed lenders that are not included in the State's database. Third, 12.35 percent of loans were converted to an extended repayment plan (known as an installment loan plan) at some point in 2015. Borrowers may convert a payday loan to an installment loan plan at any time prior to default at no charge, with 90 to 180 days to repay based on the loan amount.

Missouri's regulatory framework offers an illustrative example that bears on the Bureau's decision to require specific underwriting criteria under § 1041.5, a set of requirements that many commenters have criticized as unduly prescriptive and unnecessarily burdensome. By contrast, Missouri law requires small-dollar lenders to consider the borrower's financial ability to reasonably repay under the terms of the loan contract, but does not specify how lenders may go about satisfying this requirement. The unsatisfactory result of this law, which fails to specify how lenders must satisfy the ability-to-repay requirement and thus allows lenders to exercise latitude in this regard, was starkly illustrated in a recent Missouri case that addressed the practical results of this framework. In a debt collection case, an appeals court judge concluded that the law, “which was designed for unsecured loans of five hundred dollars or less, has through the allowance of practically unlimited interest rates charged on the loans allowed the companies that provide these loans to use the court system to collect amounts from debtors far beyond anything that could be deemed consistent with the statute's original purpose,” thus providing “a clear example of predatory lending.” The judge then presented examples from the factual record in the case as follows:

“Class member, D.W., took out a $100 loan from CSI. A judgment was entered against him for $705.18; the garnishment is still pending. So far, $3174.81 has been collected, and a balance of $4105.77 remains.

Class member, S.S., took out an $80 loan from CSI. A judgment was entered against her for $2137.68; the garnishment is still pending. So far, $5346.41 has been collected, and a balance of $19,643.48 remains.

Class member, C.R., took out a $155 loan from CSI. A judgment was entered against her for $1686.93; the garnishment is still pending. So far, $9566.15 has been collected, and a balance of $2162.07 remains.”

The judge went on to provide four other similar examples, all of which were apparently deemed by the lender to satisfy its own conception of an ability-to-repay standard, even though the judge found that “the amount the lenders are collecting or are attempting to collect on these types of loans shocks the conscience” and were “beyond the ability of many debtors to ever pay off.”

In addition, many industry participants and trade associations pointed out that payday and title lending are already regulated at the Federal level to some degree. They noted, for example, that the following laws already apply to such loans: the Truth in Lending Act, the Electronic Transfer Act, the Equal Credit Opportunity Act, the Fair Debt Collection Practices Act, and the Gramm-Leach-Bliley Act, among others. Many of these statutes have implementing regulations as well, thus adding to the pre-existing coverage of these loans under Federal law. And as recounted in part III, the Bureau has, in fact, engaged in extensive supervisory and enforcement activity with respect to payday loans and payday lenders under various provisions of the Federal consumer laws. These commenters often recognized that the Dodd-Frank Act confers separate and additional authority on the Bureau to promulgate rules to address unfair, deceptive, or abusive acts or practices, but contended that this authority should be used sparingly in light of the many statutes and regulations that already apply to such loans.

In contrast, the consumer groups and other commenters drew a very different conclusion from their review of the State regulatory frameworks. They noted that more than 90 million people live in States without payday loans—where the State usury caps are viewed as effectively prohibiting such loans from being made as a practical matter—and observed that many of these consumers manage to deal with their cash shortfalls without resort to such loans. The same commenters contended that these consumers are not harmed by the absence of payday loans and instead are able to serve their financial needs through other credit products that are less risky. In their view, the alternatives available to potential borrowers in need of short-term credit are more diverse and more extensive than industry commenters have suggested. This market, as they describe it, is much broader than payday and single-payment vehicle title loans; it also comprises products such as credit cards, subprime credit cards, certain bank and credit union products, non-recourse pawn loans, employer funds, charitable funds, and payment plans that are often made available by utilities and others. They also suggested that other non-credit strategies, such as debt counseling and credit counseling, can be productive alternatives to payday and title loans. There was a wide gap in perspectives between these consumer groups and the industry commenters, who generally contended that these borrowers have a very limited range of alternative sources of credit available to them, other than payday and title loans, and are adversely affected when they lack access to these types of covered short-term loans. This disagreement is important and is considered further in the section-by-section analysis for § 1041.4 below in the discussions of unfairness and abusiveness.

In sum, the Bureau has considered all of the comments received about the effects of the existing legal and regulatory frameworks, including the State frameworks, on the issues addressed in the proposal. Based on the Bureau's analysis of the factual data as noted above, the regulatory frameworks in most States that allow and regulate payday, title, and other covered short-term loans do not appear to have had a significant impact on reducing the amounts of default, delinquency, re-borrowing, and the other collateral harms from making unaffordable payments that confront consumers of these loans. Nor have other existing regulatory frameworks had a significant impact in mitigating those harms to consumers. For these and the other reasons discussed above, the Bureau concludes that federal intervention in these markets is warranted at this time.

Longer-Term Balloon-Payment Loans

As stated in the proposal, some longer-term payday installment loans and vehicle title loans are structured either to be repaid in a single lump-sum payment or to require a large balloon payment, often as a final payment of all principal due following a series of smaller interest-only payments. Unsurprisingly, many consumers find making such a payment as challenging as making the single payment under a traditional, two-week payday loan, and such loans frequently result in default or re-borrowing.

The Bureau concludes that consumers are likely to be adversely affected by the practice of making these loans without reasonably assessing the borrower's ability to repay the loan while paying for basic living expenses and other major financial obligations. And while there does not appear to be a large market of longer-term balloon-payment loans today, the Bureau is concerned that the market for such loans might grow if it only regulated the underwriting of covered short-term loans. Based on the evolution in small-dollar loan markets after the Military Lending Act was enacted and the initial regulations implementing the MLA were adopted, the Bureau is concerned that lenders would gravitate toward making non-underwritten balloon-payment loans that slightly exceed the time limits in the definition for covered short-term loans, resulting in similar risks and harms to consumers from default, delinquency, re-borrowing, and the collateral consequences of forgoing basic living expenses or major financial obligations to avoid default.

The Bureau received comments specifically on covered longer-term loans involving balloon payments. Several industry commenters stated that the Bureau's concerns about re-borrowing for covered longer-term loans should have focused primarily on loans with balloon payments, and argued that any restrictions should thus be limited to balloon-payment loans. The Bureau agrees with these commenters that the re-borrowing concerns with these loans are similar to the Bureau's concerns regarding covered short-term loans, and highlight similar problems from making covered longer-term balloon-payment loans without reasonably assessing the borrower's ability to repay. The thrust of these industry comments thus has tended to reinforce the judgment the Bureau has now made to address the underwriting of covered longer-term balloon-payment loans in this rule.

As discussed more fully in the section-by-section analysis of §§ 1041.2(a)(7) and 1041.3(b)(2) of the final rule, the Bureau had proposed to define a covered longer-term balloon-payment loan to mean a covered longer-term loan that, in essence, is repayable either in a single lump-sum payment or requires at least one payment that is more than twice as large as any other payment. After consideration of comments received concerning whether to maintain the proposal's approach to limiting coverage of such balloon-payment structures to those products that exceed a rate threshold and involved the taking of a leveraged payment mechanism or vehicle security, the Bureau has decided to adopt a more expansive definition that includes all such payment structures regardless of price or other factors, unless they are specifically excluded or exempted under § 1041.3 of the final rule.

Because relatively few covered longer-term balloon-payment loans appear in the market today, the Bureau is supplementing its analysis in this section with relevant information it has on related types of covered longer-term loans—such as hybrid payday loans, payday installment loans, and vehicle title installment loans. Although these types of loans would not necessarily involve balloon payments per se, the Bureau finds no reason to expect that matters such as borrower characteristics and circumstances of borrowing are likely to differ substantially as between borrowers of longer-term title loans generally, for example, and borrowers of such loans with a balloon-payment structure. The Bureau concludes as follows:

• Lower-income, lower-savings consumers in financial difficulty. While there is less research available about the consumers who use these products as compared to covered short-term loan products, available information suggests that consumers who use hybrid payday, payday installment, and vehicle title installment loans also tend to come frequently from lower- or moderate-income households, have little savings or available credit, and have been turned away from other credit products. Their reasons for borrowing and use of loan proceeds are also generally consistent with those of short-term borrowers.
• Ability-to-collect business models. Lenders of most covered longer-term loans have built their business model on their ability to collect, rather than the consumers' ability to repay the loans. Specifically, these lenders generally screen for fraud risk but do not consider consumers' expenses to determine whether a loan is tailored to what the consumers can actually afford. They tend to rely heavily on pricing structures and on leverage over the consumer's bank account or vehicle title to protect their own interests, even when the loans prove unaffordable for consumers. Lenders may continue receiving payments even when the consumer is left unable to meet her basic living expenses or major financial obligations. Again, though this tends to be the case for borrowers of covered longer-term loans, it is even more likely to be true of such borrowers if their loans have a balloon-payment structure.
• Very high default rates. Defaults are a concern with covered longer-term loans generally, and especially so if those loans reflect a balloon-payment structure. In data from one lender that the Bureau analyzed, about 60 percent of balloon-payment installment loans result in default or refinancing. In general, borrowers experienced very high levels of delinquency and default—in some cases the default rate was over 50 percent at the loan sequence level. Prior to reaching the point of default, borrowers can be exposed to a variety of harms whose likelihood and magnitude are substantially increased because of leveraged payment mechanisms or vehicle security relative to similar loans without these features.
• Re-borrowing. The combination of leveraged payment mechanism or vehicle security with an unaffordable balloon payment can compel consumers to re-borrow. They will often have to engage in costly re-borrowing when they are unable to repay the entire loan all at once and extraction of the unaffordable loan payment would leave them unable to cover basic living expenses or major financial obligations.
• Consumers do not understand the risks. The Bureau concludes that borrowers do not fully understand or anticipate the consequences that are likely to occur when they take out covered longer-term balloon-payment loans, including both the high likelihood of default and the degree of collateral damage that can occur in connection with unaffordable loans.

a. Borrower Characteristics and Circumstances of Borrowing

Stand-alone data specifically about payday installment and vehicle title installment borrowers is less robust than for borrowers of covered short-term loans, as discussed above. Yet a number of sources provide combined data for both categories. Both the unique and combined sources suggest that borrowers in these markets generally have low-to-moderate incomes and poor credit histories. Their reasons for borrowing and use of loan proceeds are also generally consistent with those of covered short-term borrowers.

1. Borrower Characteristics

As described above, typical payday borrowers have low average incomes ($25,000 to $30,000), poor credit histories, and have often repeatedly sought credit in the months leading up to taking out a payday loan. Given the overlap in the set of firms offering these loans, the similar pricing of the products, and certain similarities in the structure of the products (e.g., the high cost and the synchronization of payment due dates with borrower paydays or next deposits of income), the Bureau finds that the characteristics and circumstances of payday installment borrowers are likely to be very similar to those of short-term payday borrowers. To the extent data is available limited to payday installment borrowers, the data confirms this view.

For example, from a study of over one million high-cost loans made by four payday installment lenders, both storefront and online, median borrower gross annual income was reported to be $35,057. Similarly, administrative data from Colorado and Illinois indicate that 60 percent of the payday installment borrowers in those States have income of $30,000 or below. And a study of online payday installment borrowers, using data from a specialty consumer reporting agency, found a median income of $30,000 and an average VantageScore of 523; each of these was essentially identical as between the levels for storefront payday borrowers and for online payday borrowers.

The information about vehicle title borrowers that the Bureau has reviewed does not distinguish between single-payment and installment vehicle title borrowers. For the same reasons that the Bureau concludes that the demographic data with respect to short-term payday borrowers can be extrapolated to payday installment borrowers, the Bureau also finds that the demographic data is likely to be similar as between short-term vehicle title borrowers and vehicle title installment borrowers. As discussed above, vehicle-title borrowers across all categories tend to be low-income or moderate-income, with 56 percent having reported incomes below $30,000, and are disproportionately racial and ethnic minorities or members of female-headed households.

2. Circumstances of Borrowing

Again, less data is available that focuses specifically on the circumstances of borrowing for users of payday installment and vehicle title installment loans than is available for short-term loans, and the data must be approached with some caution, since studies that seek to examine why consumers took out liquidity loans or for what purpose face a number of challenges. For example, any survey that asks about past behavior or events runs the risk of recall errors, and the fact that money is fungible makes this question even more complicated. For example, a consumer who has an unexpected expense may not feel the full effect until weeks later, depending on the timing of the unexpected expense relative to other expenses and the receipt of income. In that circumstance, a borrower may say that she took out the loan because of an emergency or may say instead that the loan was taken out to cover regular expenses.

A 2012 survey of over 1,100 users of alternative small-dollar credit products asked borrowers separately about what precipitated the loan and what they used the loan proceeds for. Responses were reported for “very short term” and “short term” credit, with “short term” referring to non-bank installment loans and vehicle title loans. The most common reason borrowers gave for taking out “short term” credit (approximately 36 percent of respondents) was “I had a bill for an unexpected expense (e.g., medical emergency, car broke down).” About 23 percent of respondents said “I had a payment due before my paycheck arrived,” which the authors of the report on the survey results interpret as a mismatch in the timing of income and expenses, and a similar number said their general living expenses were consistently more than their income. The use of funds most commonly identified was to pay for routine expenses, with nearly 30 percent reporting “pay utility bills” and about 20 percent reporting “general living expenses,” but about 25 percent said the use of the money was “car-related,” either purchase or repair. In contrast, participants who took out “very short term” products such as payday and deposit advance products were somewhat more likely to cite “I had a bill or payment due before my paycheck arrived,” or that their general living expenses were consistently more than their incomes as compared to respondents who took out “short term” products, though unexpected expenses were also cited by about 30 percent of the “very short term” respondents. More than 40 percent of “very short term” respondents also reported using the funds to pay for routine expenses, including both paying utility bills and general living expenses.

b. Lender Practices

1. Loan Structure

As stated in the proposal, some longer-term payday installment loans and vehicle title loans are structured either to be repaid in a single lump-sum payment or to require a large balloon payment, often as a final payment of all principal due following a series of smaller interest-only payments. Unsurprisingly, many consumers find making such a payment as challenging as making the single payment under a traditional, two-week payday loan, and such loans frequently result in default or re-borrowing.

2. Failure To Assess Ability To Repay

Many lenders making longer-term balloon-payment loans—like lenders making other types of longer-term loans—have constructed a business model that allow them to offer loans profitably despite very high loan-level and sequence-level default rates. Rather than assessing whether borrowers will have the ability to repay the loans, these lenders engage in limited up-front screening to detect potential fraud and other “first payment defaults,” and otherwise rely heavily on loan features and practices that result in consumers continuing to make payments beyond the point at which they are affordable. These lenders do not seek to prevent those with expenses chronically exceeding income from taking on additional obligations in the form of payday installment or similar loans. Lending to borrowers who cannot repay their loans would generally not be profitable in a traditional lending market, but the key features of these loans—leveraged payment mechanisms, vehicle security, and high cost—turn the traditional model on its head. These product features significantly reduce lenders' interest in ensuring that payments under a covered longer-term balloon-payment loan are within the consumer's ability to repay.

Some of these consumers may repay the entire loan at the expense of suffering adverse consequences in their inability to keep up with basic living expenses or major financial obligations. Others end up defaulting on their loans at a point later than would otherwise be the case, thus allowing lenders to extract additional revenue on the way ultimately to the same adverse result. Product features that make this possible include the ability to withdraw payments directly from a borrower's deposit account or the leverage derived from the ability to repossess the borrower's means of transportation to work and for other everyday activities. The effect is especially strong when the lender times the loan payments to coincide with deposits of the consumer's periodic income into the account. In these cases, lenders can succeed in extracting payments from the consumer's account even if they are not affordable to the consumer. The lender's risk of default is reduced, and the point at which default ultimately occurs is delayed. As a result, the lender's incentive to invest time or effort into determining whether the consumer will have the ability to make the loan payments is greatly diminished.

c. Harms Spurred by Balloon-Payment Loan Structures

When these features are combined with a balloon-payment structure, lenders can operate, presumably at a profit, even when borrowers are defaulting on 50 percent of loan sequences. The circumstances of the borrowers and the structure of the loans that require a large balloon payment to be made all at once can lead to dramatic negative outcomes for many borrowers who receive unaffordable loans because the lender does not reasonably assess their ability to repay. The Bureau is particularly concerned about the harms associated with re-borrowing and refinancing; harms associated with default, including vehicle repossession or the loss of a deposit account; and harms that flow from borrowers forgoing basic living expenses or defaulting on other major financial obligations as a result of making unaffordable payments on such loans.

In the CFPB Report on Supplemental Findings, the Bureau analyzed several aspects of the re-borrowing and refinancing behavior of borrowers who take out vehicle title installment loans. For a longer-term loan with a balloon payment due at the end, the data analyzed by the Bureau demonstrated a large increase in borrowing around the time of the balloon payment, relative to loans without a balloon-payment feature. Further, for loans with a balloon payment, the re-borrowing was much more likely to occur around the time the balloon payment came due and consumers were less likely to take cash out, suggesting that the unaffordability of the balloon payment is the primary or sole reason for the re-borrowing or refinancing.

Specifically, about 60 percent of balloon-payment installment loans resulted in refinancing, re-borrowing, or default. In contrast, nearly 60 percent of comparable fully-amortizing installment loans were repaid without refinancing or re-borrowing. Moreover, the re-borrowing often only deepened the consumer's financial distress.

Balloon payments were not only associated with a sharp uptick in re-borrowing, but also with increased incidence of default. Notably, the default rate for balloon-payment vehicle title installment loans that the Bureau analyzed was about three times higher than the default rate for comparable fully-amortizing vehicle title installment loans offered by the same lender.

In addition to the harms discussed above, the Bureau is concerned that borrowers who take out these loans may experience other financial hardships as a result of making payments on unaffordable loans. Even if there are sufficient funds in the account, extraction of the payment through leveraged payment mechanisms or vehicle security places control of the timing of the payment with the lender, leading to the risk that the borrower's remaining funds will not cover their other expenses or obligations. The resulting harms are wide-ranging and, almost by definition, can be quite extreme. Consumers may experience knock-on effects from their failure to meet these other obligations, such as additional fees to resume utility services or late fees on other obligations. This risk is further heightened when lenders time the loan payment due dates to coincide with the consumer's receipt of income, which is typically the case.

Furthermore, even if the consumer's account lacks sufficient funds available to cover the required loan payment, the lender still may be able to collect the payment from the consumer's bank by putting the account into an overdraft position. Where that occurs, the consumer will incur overdraft fees and, at many banks, extended overdraft fees. When new funds are deposited into the account, those funds will go to repay the overdraft and not be available to the consumer for other expenses or obligations. Thus, at least certain types of covered longer-term loans—in particular, long-term balloon-payment loans—carry a high degree of risk that if the payment proves unaffordable, the consumer will still be forced to repay the loan and incur further adverse effects, such as penalty fees or legal actions such as vehicle repossession or eviction.

The Bureau is not able to directly observe the harms borrowers suffer from making unaffordable payments. The presence of a leveraged payment mechanism or vehicle security, however, each make it highly likely that borrowers who are struggling to pay back the loan will suffer these harms. The very high rates of default on these loans means that many borrowers do struggle to repay these loans, and it is therefore reasonable to infer that many borrowers are also suffering harms from making unaffordable payments.

d. Consumer Expectations and Understanding

The Bureau is concerned about these negative consequences for consumers that flow from covered longer-term balloon-payment loans made without reasonably assessing the borrower's ability to repay, because there is strong reason to believe that consumers do not understand the likelihood of the risk that such loans will prove unaffordable or the likelihood and extent of the adverse collateral consequences of such unaffordable loans.

As an initial matter, the Bureau finds that many consumers fail to understand that lenders making longer-term balloon-payment loans—like lenders making other types of longer-term loans—do not evaluate their ability to repay their loans and instead have built business models that tolerate default rates well in excess of 30 percent, even after many consumers have incurred the further costs of re-borrowing. While the Bureau is unaware of any borrower surveys in these two markets, these two conditions are directly contrary to the practices of lenders in nearly all other credit markets—including other subprime lenders.

The Bureau has observed that most borrowers are unlikely to take out a loan they expect to default on, and hence the fact that at least one in three sequences ends in default strongly suggests that borrowers do not understand the degree of risk to which they are exposed with regard to such negative outcomes as default or loss of their vehicle, re-borrowing in connection with unaffordable loans, or having to forgo basic living expenses or major financial obligations. Even if consumers did understand that lenders offering longer-term balloon-payment loans were largely uninterested in their ability to repay, consumers would still be hindered in their ability to anticipate the risks associated with these loans. As discussed above, most borrowers taking out longer-term loans are already in financial distress. Many have had a recent unexpected expense, like a car repair or a decline in income, or they may have chronic problems in making ends meet. Even when not facing a crisis, research shows that consumers tend to underestimate their near-term expenditures and, when estimating how much financial “slack” they will have in the future, discount even the expenditures they do expect to incur. Consumers also tend to underestimate volatility in their own earnings and expenses, especially the risk of unusually low income or high expenses. Such optimism bias tends to have a greater effect when consumers are projecting their income and expenses over longer periods. Finally, in addition to gaps in consumer expectations about the likelihood that these loans will generally prove unaffordable, the Bureau observes that consumers underestimate the potential damage from default such as secondary fees, loss of vehicle or loss of account, which may tend to cause consumers to underestimate degree of harm that could occur if a loan proved unaffordable.

In sum, the Bureau's analysis of longer-term balloon-payment loans, as supplemented by its analysis of related types of longer-term loans, indicates that many consumers are unable to appreciate the likelihood of the risk and the magnitude of the harm they face from such loans if they are made on unaffordable terms. This is likely to be the case, in particular, with covered longer-term balloon-payment loans made without reasonably assessing the borrower's ability to repay the loan according to its terms.

Section 1041.4 Identification of Unfair and Abusive Practice—Underwriting Preliminary Discussion on Covered Longer-Term Balloon-Payment Loans

The bulk of the Bureau's analysis below is tailored toward covered short-term loans because those loans are the Bureau's primary source of concern, and the market for which the Bureau has the most evidence. However, the Bureau's statement of the unfair and abusive practice in § 1041.4 of the final rule also encompasses covered longer-term balloon-payment loans as defined in § 1041.2(a)(7) of the final rule. Accordingly, these loans, like covered short-term loans, are subject to both the underwriting and payment requirements of the final rule.

The Bureau does not believe that currently there is a particularly large market for these loans, which is why most of the Bureau's evidence is focused on covered short-term loans. But as described above in Market Concerns—Underwriting, where the Bureau has observed covered longer-term loans involving balloon payments for which the lender does not assess borrowers' ability to repay before making the loan, it has seen the same type of consumer harms and other circumstances that the Bureau has observed when lenders fail to assess ability to repay before making covered short-term loans. Indeed, the Bureau's analysis of longer-term balloon-payment loans in the market for vehicle title loans found that borrowers experienced high default rates—notably higher than for similar loans with amortizing installment payments.

If the Bureau were to finalize this rule without including longer-term balloon-payment loans, it also has great concern that the market for longer-term balloon-payment loans, which is currently quite small, could expand dramatically if lenders were to begin to make efforts to circumvent its provisions by making these loans without assessing borrowers' ability to repay. The result would be that the same type of unfair and abusive practice (just with a slightly different credit product) would persist and impose similar harms on consumers.

This scenario is also more than mere speculation. The Military Lending Act was enacted in 2006 and imposed a 36 percent interest-rate cap on certain loans made to servicemembers and their dependents. Rules to implement its provisions were adopted, and the small-dollar loan industry, in particular, went to some lengths to circumvent the provisions of those rules by making changes in their loan products, such as modifying terms and conditions and extending the duration of such loans. The resulting evasion of the rules was successful enough that Congress found it necessary to revisit the law and direct that new rules be adopted to close loopholes that the prior rules had created, which had undermined the purposes of the Act. The new regulations were adopted in July 2015 and are now in effect.

The fact of this recent experience in this very industry underscores the Bureau's concern that applying the underwriting criteria of this rule to covered longer-term balloon-payment loans is necessary to effectuate its purpose to protect consumers. This point reinforces the Bureau's view, based on the limited evidence of the small size of the market currently existing for these loans, that the analysis below would apply to covered longer-term balloon-payment loans as well as to covered short-term loans if that market were to expand. Thus, the Bureau has made the judgment to similarly regulate covered longer-term balloon-payment loans.

The Bureau did not receive many comments on just the specific portion of the Bureau's proposal about covered longer-term loans involving balloon payments. However, the Bureau did receive a few. Several industry commenters stated that the Bureau's concerns about re-borrowing for covered longer-term loans should have focused primarily on loans with balloon payments, and argued that any restrictions should thus be limited to balloon-payment loans. These commenters were correct that the Bureau's concerns regarding re-borrowing, which are similar to the Bureau's concerns regarding covered short-term loans, were focused primarily on covered longer-term balloon-payment loans. This is one of the reasons why the Bureau is finalizing only this portion of the proposal involving covered longer-term loans, and provides further support for the Bureau's conclusion that the analysis below relating to covered short-term loans is applicable to covered longer-term balloon-payment loans as well. Having addressed this issue here, the remainder of the discussion in this section of the unfair and abusive practice of making loans without reasonably assessing the borrower's ability to repay the loan according to its terms will focus exclusively on covered short-term loans.

The Bureau's Approach in the Proposal

As the Bureau noted in the proposal, it is standard practice in most consumer lending markets for lenders to assess whether a consumer has the ability to repay a loan before making the loan. In certain markets, Federal law requires this. The Bureau did not propose to make a determination whether, as a general rule for all kinds of credit, it is an unfair or abusive practice for any lender to make a loan without making such a determination. Nor did the Bureau propose to resolve that question in this rulemaking. Rather, the focus of the subpart B of the proposed rule was on a more specific set of loans that the Bureau has carefully studied, as discussed in more detail above in part II and in Market Concerns—Underwriting. Based on the evidence presented in the proposal, and pursuant to its authority under section 1031(b) of the Dodd-Frank Act, the Bureau proposed to identify it as both an unfair practice and an abusive practice for a lender to make a covered short-term loan without reasonably determining that the consumer will have the ability to repay the loan under its explicit authority to prescribe rules for “the purpose of preventing [unfair and abusive] acts or practices.”

In this specific context, “ability to repay” was defined in the proposal to mean that the consumer will have the ability to repay the loan without re-borrowing and while meeting the consumer's major financial obligations and basic living expenses. The Bureau had made preliminary findings and reached preliminary conclusions about the unfairness and the abusiveness of making these loans without such a reasonable determination, based on the specific evidence cited in the proposal, which is discussed further below as well as above in part II and Market Concerns—Underwriting. The Bureau sought comment on the evidence it had presented on these issues and on the preliminary findings and conclusions it had reached in the proposal. It also sought comment on whether making the kinds of loans that meet the conditions set forth in the proposed exemption—conditions that are specifically designed as an alternative means to protect consumers against the harms that can result from unaffordable loans—should not be regarded as an unfair or abusive practice.

General Comments

The Bureau received a number of general comments about the Bureau's use of its authority to prohibit unfair, deceptive, or abusive acts or practices (“UDAAP”). The Bureau addresses those more general comments here, but specific comments on the prongs of unfairness or abusiveness are found below.

Some industry participants suggested that an act or practice can only be deemed unfair, deceptive, or abusive if there is a strong element of wrongdoing or a sense that an unconscionable advantage has been taken, which they asserted did not exist.

Many industry participants and trade associations attacked the factual foundation set forth in the proposal as inadequate. And they took particular issue with the framing of the proposal as resting on what they viewed as mere assertions and presuppositions, not clearly grounded in factual findings, as reflected in certain phrasings and characterizations (or even “slogans”). They further viewed this preliminary foundation for the proposal as reflecting bias or prejudgment on the part of the Bureau that improperly colored its approach to these issues.

Industry participants and trade associations also highlighted the Bureau's observation made in the proposal that “the evidence on the effects on consumers of access to storefront payday loans is mixed.” They argued that the Bureau cannot rest any rulemaking that imposes a substantial market intervention, including UDAAP rulemakings, on mixed evidence that is not more clearly definitive of the key points at issue. Accordingly, these commenters again contended that the Bureau was resting its proposed rule on an insufficient factual threshold.

Bank and credit union commenters, among others, suggested that the Bureau either lacked—or had failed to provide—data to support the application of the abusiveness standard (or more broadly, the UDAAP standard) in context of the kinds of short-term loans they provide, which would be covered loans under the proposal. Here again, one commenter cited the Bureau's reliance on “a set of preliminary findings” and what it “believes” to be true as indicative of the Bureau's lack of supporting data. Another suggested that loans made by community banks that are covered under the proposed rule are not predatory and do not perpetuate a cycle of indebtedness. This commenter noted that community banks have developed a business model that does not rely on rolling over loans and churning fees, that they underwrite all of their own small loans, and that default and vehicle repossession rates associated with these loans are very small. These commenters thus asserted that the Bureau lacks evidence to demonstrate that their practices associated with these loans are unfair, deceptive or abusive. For these and other reasons, community bank and credit union commenters strongly advocated for the Bureau to use its exemption authority to ensure that their lending activities would not be covered under the terms of any final rule, either in whole or in part.

Similarly, commenters asserted that the Bureau was acting improperly by resting the proposed rule on its mere “beliefs” and preliminary findings, rather than holding off until the Bureau was in a position to render definitive conclusions on the main points at issue. In particular, they contended that UDAAP rules governing these covered loans could not validly be enacted until after the Bureau makes definitive rulings based on evidence and fact.

Some commenters, comprising both industry participants and trade associations, argued that the Dodd-Frank Act does not authorize the Bureau to ban a “product,” but only to “prescribe rules” identifying unlawful UDAAP “acts or practices.” One industry commenter argued that the Bureau had mischaracterized or ignored relevant legal precedent that controls how the Bureau must interpret its UDAAP authority under the Dodd-Frank Act, going so far as to say that Bureau lawyers had a professional responsibility to correct the record, and arguing that the Bureau does not have the authority to invalidate entire contracts or whole products. Other commenters argued that the proposed rule was overbroad insofar as it rested on the sweeping conclusion that all alternative underwriting approaches would be unable to pass muster under the unfair or abusive standards laid out in the statute. Further, they contended that the proposed rule would largely eliminate payday and title loans, which are sources of credit that many consumers have long relied on, all of which would exceed the Bureau's statutory mandate. One commenter also made the point that the Bureau's proposal seemed inconsistent with the statutory objective of leveling the playing field for all competitors of consumer financial products by addressing the perceived unfairness of regulating just these covered loans without addressing all of the products that may have similar or equivalent features.

Many industry participants and trade associations submitted comments that attacked the broader legal authority of the Bureau to propose any rule governing these types of short-term loans, especially a rule under its UDAAP authority. A few of them argued that the Bureau's authority is narrowly constrained because the Truth in Lending Act and its implementing regulations provide a pervasive regulatory framework to govern consumer credit transactions. Others argued that when Congress intended to impose ability-to-repay requirements on specific lending markets, it did so explicitly by statute (as it did with mortgages and credit cards), but it did not confer such explicit authority on the Bureau to regulate payday and title loans in this manner. As a consequence, these commenters maintained that the expressio unius canon of statutory construction applies to deny the Bureau any such regulatory authority.

Some commenters stated views that conflicted with those set out above. One trade association, in particular, stated that Congress plainly recognized the problems created by unregulated and less regulated lenders, and for that reason conferred on the Bureau new authority to supervise and write rules for the payday lending industry for the first time ever at the Federal level. More generally, consumer groups were strongly supportive of the Bureau's legal authority to develop and finalize the proposed rule. Rather than viewing other ability-to-repay provisions in Federal consumer law as implied negative restrictions on the Bureau's authority, these commenters pointed to them and others (such as the Military Lending Act) as embodying a considerable trend of expanding public policy now supporting the principle that consumer lending generally should be premised on the borrower's ability to repay. They noted that, along with recent Federal law on mortgage and credit card lending, certain States now embody this principle in statute, and many more do so by judicial precedent. They noted that general statements of this principle in Federal and State law tend to define this approach as requiring the lender to establish the borrower's ability to repay the loan while meeting basic living expenses and without re-borrowing.

Approach in the Final Rule and Changes to Language in § 1041.4

The terms “unfair” and “abusive” are defined terms in the Dodd-Frank Act with multiple prongs. Under the Act, the Bureau cannot determine an act or practice to be unlawful unless “the Bureau has a reasonable basis to conclude” that the act or practice “causes or is likely to cause substantial injury to consumers which is not reasonably avoidable by consumers” and “such substantial injury is not outweighed by countervailing benefits to consumers or to competition.” The Bureau is expressly authorized to “consider established public policies as evidence” in “determining whether an act or practice is unfair.” An “abusive” act or practice is defined, among other things, as one that “takes unreasonable advantage of (A) a lack of understanding on the part of the consumer of the material risks, costs, or conditions of the product or service; [or of] (B) the inability of the consumer to protect the interests of the consumer in selecting or using a consumer financial product or service.”

In the proposal, each of the specified prongs of these two terms defined in the statute was discussed separately. Hence the comments that were submitted on these specific legal grounds regarding the Bureau's approach can be presented and addressed in this format as well, and that discussion is contained in the following sections. But the more general comments on the Bureau's legal approach to developing ability-to-repay rules under UDAAP to govern covered short-term loans, as those comments were summarized above, can be directly addressed here.

To begin with, the commenters' suggestion that an act or practice can only be deemed unfair, deceptive, or abusive if there is a strong element of wrongdoing or a sense that an unconscionable advantage has been taken is a mischaracterization of the Bureau's UDAAP authority as prescribed by law. Although public policy is a factor that the Bureau may consider for purposes of identifying unfairness, both the unfairness and abusiveness standards rest upon well-defined elements in the Dodd-Frank Act, and a sense of wrongdoing or unconscionability is not one of them. In fact, the FTC and Congress have explicitly rejected the notion that agencies should be measuring whether an act is “immoral, unethical, oppressive, or unscrupulous” or consistent with public policy to make unfairness findings. An abusive practice may require that the person take “unreasonable advantage” of various conditions, but that does not require any sense of unconscionability. The commenters do not offer any compelling justification for their position that the Bureau should, or even is authorized to, supplement the specific statutory prongs that Congress adopted to define the terms “unfair” and “abusive” with these additional and loose concepts that were not incorporated in the statute. Congress was undoubtedly aware of the unconscionability standard when it passed the Consumer Financial Protection Act, and it did not use the language of unconscionability to limit the unfairness or abusiveness standards.

Some commenters attacked various preliminary findings and conclusions set forth in the proposal by reacting to language in the proposed rule conveying that, as is true of any proposed notice-and-comment rulemaking, the Bureau always planned to wait to formulate and support its final conclusions only after receiving feedback on its proposal. The Bureau appropriately noted that various factual statements, observations, or conclusions made in the proposal were to be regarded as tentative until they could be and had been evaluated in light of comments and supporting information received through the entire rulemaking process. In fact, the Bureau is required by law to consider and analyze the comments received before deciding whether and how to finalize any regulations. As described in the section-by-section analysis for § 1014.4 and this preamble, now that the Bureau has had the opportunity to consider the high volume of input that it has received from all stakeholders, including extensive individual involvement by members of the public, it is in a position to articulate and justify the types of formal and definitive conclusions necessary to support the final rule. The factual recitation presented above in the discussion of Market Concerns—Underwriting embodies the Bureau's presentation of and response to commenters' specific points that were raised about these factual issues. The fact that the Bureau had presented some of its views in the proposal as tentative thus is not improper and was entirely appropriate at that preliminary stage of the rulemaking process.

Some commenters took virtually the opposite tack, objecting to statements made in the proposal, or made by the Bureau in the course of wide-ranging discussions on other occasions, as suggesting bias and prejudgment of certain issues underlying the proposed rule. These objections seem to lack foundation or to be based on statements taken out of context, given the considerable efforts the Bureau has undertaken to process, analyze, and digest the heavy volume of comments received and be responsive to them on the merits in formulating the final rule. The Bureau bases its UDAAP findings on the evidence and conclusions as discussed and now adopted in this section and in Market Concerns—Underwriting. Those findings are more explicitly laid out below when describing the comments and analysis that are applicable to the distinct unfairness and abusiveness prongs.

As to the statement that the Bureau based its views on “mixed” evidence, in the proposal the Bureau stated that “[i]n reviewing the existing literature, the Bureau believes that the evidence on the impacts of the availability of payday loans on consumer welfare is mixed. A reasonable synthesis appears to be that payday loans benefit consumers in certain circumstances, such as when they are hit by a transitory shock to income or expenses, but that in more general circumstances access to these loans makes consumer worse off. The Bureau reiterates the point made earlier that the proposed rule would not ban payday or other covered short-term loans, and believes that covered short-term loans would still be available in States that allow them to consumers facing a truly short-term need for credit.” In other words, the Bureau did not simply rest its preliminary findings on its determination to take one side of a debate. Instead, the Bureau analyzed the evidence, which naturally differed on methodology and subjects studied, and synthesized it into a preliminary view that payday loans benefit some consumers in certain circumstances, but generally leave many other consumers worse off, while noting that many of the consumers who benefited would still be able to access payday loans under the provisions of the proposed rule.

The Bureau finds that the comments received from banks and credit unions and their trade associations were generally well taken. Many bank and credit union loans are likely not covered by the final rule, because the Bureau is not finalizing the proposals on longer-term small-dollar loans at this time. And to the extent that community banks and credit unions make loans that would otherwise be covered on an accommodation basis for their customers, the Bureau's use of its exemption authority in the final rule assures that these loans also will not be covered (of course, nonbanks making accommodation loans would similarly be exempt).

The Bureau agrees that much of the evidence it reviewed related to loans made by nonbanks, and not banks. However, the Bureau did review evidence relating to Deposit Advance Products, made by banks, and concluded that it was consistent with the evidence the Bureau had on nonbank covered loans. Further, there appears to be no logical reason to believe that covered short-term loans, made without assessing borrowers' ability to repay, would impact consumers differently depending on the lender's charter. The Bureau thus concludes that based on the evidence it reviewed, it is appropriate to apply this rule to the banks and credit unions that are engaged in making covered loans that do not fall within the exemptions provided in the final rule. Doing so is consistent with the Bureau's objective of ensuring that “Federal consumer financial law is enforced consistently, without regard to the status of a person as a depository institution, in order to promote fair competition.”

With respect to the commenter that viewed the Bureau's proposal as inconsistent with the implicit statutory objective of leveling the playing field for all competitors of consumer financial products because it regulates covered loans without addressing every product that may have similar or equivalent features, the objection is unpersuasive. The Bureau is not required to write rules that cover every product or market all at once, and has the authority to prioritize taking action as it deems appropriate, so long as it has the data and justification for doing so for each instance. For example, the final rule does not cover the underwriting of longer-term loans. This rulemaking also does not cover overdraft services on deposit accounts. Both of those products are distinct from covered short-term loans and may be the subject of separate rulemaking efforts, as well as remaining subject to the Bureau's oversight through the exercise of its supervisory and enforcement authority.

For commenters who argued that the proposed rule was a misuse of the Bureau's prevention authority, or was too harsh and too prescriptive so as to be disproportionate to the evidence of harm to consumers that the Bureau presented in the proposal, several responses are in order. The initial question is whether the Bureau can show in this final rule that in identifying the practice described in § 1041.4 as unfair and abusive, the Bureau acted within the scope of its express legal authority to adopt rules to identify and prevent unfair and abusive acts or practices—a topic that is covered in detail in the following sections. Comments about whether the proposed ability-to-repay requirements are consistent with the Bureau's prevention authority are addressed in more detail below in the section-by-section analysis of § 1041.5.

The Bureau's determination that the failure of a lender to reasonably determine the consumer's ability to repay a covered short-term or longer-term balloon-payment loan according to its terms meets the statutory prongs of the Bureau's “unfair” or “abusive” authority, as discussed further in the following sections, and thus the Bureau is not imposing a ban on any “product” but instead is simply prescribing rules to prevent the acts or practices so identified.

The Bureau does not agree with commenters who suggest that the proposed underwriting rules would effectively have banned lenders from making covered loans. The Bureau continues to believe that even under the underwriting rules contained in the proposal, lenders would have been able to continue to make loans to consumers who, in fact, had the ability to repay those loans. In any event, the Bureau has reconsidered certain aspects of the ability-to-repay underwriting provisions presented in the proposal, in response to substantive comments that were received on various details of the proposed underwriting approach, which provisions are being implemented in a somewhat modified form in § 1041.5 below; and the Bureau is finalizing the alternative framework that it has presented for making such loans without all the underwriting criteria specified in § 1041.5, subject to a cap on how much lending could be achieved within this framework. For more details, see the Section 1022(b)(2) Analysis in part VII below and the section-by-section analysis for § 1041.5 of the final rule.

More generally, the Bureau's rule does not invalidate whole products. Section 1041.4 identifies an unfair and abusive practice in the market—the making of covered short-term and longer-term loans without reasonably determining borrowers' ability to repay the loans according to their terms. Other sections of the rule, including §§ 1041.5 and 1041.6, are intended to prevent that existing practice and the associated harms. This approach to UDAAP rulemaking (identification and then prevention) is a consistent and straightforward application of UDAAP precedent, as discussed further in part IV above.

As to whether the specified components of the ability-to-repay determinations are disproportionate to the risks posed by such lending, the law does not impose any such proportionality test, as long as the statutory prongs of unfairness and abusiveness are met and the remedy imposed bears a reasonable relationship to addressing the identified practice. Nonetheless, it is again relevant here that, as explained in detail below in the section-by-section analysis of § 1041.5, the final rule has incorporated changes in the specified underwriting criteria to harmonize them more closely with those applicable to credit cards and to render them less demanding than the ability-to-repay test used for making mortgage loans. In particular, the Bureau has reconsidered certain aspects of the ability-to-repay underwriting criteria presented in the proposal in response to substantive comments that were received on various details of its proposed approach, and as a result these criteria are being implemented in a somewhat modified form in § 1041.5 below to take account of and respond to these particular concerns raised by the commenters. In addition, the Bureau's proposal presented an alternative framework for making such loans, subject to a cap on how much lending could be achieved within this framework. That alternative framework is being adopted in the final rule, subject to certain modifications, as discussed further below in § 1041.6. For these reasons, the Bureau concludes that the approach set forth in the final rule imposes a remedy that bears a reasonable relationship to addressing the unfair and abusive practice identified by the Bureau so that it does not persist in this market.

With respect to the commenters who asserted that the TILA or any combination of Federal statutes and regulations impliedly divest the Bureau of the authority to propose any rule governing these types of short-term loans under its UDAAP authority, those provisions do not seem able to bear the weight of the argument. On the contrary, the Dodd-Frank Act plainly gave the Bureau the authority to “prescribe rules” identifying “unfair, deceptive, or abusive acts or practices” that violate Federal law, even though Congress was well aware that the TILA, in particular, already was applicable to consumer financial products, such as the covered short-term loans addressed by this rule.

Nor has Congress given any indication that it intended to restrict the Bureau from adopting an underwriting approach for this loan market (ability-to-repay underwriting, which is based on the lender making a reasonable determination that the borrower will have the ability to repay the loan) that has found increasing Congressional favor in other markets. The Bureau agrees with the commenters who took the view that Congress has plainly recognized the importance of these measures as a means of protecting consumers in two major consumer loan markets (credit cards and mortgages), which tends to support rather than undermine a finding that lending should be premised on the borrower's ability to repay in the market for these covered loans as well. Commenters arguing otherwise did not provide any case law in support of this argument, and the cases cited by a few commenters involved Congress expressly articulating its intent to limit an agency's authority in a particular manner, or an agency acting in a manner inconsistent with an express Congressional mandate. Neither applies here. Further the Bureau's action is not without precedent, as at least one other agency has issued rules to prevent unfair or deceptive practices through an ability-to-repay requirement. Before the Consumer Financial Protection Act was passed into law, the Federal Reserve Board issued a rule under the Home Ownership and Equity Protection Act imposing ability-to-repay requirements for mortgage lenders “to prevent unfairness, deception, and abuse.”

For these reasons, and as discussed further in the Bureau's analysis of each of the prongs of the statute addressed below, the Bureau is finalizing its conclusion that it is an unfair and abusive practice for a lender to make a covered short-term or longer-term balloon-payment loans without reasonably determining that the borrowers will have the ability to repay the loans according to their terms. The Bureau made four modifications to proposed § 1041.4. The Bureau has added to the phrase “ability to repay the loan” the phrase “according to its terms,” such that the final statement of the unfair and abusive practice is, in part, the failure to assess that the consumer “will have the ability to repay the loan according to its terms.” The addition was meant to address a common misimpression conveyed by commenters. Many commenters claimed that borrowers who cannot pay an originated loan nonetheless do have an ability to repay because they can repay after some amount of re-borrowing. To further reflect the Bureau's intent, both now and at the stage of the proposal, that lenders should assess the borrower's ability to repay without re-borrowing, the Bureau has added the phrase “according to its terms.”

Second, the Bureau has added covered longer-term balloon-payment loans to the statement of the unfair and abusive practice, as noted above.

Third, the Bureau added official commentary, at comment 4-1, clarifying that a lender who complies with § 1041.5 in making a covered short-term loan or a covered longer-term balloon-payment loan has not committed the unfair and abusive practice under § 1041.4. The comment further clarifies that a lender who complies with § 1041.6 in making a covered short-term loan has not committed the unfair and abusive practice under § 1041.4 and is not subject to § 1041.5. This comment is added to clarify that the combination of §§ 1041.5 and 1041.6 are the Bureau's intended method for preventing the practice in § 1041.4, that loans made under § 1041.6 are exempt from § 1041.5, and thus, that if a lender complies with § 1041.5 or § 1041.6, a lender would not be in violation of § 1041.4.

Fourth, during inter-agency consultations, the Bureau received input from a Federal prudential regulator about the singular nature of the statement of the unfair and abusive practice. The regulator believed that supervisory or enforcement actions of this particular rule should be based on a pattern or practice of activity, rather than an isolated and inadvertent instance, which the regulator believed could deter responsible lenders from making covered loans. In the interest of inter-agency cooperation, the Bureau is adopting the suggestion to pluralize the statement of the unfair and abusive practice. Relatedly, the Bureau does not intend to bring supervisory or enforcement actions against a lender for a single isolated violation of § 1041.5.

In the discussion that follows, the Bureau responds to the core arguments raised in comments that were submitted on the Bureau's proposal. The Bureau has organized the comments received such that all of the core arguments presented by the commenters are addressed in the following analysis of the statutory prongs of whether the identified practice constitutes an “unfair” practice and an “abusive” practice.

Unfairness

As discussed in the proposal, under section 1031(c)(1) of the Dodd-Frank Act, an act or practice is unfair if it causes or is likely to cause substantial injury to consumers which is not reasonably avoidable by consumers and such injury is not outweighed by countervailing benefits to consumers or to competition. Under section 1031(c)(2), the Bureau may consider established public policies as evidence in making this determination. The proposal preliminarily found that it is an unfair practice for a lender to make a covered short-term loan without reasonably determining that the consumer will have the ability to repay the loan. After issuing the proposal and receiving and reviewing comments, the Bureau is now finalizing that conclusion for covered short-term loans. The Bureau concludes that the practice causes substantial injury in the form of default, delinquency, re-borrowing, and collateral consequences associated with attempts to avoid the other injuries by making unaffordable payments. The data that the Bureau analyzed suggest that, particularly with respect to re-borrowing, the incidence of injury is quite high. The Bureau also concludes that this injury is not reasonably avoidable because a substantial population of borrowers who incur injury—from default, delinquency, re-borrowing, or other collateral consequences from making unaffordable payments—do not anticipate the harm. Lastly, the Bureau concludes that the injury to these borrowers outweighs the countervailing benefits to those and other borrowers benefited by the practice and to competition. The most notable benefit would be greater access to credit for borrowers who lack an ability to repay, but for all the reasons discussed below, the Bureau believes that the harms associated with getting unaffordable credit for a substantial population of consumers outweigh any such benefit. In addition, the Bureau reasonably anticipates that even these borrowers are likely to retain access to some covered short-term loans that comply with the terms of final § 1014.6, subject to the conditions that are imposed in that provision to prevent the risks and harms associated with extended loan sequences.

Commenters presented feedback on the Bureau's preliminary conclusions for each of the three prongs of unfairness. The Bureau addresses the comments on those prongs in turn below.

Practice Causes or Is Likely To Cause Substantial Injury

The Bureau's Proposal

The proposal noted that the Bureau's interpretation of the various prongs of the unfairness test is informed by the FTC Act, the FTC Policy Statement on Unfairness, and FTC and other Federal agency rulemakings and related case law. Under these authorities, as discussed in part IV, “substantial injury” may consist either of a small amount of harm to a large number of individuals or of a larger amount of harm to a smaller number of individuals. In this case, the proposal stated that the practice at issue causes or is likely to cause both—a substantial number of consumers suffer a high degree of harm, and a large number of consumers suffer a lower but still meaningful degree of harm.

In the proposal, the Bureau stated its judgment that the practice of making a covered short-term loan without assessing the consumer's ability to repay the loan according to its terms causes or is likely to cause substantial injury. When a loan is structured to require repayment within a short period of time, the Bureau noted that the payments may outstrip the consumer's ability to repay since the type of consumers who turn to these products cannot absorb large loan payments on top of their major financial obligations and basic living expenses. If a lender nonetheless makes such loans without determining that the loan payments are within the consumer's ability to repay, the Bureau stated that it appears the lender's conduct causes or is likely to cause the injuries described below.

The proposal stated that, in the aggregate, the consumers who suffer the greatest injury are those consumers who find it necessary to re-borrow repeatedly and end up in exceedingly long loan sequences. As discussed in the proposal, consumers who become trapped in long loan sequences pay substantial fees for re-borrowing, and they usually do not reduce the principal amount owed when they re-borrow. For example, roughly half of payday loan sequences consist of at least three loans, at which point, in a typical two-week loan, a storefront payday borrower will have paid over a period of eight weeks charges equal to 60 percent or more of the loan amount—and will still owe the full amount originally borrowed. Roughly one-third of consumers re-borrow at least six times, which means that, after three-and-a-half months with a typical two-week loan, the consumer will have paid to the lender a sum equal to 100 percent of the loan amount and made no progress whatsoever in repaying the principal. Almost one-quarter of loan sequences consist of at least 10 loans in a row, and 50 percent of all loans are in sequences of 10 loans or more. And looking just at loans made to borrowers who are paid weekly, biweekly, or semi-monthly, approximately 21 percent of loans are in sequences consisting of at least 20 loans. For loans made to borrowers who are paid monthly, 42 percent of loans are in sequences consisting of at least 10 loans. Similarly, for single-payment vehicle title loans, the Bureau found that more than half (56 percent) of loan sequences consist of at least four loans in a row; over a third (36 percent) consist of seven or more loans in a row; and about one-fourth (23 percent) had 10 or more loans.

The proposal further stated that consumers whose loan sequences are shorter may still suffer meaningful injury from re-borrowing, albeit to a lesser degree than those in longer sequences. Even consumers who re-borrow only once or twice—and, as described in the proposal, 22 percent of payday and 23 percent of vehicle title loan sequences show this pattern—will still incur significant costs related to re-borrowing or rolling over the loans.

The proposal stated that the injuries resulting from default on these loans also appeared to be significant in magnitude. As described in the proposal, 20 percent of payday loan sequences end in default, while 33 percent of single-payment vehicle title sequences end in default. Because covered short-term loans (other than vehicle title loans) are usually accompanied by some specific means of payment collection—typically a postdated check for storefront payday loans and an authorization to submit electronic debits to the consumer's account for online payday loans—a default means that the lender was unable to secure payment despite using those tools. That means a default is typically preceded by failed attempts to secure payment, which generate bank fees (such as NSF fees) that can put the consumer's account at risk and lender fees (such as late fees or returned check fees) that add to the consumer's total indebtedness. Additionally, as discussed in the proposal, where lenders' attempts to extract money directly from the consumer's account fail, the lender often will resort to other collection techniques, some of which—such as repeated phone calls, in-person visits to homes and worksites, and lawsuits leading to wage garnishments—can inflict significant financial and psychological damage on consumers.

The proposal stated that for consumers with a single-payment vehicle title loan, the injury from default can be even greater. In such cases, lenders do not have access to the consumers' bank account but instead have the ability to repossess the consumer's vehicle. As discussed in the proposal, almost one in five title loan sequences end with the consumer's vehicle being repossessed. Consumers whose vehicles are repossessed and who do not have another vehicle may end up either wholly dependent upon public transportation or family or friends to get to work, to shop, or to attend to personal needs. In many personal situations and in many areas of the country, such as rural areas and urban areas without public transportation that is reasonably available, this means they may end up without any effective means of transportation at all.

Finally, the proposal stated that the Bureau believes many consumers, regardless of whether they ultimately manage to pay off the loan, suffer collateral consequences as they struggle to make payments that are beyond their ability to repay. For instance, they may be unable to meet their other major financial obligations or may be forced to forgo basic living expenses as a result of prioritizing a loan payment and other loan charges—or having it prioritized for them, in ways they cannot control, by the lender's exercise of its leveraged payment mechanism.

Comments Received

The Bureau received many comments from stakeholders on all sides of these issues about whether the identified practice causes or is likely to cause substantial injury to consumers. As an initial matter, the Bureau received a number of comments from industry participants and trade associations on how the Bureau should measure injury before making a determination that a given act or practice is unfair. Several commenters stated that injury should be measured in relation to consumer outcomes in the absence of the act or practice (here payday lending without assessing the borrower's ability to repay). Commenters argued that the Bureau's identified injuries should be compared to the alternatives without such loans, including defaulting on other financial obligations, failing to afford basic living expenses, forgoing the purchase of goods and services, and bouncing checks. One commenter argued that the psychological injury from stress caused by the threat of repossession should be offset by the injury of the stress caused by losing electricity, heat, water, or the actual vehicle (assuming the borrower must sell or pawn the vehicle to cover the expense). Another commenter argued that the Bureau failed to identify any “metric” for measuring harm at all, and that without doing so, the Bureau was unable to estimate the scope of harm. Yet another commenter argued that injury should be measured by comparing the cost of covered loans against the cost of alternative loans.

A number of industry commenters made the similar argument that covered loans cannot cause substantial injury because they do not hurt, and perhaps improve, overall financial health. They presented various surveys and studies that they viewed as providing support for this point. They also contended that the Bureau had erred by assuming that re-borrowing was necessarily injurious and that sustained and repeated use of these loans was necessarily injurious. Another commenter reported having used the Bureau's financial well-being survey to compare the scores of its customers with the scores of similarly situated consumers in States that restrict payday lending, and reported finding that its customers had similar or better financial well-being scores.

The Bureau also received a number of comments arguing that the Bureau had overstated the scope of harm resulting from and frequency of the re-borrowing, defaults, and repossessions caused by the practice. Similarly, commenters argued that there was no evidence that covered loans cause account closures or NSF fees, as stated in the proposed rule. Those comments are addressed above in Market Concerns—Underwriting.

Some commenters suggested that because certain small-dollar loan products usually are underwritten, they have a much lower re-borrowing and default rate.

Other industry commenters objected to the premise that repeat borrowing constitutes an injury to consumers at all. They argued that the evidence shows extended borrowing is a net benefit to consumers because borrowers get a temporary reprieve from financial difficulty, or because cash-strapped consumers are able to satisfy necessary expenses. Another commenter pointed to a study finding that borrowers who engage in protracted refinancing have higher credit scores than borrowers who use shorter sequences. Still another commenter claimed that re-borrowing for title loans should not be regarded as causing an injury because re-borrowing allows consumers to avoid defaulting on other obligations along with such harms as vehicle repossession.

Industry commenters also argued that the Bureau should only count re-borrowing as an injury where consumers did not anticipate that outcome. These commenters cited Professor Mann's study to suggest that many consumers do anticipate they will need to re-borrow to the degree that they end up actually re-borrowing. Consumer groups, by contrast, disputed that premise both conceptually and factually. In particular, they criticized the Mann study by noting that the harm to consumers that results from paying “exorbitant fees” is incurred most acutely by re-borrowers who pay multiple fees, whether or not they end up defaulting.

The Bureau received a number of comments on its conclusion that harm results from default. Some of the industry commenters argued that the Bureau overstated the consequences of default. They contended that many payday loans do not affect credit scores because payday lenders do not furnish information to consumer reporting agencies. Commenters also argued that because some payday lenders may not refer accounts to debt collection, the Bureau overstated the harm of default in that manner as well. Some commenters argued that the adverse effects of debt collection practices should not be considered harm for purposes of this rule because harmful collection practices are addressed separately in the Fair Debt Collections Practices Act. One commenter even argued that borrowers benefit from defaulting on these loans, because it means they were able to get free funds that they never ended up having to repay, supposedly without ever experiencing any other negative consequences. Still another commenter argued that for certain title loans the injury resulting from default can be lower than the injury resulting from default on other types of credit, because many title loans are non-recourse loans, which limits the extent of the injury solely to the impact of vehicle repossession.

The Bureau received comments contending that it did not have sufficient evidence to substantiate the collateral consequences associated with payday and title loans that have not been underwritten, in particular the frequency and magnitude of other collateral harms from making unaffordable payments, which the Bureau cited as one of the adverse consequences associated with these loans.

Commenters also argued that the Bureau's claim that consumers are injured because they are not able to absorb loan payments on top of major financial obligations and basic living expenses is circular. They argue that consumers use covered loans because they are unable to pay major financial obligations and basic living expenses, and thus the injury the Bureau identified is pre-existing. In other words, commenters argue that the identified injuries are not caused by the identified practice of making such loans without reasonably assessing the borrower's ability to repay the loan according to its terms, and are instead, caused by borrowers' preexisting hardship. Commenters similarly suggested that making ability-to-repay assessments does not correlate to the identified injuries and thus the failure to make such assessments is not the cause of those injuries.

The Final Rule

After reviewing the comments received, and on further consideration, the Bureau is now concluding that the practice of making covered short-term loans without making a reasonable determination of the consumer's ability to repay the loan according to its terms causes or is likely to cause substantial injury to consumers. As noted in the proposal, borrowers subject to this practice experience injury when covered short-term loans are made without making a reasonable assessment of their ability to repay and they are unable to cover the loan payment on top of major financial obligations and basic living expenses. These injuries include those associated with default, delinquency, and re-borrowing, as well as the negative collateral consequences of being forced to forgo major financial obligations or basic living expenses to cover the unaffordable loan payment. The frequency and magnitude of these types of harms experienced by consumers was discussed at greater length above in Market Concerns—Underwriting. As stated in that discussion, the Bureau does not find that every borrower is necessarily harmed by this practice, because some portion of borrowers may successfully repay these loans after little or no re-borrowing and without incurring collateral harms from so doing (though it bears noting that many of these successful borrowers presumably would qualify for a loan if the lender first made a reasonable assessment that they have the ability to repay it according to its terms). But the Bureau finds that a substantial population of borrowers is harmed, many severely, when they suffer the kinds of injuries just mentioned, which are discussed at greater length above in Market Concerns—Underwriting, as a result of the identified practice of failing to make a reasonable assessment of the borrower's ability to repay before making the loan.

As noted previously, several commenters asserted that the Bureau should only consider that a practice causes substantial injury after discounting certain benefits that borrowers may get from taking out these loans, or after comparing these loans to all other possible alternatives. That approach is not required by the legal standards regarding unfair practices set forth in the statute, FTC precedent, or case law, and the Bureau has concluded that it is not appropriate here. Adopting the suggested approach would over-complicate the analysis and risk “double-counting” certain countervailing benefits (here first in minimizing the nature of the injury and then again in considering the countervailing benefits for consumers or competition). Following the long history of FTC and other judicial precedent, the Bureau has assessed “substantial injury” and “countervailing benefits” separately, and then weighed the two against each other. In this way, the Bureau will fully comply with the statutory requirements because it will not conclude that the identified practice is unfair until after it has concluded that the practice is “injurious in its net effects” because countervailing benefits for consumers or competition do not outweigh the substantial injury. The Bureau conducts that analysis and reaches that conclusion below.

Generally, the Bureau measures substantial injury by assessing the aggregate injurious consequences that the specific practice causes or is likely to cause for consumers. So, for the practice at issue in this rule, the magnitude of injury is the aggregate total injurious impact of default, delinquency, re-borrowing, and the collateral consequences caused by making unaffordable payments, all of which are the result of lenders failing to assess borrowers' ability to repay before making covered short-term loans. Injury is weighed in the aggregate, rather than simply on a consumer-by-consumer basis; and the practice need not injure every consumer if it affects any substantial number of them or if it imposes severe harm on a smaller number of them. In fact, as acknowledged above, the Bureau recognizes that some consumers do not suffer harm from the practice, and for some consumers who are harmed, the benefits to that one consumer might outweigh the harm. This may be true even of some consumers who could not satisfy the ability-to-repay standard. For example, there may be consumers who encounter a windfall after taking out the loan, but before repaying, such that none of the injuries occurs even though at the time the loan was originated the borrower would not have had an ability to repay. There also could be some consumers whose particular circumstances are such that the benefits of having immediate access to funds outweigh the harms resulting from being unable to repay the loan. The Bureau nonetheless includes the injury associated with those borrowers. Of course, the countervailing benefits to consumers are also measured in the aggregate, and the Bureau includes the benefits even to those consumers who, on net, were injured.

As to the specific argument that a practice may only be considered injurious if it is worse than all alternatives, this argument is inconsistent with the statute and not grounded in any precedent. Such a requirement would be akin to the view that as long as an alternative practice can be identified that causes even more injury to consumers, then the practice cannot cause substantial injury.

As commenters noted, the Bureau has not calculated a precise total dollar figure for the aggregate injury caused by the practice of making covered loans without making a reasonable determination of the borrower's ability to repay the loan according to its terms. That calculation would be impractical, and it represents a level of exactitude that has never been required of or attained by the FTC and the prudential regulators in regulating identifiable consumer harms under the terms of their UDAP authorities. However, in assessing the aggregate weight of injury, the Bureau was informed by all of the factual background, data, and evidence canvassed above in Market Concerns—Underwriting. When the impact of default, delinquency, re-borrowing, and other negative collateral consequences of making unaffordable payments is aggregated among all borrowers for whom lenders do not assess ability to repay before making a covered short-term loan, the sum of that injury is very substantial.

It is worth noting what is not included in the Bureau's weighing of substantial injury. Several commenters believed that the Bureau was considering all covered short-term loans to be injurious. That is not so. The Bureau has determined, more narrowly, that substantial injury is caused or likely to be caused by making a covered short-term loan without reasonably assessing the consumer's ability to repay according to its terms. Thus, the Bureau is only counting injury to consumers where the lender did not make a reasonable assessment of the borrower's ability to repay, which as discussed above leads many consumers to experience the harms from default, delinquency, re-borrowing, and other collateral consequences from attempting to avoid these other injuries by making unaffordable payments.

The Bureau concludes that, contrary to some commenters' assertions, re-borrowing should be considered consumer injury when the borrower is forced to do so owing to an inability to cover the unaffordable payment, basic living expenses, and major financial obligations. The costs of re-borrowing are not a part of the original loan agreement. When a lender makes a loan without assessing ability to repay, and the borrower ultimately does not have enough funds to cover the unaffordable payment, basic living expenses, and major financial obligations, the consumer is forced to choose between three outcomes (default, re-borrowing, or the default avoidance costs of having to forgo basic living expenses or major financial obligations). Each of these outcomes involves “monetary harm,” which is the most traditional form of injury for unfairness analyses.

Injury can be acute for borrowers when the lender's failure to assess ability to repay sets off a chain reaction of multiple rounds of re-borrowing, which incur additional fees and perhaps penalty fees as well. After each new loan, the borrower faces an unrepayable balloon payment that leads the borrower to incur additional fees that were not a part of the original agreement. That the borrower incurs the cost of re-borrowing instead of other injuries as perhaps a least-bad option at that juncture (when compared with default, repossession, or forgoing basic living expenses or major financial obligations), does not make the re-borrowing non-injurious. When the loan comes due, the borrower may be able to incur one type of injury over another, but the borrower does not thereby avoid being injured at all. One commenter provided an illustrative example of a borrower who paid $12,960 to borrow $1,020 in principal because the borrower continued to re-borrow the original principal. Each instance of re-borrowing was the result of a new choice between re-borrowing, default, or forgoing expenses, and each of those decisions was forced upon the consumer because the original loan was made without assessing the borrower's ability to repay the loan according to its terms.

Note that the Bureau is not, as some commenters stated, addressing in this rulemaking the sustained use of credit, or long-term indebtedness, standing alone. Such matters could bear scrutiny in particular instances under the Bureau's supervision or enforcement authority. But for purposes of this rulemaking, continued or repetitious re-borrowing is considered injurious for unfairness purposes here because it imposes new costs on the borrower that were not specified in the original loan agreement, and these costs are caused by the lender's failure to make a reasonable assessment of the borrower's ability to repay the original loan according to its terms.

The Bureau is unpersuaded by commenters' claims that protracted refinancing is not harmful because credit scores may actually improve for some borrowers. The study that these commenters cite compares borrowers who roll over covered short-term loans with borrowers who do not. Again, the fact that some borrowers may have positive experiences or some particular form of positive outcomes with these loans is not immaterial, but it fails to address the core point of the data about this market, which shows that for a further substantial population of borrowers, the harms experienced from repeated re-borrowing can be quite severe.

Moreover, the possibility that one form of the identified injury may be less injurious than another in one particular respect does not prove that the injury identified is not in fact injurious in other respects. When a lender makes covered loans without assessing ability to repay the loan according to its terms, borrowers may be able to incur one form of injury rather than another from amongst the likely set of injuries—again, default, delinquency, re-borrowing, and the collateral consequences of making unaffordable loan payments—and some may be able to mitigate that injury to an appreciable extent or even to nullify its effects, but many borrowers who have taken out an unaffordable loan will not be able to avoid being gravely injured in this situation.

Similarly, the argument that re-borrowing on title loans is not injurious because it allows borrowers to avoid default, and thus repossession, is unpersuasive. The potential injuries that consumers face in these situations include default, delinquency, re-borrowing, and the collateral consequences of forgoing other basic living expenses or major financial obligations. In these instances, re-borrowing may be less injurious than another greater injury, but many borrowers will still be injured by the impact of re-borrowing as described at greater length above in Market Concerns—Underwriting, including the collateral consequences of attempting to avoid these other injuries by making unaffordable payments.

The Bureau recognizes, as commenters suggest, that some borrowers will be able to anticipate, before they take out the first covered short-term loan, that they may have to re-borrow. These industry commenters argue that re-borrowing should not be considered harmful to the extent that borrowers could anticipate it happening. But the most relevant data analyzing borrowers' ability to anticipate re-borrowing supports the conclusion that a high number of borrowers are not, in fact, able to accurately predict the length of their indebtedness to lenders that offer payday loan products.

The 2014 study by Professor Mann that asked borrowers about their expectations for re-borrowing then compared those with their actual borrowing experience, yielded insights directly relevant for this rule. As described in the proposal and the Section 1022(b)(2) Analysis, the study found that borrowers who wound up with very long sequences of loans had very rarely expected those long sequences. See the discussion regarding reasonable avoidability below, and the Section 1022(b)(2) Analysis, for more on the Bureau's interpretation of the Mann study.

Thus, the Bureau continues to believe that the response from these industry commenters glosses over the point that many borrowers are not able to anticipate the nature and the likelihood and the magnitude of the harms that may occur through re-borrowing. To the extent that re-borrowing imposes new costs on the borrower that were not part of the costs specified in the original loan agreement—including additional fees and the other collateral consequences of attempting to avoid default by making unaffordable payments while forgoing basic living expenses and major financial obligations—the re-borrowing that occurs can create unexpected harm once the borrower has taken out an initial unaffordable loan. Indeed, many consumers who may anticipate some re-borrowing also seem likely to be unable to anticipate the likelihood and severity of these harms, which is a point the Bureau addresses more fully in the section below on whether injury is reasonably avoidable.

Moreover, just as the two prongs of “substantial injury” and “reasonably avoidable” are set out as distinct and independent in the statute, the Bureau concludes that even if some borrowers do accurately predict their length of re-borrowing, this would not change the broader conclusion that the practice causes substantial injury in the aggregate. The Bureau also concludes, as addressed above in Market Concerns—Underwriting, that, contrary to the assertions made by some commenters, it did not significantly overestimate the types of injury caused by default, delinquency, re-borrowing, and the negative collateral consequences of making unaffordable payments when it issued the proposed rule.

The Bureau is highly dubious of the claim made by some industry commenters that consumers suffer no harm in the event of a default on a covered loan. The Bureau has seen many examples of payday lenders that engage in strenuous efforts, either on their own behalf or by contracting with debt collectors (or selling the debt to debt buyers), to pursue borrowers for payment in the event of default. And the commenters did not present any evidence to show the extent to which lenders of covered short-term loans actually do refrain from seeking to collect on overdue debts. Moreover, nothing prevents such third-party debt collectors or debt buyers from reporting the negative information to consumer reporting agencies, which is a technique some collectors use to facilitate collection. In any event, the underlying premise is quite implausible. If there were no real consequences to defaulting on these loans, it is difficult to understand why so many borrowers would engage in repeat re-borrowing, rather than simply defaulting.

The Bureau also finds that its assessment of injury should include repossessions resulting from failing to assess ability to repay before making covered vehicle title loans. As noted above, some industry commenters claimed that repossession is not harmful, or not as harmful as the Bureau indicated in its proposal. They rest this argument on two claims. First, they contend that most borrowers can find other means of transportation, citing what they present as a supportive survey, and thus would not be harmed by the loss of their vehicle. Second, they contend that the extent of the direct economic loss that borrowers sustain by having their vehicle repossessed is relatively insignificant.

On the first point, the potential consequences of the loss of a vehicle depend on the transportation needs of the borrower's household and the available transportation alternatives. According to two surveys of title loan borrowers, 15 percent report that they would have no way to get to work or school if they lost their vehicle to repossession. For these borrowers, the effects of repossession could thus be catastrophic from an economic standpoint, particular in rural areas or in urban areas where public transportation is not reasonably available. And more than one-third (35 percent) of borrowers pledge the title to the only working vehicle in the household. Even those with a second vehicle or who are able to get rides from friends or take public transportation would presumably experience significant inconvenience or even hardship from the loss of a vehicle. This hardship goes beyond simply getting to work or school, and would as a practical matter also adversely affect the borrower's ability to conduct their ordinary household affairs, such as obtaining food or medicine or other necessary services. The commenters countered that borrowers often can find other means of transportation, citing what they present as a supportive survey. Their interpretation of the data is not convincing, however, as even the authors of the survey cautioned against making simplistic calculations about factors and probabilities that are intertwined in the analysis, and which thus may considerably understate the incidence of hardship, especially for more economically vulnerable populations.

As to the second point about the extent of the direct economic loss, the commenters rest this argument either on the low average value of collateralized vehicles or on their claim that some borrowers deliberately choose to liquidate the value of the vehicle by taking out a title loan and then promptly abandoning the vehicle to repossession. While some vehicles used for collateral may not have high value, they still can be crucial as the consumer's principal means of transportation to and from work or to conduct everyday affairs such as obtaining medical care or buying groceries, medicine, and other essentials. The Bureau describes the harms of repossession in more detail both in Market Concerns—Underwriting and the section-by-section analysis for § 1041.6.

The Bureau also finds unpersuasive the assertion made by some commenters that a significant population of consumers would take out a title loan and then intentionally abandon the vehicle instead of just selling it, especially in light of the observations made in Market Concerns—Underwriting that title lenders usually only make loans where the value of the collateral exceeds the principal. Indeed, it appears implausible that consumers would choose to dispose of a vehicle by this means rather than simply selling the vehicle, as the latter approach very likely would usually yield more funds without involving the consumer in any adverse risks or costs of collections activities or repossession fees. It may be that some borrowers take out a title loan and immediately default on it, perhaps even intentionally, and such borrowers may not necessarily experience all of the same harms as other borrowers whose vehicles are repossessed. But no evidence plausibly suggests that this alleged population is at all significant, and thus this fact does not change the Bureau's overarching conclusion. As for the commenter who argued that the stress associated with repossession is no worse than other forms of financial stress, this argument is speculative and unpersuasive, and at least implicitly acknowledges the fact that potential psychological injury does accompany the threat of repossession.

The Bureau also rejects the claim made by some commenters that its arguments about substantial injury are circular because the injuries identified were primarily caused by the original financial hardship that induced the borrower to seek a covered loan, rather than by the covered loan itself. This is a variant on the argument that the real harm to consumers does not flow from the identified practice of failing to underwrite these loans in a reasonable manner but from the fact that many consumers lack the money to meet their obligations. First, to the extent this argument seeks to rely on the benefits provided by access to credit through covered loans in order to cover the borrower's expenses, or is an exercise in weighing those benefits against the injuries associated with the harm, it is most appropriately treated in the section below on “countervailing benefits.” But more to the point, the Bureau finds that the specific injuries which flow from default, delinquency, re-borrowing, and the collateral consequences of making unaffordable payments, including forgoing major financial obligations or basic living expenses in order to avoid default, are not caused by the borrower's pre-existing financial hardship for one key reason: These injuries flow from the loan itself and the fact that it was made without reasonably assessing the borrower's ability to repay the loan according to its terms. These outcomes would not have occurred without the lender engaging in the identified practice of making such loans in such manner. The borrower would have faced other difficulties flowing from her distressed circumstances, but not the harms identified here.

In other words, the fact that many consumers are in financial difficulty when they seek out a covered loan—a fact the Bureau has repeatedly recognized—does not mean they are not injured by the identified practice. For certain individual borrowers in particular situations, being able to replace a default on a different obligation with the injury identified in this section might seem to be worthwhile. But the right place to address that potential trade-off is when the analysis turns to assessing whether countervailing benefits outweigh the injury, in the aggregate rather than on an individual borrower basis—matters that are discussed further below.

In any event, the pre-existing financial stress of many consumers does not relieve lenders of responsibility for engaging in practices that are unfair or abusive. As the court in FTC v. Neovi stated, the contribution of “independent causal agents . . . do[es] not magically erase the role” of lenders' in causing the harm. When lenders do not assess ability to repay before making loans, they end up making loans to some borrowers who lack the ability to repay. The fact that these borrowers who obtain unaffordable loans will default, become delinquent, re-borrow, or experience negative collateral consequences is a natural result of the practice that lenders should expect.

In sum, based on the analysis presented here and above in the section on Market Concerns—Underwriting, and upon further consideration after reviewing the high volume of comments received from the public, the Bureau concludes that the identified practice causes or is likely to cause substantial injury.

Injury Not Reasonably Avoidable

The Bureau's Proposal

The second prong of the statutory definition of unfairness is that the “substantial injury” to consumers “is not reasonably avoidable by consumers.” The Bureau proposed to interpret this requirement to mean that unless consumers have reason generally to anticipate the likelihood and severity of the injury and the practical means to avoid it, the injury is not reasonably avoidable. Under the proposed rule, the Bureau stated that in a significant proportion of cases, consumers appear to be unable to reasonably avoid the substantial injuries caused or likely to be caused by the identified practice. Prior to entering into a payday, single-payment vehicle title, or other covered short-term loan, many consumers do not reasonably anticipate the likelihood and severity of the injuries that frequently result from such unaffordable loans, and after entering into the loan, consumers do not have the practical means to avoid the injuries that result from being unable to repay it.

As stated in the proposal, many consumers seem unable to reasonably anticipate the likelihood and severity of the consequences of being unable to repay a loan that is unaffordable according to its terms. As discussed in the proposal, the typical consumer is likely generally aware that taking out any loan can lead to adverse consequences if the loan is not repaid, but is not likely to be familiar with all of the harms that can flow from a loan that is made without a reasonable assessment that the borrower will be able to repay it according to its terms. Some additional harms beyond the costs incurred on the loan can include, for example, the risk of accumulating penalty fees on their bank account, the potential loss of their account, or (for title loans), or the risk of aggressive collections. Moreover, even if consumers recognize these harms as possibilities, many are likely not to have sufficient information to understand the frequency with which these adverse effects may occur to borrowers who are affected by the identified practice or the severity of the consequences befalling a typical borrower who obtains an unaffordable loan. An especially compelling example of how consumers may be prone to error in making reasonable evaluations about the injuries to which they are exposed by the identified practice is the substantial number of consumers who re-borrow, many of them repeatedly, prior to eventually defaulting on these loans. But unless consumers are reasonably aware of the likelihood and severity of these injuries, it would not be reasonable for them to make special efforts to avoid such injuries where they are not in position to accurately evaluate the risks. This may be especially the case where the lender qualifies them for a loan without making a reasonable assessment of their ability to repay, as many consumers would be unlikely to expect that lenders would intentionally offer them an unaffordable loan that they would likely be unable to repay.

That is not to say that every consumer must understand everything about the potential risks or must be able to anticipate these risks with mathematical precision. Instead, it is only to say that consumers must have a sense of the order of magnitude of the risk, both in terms of its likely frequency and its likely severity. Yet the Bureau also noted in the proposal that in analyzing reasonable avoidability under the FTC Act unfairness standard, the FTC and other agencies have at times focused on factors such as the vulnerability of affected consumers, as well as those consumers' perception of the availability of alternative products. Likewise, the Bureau stated that the substantial injury from covered short-term loans may not be reasonably avoidable in part because of the precarious financial situation of many consumers at the time they take out such loans and their belief that searching for potential alternatives will be fruitless and costly. As discussed in the proposal, consumers who take out payday or single-payment vehicle title loans typically have tried and failed to obtain other forms of credit before turning to these covered loans as a last resort. Thus, based on their prior negative experience with attempting to obtain credit, they may reasonably perceive that alternative options would not be available. Consumers facing an imminent liquidity crisis may also reasonably believe that their situation is so dire that they do not have time to shop for alternatives and that doing so could prove costly.

The Bureau also stated in the proposal that consumer predictions about their experience with covered short-term loans may be overly optimistic, especially if they are unaware of the risks posed by lenders making these loans without reasonably assessing the borrower's ability to repay the loan according to its terms. In particular, consumers who experience long sequences of loans often do not expect those long sequences to occur when they make their initial borrowing decision. As detailed above in Market Concerns—Underwriting, empirical evidence suggests that consumers are best able to predict accurately the duration of their borrowing if they repay after little or no re-borrowing, though many underestimate the expected duration while others overestimate it. Notably, borrowers who end up in extended loan sequences are especially likely to err in their predictions of how long their loan sequences will last, usually taking the form of underestimating the expected duration. So consumers are particularly poor at predicting long sequences of loans, a fact that does not appear to differ for those borrowers who have past borrowing experience.

As discussed in the proposal, the Bureau observes other factors that prevent consumers from reasonably anticipating and avoiding the substantial injury caused by unaffordable short-term loans. Such loans involve a basic mismatch between how they appear to function as short-term credit and how they are actually designed and intended by lenders, as part of their business model, to function in long sequences of re-borrowing for a substantial population of consumers. Lenders present these loans as short-term, liquidity-enhancing products that consumers can use to bridge an income shortfall until their next paycheck. But in practice, across the universe of borrowers, these loans often do not operate that way. The term of the loan, its balloon-payment structure, and the common use of leveraged payment mechanisms, including vehicle security, all tend to magnify the risks and harms to the borrower. The disparity between how these loans appear to function and how they actually function creates difficulties for consumers in estimating with any accuracy how long they will remain in debt and how much they will ultimately pay for the initial extension of credit.

Lenders who make covered short-term loans without reasonably assessing the borrower's ability to repay the loan according to its terms, to borrowers who often do not reasonably anticipate the likelihood and severity of the risks posed, often further magnify these risks through the way they market the option of repeat borrowing. Payday lenders and title lenders typically present only two options: the re-borrowing option, with its costs limited to another set of fees but no repayment of principal, and the full repayment option of requiring the entire balloon payment to be repaid all at once, with no options offered in between these two. Low-cost repayment or amortization options are typically not presented or are obscured, even where they may be required to be available under State law. Even consumers who are delinquent and have further demonstrated their inability to repay the loan according to its terms are encouraged to re-borrow, which leads many consumers to engage in extensive re-borrowing even where they eventually wind up in default. For many re-borrowers, the upshot is that they end up making repeated payments that become increasingly unaffordable in the aggregate over time, even though a substantial number of them still will sustain the harms associated with default.

The proposal stated that not only are consumers unable to reasonably anticipate the likelihood and severity of many of these potential harms before entering into a payday or title loan, but after they have entered into a loan, they do not have any practical means to avoid the injuries that will occur if the loan proves to be unaffordable. Consumers who obtain a covered short-term loan that is beyond their ability to repay confront the harms of default, delinquency, re-borrowing, or the collateral consequences of making unaffordable payments that would cause them to miss payments on their major financial obligations and basic living expenses. They can make choices among these competing harms, but once they are facing an unaffordable payment, some form of substantial injury is almost inevitable regardless of what actions they take in that situation. And as discussed in the proposal, lenders engage in a variety of practices that further increase the likelihood and degree of harm, for instance by encouraging additional re-borrowing with its attendant costs even for consumers who are already experiencing substantial difficulties as they are mired in extended loan sequences, and by engaging in payment collection practices that are likely to cause consumers to incur substantial additional fees beyond what they already owe on the terms of the existing loan.

Comments Received

The Bureau received many comments on whether the substantial injury identified was reasonably avoidable by consumers. A number of commenters opined on the legal standards the Bureau should use when assessing reasonable avoidability. One commenter argued that the proper standard for assessing whether injury is reasonably avoidable is whether the consumer has the ability to anticipate the impending harm and has means to avoid it. In other words, even if consumers do not actually tend to anticipate the likelihood and severity of the impending harm, it could still be viewed as reasonably avoidable as long as knowledge of the impending harm is conceptually attainable.

Various parties submitted comments to the Bureau arguing that borrowers can in fact accurately predict the consequences of getting a covered loan. This point is addressed more fully above in the Market Concerns—Underwriting. One commenter claimed that a study showed borrowers who have previously used title loans are more capable of anticipating how long they will be indebted, predicting six or more additional months of indebtedness as compared to consumers who had never used title loans.

Some industry commenters also claimed that borrowers must be able to anticipate the consequences of failing to repay a title loan because title loans are simple products, and the use of vehicles as collateral to secure the loan is a defining and obvious feature of these loans. Commenters made similar arguments about payday loans.

Various industry commenters claimed that consumers do have the means to avoid the injuries that are caused or likely to be caused by the identified practice. Many of these commenters argued that consumers have the means to avoid the injury simply by forgoing the first covered loan altogether. Commenters argued that such consumers could turn instead to friends and family. They also argued that consumers could instead obtain other forms of credit, such as a traditional non-recourse pawn loan. Others noted that there are further ways to avoid these injuries even after having taken out the first covered loan. Some argued that borrowers could simply budget carefully to ensure timely payment, could take advantage of legal protections that may be available in some States that allow them to lower or extend payments, or could obtain credit counseling or other assistance. Others contended that borrowers could minimize or avoid the harms they experience from these loans by engaging in strategic default, asserting that defaults on such loans do not lead to any further negative consequences for the borrower. Similarly, some commenters claimed that where consumers have consented to leveraged payment mechanisms such as post-dated checks or automatic account withdrawals, they could avoid consequent harms by simply withdrawing their consent at a later point.

One commenter asserted that the Bureau falsely assumed that any re-borrowing was a consequence of borrowers having no other credit options. This commenter regarded the data as establishing instead that borrowers do have other options and may have reasons why they would choose to re-borrow even where they can afford to repay the prior loan.

In response to the Bureau's claim that it is reasonable for many consumers in typical circumstances to fail to shop for alternative forms of credit, one commenter argued that whenever alternatives are available, a reasonable consumer would shop for them and obtain them. In other words, even if borrowers do not generally tend to shop for alternatives, any injury could still be reasonably avoidable if consumers could have exercised the ability to shop.

Other commenters argued that acts or practices can only be unfair if the lender's actions alone caused the injury not to be avoidable. In other words, if any of the reasons that consumers could not avoid the harm caused by a lender was not itself also caused by the lender, the act or practice cannot be unfair. Commenters also argued that injury is reasonably avoidable when consumers have a “`free and informed choice' not to purchase the product,” citing FTC v. Neovi. At least one commenter took the opposite position, arguing that consumers' financial situations can give rise to a reasonable conclusion that an injury from the identified practice is not reasonably avoidable.

Alternatively, consumer groups observed that whether consumers could have anticipated the injury is irrelevant to whether the injury is reasonably avoidable if consumers lack the means to avoid the injury even if it were to be anticipated. They argued that even if some borrowers can more accurately anticipate the length of their indebtedness, they might nonetheless fail to understand the full range of injuries that can often occur at the end of the sequence, which the Bureau noted in its proposed rule, and which are discussed at greater length above in Market Concerns—Underwriting. Where consumers do not understand that full range of potential harms, such injury is not reasonably avoidable.

The Final Rule

After reviewing the comments received and taking into account the factual analysis of how such loans work in practice as set forth above in Market Concerns—Underwriting, the Bureau concludes that the substantial injury caused by the identified practice is not reasonably avoidable by consumers.

The specific question here is whether the practice at issue causes substantial injury to consumers “which is not reasonably avoidable by consumers.” Starting with the established point, already discussed, that there is substantial injury to consumers from making covered short-term loans without reasonably assessing the borrower's ability to repay the loan according to its terms. In approaching the “reasonably avoidable” criterion, the Bureau is tasked by Congress to ask whether, if lenders engage in the practice of making these loans available without assessing ability to repay, the resulting injuries are reasonably avoidable by consumers acting on their own. As noted above, the Bureau interprets this criterion to mean that unless consumers have reason generally to anticipate the likelihood and severity of the injury, and the practical means to avoid it, the injury is not reasonably avoidable. As also noted earlier, the D.C. Circuit has held that the presence of a market failure or imperfection is highly relevant to the “reasonably avoidable” inquiry, as it may hinder consumers' free-market decisions and prevent the forces of supply and demand from maximizing benefits and minimizing costs.

In addressing this issue, the Bureau does not accept, and the FTC and prudential regulators have never been satisfied with, the notion that injury is avoidable just because a consumer has the right not to enter the market in the first place. No precedent supports the idea that the existence of such a right is by itself an answer to the “reasonably avoidable” issue. Indeed, a consumer generally has a right to decline to initiate the purchase of any product or service, and if the mere existence of that right were the end of the “reasonably avoidable” question, then no act or practice by a seller would ever be subject to regulation on unfairness grounds.

The Bureau specifically rejects the arguments advanced by some commenters who contended that acts or practices can only be unfair if the lender's actions alone caused the injury not to be reasonably avoidable. The practice at issue is the making of covered short-term loans without reasonably assessing the borrower's ability to repay the loan according to its terms. The making of such loans in this manner—which is an action that is entirely within the lender's control—is the act that causes injury to consumers, which, as discussed above, is not reasonably avoidable by consumers. The lender need not also be the source that has created all the reasons why that injury is not reasonably avoidable, given the ordinary circumstances of typical consumers, including their general understanding of the likelihood and severity of the risks posed. Nonetheless, as discussed in the proposal and above, as well as in the section on Market Concerns—Underwriting, the Bureau has concluded that the manner in which lenders structure these products—including the term of the loan, its balloon-payment structure, and the common use of leveraged payment mechanisms, and vehicle security—likely contributes significantly to the market failure and market imperfections that the Bureau has observed.

Commenters opposing the proposed rule who addressed the “reasonably avoidable” criterion generally took the position that the consumers who seek these loans are nonetheless fully capable of reasonably avoiding these injuries in order to protect their own self-interest. Many of these positions were based on their intuitive descriptions or stories about what consumers understand about the risks of loans that they do not have the ability to repay, and how consumer decision-making works. Their intuition is inconsistent with the evidence on which the Bureau has based its findings that the injury is not reasonably avoidable, including survey data showing that past borrowing experience is not indicative of increased understanding of product use. Indeed, those who had borrowed the most in the past did not do a better job of predicting their future use, and as Professor Mann noted, “heavy users of the product tend to be those that understand least what is likely to happen to them.”

Whereas various commenters cited Professor Mann's study to show that most consumers are able to make accurate predictions about their extent of re-borrowing, as noted above in Market Concerns—Underwriting, this was mostly driven by borrowers who anticipate and experience relatively short sequences and manage to repay very quickly.

The Bureau appreciates that, as commenters pointed out, Mann's study, discussed below and in the Section 1022(b)(2) Analysis, suggest that some borrowers are better able to predict their likelihood of re-borrowing. Nonetheless, the Bureau's primary concern is for those longer-term borrowers who find themselves in extended loan sequences and thereby experience the various harms that are associated with a longer cycle of re-borrowing. For those borrowers, the picture is quite different, and their ability to estimate accurately what will happen to them when they take out a payday loan is quite limited. As Mann noted, very few of those borrowers who experienced the longest sequences anticipated that they would end up in a period of prolonged indebtedness, and in fact “both the likelihood of unexpectedly late payment and the proportionate size of the error increase substantially with the length of the borrower's prediction.” Nor does their accuracy appear to improve with more experience; as he noted in his paper, “heavy users of the product tend to be those that understand least what is likely to happen to them.” The further discussion in the comments of Professor Mann's study, including his own submission, did not alter these results, for as he noted, “the absolute size of the errors is largest for those with the longest sequences,” and “the borrowers who have borrowed the most are those who are in the most dire financial distress, and consequently least able to predict their future liquidity.”

And as the Bureau discusses at length in Market Concerns—Underwriting, and in the Section 1022(b)(2) Analysis, multiple different conclusions can be made based on Mann's findings. Certainly, it is possible that many borrowers accurately anticipate their debt durations, as Mann asserts in both his 2013 paper and comment to the proposed rule. However, Mann's study supports the conclusions that most of those borrowers with long duration sequences did not accurately anticipate this outcome; that a large share of borrowers who anticipated no re-borrowing remain in debt for multiple loans, with many being unable to even offer a guess as to the duration of their indebtedness, let alone a precise prediction; and that there appears to be no discernable relationship between borrowers' individual expectations, and their ultimate outcomes.

Indeed, the 2013 Mann study showed that of the borrowers who remained in debt at least 140 days (10 bi-weekly loans), a hundred percent had underestimated their times in debt, with the average borrower in this group spending 119 more days in debt than anticipated (i.e., the equivalent to eight and half unanticipated rollovers. Meanwhile, over 95 percent of the borrowers who spent 90 or more days in debt had underestimated their time in debt, spending an average of 92 more days in debt than anticipated (i.e., the equivalent to six and a half unanticipated rollovers). And as described in the proposal, Mann (2014) found that borrowers who wound up with very long sequences of loans had rarely expected those long sequences; that only 40 percent of respondents expected to re-borrow at all even though over 70 percent would actually re-borrow; and, that borrowers did not appear to become better at predicting their own borrowing. Thus, while many individuals appear to have anticipated short durations of use with reasonable accuracy, the Bureau is persuaded that virtually none anticipated long durations with anything approaching reasonable accuracy. The harms associated with the long durations outside the scope of the consumers' anticipation capabilities are precisely the market failure that the final rule seeks to address.

The heart of the matter here is consumer perception of risk, and whether borrowers are in position to gauge the likelihood and severity of the risks they incur by taking out covered short-term loans in the absence of any reasonable assessment of their ability to repay those loans according to their terms. It appears based on the evidence that many consumers do not understand or perceive the probability that certain harms will occur, including the substantial injury that can flow from default, re-borrowing, and the negative collateral consequences of making unaffordable payments as described above in Market Concerns—Underwriting. Other features of these loans—including their term, balloon-payment structure, and the common use of leveraged payment mechanisms or vehicle security—tend to magnify the risks posed when they are obliged to repay the full amount when the loan comes due, on top of all their other existing obligations. Whether consumers can “reasonably avoid” the injuries that flow from the identified practice will depend, in the first instance, on whether they understand the likelihood and the severity of these risks so that they are able to make a reasoned judgment about whether to incur or to forgo such risks. As the Bureau perceives the matter, based on its experience and expertise in addressing consumer financial behavior, the observed evidence described more fully in the Section 1022(b)(2) Analysis and Market Concerns—Underwriting indicates that a large number of consumers do not understand even generally the likelihood and severity of these risks.

There are a variety of explanations why consumers will take out covered short-term loans that they actually lack the ability to repay without fully appreciating the nature and magnitude of the risks involved. As the Bureau discussed in connection with the proposed rule, and as described further in Market Concerns—Underwriting and the paragraphs above, the way the product is marketed and presented to them is calculated to obscure the risks. And while many consumers may operate as fully informed rational actors, and thus be able to predict their repayment capacity, those consumers who lack the ability to repay (and thus are most likely to be harmed by the identified practice) tend to be overly optimistic, at least when they are operating under short-term financial stress. The data available from Professor Mann, for example, tends to confirm that a substantial proportion of borrowers—those in extended loan sequences, who are the most vulnerable to harm—have great difficulty in predicting their own repayment capability. And the widespread industry practice of framing covered loans as short-term obligations, even though lenders know that their business model depends on these loans becoming long-term cycles of debt for many consumers, likely exacerbates these misimpressions among borrowers.

Some of the particular behavioral obstacles to consumers' ability to fully understand the magnitude and likelihood of the risks they face, including the difficulties of assessing their likelihood of nonpayment and of appreciating the severity of injury they would face in such an event, are discussed at greater length above in Market Concerns—Underwriting and the Section 1022(b)(2) Analysis. Once again, the economic literature, including studies in the field of behavioral economics but also those modeled on rational expectations, suggests that these considerations are particularly acute for consumers who are under financial stress (such as consumers who lack the ability to repay a covered loan) and under acute time pressure. These considerations, which are well known to economists, may especially degrade the borrower's ability to reliably evaluate the risks presented in their circumstances.

Each of the multiple factors listed in the proposal and above in Market Concerns—Underwriting that may limit consumers' ability to appreciate the magnitude and severity of risks may operate differently, and to different degrees, on particular consumers. Whether borrowers do not actually have any alternatives, do not perceive any alternatives, do not have time to shop for alternatives, or cannot otherwise anticipate the probability or extent of the harm, it is demonstrably true that a substantial population of consumers to whom industry has traditionally marketed these loans, and who lack the ability to repay, will sign up for a covered loan and, in the aggregate, will suffer substantial injury as a consequence of the identified practice. Stated differently, it is a plausible inference that the substantial injury many reasonable consumers sustain, as actually observed in the marketplace for covered short-term loans, is not in fact avoided by normal consumer decision-making. In its current form, the market does not appear to be self-correcting.

Furthermore, once borrowers find themselves obligated on a loan they cannot afford to repay, the resulting injury is generally not reasonably avoidable at any point thereafter. But the Bureau acknowledges that there are limited exceptions to this rule. For example, there may be consumers who encounter a windfall after taking out the loan, but before repaying, such that none of the injuries occurs even though at the time the loan was originated the borrower would not have had an ability to repay. The most common injury is re-borrowing, which operates as a mechanism that is intended (though often unsuccessfully) to manage the potential injuries caused by the identified practice, rather than as an effective escape from injury. Most consumers, after having taken out a covered short-term loan they cannot afford to repay, are confronted with a choice of which injury to incur—default, delinquency, re-borrowing, or collateral consequences of making unaffordable payments, including forgoing essential expenses—or how to minimize the accumulated harm from more than one such injuries. Merely having a choice among an array of injuries does not give borrowers the ability to reasonably avoid any injury.

Some industry commenters argued that consumers have other options available to them, so those who re-borrow are choosing to do so. It bears note that this argument is to some extent inconsistent with those made elsewhere by the same and other industry commenters, who argue that borrowers would be left worse off if they did not have access to covered loans because they lack other plausible options. In addition, the Bureau has found that many such alternatives are not widely available to these borrowers, who may not find them to be desirable alternatives in any event. Moreover, here again the Bureau notes that once a consumer has taken out an unaffordable loan, the decision to re-borrow becomes an unsatisfactory choice among the injuries produced by such loans, as just discussed above, rather than an unfettered choice among various alternatives, as might have been the case before the first unaffordable loan was obtained.

As for the commenters who suggested consumers can avoid harm by simply defaulting on the loan, this approach would not achieve that objective because the Bureau has identified default as an injury for all the reasons discussed above in Market Concerns—Underwriting. Again, a choice between types of injury is not a mechanism for reasonably avoiding all injury. And the commenters who suggested that such consumers could avoid any further harm by withdrawing their consent to a leveraged payment mechanism they previously granted to the lender are equally wide of the mark. First, for storefront payday loans and other covered short-term loans that require the borrower to give the lender a post-dated check, it is impractical for the consumer to withdraw consent to that payment mechanism after the loan has been made. Because that mechanism is a condition precedent to making the loan, attempting to withdraw consent later would either be ineffectual or would lead directly to default. As for the leveraged payment mechanism of automated withdrawals from the borrower's account, such as are commonly granted with on-line covered loans, as discussed in Market Concerns—Payments, consumers experience many practical difficulties in successfully withdrawing their consent after-the-fact. Even for those borrowers who do manage to avoid that harm, there are other harms attributable to default, as laid out above in Market Concerns—Underwriting.

Accordingly, the Bureau concludes that the practice of making covered short-term loans without reasonably assessing the borrower's ability to repay the loan according to its terms causes substantial injury to consumers, which is not reasonably avoidable by them.

Injury Not Outweighed by Countervailing Benefits to Consumers or to Competition

The Bureau's Proposal

As noted in part IV and in the proposal, the Bureau's interpretation of the various prongs of the unfairness test is informed by the FTC Act, the FTC Policy Statement on Unfairness, and FTC and other Federal agency rulemakings and related case law. Under those authorities, it is generally appropriate for purposes of the “countervailing benefits” prong of the unfairness standard to consider both the costs of imposing a remedy and any benefits that consumers enjoy as a result of the practice, but the determination does not require a precise quantitative analysis of the benefits and the costs.

The Bureau stated in the proposal that it appears that the practice of making payday, single-payment vehicle title, and other covered loans without reasonably assessing that the consumer will have the ability to repay the loan according to its terms does not result in benefits to consumers or competition that outweigh the substantial injury that consumers cannot reasonably avoid. As discussed in the proposal and for the reasons stated here, the amount of injury that is caused by the unfair practice, in the aggregate, appears to be quite substantial. Although some consumers may be able to avoid the injury, as noted above, a significant number of consumers who end up in very long loan sequences can incur severe financial injuries that are not reasonably avoidable. Moreover, the proposal stated that some consumers whose short-term loans turn into short- to medium-length loan sequences incur various degrees of injury ranging from modest to severe depending on the particular consumer's circumstances (such as the specific loan terms, whether and how much the consumer expected to re-borrow, and the extent to which the consumer incurred any collateral harms from making unaffordable payments). In addition, many borrowers who default or become delinquent on the loan also may experience substantial injury that is not reasonably avoidable as a result of the identified practice.

Against this very significant amount of harm, the Bureau recognized that it must weigh several potential countervailing benefits to consumers or competition of the practice in assessing whether the practice is unfair. Accordingly, in the proposal the Bureau divided consumers into several groups of different borrowing experiences to analyze whether the practice of extending covered loans without determining that the consumer has the ability to repay the loan yielded countervailing benefits to consumers.

The first group consisted of borrowers who repay their loans without re-borrowing. The Bureau referred to these borrowers as “repayers” for purposes of this countervailing benefits analysis. As discussed in the proposal, 22 percent of payday loan sequences and 12 percent of single-payment vehicle title loan sequences end with the consumer repaying the initial loan without re-borrowing. The Bureau stated that many of these consumers may reasonably be determined, before getting a loan, to have the ability to repay their loan, such that the ability-to-repay requirement in the proposed rule would not have a significant impact on their eligibility for this type of credit. The Bureau stated that, at most, it would reduce somewhat the speed and convenience of applying for a loan under the current practice, though it was not clear that any such differential would be a material factor for any prospective borrowers. The Bureau stated that, under the status quo, the median borrower lives five miles from the nearest payday store. Consumers generally can obtain payday loans simply by traveling to the store and showing a pay stub and evidence of a checking account; online payday lenders may require even less of a showing in order to extend a loan. For title loans, all that is generally required is that the consumer owns their vehicle outright without any encumbrance.

The proposal stated that there could be a significant contraction in the number of payday stores if lenders were required to assess consumers' ability to repay in the manner required by the proposal, but the Bureau projected that 93 to 95 percent of borrowers would not have to travel more than five additional miles to get a loan. Lenders likely would have to require more information and documentation from the consumer. Indeed, under the proposed rule consumers would have been required in certain circumstances to provide documentation of their income for a longer period of time than their last pay stub. Under the proposal, consumers would also be required to complete a written statement with respect to their expected future income and major financial obligations.

Moreover, when a lender makes a loan without determining a consumer's ability to repay the loan according to its terms, the lender can make the loan upon obtaining a consumer's pay stub or vehicle title. The Bureau acknowledged in the proposal that lending under the proposed rule may not be so immediate, though automated underwriting systems could achieve similar levels of speed. If lenders assessed consumers' ability to repay as stated in the proposal, they would secure extrinsic data, such as a consumer report from a nationwide consumer reporting agency, which could slow the process down somewhat. Indeed, under the proposed rule lenders would be required to review the consumer's borrowing history using the lender's own records and a report from a registered information system, and lenders would also be required to review a credit report from a nationwide consumer reporting agency. Using this information, along with verified income, under the proposed rule lenders would have to project the consumer's residual income.

As discussed in the analysis contained in the proposal, the proposed rule was designed to enable lenders to obtain electronic income verification, to use a model to estimate rental expenses, and to automate the process of securing additional information and assessing the consumer's ability to repay. The Bureau anticipated that consumers who are able to demonstrate the ability to repay under the proposed rule would be able to obtain credit to a similar extent as they did in the current market. While the speed and convenience fostered by the current practice may be somewhat reduced for these consumers, the Bureau concluded in the proposal that the proposed requirements would not be overly burdensome in these respects. In particular, the Bureau estimated that the required ability-to-repay determination would take essentially no time for a fully automated electronic system and between 15 and 20 minutes for a fully manual system.

While the Bureau stated in the proposal that most repayers would be able to demonstrate their ability to repay under the proposed rule, the Bureau recognized there may be a sub-segment of repayers who could not demonstrate their ability to repay if required to do so by a lender. For them, the current lender practice of making loans without determining their ability to repay could enables them to obtain credit that, by hypothesis, they may actually be able to afford to repay. The Bureau acknowledged that this group of “false negatives” may benefit by being able to obtain covered loans without having to demonstrate their ability to repay in the manner prescribed by the proposed rule.

However, the Bureau judged that under the proposed rule lenders would generally be able to identify consumers who are able to repay and that the size of any residual “false negative” population would be small. It assessed this to be especially true to the extent that this class of consumers is disproportionately drawn from the ranks of those whose need to borrow is driven by a temporary mismatch in timing between their income and expenses rather than those who have experienced an income or expense shock or those with a chronic cash shortfall. The Bureau inferred that it is very much in the interest of these borrowers to attempt to demonstrate their ability to repay in order to receive the loan they are seeking, and that lenders will have every incentive to err on the side of finding such ability. Moreover, even if these consumers could not qualify for the loan they would have obtained absent an ability-to-repay requirement, they may still be able to get different credit within their demonstrable ability to repay, such as a smaller loan or a loan with a longer term. For these reasons, the Bureau did not conclude that any “false negative” population resulting from lenders making ability-to-repay assessments would represent a significant amount of countervailing benefit.

Finally, the proposal stated that some repayers may not actually be able to afford to repay the loan, but choose to repay it nonetheless, rather than re-borrow or default—which may result in their incurring ancillary costs in connection with another obligation, such as a late fee on a utility bill. Such repayers would not be able to obtain the same loan under the proposed rule that they would have obtained absent an ability-to-repay requirement, but the proposal stated that any benefit they receive under the current practice would appear to be small at most.

The second group identified in the proposal consisted of borrowers who eventually default on their loan, either on the first loan or later in a loan sequence after having re-borrowed, perhaps multiple times. The Bureau referred to these borrowers as “defaulters” for purposes of its analysis of countervailing benefits in the proposal. As discussed in the proposal, borrowers of 20 percent of payday and 33 percent of single-payment vehicle title loan sequences fall within this group. For these consumers, the current lender practice of making loans without regard to their ability to repay the loan according to its terms may enable them to obtain what amounts to a temporary “reprieve” from their current situation. They can obtain some ready cash, which may enable them to pay a current bill or current expense. However, the proposal stated that for many consumers, the reprieve can be exceedingly short-lived: 31 percent of payday loan sequences that default are single-loan sequences, and an additional 27 percent of loan sequences that default are two or three loans long (meaning that 58 percent of defaults occur in loan sequences that are one, two, or three loans long). The proposal stated that 29 percent of single-payment vehicle title loan sequences that default are single-loan sequences, and an additional 26 percent of loan sequences that default are two or three loans long (meaning that 55 percent of defaults occur in loan sequences that are one, two, or three loans long).

The proposal stated that these consumers thus are merely substituting a payday lender or vehicle title lender for a pre-existing creditor, and in doing so, they end up in a deeper hole by accruing finance charges, late fees, or other charges that are imposed at a high rate. Title loans can have an even more dire consequence for defaulters: 20 percent of them have their vehicle repossessed. The Bureau stated in the proposal that it therefore did not find that defaulters obtain significant benefits from the current lender practice of making loans to them without determining their ability to repay.

The final and largest group of consumers identified in the proposal consisted of those who neither default nor repay their loans without re-borrowing. Instead, this group of consumers will re-borrow some number of times before eventually repaying the loan. In the proposal, the Bureau referred to consumers with such loan sequences as “re-borrowers” for purposes of its discussion of countervailing benefits. These consumers represent 58 percent of payday loan sequences and 56 percent of title loan sequences. For these consumers, as for the defaulters, the practice of making loans without regard to their ability to repay the loan according to its terms enables them to obtain a temporary reprieve from their current situation. But for this group, the proposal stated that such a reprieve can come at a greater cost and pose a higher likelihood of risk than they would have initially expected, and for many consumers it will come at a substantially greater cost and a much higher likelihood of risk.

The proposal stated that some re-borrowers are able to end their borrowing after a relatively small number of additional loans; for example, approximately 22 percent of payday loan sequences and 23 percent of title loan sequences are repaid after the consumer re-borrows once or twice. But even among this group, many consumers do not anticipate before taking out a loan that they will need to re-borrow at all. These consumers cannot reasonably avoid their injuries, and while their injuries may be less severe than the injuries suffered by consumers with extremely long loan sequences, their injuries can nonetheless be substantial, particularly in light of their already precarious finances. Conversely, some of these consumers may expect to re-borrow and may accurately predict how many times they will have to re-borrow. For consumers who accurately predict their re-borrowing, the Bureau did not count their re-borrowing costs on the “injury” side of the countervailing benefits scale.

The proposal stated that while some re-borrowers end their borrowing after a relatively small number of additional loans, a large majority of re-borrowers end up in significantly longer loan sequences. Of storefront payday loan sequences, for instance, one-third contain seven or more loans, meaning that consumers pay finance charges equal to or greater than 100 percent of the amount borrowed. About a quarter of loan sequences consist of 10 or more loans in succession and even larger aggregate finance charges. For single-payment vehicle title borrowers, the consequences described in the proposal were similarly dramatic: Only 23 percent of loan sequences taken out by re-borrowers on title loans are repaid after two or three successive loans, whereas 23 percent of the loan sequences are for 10 or more loans in succession. The Bureau did not find that any significant number of consumers anticipated such lengthy loan sequences, and such empirical research as is available indicates that borrowers who end up in extended loan sequences are the least accurate in predicting the duration of their borrowing.

Thus, the Bureau stated its view in the proposal that the substantial injury suffered by the defaulters and those re-borrowers who incurred unanticipated injury—the categories that represent the vast majority of overall borrowers of covered loans—dwarfs any benefits these consumers may receive in terms of a temporary reprieve and also dwarfs the speed and convenience benefits that the repayers may experience. The Bureau acknowledged that any benefits derived by any aforementioned “false negatives” may be reduced under the proposed rule, but it judged that the limited benefits that may be received by this relatively small group are far outweighed by the substantial injuries sustained by the defaulters and re-borrowers, as discussed above. Further, the Bureau stated that under the proposed rule, many borrowers could be led to find more sustainable loan options, such as underwritten credit on terms that are more affordable and better tailored to their budget needs.

Turning to the benefits of the practice for competition, the Bureau acknowledged in the proposal that the current practice of lending without regard to consumers' ability to repay has enabled the payday industry to build a distinctive business model. Under this model, fully half or more of the revenue on these kinds of loans comes from consumers who borrow 10 or more times in succession. This, in turn, has enabled a substantial number of firms to extend such loans from a substantial number of storefront locations. The Bureau estimated that the top 10 storefront payday lenders controlled only about half of the market, and that 3,300 storefront payday lenders were small entities as defined by the SBA. The Bureau also acknowledged that the anticipated effect of limiting lenders to making loans that consumers can actually afford to repay would be to shrink the number of loans per consumer fairly substantially, which may, in turn, result in a more highly concentrated market in some geographic areas. Moreover, the Bureau acknowledged that the practices underlying their current business model enabled lenders to avoid many of the procedural costs that the proposed rule would impose.

However, the Bureau did not believe the proposed rule would materially reduce the competitiveness of the payday or title loan markets as a practical matter. As discussed in the proposal, most States in which such lending takes place have established a maximum price for these loans. Although in any given State there are a large number of lenders making these loans, located typically in close proximity to one another, the Bureau preliminarily found from existing research that there is generally no meaningful price competition among these firms. Rather, the Bureau stated that lenders generally charge the maximum possible price allowed in any given State. Lenders that operate in multiple States typically vary their prices from State to State to take full advantage of the parameters that are allowed by local law. Thus, for example, lenders operating in Florida are permitted to charge $10 per $100 loaned, and they do; when those same lenders are lending in South Carolina, they are permitted to charge $15 per $100, and they do that instead. In addition, despite some amount of consolidation that could be expected in the industry, the Bureau preliminarily found that under the proposed rule, based on experience of recent legislative reforms in various States, lenders would likely remain in relatively close proximity to the vast majority of borrowers.

In sum, the Bureau stated in the proposal that the benefits of the identified unfair practice for consumers and competition—failing to underwrite covered loans by making a reasonable assessment of the borrower's ability to repay the loan according to its terms—do not appear to outweigh the substantial injury that is caused or likely to be caused by the practice, and which is not reasonably avoidable by consumers. On the contrary, the Bureau preliminarily determined that the very significant injury caused by the practice outweighs the relatively modest benefits of the practice for consumers or for competition.

Comments Received

The Bureau received a number of comments on its proposed analysis of whether the substantial injury was outweighed by countervailing benefits to consumers or competition. Several industry participants and trade association commenters contended that this test was simply not met, arguing that the negative effects of the proposed rule would exceed its benefits. They argued that all consumers would be deprived of loans precluded by the rule, not just the “false negatives” or those who may be harmed by them.

Some commenters stated their point in a more general way, complaining that the Bureau had failed to present any objective metric or provide hard quantitative evidence to determine the costs and benefits of the identified practice to consumers or to competition in a more rigorous manner. Aside from attacking the general framework of the Bureau's analysis, commenters also maintained that the Bureau underestimated the costs that the rule would impose on lenders, greatly impeding the industry's ability to make appropriate covered loans. Some argued that the Bureau should have considered the costs of complying with the rule aggregated with the costs associated with complying with State law requirements.

Commenters listed a variety of potential benefits to consumers associated with covered short-term loans, and suggested that the Bureau both understated the benefits and overstated the extent of injury for re-borrowers. The list included that such loans help consumers cope with income shocks, achieve income smoothing, realize an overall improvement in their ability to manage accumulated debt, avoid bounced checks and problems with debt collection firms, reduce delinquency or defaults on other accounts, reduce unemployment, and reduce bankruptcies. Others emphasized that covered short-term loans can allow consumers to avoid riskier and more costly forms of credit, and thus these loans are simply the best and least expensive choice available for cash-strapped consumers with limited credit options. These commenters maintained that such loans allow consumers to avoid the inferior substitutes of even more costly alternatives, such as pawnbrokers, bank overdraft services, credit card cash advances, over-limit credit-card fees, and late-payment fees. As for vehicle title loans, commenters noted that they have the advantage of allowing consumers to tap into an asset to meet current needs and are structured to limit the potential harms to consumers because they are largely non-recourse loans; yet the restrictions posed by mandatory ability-to-repay underwriting would constrict the market for such loans and correspondingly impair the benefits to consumers.

Some commenters asserted that studies show that consumer access to payday loans has no negative effect on various measures of consumer financial health. They suggested that credit scores were better for longer-term borrowers as compared to borrowers who engaged in less re-borrowing and for borrowers in States with fewer payday loan restrictions as compared to States with greater restrictions, and that some studies conclude that payday lending bans lead to more bounced checks and overdraft fees as well as increased bankruptcy filings. They therefore surmised that covered loans improve the financial well-being of consumers. Several commenters cited as evidence of customer satisfaction the small proportion of complaints submitted to the Bureau about the product, the many positive accounts of covered loan usage in the “Tell Your Story” portion of the Bureau's Web site, and substantial product use without substantial levels of complaints to State regulators.

Similarly, as stated above in the substantial injury section, a number of commenters believed the identified practice was net beneficial. Many of these commenters argued that borrowers were merely replacing other obligations with a covered short-term loan, and thus the harm of the one was offset by the benefit of being able to pay the other. Some commenters argued that borrowers were not harmed, or were only minimally affected, by defaulting on these loans because those defaults generally do not affect consumers' credit reports and some lenders do not pursue collection efforts on defaulted loans. The Bureau received a large volume of comments from consumers who attested to the benefits of payday lending from their own personal experiences, though it also received many other comments from individual borrowers and consumer groups complaining about the injuries identified in the proposed rule.

One respected academic in the field commented that while economists have generally concluded that payday loans may destroy consumer welfare in some situations and may improve consumer welfare in others, there is disagreement over how many consumers fall in each category. This commenter asserted that the Bureau would only have to resolve this debate about consumer welfare if it were choosing whether to ban payday lending entirely.

Many industry commenters, and other commenters including a group of State Attorneys General, argued that by eliminating or limiting access to covered loans, the proposed rule would make consumers worse off because they would be forced to seek more expensive or otherwise more harmful alternatives, and that the Bureau had failed to factor the benefit of being able to avoid these harmful alternatives into its preliminary analysis of unfairness (i.e., countervailing benefits). A number of commenters including a trade group and a university-affiliated research center, among others, argued that consumer demand for credit will continue while the rule will only restrict supply. These comments were made about all of the proposed restrictions on making all three types of covered loans: Covered short-term loans, covered longer-term balloon-payment loans, and other covered longer-term loans (i.e., certain high-cost installment loans). And many comments in this vein focused on particular proposed restrictions, with particular emphasis on the 30-day cooling-off periods after a sequence of three loans made under § 1041.5 or § 1041.6, and the limitation on the total number of conditionally exempt covered short-term loans under proposed § 1041.6 to six loans or 90 days of indebtedness in a 12-month period. These commenters asserted that these restrictions would force consumers to substitute alternative forms of credit that are more costly and harmful than covered loans, claiming this to be true of loans ranging from pawn loans, to overdraft, to loans from unlicensed and unregulated online lenders, and even to loans from neighborhood loan sharks. Numerous consumers writing as part of organized letter-writing campaigns raised similar issues, expressing concern about the possibility of not having unlimited access to covered loans and the lack of alternative options. Some commenters referenced or submitted research studies, law review articles, or other analyses of these issues, some of which are described in detail below in the responses to the comments.

Some commenters raised one countervailing benefit to the Bureau's attention that was not included in the proposed rule—that borrowers do not have to undergo a credit check when taking out a covered loan that is originated without underwriting. Others noted that the current practices of many lenders, which do not engage in ability-to-repay underwriting of covered loans, avoids the additional privacy and security risks of maintaining more documentation on borrowers.

In addition to the points they made about countervailing benefits for consumers, industry commenters also objected to the Bureau's analysis of the countervailing benefits to competition. The Bureau received some comments arguing that the Bureau's statement that there is “generally no meaningful price competition” was inaccurate. Lenders provided assessments of their own market experience that purported to rebut that claim and indicated that covered loans create additional competition for other types of credit. They also argued that the Bureau had not appropriately included in the countervailing benefits the efficiencies of not having to assess the borrower's ability to repay, which reduce procedural costs to the entity and thus the prices offered to consumers. Commenters further asserted that the Bureau had failed sufficiently to take account of how the identified practice fosters non-price competition among lenders. They also noted that the proposal impedes consumer free choice and that it fails to consider the negative effects it may have on rural consumers. Some commenters emphasized that the proposed rule would lead to market concentration, eliminating thousands of jobs while denying access to a form of credit that millions of consumers currently rely on. Others suggested that lack of clarity over the application of the proposed rule to banks and credit unions could lead them to stop making small-dollar loans to their customers.

A coalition of consumer groups commented that the market for short-term small-dollar credit is much broader than the payday and single-payment vehicle title loans covered by this rule. In their analysis, the broader market comprises substitute products they viewed as more advantageous than covered short-term loans, including credit cards, subprime credit cards, certain bank and credit union products, non-recourse pawn loans, employer funds, charitable funds, and payment plans that are often made available by utilities and others. They also suggested that other non-credit strategies, such as debt counseling and credit counseling, should be viewed as preferable alternatives to taking out payday and title loans. They went even further by arguing that payday loans should not even be considered as “credit” to be accessed, as in their view most of these loans generate their own demand through repeated rollovers, rather than meeting the independent credit needs of consumers.

The Final Rule

After having reviewed and analyzed the comments submitted in response to the proposed rule, the Bureau concludes that though the identified practice of making covered loans without reasonably assessing the borrower's ability to repay the loan according to its terms presents some countervailing benefits to consumers and competition, those benefits do not outweigh the substantial injury that consumers are unable reasonably to avoid and that stems from the identified practice.

Methodology

Again, the Bureau approaches this determination by first weighing substantial injury in the aggregate, then weighing countervailing benefits in the aggregate, and then assessing which of the two predominates. If the benefits predominate, then the practice is not unfair. If the benefits do not predominate, then the practice is unfair. As described above, the substantial injury is incurred through default, delinquency, re-borrowing, and the collateral consequences of making unaffordable payments, including harms from forgoing major financial obligations or basic living expenses in an attempt to avoid these other injuries.

It is important to start by recognizing that the Bureau is not assessing the benefits and injury of covered short-term loans. As one academic commenter noted, this would only be necessary if the Bureau were seeking to ban all payday lending in its entirety. Rather, the Bureau is weighing the benefits and injury of the identified practice, which is making such loans without reasonably assessing that borrowers have an ability to repay the loan according to its terms. In other words, the countervailing benefits to consumers consist of the benefits that consumers receive as a result of lenders making these loans without assessing ability to repay (i.e., not having to comply with any of the underwriting criteria of this rule). In weighing the countervailing benefits, the Bureau considers the various costs that a remedy would entail. Costs not incurred to remedy the practice, like costs of complying with independent State law requirements, are not included in the analysis.

As the Bureau noted in the proposal, unfairness determinations do not require an exact quantification of costs and benefits. To do so would be impracticable, despite the suggestion made by some commenters that a specific metric or objective quantification was needed to meet the requirements of the statute—a suggestion that was made without any specificity as to methodology and in reliance on no existing precedent. And, in fact, the Bureau has quantified such data as are available about the frequency and extent of re-borrowing, the frequency of default, the frequency of payment failures, the severity of the resulting harms, and various other relevant items, even if some factors (such as the frequency and extent of default avoidance, for example) are not subject to being quantified as a practical matter.

At the proposal stage, the Bureau believed that the injury caused by the practice outweighed the benefits to consumers or competition, the latter of which includes the costs associated with complying with the remedy to the extent they would be passed on to consumers (and thus the absence of which is a benefit to consumers). The Bureau has had the chance to process and digest over a million comments that were submitted on the proposed rule and now concludes that this assessment was correct. However, in light of the considerable volume of input received from the public, the Bureau has decided to modify certain parameters of the proposed rule so as to simplify its scope, reduce the potential impact on access to credit, streamline the underwriting process, and add more flexibility within the existing framework. The effect of these adjustments is to reduce the costs associated with complying with the rule and reduce the impact it will have on access to credit, thereby reducing the weight on the countervailing benefits side of the scale.

This is so because in assessing the identified practice, the Bureau weighs the injury against the countervailing benefits, and according to the FTC Statement on Unfairness, the costs associated with implementing the remedy (i.e., assessing ability to repay) are included in the benefits that lenders could avoid if they did not have to comply with the underwriting criteria of the final rule. The Bureau's efforts to ensure that its remedy does not overly restrict access to credit, including adjustments made in § 1041.5 of the final rule that simplify and streamline some of the underwriting criteria that had been contained in the proposal, decrease the costs of the remedy, which in turn reduces the weight that is attributed to the countervailing benefits side of the scale. And the allowance of loans that can be made pursuant to § 1041.6 of the final rule without having to meet those specific underwriting criteria further reduces the weight on this side of the scale. In other words, the Bureau has reacted to commenters who feared the proposed rule was too complex and overly burdensome by reducing complexity and burden. These adjustments affect the balance between consumer injury and countervailing benefits, which results in the injury from the identified practice outweighing the countervailing benefits to consumers by even more than it did at the proposal stage.

With these changes, which are described more specifically in the relevant explanation of § 1041.5 of the final rule, the Bureau is reinforced in its conclusion that the substantial injury is not outweighed by countervailing benefits to consumers or to competition.

Assessing Benefits to Consumers

To evaluate this assessment in light of the points made by the commenters, it is useful again to divide consumers into several groups of different borrowing experiences, in order to analyze whether and how the practice of making covered short-term loans without reasonably assessing whether the consumer has the ability to repay the loan according to its terms yields countervailing benefits to consumers. Those groups, once again, can be characterized as “repayers,” “defaulters,” and “re-borrowers” for purposes of this analysis.

To begin with “repayers,” several commenters stated that the proposed rule would have such a substantial financial impact on lenders that even borrowers who have an ability to repay would not have access to covered loans as a result of the rule. The Bureau acknowledges that some borrowers who might end up repaying their loans because of windfalls or other unexpected developments would be unable to obtain a loan if they cannot meet the ability-to-repay criteria, though it does not anticipate there are large numbers of such consumers. Yet the Bureau stands by its analysis in the proposed rule on how the market will likely consolidate and thus survive as a result of the proposed rule, and thus that lenders will continue to make loans to borrowers who have the ability to repay. Any other conclusion would require the industry to concede that it cannot execute on a successful business model for making these loans unless it can be assured of a relatively large number of borrowers who find themselves caught up in extended loan sequences. The Bureau addresses more specific comments about its analysis of this point in part VII, which considers the benefits, costs, and impacts of the final rule on consumers and covered persons pursuant to section 1022(b)(2)(A) of the Dodd-Frank Act.

As to whether the rule will drive up prices for borrowers with the ability to repay, the Bureau does not believe it will do so. The Bureau noted in the proposal, and above in Market Concerns—Underwriting, that many covered loans are already offered at the maximum price allowed under State law. Instead of increasing prices, which they typically cannot do, lenders will likely address additional compliance costs and reduced volume by consolidating to some degree, as the Bureau anticipated.

The Bureau also has no reason to believe that lenders will be overly conservative and restrictive by lending to an even smaller group of people than the rule would allow. Without evidence to the contrary, the Bureau expects that the industry will act rationally and make those loans that are allowed by the rule. It may be that some lenders will choose to take a conservative approach and decline to lend to borrowers who would be eligible under the rule due to concerns about compliance risk; if so, that would be an unfounded and imprecise reaction to the rule, yet it is a possible outcome in some instances. Even so, the effect on the countervailing benefits determination should be marginal at best. Nonetheless, as set out in the relevant explanation of § 1041.5 of the final rule, the Bureau has made certain adjustments to streamline and simplify the final rule's underwriting criteria with the intent of reducing the number of industry participants that would restrict access to credit based on overly conservative assessments of compliance risk.

Thus, the Bureau continues to be persuaded that lenders will be able to make covered short-term loans to the population of consumers who have the ability to repay them, and that the “false negative” category of borrowers will be low, especially in light of the adjustments that are made in the final rule to respond to these comments to streamline the underwriting criteria in certain respects. Further, the Bureau notes that the proposed rule, and now the final rule, allows lenders to make some covered loans under the terms set forth in § 1041.6, without all the specific underwriting criteria that would otherwise apply under § 1041.5 because other conditions are imposed that effectively prevent extended loan sequences. Based on the lack of persuasive evidence demonstrating otherwise—and in light of the further changes to the rule that simplify, reduce burden, add flexibility, and ensure broader access to credit—the Bureau concludes that the lending industry should be able to adjust to the rule, and consumers who can afford to repay covered short-term loans according to their terms will generally continue to have access to them. The Bureau thus concludes that restrictions on access to credit for borrowers who have the ability to repay will be minimal.

The Bureau also finds that it did not underestimate other benefits to these consumers, such as the speed and convenience associated with lenders not having to underwrite loans by making ability-to-repay determinations. The Bureau continues to maintain the view that the underwriting process for these loans can be largely automated. But as a matter of caution and in response to the comments received, the Bureau decided to make adjustments to further streamline some of the underwriting criteria contained in the proposed rule. For example, as discussed above and in contrast to the proposal, the Bureau has removed some of the complexity around the residual income test, changed the documentation requirements in a variety of ways (including by allowing lenders to rely on consumer statements to authenticate rental expenses), and allowed lenders to take account of income from someone other than the borrower if the borrower has a reasonable expectation of access to that income. Lenders also will be able to assess ability to repay, in the alternative, by using a debt-to-income ratio. And rental expenses can now be based solely on a borrower's statement without the need to validate such statements through survey or other data. In fact, under the final rule, most borrowers who have the ability to repay typically should be able to get a covered loan without having to present any more documentation of income than a pay stub or a paycheck, which commenters indicated is the kind of income documentation that is already required by many lenders.

The second group of consumers consists of borrowers who eventually default on their loans, either on the first loan or later in a loan sequence after having re-borrowed, perhaps multiple times. As for these “defaulters” who lack the ability to repay the loan according to its terms, the Bureau did not underestimate the countervailing benefits to them. It is apparent, as a number of commenters attested, that these borrowers typically would not be able to obtain loans under the terms of the final rule. Put another way, the current practice of failing to make a reasonable assessment of whether a borrower can repay a covered loan results in this population of borrowers obtaining loans they do not have the ability to repay, which leads either immediately or eventually to default. As industry commenters noted, losing access to non-underwritten credit may have consequences for some consumers, including the inability to pay for other needs or obligations or the need to seek out alternative credit options or budgeting strategies. The Bureau considered the impact of the identified practice on access to credit in the proposal, which inherently included the natural consequences of losing access to such non-underwritten credit. The Bureau continues to regard the current access to credit that would be foreclosed under the ability-to-repay requirement as not an insignificant countervailing benefit.

While the vast majority of borrowers who would eventually become defaulters will not be able to obtain covered short-term loans, this forgone benefit must be weighed against the forgone injury. Again, the figures presented in the proposal are instructive in terms of the comparison at issue here. As discussed in the proposal, borrowers of 20 percent of payday and 33 percent of single-payment vehicle title loan sequences fall within this group of “defaulters.” For these consumers, their current access to non-underwritten credit may enable them to obtain a temporary “reprieve” from their current situation by obtaining the cash to pay a current bill or expense. But for many consumers, this reprieve is exceedingly brief: 31 percent of payday loan sequences that default are single-loan sequences, and an additional 27 percent of loan sequences that default are two or three loans long (meaning that 58 percent of defaults occur in loan sequences that are one, two, or three loans long). The proposal also stated that 29 percent of single-payment vehicle title loan sequences that default are single-loan sequences, and an additional 26 percent of loan sequences that default are two or three loans long (meaning that 55 percent of defaults occur in loan sequences that are one, two, or three loans long). Thus these consumers are merely substituting a payday lender or title lender for a pre-existing creditor, and they quickly find themselves in a new and potentially deeper hole by accruing finance charges, late fees, or other charges that are imposed at a high rate as well as the adverse consequences of ultimate default. Title loans can have an even more dire consequence for defaulters: 20 percent of them have their vehicle repossessed, with further adverse consequences, which may be take a severe toll on the consumer's economic situation if it affects their ability to get to work or carry on a variety of everyday household affairs. The Bureau thus finds that most defaulters do not obtain any significant benefits from the current lender practice of making loans to them without reasonably assessing their ability to repay the loan according to its terms.

There is another important point here about the calculus of benefits and injury with respect to “defaulters” that was not discussed in the proposal, yet which underscores the fact that their current access to non-underwritten credit does not benefit them and in fact leads to considerable harm. That is the adverse economic effect of the unsuccessful struggle to repay the unaffordable loan on the remaining population of “defaulters” that were omitted from the above discussion. Note that 58 percent of defaults on payday loans, and 55 percent of defaults on title loans, occur in loan sequences that are one, two, or three loans long. What this leaves aside is that fully 42 percent of default on payday loans, and 45 percent of defaults on title loans, occur after the borrower has already had an extended loan sequence of four or more loans, and then defaults. In many instances, this scenario is strong evidence of consumer mistake, since a consumer who anticipates defaulting should not also incur the high and accumulating costs of re-borrowing (which, for a sequence of at least four loans, amounts to more than half of the principal of the original loan, with the total mounting as the sequence extends even further). It is thus quite implausible that these borrowers, who constitute a substantial segment of all “defaulters,” obtain any significant benefits from the current lender practice of making loans to them without reasonably assessing their ability to repay the loan according to its terms. Indeed, quite the contrary is very likely to be the case for the vast majority of these borrowers, and the harm they suffer in these circumstances will generally amount to a very substantial injury.

This account provides a strong refutation of the claim by certain commenters that borrowers who default on covered short-term loans do not sustain any substantial injury in light of the corresponding benefits, or that they experience a net benefit because they are able to keep the proceeds of the defaulted loan and perhaps avoid defaulting on some other obligation with more severe consequences. Although that might conceivably be true in some instances, it is implausible in any functioning market that it is likely to be true very often, and that is particularly the case in the context of title loans, where the damaging consequences of vehicle repossession multiply the potential harm even further. So even if there is a small number of such borrowers, it is unlikely to have any material impact on the analysis here. As for the commenters who asserted that default does not affect consumers' credit reports and sometimes does not lead to debt collection efforts, these are marginal matters when compared to the core harms associated with unaffordable loans that end in default. But in any event, the Bureau's experience from engaging in supervisory oversight and investigations of these types of lenders have led to numerous enforcement actions demonstrating that many such lenders do seek to collect debts that are due on defaulted loans, which have led to findings of illegal conduct in aggressively seeking to pursue collection of such loans. And nothing prevents third party debt collectors or debt buyers from reporting negative information to consumer reporting agencies, which some collectors do to facilitate collection.

The third category of consumers is the “re-borrowers” who find themselves in extended loan sequences but eventually manage to find some way to repay the loan, even if only nominally. They are a majority of all borrowers—representing 58 percent of payday loan sequences and 56 percent of title loan sequences. For these consumers, as with the “defaulters,” the identified practice of making loans without reasonably assessing their ability to repay can allow them to obtain a temporary reprieve from the difficulties of their current financial situation. Some commenters suggested that many of them may benefit by literally buying time and to pay off some of their cumulative obligations later rather than sooner and that some financial indicia such as credit scores and bankruptcy filings appear to be more positive for these re-borrowers.

It is undoubtedly true that some borrowers who lack the ability to repay may gain an overall benefit from having access to covered short-term loans. Again, these could be borrowers who incur some sort of windfall or positive change in circumstances, or accurately anticipate the extent of their re-borrowing, and may be engaged in either income smoothing or spreading an unexpected cost across a longer time span. In some cases, these borrowers may be substituting a payday lender for some other creditor, such as a landlord or a utility company. It is however, the Bureau's judgment that the injury to other “re-borrowers” who do not accurately anticipate the length of re-borrowing, and many who find themselves unexpectedly trapped in extended loan sequences, is so substantial as to outweigh the benefits to these other consumers. This point is bolstered by comments received from individual borrowers, consumer groups, and faith groups who related many similar stories about the financial harms sustained by borrowers who found themselves caught up in extended loan sequences—whether or not those sequences ultimately ended in default, as some but not all do.

In this regard, it is notable that any such reprieve can pose a higher likelihood of risk and come at a greater cost than many borrowers may have initially expected, and a substantial population of “re-borrowers” can be expected to find that it will come at a much higher likelihood of risk and a substantially greater cost. It is worth restating why this is so. Once again, the dynamic of covered short-term loans is such that once the first loan has been made to a borrower who lacks the ability to repay it, the range of choices open to the borrower is sharply constrained. At the point of taking out the initial loan, the borrower can make a direct choice among competing alternatives as a means of meeting their immediate financial needs, and it is plausible that for some borrowers the decision to take out a covered short-term loan may seem or be superior to other available means of coping with the difficulties of their situation. But after the first loan has been made, the circumstances change significantly. When this first loan comes due, and for any and all subsequent loans, the borrower is no longer at liberty to make an unencumbered choice among competing alternatives. Instead, the borrower now must confront the range of risks and harms that are by now familiar, as they have been set out at length and discussed so often in the proposal and above—default, delinquency, re-borrowing, and the negative collateral consequences of making unaffordable payments, including harms from forgoing major financial obligations or basic living expenses in an attempt to avoid these other injuries.

This is the changed situation that borrowers confront as they find themselves facing the constrained choices that lead many of them into extended loan sequences, often unexpectedly, and cause them to bear the high costs of repeatedly rolling over their loans (which, by the time an extended loan sequence reaches seven loans, as one-third of storefront payday loan sequences actually do, means the borrower will have paid charges equal to 100 percent of the original amount borrowed and still owe the full amount of the principal). So while it is certainly likely that some borrowers may choose to take out these loans intentionally to spread a large, unexpected expense across a longer time span, it is equally apparent that many others find themselves in significant trouble if they have taken out such an unaffordable loan as an initial matter, even though they do find a way to manage to pay it back eventually after experiencing the types of harm that accompany the experience of an extended loan sequence. For those borrowers who accurately predict the length of their re-borrowing, the Bureau does not count these costs on the “injury” side of the ledger as against countervailing benefits.

In evaluating whether most consumers would or would not be likely to make this choice intentionally and based on accurate predictions, it is relevant here that the evidence suggests that consumers seem to be best able to gauge the expected duration of re-borrowing when the loan sequences are shorter, and such empirical research as is available indicates that borrowers who end up in extended loan sequences are the least accurate in predicting their duration of re-borrowing. Again, about one-quarter of storefront payday loan sequences consist of 10 or more loans taken out in succession, and 23 percent of title loan sequences consist of 10 or more loans in succession. The Bureau does not find evidence that any significant number of consumers anticipated such lengthy loan sequences.

Another set of considerations that is germane to the circumstances of “re-borrowers” is the effect of lender practices in the market for covered short-term loans. Although these loans are presented and marketed as stand-alone short-term products, lenders are aware (though many consumers likely are not) that only a relatively small number of borrowers repay such loans without any re-borrowing, and their core business model relies on that fact. Moreover, the decision that many lenders have made to offer these loans without reasonably assessing the borrower's ability to repay the loan according to its terms is the identified practice that causes injury to consumers, which, as discussed above, is not reasonably avoidable by consumers who are often likely to fail to fully understand the likelihood and severity of the risks posed. The Bureau also has concluded that the manner in which lenders structure these products—including the term of the loan, its balloon-payment structure, and the common requirement that the borrower provide a cancelled check or ACH access or provide vehicle security—likely contributes significantly to the result that many borrowers have no good alternatives to ending up in extended loan sequences of repeated re-borrowing that often extend well beyond their initial expectations.

It is also worth emphasizing that even these “re-borrowers” who would not have access to most covered short-term loans under § 1041.5 of the final rule, because they lack the ability to repay the loan according to its terms, would have access to loans made subject to the protections found in § 1041.6, with a corresponding reduction in the weight that falls on the countervailing benefits side of the scale. In the end, after aggregating the injury and benefits of these three populations of borrowers, the Bureau believes that the aggregate injury clearly outweighs the aggregate benefits. Substantial groups of consumers suffer acute harm as a result of the various scenarios analyzed above. These outcomes are bolstered by commenters who provided examples of consumers who ended up in extremely long loan sequences and ultimately were required to pay many multiples of the original principal of the loan. Based on the Bureau's research, 62 percent of these loans were in loan sequences of seven or more, and 15 percent of loan sequences involved 10 or more loans. The scope of that injury is quite substantial across the entire market for these loans. The Bureau concludes that this aggregate injury to many “re-borrowers” outweighs the countervailing access-to-credit benefits that other “re-borrowers” may receive as a result of lenders not reasonably assessing the borrower's ability to repay the loan according to its terms, in light of all the provisions of the final rule, including the effect that § 1041.6 will have in reducing the magnitude of those benefits.

As for the commenters who cited studies purporting to show that payday loans improved financial outcomes, the Bureau notes that all of the studies varied in their empirical rigor and the connection of their causal inferences to their documented findings. Based on its experience and expertise, the Bureau finds some studies to be more compelling than others. For example, several of these studies predicated their conclusions on comparisons of financial outcomes for consumers with and without access to payday loans, relying on access to payday loans based on geographic location as a proxy for actual use. Others that reached conclusions about better or similar financial outcomes for these groups relied on changes in credit scores, a narrow measure of financial well-being for the population of payday loan borrowers, whose credit scores are already strongly skewed toward the bottom of the customary ranges. The Bureau discussed many of these studies in the proposal; additional studies are mentioned here in light of comments received and are also discussed in further depth in the Section 1022(b)(2) Analysis in part VII below.

Findings based on the access proxy, which are possible largely due to State-level variation in payday lending laws, do not demonstrate better financial outcomes for actual payday loan borrowers. While certainly instructive, the Bureau finds these studies are generally less compelling than those based on individual-level data that can identify actual payday borrowers and their use. Further, this research has focused almost exclusively on the question of what happens when all access to a given form of credit is eliminated, as opposed to when it is merely restricted (or, as in this rule, restricted only as to borrowers who cannot demonstrate an ability to repay). The evidence available from States that have imposed strong restrictions on lending, but not outright or de facto bans, suggests that, even after large contractions in this industry, loans remain widely available, and access to physical locations is not unduly limited.

One such study cited by commenters attempted to determine how households in North Carolina and Georgia fared following State actions to restrict payday lending. They reported an increase in the rate of bounced checks, Chapter 7 bankruptcy filings, and complaints against debt collectors and creditors. In an update to that paper, the authors expanded the time frame, analyzed more State-level payday bans, and considered the effects of enabling payday lending as well. They again found evidence that in response to limits on payday borrowing, bounced checks increased, as did complaints about debt collectors to the FTC, whereas Chapter 13 bankruptcy filings decreased. Numerous industry comments cited these studies, along with a related study that is no longer available. However, these studies each rely on a methodology that severely undermines their conclusions. Specifically, the original study's assertion that checks are returned more frequently from States without payday lending—notably Georgia and North Carolina—relies on data that intermingles data from those States with data from numerous authorizing States (such as Louisiana, Alabama, Tennessee, and others), which makes the conclusions dubious at best. Indeed, in the original paper, more than half of the checks processed at the Charlotte, North Carolina check processing center actually came from States with payday loans. Additionally, the complaint data they cited are limited by the fact that the FTC is unlikely to receive complaints about payday lending (at the time, State regulators were more likely to receive such complaints). As such, the measure of complaints that the authors employ may not indicate the actual rate of credit-related complaints, let alone overall consumer satisfaction. While the later study improves on the previous studies by including more States, a longer period of analysis, and additional outcome measures, they still do not adequately address the shortcomings of their previous studies. This study also relies on data sources that commingle returned checks from States with payday bans with those from States that permit payday lending, which undermines its conclusions, and again relies on the simplistic measure of complaints received by the FTC.

Other studies, rather than using differences across States in the availability of payday loans, have used data on the actual borrowers who apply for loans and are either offered loans or are rejected. One study used this approach to find that taking out a payday loan increases the likelihood that the borrower will file for Chapter 13 bankruptcy. The authors found that initial approval for a payday loan essentially doubled the bankruptcy rate of borrowers. Another study used a similar approach to measure the causal effects of storefront borrowing on borrowers' credit scores. The authors found that obtaining a loan had no impact on how the consumers' credit scores evolved over the following months. The authors noted, however, that applicants generally had very poor credit scores both prior to and after borrowing (or being rejected for) a payday loan. In each of these studies, the authors were unable to determine whether borrowers who were rejected by the lender from which they had data were able to take out a loan from another lender.

Two other studies have used data on payday borrowing and repayment behavior to compare changes over time in credit scores for different groups of borrowers. One measured changes over time in credit scores for borrowers who re-borrowed different numbers of times, and found that in some cases it appeared that borrowers who re-borrowed more times had slightly more positive changes in their credit scores. These differences were not economically meaningful, however, with each additional loan being associated with less than one point in credit score increase. The other compared the changes in credit scores of borrowers who defaulted on their loans with borrowers who did not, and also found no difference. Neither study found a meaningful effect of payday loan borrowing behavior on credit scores.

Commenters also cited a laboratory experiment in which undergraduate students completed a novel computer exercise designed to test whether access to payday loans increased or decreased the likelihood of financial survival in the face of expense shocks. The experiment found that while subjects who used payday loans sparingly were more likely to survive the simulated 30-month period than those with no payday loans, heavy users that took out 10 payday loans or more over the course of the 30 months were less likely to survive than those who had no access to payday loans.

One comment described the lender's use of the Bureau's financial well-being scale to compare the scores of its borrowers to those of consumers deemed by the commenter to be “similarly situated” who did not use payday loans or did not have access to payday loans due to their State prohibiting the product. However, the commenter's analytic methods cannot be used to determine causality, and their findings do not appear fully consistent with their conclusions. Furthermore, the comment noted that customers were more likely than non-customers to have incomplete surveys. It is unclear whether the survey may therefore have been affected by non-response bias by customers in greater financial distress. Non-customers may also have had characteristics that make them ineligible for a payday loan despite being “similarly-situated” based on other metrics. These factors, such as being unbanked or not having documented income, may also have influenced well-being scores.

In the commenter's first analysis, they report the median and mean financial well-being scale scores by State and overall for its payday customers and non-customer population and found that, in 11 States in which a high response rate was achieved, its median customer scored one point lower than a non-customer, and that the average customer scored 2.3 points lower than the average non-customer. The lender concluded this result showed no real negative effect of payday borrowing. However, the commenter also highlighted the findings from Texas, where customers had a higher score than non-customers, although the differences were the same or smaller than those reported nationally where the commenter surmised there was no significant effect. The Bureau recently conducted a national study of American consumers which found that the adults who reported using products such as payday, non-recourse pawn, and vehicle title loans in the previous 12 months had an average financial well-being score of 42, which was 13 points lower than adults who did not report using these products. Additionally, there is little overlap in the distribution of financial well-being scores among those consumers who have and have not used payday, non-recourse, and vehicle title loans.

A second analysis conducted by the lender compared the scores of customers across different levels of payday loan usage and borrowing outcomes. Customers within the last year were grouped into five categories by the number of transactions they had, and grouped into four categories based on the outcome they experienced. Based on the median scores for each of the 20 categories a customer could be placed in given their borrowing and outcome status, the commenter concluded that there is no correlation between borrowers' financial well-being score and the number of transactions. However, the commenter also acknowledged finding lower scores for those that have their balances written off. Despite this finding, the lender still concluded that there is no evidence to support a theory that payday loan use has a negative effect on financial well-being.

More generally, the Bureau notes that all of these studies sought to measure the impact of payday loans, or eliminating payday lending, on all consumers generally. The Bureau is not opining on whether the payday industry, generally, is beneficial to consumers taken as a whole. Rather, the Bureau is assessing the impact of the identified practice of making payday loans (and other covered short-term loans and covered longer-term balloon-payment loans) to borrowers without making reasonable determinations that the borrowers have the ability to repay the loans according to their terms. In fact, the Bureau believes that covered short-term loans will still be available to consumers facing a truly short-term need for credit in those States that allow them. More specifically, the Bureau believes the vast majority of consumers would be able to get at least six covered short-term loans in any 12-month period, with those borrowers who are able to satisfy an ability-to-repay assessment being able to get some number of additional loans. Notably, however, none of these studies was focused on the impact that payday lending has on the welfare of the sub-population of borrowers who do not have the ability to repay their loans.

Industry commenters also suggested that consumers seem to be satisfied with covered short-term loan products, as shown by low numbers of complaints and the submission of positive stories about them to the “Tell Your Story” function on the Bureau's Web site. In response, as noted earlier, the Bureau observed from its consumer complaint data that from November 2013 through December 2016 more than 31,000 debt collection complaints cited payday loans as the underlying debt, and over 11 percent of the complaints the Bureau has handled about debt collection stem directly from payday loans. And when complaints about payday loans are normalized in comparison to other credit products, the numbers do not turn out to be low at all. For example, in 2016, the Bureau received approximately 4,400 complaints in which consumers reported “payday loan” as the complaint product and about 26,600 complaints about credit cards. Yet there are only about 12 million payday loan borrowers annually, and about 156 million consumers have one or more credit cards. Therefore, by way of comparison, for every 10,000 payday loan borrowers, the Bureau received about 3.7 complaints, while for every 10,000 credit cardholders, the Bureau received about 1.7 complaints. In addition, faith leaders and faith groups of many denominations from around the country collected and submitted comments, which suggested that many borrowers may direct their personal complaints or dissatisfactions with their experiences elsewhere than to government officials.

In addition, though the Bureau did receive a large number of comments from individual consumers relating their general satisfaction with these loan products, it also received a sizable number of comments to the contrary, where consumers or persons writing on their behalf detailed that many consumers experience negative effects with extended loan sequences.

Furthermore, based on the analysis set forth above in Market Concerns—Underwriting, the Bureau did not overstate the extent of the injury to “re-borrowers” who receive single-payment vehicle title loans, which were found to pose similar harms to consumers. Even though such loans may be non-recourse, which limits the extent of some harms, the injury to consumers of the risks of vehicle repossession often are extremely consequential on top of the other harms that flow from the structure and term of these loans, all of which leads to similar conclusions about the risks and harms of these loans.

In the proposal, the Bureau did not address one countervailing benefit to consumers resulting from the identified practice—some commenters noted that some borrowers, even ones with an ability to repay, are currently able to obtain a non-underwritten loan without inquiries showing up on the borrower's credit report. The Bureau acknowledges this can be a benefit to some consumers. However, the Bureau notes that the impact that a credit check will have on a borrower's overall credit profile is limited and uncertain, given that every consumer's consumer report differs and different creditors use different credit scoring models. One of the most experienced scoring companies, FICO, says the following about the impact of credit inquiries on a consumer's score: “The impact from applying for credit will vary from person to person based on their unique credit histories. In general, credit inquiries have a small impact on one's FICO Scores. For most people, one additional credit inquiry will take less than five points off their FICO Scores. For perspective, the full range of FICO Scores is 300-850.” ⁶⁹⁰ Thus this minor effect has little bearing on the Bureau's overall assessment of benefits and injury to consumers, especially in light of the adjustments made to the underwriting criteria in § 1041.5 of the final rule.

Substitute Products

The Bureau has several responses to the commenters asserting that the proposed rule's restrictions would make consumers worse off by forcing them to substitute more expensive and harmful credit products, and that the Bureau failed to account—or at least fully account—for the countervailing benefit that borrowers of covered loans do not incur the harms caused by these substitute products.

As noted above, the Bureau has decided not to finalize proposed §§ 1041.8 to 1041.10. These proposed sections would have required lenders making covered longer-term loans, including both high-cost installment loans and loans with balloon-payment features, to comply with the ability-to-repay requirements. The proposed rules as applied to longer-term installment loans were one focus of the comments described above. Accordingly, to the extent those comments were predicated on such restrictions applying to covered longer-term installment loans, they have been rendered largely moot by the Bureau's decision. The following discussion is thus limited to comments about the effects of the proposed restrictions on the making of covered short-term loans and covered longer-term balloon-payment loans.

As a threshold matter, it is important to put the effects of the final rule's restriction on borrowing in the proper context. A consumer would be denied an additional covered short-term or longer-term balloon-payment loan only if the consumer was neither able to demonstrate an ability to repay the loan nor eligible for a conditionally exempt covered short-term loan. Bureau simulations described in the Section 1022(b)(2) Analysis indicate the final rule would restrict only six percent of borrowers from initiating a sequence they would have started absent the rule. Furthermore, even if the impact of the decline in lending results in the closure of a substantial number of storefronts offering covered short-term or longer-term balloon-payment loans, the Bureau expects that the vast majority of consumers will not see a sizable increase in the distance to the nearest storefront. As discussed in more detail in the Section 1022(b)(2) Analysis, the Bureau's analysis of the impact of storefront closures in several States after the imposition of State restrictions on payday lending found that over 90 percent of payday borrowers had to travel no more than five additional miles to access their nearest payday lending storefront. This is in addition to the option of obtaining a covered loan online.

It is equally important to note that predicting how this relatively limited number of consumers will react to a particular restriction on covered loans in a particular circumstance is an imprecise matter given that, as noted above, the particular suite of restrictions imposed by the final rule has not been imposed by any State. The best that can be done is to make reasonable predictions about how consumers will react to these restrictions based on research concerning similar restrictions imposed by various States and other types of research, and the Bureau accordingly relies on such research in this discussion to the extent possible.

In addition, even assuming that each of the alternatives identified by the commenters is in fact more expensive or harmful than covered short-term or longer-term balloon-payment loans, to the extent that a given consumer who cannot obtain a loan under § 1041.5 or § 1041.6 has access to other alternatives that are as or less expensive than other alternatives, that consumer could use those less expensive substitutes rather than one or more of the allegedly worse alternatives.

In this regard, it is important to note that the Bureau's decision not to finalize proposed §§ 1041.8 to 1041.10 means that covered longer-term installment loans will be at least as available after the rule goes into effect as they are in current market. Thus consumers who cannot obtain a covered short-term or longer-term balloon-payment loan may be able to turn to a longer-term installment loan which, in the view of the commenters who were concerned about inferior alternatives, is not injurious. The Bureau emphasizes, however, that it remains concerned about potential consumer harms from longer-term installment loans where loan pricing and structure may reduce the incentive for lenders to engage in careful underwriting, and the Bureau will monitor evolution of the market and take action under its supervisory and enforcement authorities as necessary to address identified consumer harms.

In addition, the Bureau observes that some consumers may have access to some forms of credit that are typically less harmful than covered short-term loans and covered longer-term balloon-payment loans. These include some of the types of loans excluded from the final rule, including non-recourse pawn loans (discussed further below), no-cost advances, and advances made under wage advance programs that enable employees to access earned and accrued wages ahead of their payday. These options also include loans made by lenders who choose to comply with the conditional exemptions for alternative loans (akin to the PAL products administered by the NCUA) and accommodation loans.

The Bureau now turns to a consideration of evidence and arguments concerning each of the alleged inferior alternatives identified by industry commenters.

Non-recourse pawn loans. As noted in the section-by-section analysis for § 1041.3(d)(5), which excludes non-recourse pawn loans from the scope of coverage of the final rule, the Bureau believes that non-recourse pawn loans do not pose the same risks to consumers as covered loans because consumers are more likely to understand and appreciate the risks associated with non-recourse pawn loans, and the loss of a pawned item that the lender has physical possession of is less likely to affect the consumer's other finances. In addition, a consumer who cannot afford to repay a non-recourse pawn loan at the end of the loan term has the option not to return for the previously-surrendered household item, thus ending his indebtedness to the lender without defaulting, re-borrowing, or impacting his ability to meet other financial obligations. A study described in the Section 1022(b)(2) Analysis found that non-recourse pawn lending increased in States that banned payday lending; a similar substitution effect may occur to some degree for consumers who are unable to obtain additional covered loans.

Overdraft. Industry commenters and some individual consumer commenters expressed concern that consumers who are unable to access additional covered loans after exhausting the options permitted under the proposal will overdraw their bank accounts more frequently. Before considering whether there is likely to be a substitution effect towards overdraft, the Bureau notes that because many lenders of covered loans obtain access to a consumer's bank account for repayment, these loans are often the cause of overdrafts for consumers who are unable to repay, and they contribute to account closures. See Market Concerns—Payments and the section-by-section analysis for §§ 1041.7 and 1041.8 for more details. Thus, even if overdrafts and bounced checks were to serve as a substitute for covered loans among some consumers, there still might be a net reduction in overdraft usage as a result of the rule.

Further, Bureau research discussed in the proposal and the Supplemental Report calls into question certain commenters' assumptions that consumers who cannot obtain covered short-term or longer-term balloon-payment loans will overdraw their bank accounts more frequently. The Bureau analyzed substitution patterns among former users of the deposit advance product (DAP) offered by several depository institutions when the offering of this product was discontinued in the wake of the prudential regulator guidance. With discontinuation of DAP, consumers who had previously taken DAP advances did not discernably substitute towards other credit products or exhibit sustained negative outcomes compared to their non-user counterparts. Specifically, the former DAP users did not overdraw their bank accounts more frequently relative to non-users after the discontinuance of DAP, nor did they experience long-term increases in bank account charge-off rates following DAP's discontinuation. In addition, the analysis also found that former DAP users did not change their use of payday loans offered by non-depository institutions in any meaningful way relative to those that did not use DAP. Additionally, an academic paper exploring the relationship between payday loan access and overdrafts shows that reduced access to payday loans leads to a decrease in the number of days a household experiences overdrafts or bounced checks.

The Bureau notes, however, that if demand for short-term liquidity is inelastic and outside options were limited, a decrease in access to one option will necessarily increase the demand for its substitutes. The Bureau also notes the 2008 Morgan and Strain study discussed in the Section 1022(b)(2) Analysis and cited by several commenters, updated in 2012, which found that bounced checks and complaints about debt collectors to the FTC increase, and Chapter 13 bankruptcy filings decrease, in response to limits on payday lending. The updated study found that the service fees received on deposit accounts by banks operating in a single State tend to increase with limits on payday lending, and the authors interpreted this as an indication that payday loans help to avoid overdraft fees. The Bureau reiterates its critiques of the Morgan and Strain study as described the Section 1022(b)(2) Analysis.

Unregulated Loans. As noted, some commenters argued that limiting the number of covered loans a consumer could obtain may result in a consumer who cannot obtain a loan under § 1041.5 or § 1041.6 using unregulated or illegal loans. Evidence does not suggest that additional regulation of covered loans leads to more borrowing of these loans. The Bureau notes that the comments often conflate two distinct things. The first is unregulated loans made over the Internet (sometimes from Tribal lands or offshore locations) to consumers who may live in States where payday loans are prohibited by usury restrictions. The second loans made by individuals associated with local criminal enterprises (i.e., neighborhood loan sharks). For instance, commenters sometimes describe in vivid terms the possibility of the rule resulting in criminal loan sharking accompanied by violent behavior, but then go on to present as evidence for that possibility some data or anecdotes about unregulated lenders operating online. The Bureau treats these cases differently in turn below.

One study compared usage of online payday loans in States with restrictive payday lending regulations to usage in States with permissive payday lending regulations, since some unlicensed lenders of online payday loans may offer such loans without regard to the law of the State in which the consumer resided. The study concludes that usage rates of online payday loans do not significantly differ between States with restrictive and permissive payday loan laws, calling into question the notion that more consumers would turn to illegal lending sources if covered loans offered by compliant lenders were curtailed. Similarly, another analysis examined the market penetration of non-licensed lending in States with varying payday lending regulations and found that the presence of non-licensed lenders was relatively minimal in all States, though somewhat higher in States with restrictive payday lending regulations overall in some years and somewhat lower in States with restrictive regulations in other years. However, States with restrictive payday lending regulations that also vigorously enforced those laws consistently had very low market penetration for non-licensed payday lending.

A trade group critical of the proposal submitted a comment referencing a study that it stated “confirms that where payday credit has been restricted, consumers turn to online and unlicensed lenders.” The Bureau has reviewed the underlying study and does not believe that it confirms the commenter's premise. The analysis posits that after Texas enacted its payday and vehicle title regulations in 2012, there was an increase in online payday lending applications and at the same time a subsequent decrease in storefront payday lending applications—which the author takes to mean that borrowers turned to online lenders when storefront loans became less available. However, the Texas regulations involved a licensing and disclosure regime that did not limit access to payday lending. An alternative explanation may be that these developments reflect the general market trends of storefront payday lending decreasing relative to online lending, which was experiencing large national growth during this period. Relatedly, the study's finding that non-licensed lenders increased their online lending market share in Texas between 2011 and 2012 is likely similar to what happened nationally and was not caused by Texas law. The author also found that payday lending occurs to some degree in all States, regardless of how intensely it is regulated. If the author's hypothesis held true that payday demand is inelastic and non-licensed lenders would step in to fill a void that licensed lenders could not, the Bureau would expect the usage rates to be fairly similar in each of these groups of States, since they are all indexed to the subprime population. But it should be noted that use in restrictive and banned States is lower than in permissive States.

Illegal lenders/loan sharks. Finally, the Bureau believes the risk that consumers will be denied access to credit due to the impacts of the final rule and will be forced to turn to illegal lenders such as loan sharks is not supported by available evidence. Although a number of commenters made this argument, they offered little to no specific evidence about the prevalence of loan sharking in States that restricted payday and vehicle title lending.

The Bureau notes the receipt of a comment letter from a trade group referencing a paper that discusses, among other issues, analyses of loan sharking activity in other countries. The Bureau does not find this analysis to be persuasive, since the regulatory context, access to credit for subprime populations, and characteristics of unlicensed lending are quite different in those jurisdictions than in the United States, as the author of the study acknowledges. In addition, as noted above, under the final rule credit-impaired borrowers could still obtain credit through various alternatives discussed above (including conditionally exempt loans provided for in the rule and longer-term installment loans which are not subject to the ability-to-repay requirements of the final rule).

Similarly, a State trade group commenter argued that the Bureau had not properly accounted for the possibility of loan sharking in its assessment of costs and benefits, arguing that racketeering actions related to lending are more highly concentrated in jurisdictions that do not allow alternative forms of credit such as Pennsylvania, New York, and New Jersey. However, the Bureau views what was cited as supposed support to be anecdotal, non-specific, and lacking evidentiary weight. Even if the Bureau assumed the commenter was correct that loan sharking activities are prevalent in those jurisdictions, the Bureau believes the evidence cited fails to establish even a basic correlation between loan sharking and State differences in authorizing small-dollar lending, let alone a causal link.

The Bureau also notes receipt of a comment letter attaching a law review article analyzing the history of loan sharking in the consumer credit markets and the relationship between loan sharking and usury caps in the United States. The article argues that the “loan-shark thesis” offered by proponents of deregulating the credit markets is “seriously flawed.” Among the evidence cited was that in Vermont, which has one of the lowest interest rate caps in the nation, no Federal indictments have been recorded in the State during the 20-year period prior to 2012 (when the article was published) for engaging in an extortionate credit transaction, nor had the local press published a single story in that time about local black-market lending.

The Bureau further notes that the U.K. Financial Conduct Authority (the FCA) recently issued a report summarizing feedback it had received in assessing the impacts of the FCA's 2015 price cap on high-cost short-term credit. The FCA wrote, “We do not see strong evidence of a rise in illegal money lending because of the price cap.” The report explains the basis for the prediction it had made, in imposing the price cap, that less than 5 percent of declined applicants would consider turning to illegal money sources, and in the recent report the FCA stated that the results from their recent survey confirmed this prediction. The FCA cautioned that the individuals who use illegal money lenders are difficult to reach and reluctant to talk about their experience, but noted that they gleaned information through discussions with social service organizations and other individuals who could speak with authority on the prevalence of illegal lending behavior in the United Kingdom. If the hypothesis was that regulating payday and vehicle title lending in ways that restrict access would lead to an increase in illegal lending, then a nationwide price cap is the type of broad, substantive restriction on small-dollar lending that one may surmise would cause such a rise. Given the difficulty in generalizing across different legal systems and credit markets, the Bureau does not view such findings as dispositive, but does view them as instructive. At the very least, they cast doubt on the assertions made by the trade group that had cited the study about illegal lending in Germany and Japan discussed above.

Finally, the Bureau reemphasizes that the various types of alternatives described above will remain available. Thus, the Bureau concludes that the number of consumers who would seek these illegal options as a first resort is next to zero, and as a last resort is still quite low.

Assessing Benefits to Competition

In the proposal, the Bureau concluded that the rule would not have a significant impact on competition, in part because the Bureau had observed, as discussed above, that when lenders make covered short-term loans they typically charge the maximum price permitted under State law. Many lenders objected to that claim in their comments, and some provided examples of how prices can differ—including statistics on the difference between State-regulated lender prices and online lender prices, and differences between nationwide average prices versus industry medians. Other commenters noted that lenders compete on non-price terms. The Bureau acknowledges that a certain amount of market consolidation may impact the competition involved in non-price terms, meaning consumers may be presented with fewer choices as to where to go to obtain a loan. The impact that market consolidation has on pricing, however, is generally capped by existing State law requirements.

Another point made by industry commenters was that the Bureau's own analysis showed that the proposed rule would lead to increased concentration in the market for covered short-term loans, thereby undermining competition. Indeed, these commenters asserted that the Bureau had understated the amount of decline in revenue that would follow from its proposal and thus had underestimated the impact of the proposal in reducing competition. These comments, however, largely misunderstood the Bureau's analysis of the actual effects on competition. The Bureau did believe that the requirement to underwrite covered loans by making a reasonable assessment of the borrower's ability to repay the loan according to its terms would cause consolidation in the market, which the Bureau attempted to estimate to the extent feasible. Yet the Bureau presented preliminary findings, based on its observed experience of the markets in States that had adopted modifications to their own payday lending regulations, which indicated that market consolidation would not reduce meaningful access to credit among consumers. As discussed above, the upshot of such consolidation was that lenders remained almost as proximate and available to consumers as before. To the extent the industry commenters present different estimates, the Bureau is not persuaded of their likely accuracy, and these issues are addressed further in part VII, which presents the Bureau's consideration of the benefits, costs, and impacts of the final rule on consumers and covered persons pursuant to section 1022(b)(2)(A) of the Dodd-Frank Act.

Moreover, as discussed above, in light of the comments received, the Bureau has adjusted certain parameters of the proposed rule to simplify its scope, streamline the underwriting process, and add more flexibility within the existing framework, as described more fully below in the explanation of § 1041.5 of the final rule. The effect of these adjustments is to reduce the costs associated with complying with the rule, which likely will reduce the estimated amount of consolidation in the market for covered short-term loans.

For all of these reasons, the Bureau concludes, based on its judgment and expertise, the comments it received on all sides of these issues, and the data on injury and the effects of the identified practice set forth above in Market Concerns—Underwriting and the analysis in part VII below, which presents the Bureau's consideration of the benefits, costs, and impacts of the final rule on consumers and covered persons, that the practice of making covered loans without reasonably assessing the borrower's ability to repay the loan according to its terms is injurious to consumers, on net and in the aggregate, taking into consideration the countervailing benefits of the identified practice.

Consideration of Public Policy

The Bureau's Proposal

Section 1031(c)(2) of the Dodd-Frank Act allows the Bureau to “consider established public policies as evidence to be considered with all other evidence” in determining whether a practice is unfair, as long as the public policy considerations are not the primary basis of the determination. In the proposal, the Bureau stated that public policy supports the proposed finding that it is an unfair practice for lenders to make covered loans without determining that the consumer will have the ability to repay the loan according to its terms.

Specifically, as noted in the proposal, several consumer financial statutes, regulations, and guidance documents require or recommend that covered lenders must assess the customer's ability to repay before extending credit. These include the Dodd-Frank Act provisions on closed-end mortgage loans, the CARD Act provisions on credit cards, guidance from the OCC on abusive lending practices, guidance from the FDIC on small-dollar lending, and guidance from the OCC and FDIC on deposit advance products. In addition, the Federal Reserve Board promulgated a rule requiring an ability-to-repay determination for higher-priced mortgages, although that rule has since been superseded by the Dodd-Frank Act's ability-to-repay requirement and the Bureau's implementing regulations, which apply generally to mortgages regardless of price. In short, the Bureau stated in the proposal that Congress, State legislatures, and other agencies have found consumer harm to result from lenders failing to determine that consumers have the ability to repay before extending credit to them. The Bureau stated that these established policies provide support for its preliminary finding that it is unfair for a lender to make covered loans without determining that the consumer will have the ability to repay; and they likewise were seen as supporting the Bureau's proposed imposition of the consumer protections in the proposed rule. The Bureau gave weight to the policy contained in these Federal consumer laws, and based its preliminary finding that the identified practice is unfair, in part, on that significant body of public policy. Yet the Bureau did not make this consideration the primary basis for its preliminary determination of unfairness.

Comments Received

The Bureau received comments relating to the public policy implications of the proposed rule. One industry commenter argued that because the Bureau lacked substantial evidence for its other determinations, it was essentially basing the unfairness determination primarily on public policy, which is prohibited by the Dodd-Frank Act. Other industry commenters contended that public policy considerations militate against promulgating a rule that restricts access to credit to the extent described in the proposal. For example, some commenters claimed that restricting access to credit for certain borrower populations conflicts with public policy considerations underlying fair lending laws.

Industry commenters also cited perceived conflicts with other sources of law as contravening public policy. One commenter made a similar argument about the proposal's coverage of the furnishing and review of credit information, which it viewed as inconsistent with the Fair Credit Reporting Act and thus as inconsistent with public policy. Other commenters more simply argued that in addressing the perceived issues with covered loans, the Bureau should be required to defer to existing State regulatory approaches.

Some commenters stated quite different views, as discussed previously. One trade association, in particular, stated that Congress plainly recognized the problems created by unregulated and less regulated lenders, and for that reason conferred on the Bureau new authority to supervise and write rules for the payday lending industry for the first time ever at the Federal level. More generally, consumer groups were strongly supportive of the Bureau's legal authority to develop and finalize the proposed rule. Rather than viewing other ability-to-repay provisions in Federal consumer law as implied negative restrictions on the Bureau's authority, these commenters pointed to them and others (such as the Military Lending Act) as embodying a considerable trend of expanding public policy now supporting the principle that consumer lending generally should be premised on the borrower's ability to repay. They also noted that some States now embody this principle in statute, and many more do so by judicial precedent. They noted that general statements of this principle in Federal and State law tend to define this approach as requiring the lender to establish the borrower's ability to repay the loan while meeting basic living expenses and without re-borrowing.

One commenter argued that the proposed rule contradicts other recent Federal policy that authorizes and even promotes mortgages, auto loans, and other types of long-term lending. Several commenters argued that the rule violates the public policy of federalism because it would prohibit certain lending practices that are otherwise allowed and regulated by State laws, which reinforce the structure of such loans and mitigate harms to consumers. On the other side of the issue, commenters argued that the Bureau's rule is increasingly consistent with the evolving direction of State law.

The Final Rule

As an initial matter, the Bureau notes that public policy is only one factor that it uses to inform its unfairness assessments; it is not a prerequisite or an element of the legal determination or its primary basis. The Bureau has concluded that this rule is consistent with public policy, but commenters' argument that the rule is primarily based on public policy is inaccurate. As stated in the proposal, the identified practice of making covered loans without reasonably assessing the borrower's ability to repay the loan according to its terms is unfair because it meets the three legal elements of unfairness, and the rule is also supported by public policy.

The rule does not conflict with Federal fair lending laws. The Bureau will continue to expect creditors to treat borrowers of protected classes equally. Additionally, the rule does not conflict with the Fair Credit Reporting Act. Lenders can comply with the provisions of both this rule and the FCRA and will be expected to do so.

To the extent that Federal policy is intended to promote long-term lending, this rule does not conflict with that objective. First, the Bureau is unaware of any Federal policy that specifically prefers long-term lending simply for the sake of long-term indebtedness. Certain Federal policies may allow longer-term installment lending in order to reduce payment amounts, but the covered short-term loans at issue in this rule do not involve reduced payment amounts as a result of re-borrowing.

The Bureau does not agree with the commenters who claimed that this rule conflicts with general principles of federalism, even though some loans that would not be permissible under the rule would currently be permissible under State law. If the commenters' argument were to be accepted, then any Federal regulation (other than rules prohibiting only the exact conduct already prohibited by the States) would create an impermissible conflict with principles of federalism. Yet that is not how our system of federalism works. Under the Constitution, both the States and the Federal government have coexisting, overlapping authority. This rule preserves that settled framework by stating explicitly that it does not preempt any State law that is more restrictive in its effects than the provisions of this rule. Existing State regulatory frameworks will continue to exist alongside this rule, in a version of cooperative federalism that is analytically similar to the way parallel State and Federal laws have long operated in such fields as securities law, antitrust law, environmental law, and many others. The Bureau is unaware of any State laws that a lender of covered short-term loans cannot comply with as a consequence of this rule.

Indeed, the making of covered short-term loans pursuant to State regulatory frameworks is already subject to significant Federal laws and regulations, as many commenters acknowledge. Those Federal laws include the Truth in Lending Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, and others. To the extent those laws control or modify various aspects of the covered loans made pursuant to State law, they do not thereby contravene the principles of federalism. In fact, the final rule adopted by the Bureau also provides support for those States that effectively prohibit the making of certain types of covered loans by imposing a hard usury cap on such lending, insofar as the rule will restrict lenders from offering non-underwritten covered loans on-line or by other avenues of cross-border lending into those States, which are also empowered to enforce their usury caps against cross-border loans that violate those caps.

The Bureau disagrees with the contention that it only has the authority to issue rules based on unfairness that incorporate an ability-to-repay standard if Congress expressly specified the use of such a standard. On the contrary, Congress created the Bureau and chartered it with the responsibility to identify and prevent unfair practices, employing general statutory definitional criteria as set forth in the Dodd-Frank Act. Congress did not explicitly preclude the issuance of rules based on unfairness that incorporate an ability-to-repay standard, and the Bureau has not found in the statute, its legislative history, or other authoritative sources any implied preclusion of rules based on unfairness that incorporate an ability-to-repay standard. And the Bureau is authorized to adopt appropriate rules when it has determined that an ability-to-repay standard is appropriate to address a practice that it has identified as meeting the definition of “unfair” under the criteria enunciated by Congress in the statute. Indeed, Congress reinforced the Bureau's authority to engage in rulemaking in this particular market by providing in section 1024(a)(1)(E) of the Dodd-Frank Act that this was one of three specified markets (along with mortgages and private student loans) where the Bureau had broad authority to adopt regulations that apply to “any covered person who . . . offers or provides to a consumer a payday loan.”

As for those commenters who stated that the Bureau is obliged to consider and defer to State-law regimes for regulating covered loans, it suffices to note that this approach does not square with the terms of Federal law as prescribed in the Dodd-Frank Act. It also fails to recognize that even in light of varying State regulatory structures, the injury caused by covered loans persists in those States where it is permitted to exist. And those States, of course, are the sources of all the data that the Bureau has compiled on the harms of covered loans in the United States (since the so-called “prohibition States” cannot, by definition, be the source of any current data on the making or effects of those loans).

Finally, commenters who criticized the Bureau as violating some version of public policy by acting too aggressively to limit or even eliminate covered short-term loans altogether were overstating their point while at the same time missing the point. Again, the approach proposed by the Bureau and now adopted in the final rule does not eliminate such loans. Rather, it merely imposes a requirement that they be underwritten by the lender making a reasonable assessment that the borrower will be able to repay the loan according to its terms. And especially in light of various adjustments the Bureau has now made to simplify and streamline the underwriting provisions in § 1041.5 of the final rule, along with some ability to make covered loans under the alternative provisions of § 1041.6, the notion that the final rule will eliminate these loans altogether is not well grounded in any factual analysis.

Abusiveness

Under sections 1031(d)(2)(A) and (B) of the Dodd-Frank Act, the Bureau may find an act or practice to be abusive in connection with a consumer financial product or service if the act or practice takes unreasonable advantage of: (A) A lack of understanding on the part of the consumer of the material risks, costs, or conditions of the product or service or of (B) the inability of the consumer to protect the interests of the consumer in selecting or using a consumer financial product or service. In the proposal, the Bureau stated that it appeared that a significant population of consumers does not understand the often-hidden risks and costs of taking out payday, single-payment vehicle title, or other covered loans, and further lack the ability to protect their interests in selecting or using such loans. It also stated that it appeared that lenders take unreasonable advantage of these consumer vulnerabilities by making loans of this type without reasonably determining that the consumer will have the ability to repay the loan.

After considering the comments received, for the reasons described below, the Bureau concludes that it is an abusive practice to make covered short-term loans without reasonably assessing that the borrower will have the ability to repay the loan according to its terms. The Bureau concludes that many borrowers lack an understanding of the material risks and costs of these loans, based on evidence that many borrowers do not seem to understand the likelihood or the severity of the harms that can result from such unaffordable loans. The Bureau concludes that borrowers are unable to protect their interests based on the circumstances of many borrowers, such as their typically urgent need of credit, their perception that they often lack a realistic ability to shop for alternatives, and above all the difficulties they face after origination of the first unaffordable loan based on various features of the loan product that create and magnify the potential risks and harms. And finally, by making covered short-term loans without reasonably assessing the borrower's ability to repay the loan according to its terms, and based on various features of the structure of such loans, lenders are taking unreasonable advantage of these vulnerabilities.

General Comments

Before turning to its analysis of the statutory prongs of the abusiveness standard, the Bureau can first address a small set of general comments on its use of the abusiveness standard generally. Some commenters asserted that the proposed rule improperly amounts to a “ban” on certain products, instead of focusing on the identified practice of making covered loans without reasonably assessing consumers' ability to repay. Other commenters asserted that when a practice is expressly permitted by some applicable law, including State law, it cannot also be abusive. One commenter pointed to statements made in the Bureau's own exam manual as ostensible support for opposing the Bureau's use of its abusive authority to impose this rule.

The suggestions that the rule effectuates a “ban” on products rather than a prohibition against acts or practices are inaccurate. The Bureau did not propose, and this final rule does not provide, that any covered short-term loans are prohibited. The practice of failing to make such an assessment has been identified by the Bureau as the practice that is both unfair and abusive. In response, the rule simply requires that such loans must be underwritten with a reasonable assessment of the borrower's ability to repay the loan according to its terms. Further analysis on the effect of this rule on the market for such loans can be found above in the discussion of the statutory unfairness prong, as well as in part VII, where the Bureau presents its assessment of the costs, benefits, and impacts of the final rule on consumers and covered persons pursuant to section 1022(b)(2)(A) of the Dodd-Frank Act.

As to the assertion that a practice cannot be abusive when it is expressly permitted by some applicable law, this statement seems overbroad and inaccurate, for when a new rule is promulgated, it would often be the case that the conduct it now addresses would previously have been permitted, and perhaps even explicitly permitted, before the law was changed by the new rule. By the same token, the observation made about the Bureau's examination manual is irrelevant, because the manual would only have been describing the existing state of the law prior to the promulgation of this new rule. Many if not most new rules adopted by the Bureau that add new substantive requirements may not be anticipated by examination manuals written to guide examiners in applying the pre-existing legal landscape before the rule was adopted. As is common when new rules are adopted, the Bureau plans to produce new examination procedures to reflect the new substantive requirements of this final rule.

Moreover, the Bureau may properly exercise its statutory authority at any time to consider whether an identified practice meets the definitional prongs of unfairness or abusiveness, based on substantial evidence and research. When it does so, it reaches an appropriate conclusion that the identified practice is illegal under the provisions of the Federal statute, regardless of whether lenders had been engaging in the practice prior to the time the Bureau completed its new analysis. Furthermore, the fact that State laws on the same subject may be less restrictive in some respects than Federal law does not prohibit the promulgation of a regulation that is authorized by Federal statute, even though it may be more restrictive in some respects than those State laws. This is typical of how federalism traditionally works in other areas of parallel Federal and State law, such as securities, antitrust, environmental law, and many other areas.

Consumers Lack an Understanding of Material Risks and Costs

The Bureau's Proposal

As discussed in the proposal, covered short-term loans, including payday and title loans, can and frequently do lead to a number of negative consequences that can pose serious financial problems for consumers. These effects flow from the identified practice of failing to underwrite such loans by making a reasonable assessment of the borrower's ability to repay the loan according to its terms. The harms that borrowers tend to experience once they have taken out an unaffordable loan of this kind include default, delinquency, re-borrowing, and the collateral consequences of making unaffordable payments, including forgoing basic living expenses and major financial obligations to avoid the other injuries. All of these potentially harmful effects—including the direct costs that the borrower has to pay to the lender, as well as other costs that often are incurred as well—are among the “material risks and costs” of these loans, as the Bureau understood and reasonably interpreted that phrase.

In the proposal, the Bureau recognized that borrowers who take out a payday, title, or other covered short-term loan typically understand that they are incurring a debt which must be repaid within a prescribed period of time and that if they are unable to do so, they will either have to make other arrangements or suffer adverse consequences. The Bureau stated, however, that it did not believe that such a generalized understanding suffices to establish that consumers actually understand the material risks and costs of these products, and in particular the magnitude and severity of the risks and harms. Rather, the Bureau stated that it believed it was reasonable to interpret “understanding” in this context to mean more than a mere awareness that it was within the realm of possibility that a negative consequence could be experienced as a result of using the product. For example, consumers may not understand that a certain risk is very likely to materialize or that—even though relatively rare—the impact of a particular risk would be severe.

As discussed in the proposal, the single largest risk to a consumer of taking out an initial covered short-term loan is that it will lead to an extended cycle of indebtedness that poses material risks and costs to the consumer. This occurs in part because of the identified practice, which can lead to lenders making unaffordable loans. It also occurs, in large part, because the term and structure of the loan generally require the consumer to make a lump-sum balloon payment within a short period, typically two weeks or a month after the loan is made, often absorbing such a large share of the consumer's disposable income as to leave the consumer unable to pay basic living expenses and major financial obligations.

As the Bureau stated in the proposal, in States where it is permitted, lenders often offer borrowers the enticing—but ultimately costly—alternative of paying a fee and rolling over the loan or taking out a new loan to pay off the previous one, leaving the principal amount intact. Many borrowers choose this option, and a substantial population of them ends up in extended loan sequences because when the loan next comes due, they are in exactly the same situation all over again. Alternatively, borrowers may repay the loan in full when it comes due, but find it necessary to take out another loan over the course of the ensuing expense cycle because the large amount of money needed to repay the first loan, relative to their income, leaves them without sufficient funds to meet their other obligations and expenses. This also can often lead to an extended cycle of debt, posing material risks and costs to the consumer's financial situation.

This cycle of indebtedness affects a large segment of borrowers: As described above in Market Concerns—Underwriting, half of all storefront payday loan sequences contain at least four loans. One-third contain seven loans or more, by which point consumers will have paid charges equal to 100 percent of the original amount borrowed and still owe the full amount of the principal. Almost one-quarter of loan sequences contain at least 10 loans in a row. And looking just at loans made to borrowers who are paid weekly, bi-weekly, or semi-monthly, more than one-fifth (21 percent) of those loans are in sequences consisting of at least 20 loans. For loans made to borrowers who are paid monthly, almost half (46 percent) of the loans are in sequences consisting of at least 10 loans.

The evidence summarized in the proposal and reinforced above in Market Concerns—Underwriting and again in the section on unfairness also shows that many consumers who take out these loans appear not to understand, when they first take out the loan, how long they are likely to remain in debt and how costly and harmful that situation could be for them. Many borrowers tend to overestimate their likelihood of repaying the loan without re-borrowing and do not understand the likelihood that they will end up in an extended loan sequence. As the Bureau stated in the proposal, empirical evidence shows that a substantial population of borrowers, and especially those who end up in extended loan sequences, are not able to predict accurately how likely they are to re-borrow and thus how much they will end up paying over time. One study, in particular, found that consumers who end up re-borrowing numerous times—which are the consumers who suffer the most harm—are particularly bad at predicting the number of times they will need to re-borrow. Thus, many consumers who find themselves in a months-long cycle of indebtedness do not understand the material risks and costs of that consequence, and end up paying hundreds of dollars in fees above what they expected, while struggling to meet their other financial obligations.

As recounted in the same sections identified above and in the proposal, the Bureau has observed similar outcomes for borrowers of single-payment vehicle title loans. For example, 83 percent of title loans are re-borrowed on the same day that a prior loan was due, and 85 percent of vehicle title loans are re-borrowed within 30 days of a previous vehicle title loan. Fifty-six percent of vehicle title loan sequences consist of more than three loans, 36 percent consist of at least seven loans, and almost one quarter—23 percent— consist of more than 10 loans. While there is no comparable research on the subjective expectations of title borrowers, the Bureau preliminarily found that the research in the payday context can be extrapolated to these other single-payment short-term products, given the significant similarities in the product structures, the characteristics of the borrowers, and the outcomes that many borrowers experience, as detailed above in part II and in Market Concerns—Underwriting.

Consumers are also exposed to other material risks and costs in connection with these kinds of loans. As discussed in more detail in Market Concerns—Underwriting, the unaffordability of the payments creates, for many consumers, a substantial risk of default. Indeed, 20 percent of payday loan sequences and 33 percent of title loan sequences end in default. And 69 percent of payday loan defaults occur in loan sequences in which the consumer re-borrows at least once. For a payday borrower, the cost of default generally includes the cost of at least one, and often multiple, NSF fees assessed by the borrower's bank when the lender attempts to cash the borrower's postdated check or debit the consumer's account via ACH transfer and the attempt fails. It is also known that NSFs on on-line payday loans are associated with a high rate of bank account closures, further jeopardizing the financial health and stability of these consumers. Defaults often expose consumers to other adverse consequences, such as aggressive debt collection activities. The consequences of default can be even more dire for a title borrower, including repossession of the consumer's vehicle—which is the result in 20 percent of single-payment vehicle title loan sequences and can greatly complicate the borrower's ability to earn the funds needed to repay such loans.

The Bureau stated in the proposal that it believed a substantial population of consumers who take out payday, title, or other covered short-term loans do not understand the magnitude of these additional risks. The proposal also stated that borrowers—at least at the point where they are first deciding whether to take out the loan—are not likely to factor into their decision-making the severity of the harms they may suffer from default, delinquency, re-borrowing, and the collateral consequences of making unaffordable payments in an attempt to avoid these other injuries. Further adverse effects can include expensive bank fees, the potential loss of their bank account, aggressive debt collection efforts, and, with title loans, the risks and costs of losing their basic transportation to get to work or conduct their ordinary personal affairs.

As discussed in the proposal, several factors can impede consumers' understanding of the material risks and costs of these loans. At the outset, as discussed above, there is a mismatch between how payday and single-payment vehicle title loans are structured and marketed to consumers and how they operate in practice to support a business model based on repeated re-borrowing. Although the loans are presented and marketed as stand-alone short-term products, lenders know and rely on the fact that only a minority of payday loans are repaid without any re-borrowing. As discussed above, these loans often, instead, produce lengthy cycles of indebtedness through extended loan sequences of repeat re-borrowing. This is influenced by the term and the balloon-payment structure of the loans, which offer the limited options of either re-borrowing by paying additional fees without paying down the principal amount or requiring a large payment to be made all at once, which can lead to severe consumer harm if the lender makes an unaffordable loan without reasonably determining that the borrower has the ability to repay the loan according to its terms.

In addition, consumers in extreme financial distress tend to focus on their immediate liquidity needs, rather than potential future costs, in a way that makes them highly susceptible to lender marketing. Payday and title lenders are generally aware of this vulnerability and often advertise the speed with which the lender will provide funds to the consumer, which may further cloud consumers' ability to understand the risks and costs. But while covered short-term loans are marketed as being intended for short-term or emergency use, a substantial percentage of consumers do not repay the loan quickly and thus confront the harms of default, delinquency, re-borrowing, and the collateral consequences of making unaffordable payments in an attempt to avoid these other injuries. Many consumers find themselves caught in a cycle of re-borrowing that is both very costly and very difficult to escape.

Comments Received

The Bureau received many comments relating to this prong of the abusiveness definition concerning consumers' lack of understanding of material risks and costs associated with the kinds of loans covered by the rule. Industry participants, trade associations, and others who criticized the Bureau for proposing the rule in response to this concern maintained that consumers do understand the terms of the loans and the possible outcomes, making a more detailed understanding of the risks unnecessary, and making the rule unnecessary as well. They argue that it is unrealistic to require, as they believed the Bureau's proposed rule did, that consumers develop an expert understanding of the characteristics of covered short-term loans.

Those commenters who maintained that the risks and costs are sufficiently understood by consumers claimed that the proposed rule improperly substitutes the Bureau's own judgments for those of consumers, denying them the ability to make a free choice to purchase products about which they do, in fact, know and appreciate how they work. Many commenters, including individual users of covered short-term loans, asserted that consumers use them effectively to cope with unexpected temporary expenses or shortfalls in income, to manage uneven income and cash flow challenges, and to avoid more expensive alternatives for handling other debt. They cited various studies to support the proposition that consumers understand the challenges and disadvantages of these loans, but opt for them as the best choice available among unappealing alternatives. Other commenters stated that no evidence suggests borrowers of covered loans generally suffer from infirmity or ignorance, but rather are well-educated and sophisticated in how they use financial services.

Several commenters pointed to the relatively small number of consumer complaints submitted to the Bureau about these kinds of loans, and to the high volume of positive comments submitted about such loans in response to the proposal, which were viewed as showing that consumers who use these loans understand them. Many individual users of such loans likewise commented that they use these products advisedly to meet their particular needs.

In the alternative, industry commenters contended that the Bureau's method for determining that consumers do not understand these risks is flawed, such as by relying too heavily on concepts of behavioral economics, which would leave an essential premise for the rule unproven. Other commenters argued that consumers are generally accurate in predicting the duration of their borrowing, citing the Mann study and Professor Mann's response to the Bureau's proposal, a point that was raised and discussed earlier in Market Concerns—Underwriting, as well as in the section on unfairness.

Other commenters such as consumer groups agreed with the Bureau's assessment in the proposal that many consumers do not understand the material risks and costs associated with these kinds of loans, which they viewed as resting on sound underpinnings of the facts and data marshaled by the Bureau. Once again, the commenters said this was especially true of borrowers who end up in extended loan sequences, and the financial circumstances of these consumers are materially undermined by their experience with such loans. They are unable to repay the loans when they come due, which leads them to re-borrow repeatedly and, in many instances, to suffer the injuries associated with being trapped in extended loan sequences. Consumer groups expressly agreed with the weight placed by the Bureau on concepts from behavioral economics such as “tunneling risk” and “optimism bias,” which they stated are well-established phenomena. Another commenter noted that their experiences with legal assistance clients showed consistent confusion about the risks, costs, and conditions of these loans, as well as the excessive optimism many consumers have about their expected ability to pay off the loans as they come due. This perspective was supported by many comments by and about individual users of such loans, whose experiences contrasted sharply with other cohorts of borrowers who commented on the proposal in more critical terms.

Some industry commenters argued that lack of understanding must be evaluated at the level of each consumer and thus cannot serve as the basis for a broad rulemaking of general applicability. Some commenters pointed to prior statements by the Bureau's Director, who stated that abusiveness cases are “unavoidably situational” and depend on an individualized inquiry of the facts and circumstances presented. Other commenters noted that the abusiveness standard is worded in the singular—“a lack of understanding on the part of the consumer”—to support this assertion.

Another commenter suggested that measures should be taken to combat advertising and marketing problems rather than accepting the restrictions on access to credit that would result from the proposed rule. Yet another industry commenter took a different approach, objecting that there was no evidence that the proposed rule could prevent the harms to consumers that it purported to address.

The Final Rule

After careful consideration of the comments received, the Bureau has concluded that when lenders make covered short-term loans without reasonably assessing whether borrowers have the ability to repay the loans according to their terms, consumers often lack understanding of the material risks and costs of these loans, which are often unaffordable and lead to the risks and harms of default, delinquency, re-borrowing, and the negative collateral consequences of forgoing basic living expenses and major financial obligations in order to avoid defaulting on their loans.

Many of the points made by commenters objecting to whether the rule satisfies this prong of the definition of abusive practices rely on arguments that conflict with credible evidence cited by the Bureau in support of the proposed rule. That evidence is discussed more thoroughly in Market Concerns—Underwriting, the Section 1022(b)(2) Analysis, and the preceding section on unfairness. After consideration of the evidence and perspectives propounded by commenters, the Bureau generally adopts the evidentiary basis it had preliminarily set forth in the proposed rule as the basis for meeting this prong of the definition of abusiveness for purposes of the final rule.

As stated in the proposal, the section on unfairness, Market Concerns—Underwriting, and the Section 1022(b)(2) Analysis, the Bureau has evidence showing that a significant proportion of consumers do not understand the kinds of harms that flow from unaffordable loans, including those imposed by default, delinquency, re-borrowing, and the collateral consequences of making unaffordable payments to attempt to avoid these other injuries. As noted above, the adverse effects for many consumers who find themselves caught up in extended loan sequences constitute severe harm, the likelihood of which is not understood by many consumers in advance. The Bureau thus concludes that a substantial population of borrowers lacks understanding of the material risks or costs of these loans.

The Bureau does not dispute that many consumers may be knowledgeable about covered short-term loans and use them effectively, including making accurate predictions about their duration of borrowing. Yet for all the reasons discussed previously, the Bureau concludes that a significant population of consumers does not understand the material risks and costs of unaffordable loans that are made without reasonably assessing the borrower's ability to repay the loan according to its terms. This does not mean that consumers are required to be experts in all aspects of how such loans function as a practical matter. But it does mean that if borrowers do not understand either their likelihood of being exposed to the risks of these loans or the severity of the kinds of costs and harms that may occur, then it is quite difficult to maintain the position that those same borrowers in fact understand the material risks and costs associated with unaffordable short-term loans. And the kinds of harms involved in the risks of default, delinquency, re-borrowing, and the collateral consequences of making unaffordable payments to avoid these other injuries—including the interrelations among these injuries—can pose complex dynamics that are not likely to be well understood by many consumers.

A number of commenters supported this view as well. Some noted that while some consumers might have a generalized understanding of how the debt associated with a covered loan can affect their economic circumstances, that understanding cannot be presumed to include an understanding of the broader risks and harms of such loans. These commenters also agreed with the Bureau that behavioral issues such as “tunneling” and “optimism bias” could have effects on decision-making that may affect consumers' ability to use and manage covered loans successfully. Although some commenters criticized this approach as “novel” and relying too heavily on behavioral economics, the Bureau has no reason to believe that these theories and methodologies are particularly unconventional at this point of their development in the field of economics. Regardless, however, the Bureau concludes that these behavioral phenomena are equally consistent with economic analyses that would rest on models of rational behavior, given the particular circumstances of the consumers of these kinds of loans.

The claim made here by industry commenters that payday loans have generated few consumer complaints, which mirrors the same claim made elsewhere by these commenters, is unpersuasive for reasons that have already been laid out in Market Concerns—Underwriting and the section on unfairness. When payday complaints are normalized, for example, in comparison to credit card complaints in view of the user population for each product, payday complaints occurred more than twice as frequently. In any event, the volume of consumer complaints received by the Bureau is by no means an effective measure, by itself, to establish the presence or absence of consumer understanding. The Bureau believes there are a number of reasons why borrowers who find themselves in extended loan sequences do not submit a complaint to the Bureau about their negative experience with such loans. First, some borrowers may be embarrassed and thus less likely to submit complaints about their situation. Second, they may blame themselves for having gotten themselves caught up in a cycle of debt authorized by State law. Third, as some commenters indicated and the Bureau has observed around the country, faith leaders and faith groups may seem a more natural audience for some borrowers to appeal in relating their dissatisfactions with these experiences.

The claim that abusiveness claims are “unavoidably situational,” and therefore the Bureau must make an individualized determination of abusiveness for each consumer, is unfounded. All decisions consumers make are individualized, but that fact does not preclude the Bureau from developing a general rule based on the statutory definitions of unfairness or abusiveness, as Congress clearly contemplated in section 1031(b) of the Dodd-Frank Act. It is true that the abusiveness standard is expressed in the statute in the singular. However, the Bureau also notes that it has the authority to declare “acts or practices” abusive, and it would be a reasonable interpretation of the statute to assume that Congress would not label abusive conduct aimed at a single consumer a “practice.” Further, it is true that each practice must be assessed based on the specific facts and circumstances before coming to an abusiveness conclusion, yet the Bureau has done so here, and this does not mean it must assess the facts and circumstances as to each consumer.

Comments suggesting that the Bureau did not prove borrowers were either infirm or ignorant are beside the point. The Bureau did not reach that conclusion, nor is it relevant under the terms of the statute applicable here. Rather, this prong of abusiveness only requires a lack of understanding.

The final point raised by many industry and trade association commenters was that any lack of consumer understanding could be addressed by improved disclosures. They reinforced this point by asserting that the Bureau is obligated to seek reformed disclosures as a more modest intervention than requiring new underwriting criteria. These comments urging that the rule should mandate disclosures rather than adopt ability-to-repay requirements are addressed in more detail below in the section-by-section analysis of § 1041.5.

For these reasons, the Bureau finds that many consumers lack an understanding of the material risks and costs associated with covered short-term loans made according to the identified practice of failing reasonably to assess the borrower's ability to repay the loan according to its terms.

Consumer Inability To Protect Interests

The Bureau's Proposal

Under section 1031(d)(2)(B) of the Dodd-Frank Act, an act or practice is abusive if it takes unreasonable advantage of the inability of the consumer to protect the interests of the consumer in selecting or using a consumer financial product or service. As the Bureau stated in the proposal, consumers who lack an understanding of the material risks and costs of a consumer financial product or service often will also lack the ability to protect their interests in selecting or using that product. Nonetheless, if a consumer lacks understanding of the risks and costs of taking out such loans and yet could still find it easy to protect against them, then the consumer might be judged able to protect her interests. The Bureau also noted in the proposal that the structure of section 1031(d) is in the disjunctive, separately declaring it to be abusive to take unreasonable advantage either of consumers' lack of understanding of material risks and costs or of their inability to protect their interests in using or selecting a product or service. As a matter of logic, then, Congress has determined that there could be situations where consumers do understand the material risks and costs of covered short-term loans yet are nonetheless unable to protect their interests in selecting or using these products.

In particular, the Bureau stated in the proposal that consumers who take out covered short-term loans may be unable to protect their interests in selecting or using such loans, given their immediate need for credit and their inability in the moment to search out or develop alternatives that would enable them either to avoid the need to borrow or to borrow on terms within their ability to repay. As discussed in Market Concerns—Underwriting, consumers who take out these loans typically are financially vulnerable and have very limited access to other sources of credit. Their need is often acute. And consumers facing an immediate liquidity shortfall may believe that a covered loan is their only choice; a Pew study found that 37 percent of borrowers say they have been in such a difficult financial situation that they would take a payday loan on almost any terms offered. They may not have the time or resources to seek out, develop, or take advantage of alternatives. These factors may place them in such a vulnerable position when taking out these loans that they are unable to protect their interests.

The Bureau also stated in the proposal that once consumers have commenced a loan sequence by taking out an unaffordable loan, they are likely to be unable to protect their interests in selecting or using subsequent loans. After they take out the initial loan, consumers are no longer able to protect their interests as a practical matter because they are already face to face with the competing injuries of default, delinquency, re-borrowing, or the collateral consequences of making unaffordable payments, with no other way to opt out of the situation. An unaffordable first loan can thus ensnare consumers in a cycle of debt from which they cannot extricate themselves without incurring some form of injury, rendering them unable to protect their interests in selecting or using these kinds of loans.

Comments Received

One commenter began by making a linguistic point that questioned whether the Bureau had conflated this prong of the abusive standard with the prior prong, suggesting that it was simply assuming that consumers taking out covered short-term loans inherently demonstrate an inability to protect their own interests, whereas many other consumers adequately protect their interests by deciding not to take out covered loans. More generally, commenters argued that lack of understanding is not enough to prove that a borrower has an inability to protect his interests. Rather, these commenters asserted that the Bureau must show that it is actually impossible for consumers to protect their interests. In the same vein, an industry commenter argued that the Bureau's claim in the proposal that consumers believe there are no better alternatives or that it would be too costly to shop for them fails to show inability to protect where such alternatives actually exist.

Others repeated points they had made about the prior prong, observing that users of covered loans are not vulnerable or unsophisticated or irrational, but rather they do understand the terms and costs of those loans. One commenter analogized the language of this prong to the prohibition against unconscionable contracts in the Uniform Consumer Sales Practices Act, and asserted that the Bureau must therefore find consumers to be infirm, illiterate, or ignorant in order to satisfy this prong.

Industry commenters also repeated their arguments that consumers tend to be accurate in their estimates of the duration of borrowing, and contended that re-borrowing is simply a preference for many consumers, rather than indicating an inability to protect their interests. These commenters also questioned the Pew study relied on by the Bureau, noting that the fact that 37 percent of short-term borrowers acknowledge they have been in an “immediate liquidity shortfall,” which they would pay off with payday loans on almost any terms offered, does not demonstrate consumers' inability to protect their own interests. On the contrary, they argued that both competition and State laws protect consumers against problematic loan features and the study showed that the other 63 percent of consumers seek alternatives to covered loans when they perceived such loans to be harmful or problematic to them.

Commenters also asserted that no “seller behavior” occurs in making covered loans that deprives consumers of their ability to make informed decisions about their use of such loans.

By contrast, consumer groups commented that covered loan borrowers are faced with an array of bad options, none of which provides them with the ability to protect their own interests. They described the significant difficulties that consumers regularly face when they are using covered short-term loans, which are traceable directly to the initial decision to take out loans that may prove to be unaffordable. And they urged that this consistent pattern is a reasonable demonstration of the proposition that a substantial portion of consumers using covered short-term loans are unable to protect their own interests.

The Final Rule

After consideration of the comments received, the Bureau now concludes that when borrowers of covered loans are subjected to the identified lender practice of making such loans without reasonably assessing the borrower's ability to repay, they are unable to protect their interests in selecting or using the loan product given the dynamics of this market and the structure and terms of these loans as described above and in Market Concerns—Underwriting.

Once again, under section 1031(d)(2)(B) of the Dodd-Frank Act, an act or practice is abusive if it takes unreasonable advantage of the inability of the consumer to protect the interests of the consumer in selecting or using a consumer financial product or service. Consumers who lack an understanding of the material risks and costs of a consumer financial product or service often will be unable to protect their interests in selecting or using covered short-term loans because if they misunderstand the likelihood and extent of those material risks, they may not be aware that they should undertake efforts to protect their interests against those risks. And if they cannot reasonably estimate the nature and magnitude of the costs they could incur from unaffordable loans made in accordance with the identified practice, then they may not, as a practical matter, have the ability to protect their interests in the face of those material costs. To this extent, the provisions of section 1031(d)(2)(B) of the Dodd-Frank Act flow from the provisions of section 1031(d)(2)(A) on consumers who lack understanding, as noted in the proposal.

But there are further reasons why consumers may be unable to protect their interests in using these loan products even if they largely understand the risks and costs involved. As discussed in the proposal and above in the section on unfairness, consumers who take out covered short-term loans may be unable to protect their interests in selecting or using such loans because many of them typically have an immediate need for credit and they cannot, in the moment, effectively identify or develop alternatives that would vitiate the need to borrow, allow them to borrow on terms within their ability to repay, or even allow them to borrow on terms not within their ability to repay but nonetheless on terms more favorable than those of a covered short-term loan. And as discussed in Market Concerns—Underwriting, many borrowers of these loans are financially vulnerable and have very limited access to other sources of credit. Confronted with an immediate liquidity problem, they may determine that a covered loan is the only option they have, as shown by the Pew study cited in the proposal, which found that 37 percent of borrowers say they have been in such a difficult financial situation that they would take a payday loan on almost any terms offered. Because they find themselves in such vulnerable circumstances when they are deciding whether to take out an initial covered short-term loan, they are unable, as a practical matter, to protect their interests.

At this point, moreover, the dynamic changes even more dramatically, as described earlier in Market Concerns—Underwriting. Borrowers who take out an initial loan on unaffordable terms are generally unable to protect their interests in selecting or using further loans. After the first loan in a sequence has been consummated, the borrower is legally obligated to repay the debt. Consumers who lack the ability to repay that initial loan are faced with making a choice among competing injuries: default, delinquency, re-borrowing, or making unaffordable payments in an effort to avoid these other injuries while forgoing basic living expenses or major financial obligations in order to repay the loan. At this juncture, the consumer has no way out of the situation other than by deciding among competing harms. Having taken out the unaffordable first loan, borrowers generally will be not be able to protect their interests in selecting or using these kinds of loans. But the Bureau acknowledges that there are exceptions to this rule. For example, there may be consumers who encounter a windfall after taking out the loan but before repaying, such that none of the injuries occurs even though at the time the loan was originated the borrower would not have had an ability to repay.

In addition, the set of problems faced by consumers who have already taken out an unaffordable loan can result in increased costs to consumers—often very high and unexpected costs—that harm their interests. Sometimes these harms can occur in combination at different points in a single loan sequence, and the dynamics of how they interact with one another in their effects on the consumer can be complex. An unaffordable first loan can thus ensnare consumers in a cycle of debt with no reasonable means to extricate themselves without incurring further harm, rendering them unable to protect their interests in selecting or using these kinds of loans.

The Bureau disagrees with the commenters who suggested that its determination that consumers taking out these loans are very often unable to protect their interests relied on the proposition that taking out such a loan is inherently demonstrative of an inability to protect oneself. Instead, the Bureau based its conclusions on the evidence that borrowers of these loans often have an urgent need and do not perceive any other options, especially once they have taken out an unaffordable loan and must confront the types of injury that they face when the next unaffordable payment comes due on their loan. A stark example of how consumers are unable to protect their interests by avoiding the injuries to which they are exposed by the identified practice is the substantial number of consumers who re-borrow—many of them repeatedly, and then eventually default—an outcome that is not in the interests of such consumers and thus one from which they would protect themselves if they were able.

Other factors also hinder consumers in being able to protect their interests, such as the mismatch between how these loans are presented to consumers—as short-term, liquidity-enhancing products that they can use to bridge an income shortfall until their next paycheck—and how they are actually designed and intended by lenders, as part of their business model, to function in long sequences of re-borrowing for a substantial population of consumers. Lenders offer a product whose term and balloon-payment structure, along with the common use of leveraged payment mechanisms or vehicle security all tend to magnify the risks and harms to the borrower who fails to avoid the injuries that occur with extended loan sequences. Many consumers are unlikely to be able to protect their interests if they are extended an unaffordable loan and are rigidly confined within the limited options of repaying in full or re-borrowing, with no low-cost repayment or amortization options being extended. Consumers in this situation have the ability to make choices among the competing harms of default, delinquency, re-borrowing, or the collateral consequences of making unaffordable payments—though even the dynamics of these interrelated harms can become complex—but they are unable to protect their interests in avoiding those harms.

The Bureau thus takes strong exception to the comment that re-borrowing is simply a preference for many consumers. If each loan in an extended loan sequence was itself an initial loan, such that it could be entered into simply with a view to the considerations moving the borrower to decide to take out a new credit obligation, then the comment would have more force. But a large volume of covered short-term loans is not at all of that kind: Many of these loans are repeat re-borrowing that occurs in a setting where consumers generally face an unavoidable choice among different harms, including potentially severe harms from unaffordable loans and thus are unable to protect their interests.

Therefore, the Bureau concludes that though borrowers of covered loans are not irrational and may generally understand their basic terms, these facts does not put borrowers in a position to protect their interests, given the nature of these loans if they are made on unaffordable terms. The Bureau again finds the comment that consumers accurately estimate their duration of borrowing to be a misleading account of the evidence it relies on here and elsewhere, which in fact shows that consumers who are best able to predict accurately the duration of their borrowing are those who repay after little or no re-borrowing, and borrowers who end up in extended loan sequences are especially likely to err in estimating how long their loan sequences will last, though they are least able to protect their interests. Here as elsewhere, the key point is not that all consumers are unable to protect their interests, but that a substantial population of borrowers is unable to protect their interests in these circumstances.

The Bureau does not agree that the language in the Dodd-Frank Act should be construed in light of the very different language of the Uniform Consumer Sales Practices Act, which one commenter urged should be interpreted as synonymous. The Dodd-Frank Act does not limit the instances in which a lender can take advantage of consumers' inability to protect their interests to those where that inability is caused by infirmity, ignorance, illiteracy, or inability to understand the language of an agreement.

Nor does the Bureau agree with commenters that asserted, in effect, that to satisfy the inability to protect condition, the Bureau must show there is no possible way for consumers to protect their interests. Rather, the Bureau reasonably interprets “inability to protect” in a practical manner under the circumstances. Thus, as the Bureau explained in the proposal and above, consumers who take out a covered short-term loan in the circumstance of their urgent need for funds, lack of awareness or availability of better alternatives, and no time to shop for such alternatives, are unable to protect their interests in selecting and using such a loan.

The claim that no “seller behavior” occurs in making covered short-term loans that causes consumers to be unable to protect their interests is both incorrect and beside the point. First, it is incorrect because the identified practice of making these loans without reasonably assessing the borrower's ability to repay the loan according to its terms is itself seller behavior that causes some consumers—those who have been extended a loan—to be unable to protect their interests when the loan comes due and the consumer is unable to repay. Second, though seller behavior does bear on the “takes unreasonable advantage” prong of the definition and will be discussed further below, it has no relevance to the question of whether consumers lack the ability to protect their interests in the selection or use of the product.

The Bureau does not find anything in the comments that undermines the soundness of the Pew study, which demonstrates that, by their own admission, consumers who take out these loans often find themselves in circumstances where they are not able to protect their interests. Moreover, the Bureau disagrees with the commenter that interpreted the negative answer to the survey question as meaning that 63 percent of respondents would seek alternatives to payday loans if the terms were perceived by them as harmful. This is pure speculation. One could likewise speculate that a negative response meant that the respondent would not seek an alternative loan and address their dire situation in some other manner. Moreover, there are many other reasons why a substantial majority of consumers may have opted not to utilize a covered loan, including that some do not need a loan at all. In contrast, there is only one plausible interpretation of an affirmative answer to the survey question, which is the one the Bureau has provided.

The suggestion that consumers are adequately protected from the risks and consequences of covered short-term loans by industry competition and State laws is inaccurate in light of the data and analysis the Bureau has presented about the substantial risks and costs of these loans, which exist despite industry competition and the existing provisions of State laws.

Having considered the comments submitted, the Bureau has concluded that many consumers are unable to protect their interests in selecting or using covered short-term loans made in accordance with the identified practice of failing to make a reasonable assessment of the borrower's ability to repay the loan according to its terms.

Practice Takes Unreasonable Advantage of Consumer Vulnerabilities

The Bureau's Proposal

Under section 1031(d)(2) of the Dodd-Frank Act, a practice is abusive if it takes unreasonable advantage of any of several consumer vulnerabilities, including lack of understanding of the material risks, costs, or conditions of such loans or inability to protect their interests in selecting or using these loans. The Bureau stated in the proposal that the lender practice of making these loans without reasonably assessing that the consumer will have the ability to repay may take unreasonable advantage of both types of consumer vulnerabilities, though either would suffice to meet this prong of the abusiveness definition.

The Bureau recognized that in any transaction involving a consumer financial product or service there is likely to be some information asymmetry between the consumer and the financial institution. Often the financial institution will have superior bargaining power as well. Section 1031(d) of the Dodd-Frank Act does not prohibit financial institutions from taking advantage of their superior knowledge or bargaining power to maximize their profit. Indeed, in a market economy, market participants with such advantages generally pursue their self-interests. However, section 1031 of the Dodd-Frank Act makes plain that there comes a point at which a financial institution's conduct in leveraging its superior information or bargaining power becomes unreasonable advantage-taking and thus is abusive.

The Dodd-Frank Act delegates to the Bureau the responsibility for determining when that line has been crossed. Several interrelated considerations led the Bureau to believe that the practice of making payday, vehicle title, and other covered short-term loans without regard to the ability to repay may cross the line and take unreasonable advantage of consumers' lack of understanding and inability to protect their interests.

First, the Bureau noted in the proposal that the practice of making loans without regard to the consumer's ability to repay the loan according to its terms stands in stark contrast to the practice of lenders in virtually every other credit market, and upends traditional notions of responsible lending enshrined in safety-and-soundness principles as well as in a number of other laws. The general principle of credit markets is that the interests of lenders and borrowers are closely aligned: Lenders succeed (i.e., profit) only when consumers succeed (i.e., repay the loan according to its terms). For example, lenders in other markets, including other subprime lenders, typically do not make loans without first making an assessment that consumers have the capacity to repay the loan according to the loan terms. Indeed, “capacity” is one of the traditional three “Cs” of lending and is often embodied in tests that look at debt as a proportion of the consumer's income or at the consumer's residual income after repaying the debt.

In the markets for covered loans, however, lenders have built a business model that—unbeknownst to borrowers—depends on repeated re-borrowing, and thus on the consumer's lack of capacity to repay such loans without needing to re-borrow. As explained in the proposal and in part II and Market Concerns—Underwriting above, the costs of maintaining business operations (which include customer acquisition costs and overhead expenses) often exceed the revenue that could be generated from making individual short-term loans that would be repaid without re-borrowing. Thus, in this market the business model of the lenders depends on a substantial percentage of consumers not being able to repay their loans when they come due and, instead, taking out multiple additional loans in quick succession. Indeed, upwards of half of all payday and single-payment vehicle title loans are made to—and an even higher percentage of revenue is derived from—borrowers in a sequence of 10 loans or more. This dependency on revenue from long-term cycles of debt has been acknowledged by industry stakeholders. For example, as noted in Market Concerns—Underwriting, an attorney for a national trade association representing storefront payday lenders asserted in a letter to the Bureau that “[i]n any large, mature payday loan portfolio, loans to repeat borrowers generally constitute between 70 and 90 percent of the portfolio, and for some lenders, even more.”

Also relevant in assessing whether the practice identified here—of making covered short-term loans without reasonably assessing the borrower's ability to repay the loan according to its terms—involves unreasonable advantage-taking is the vulnerability of the consumers seeking these types of loans. As discussed above in Market Concerns—Underwriting, payday and vehicle title borrowers—and by extension borrowers of similar covered short-term loans—generally have modest incomes, little or no savings, and have tried and failed to obtain other forms of credit. They generally turn to these products in times of need as a “last resort,” and when the loan comes due and threatens to take a large portion of their disposable income, their situation becomes, if anything, even more desperate.

In addition, the evidence described above in Market Concerns—Underwriting suggests that lenders engage in practices that further exacerbate the risks and costs to the interests of consumers. In addition to the identified practice of making such loans without any underwriting to gauge their affordability, lenders rely on the term and balloon-payment structure of these loans to yield the intended result of extensive re-borrowing. Lenders market these loans as being for use “until next payday” or to “tide over” consumers until they receive income, thus encouraging overly optimistic thinking about how the consumer is likely to use the product. Lenders also make this re-borrowing option easy and salient to consumers in comparison to repayment of the full loan principal. Moreover, lenders typically limit the options available to borrowers by not offering or not encouraging borrowers to make use of alternatives that would reduce the outstanding principal over the course of a loan sequence, which would help consumers extricate themselves from the cycle of indebtedness more quickly and reduce their costs from re-borrowing. Storefront lenders, in particular, encourage extended loan sequences by encouraging or requiring consumers to repay in person in an effort to frame the consumer's experience in such a way to promote re-borrowing. Lenders often give financial incentives to employees to produce this outcome and thus reward them for maximizing loan volume.

Comments Received

One trade association commented that lenders are allowed to take advantage of their superior knowledge and bargaining power and doing so is not contrary to law. In their view, the Bureau's perspective that the re-borrowing model undergirding the market for covered loans stands in contrast to other markets is attributable to the restrictions imposed by State laws rather than by borrower needs and expectations. They also maintained that lenders have little incentive to take advantage of borrowers who they hope will return to them for subsequent loans after repaying those which are outstanding.

By contrast, although consumer groups agreed with the general proposition that lenders can take advantage of superior knowledge and bargaining power, they emphasized that the proposed rule would prevent lenders from taking unreasonable advantage of consumers. They also noted that the financial vulnerability of many consumers who are likely to seek covered short-term loans is relevant to this inquiry.

One commenter noted that a lender cannot take unreasonable advantage of a borrower through “acts of omission,” such as by failing to ask for pay stubs or other verification evidence or failing to check with consumer reporting agencies for information about the borrower's credit history. Others asserted that an unreasonable advantage is not taken when lenders make loans to consumers with damaged credit or in need of cash, or advertise their loans as “quick” or “speedy” to cater to borrower needs, or offer terms that are readily and easily understood by borrowers. Some argued that the rule simply substitutes the Bureau's judgment and risk tolerance for that of consumers. Still others argued that a lender cannot take unreasonable advantage of a consumer when the benefits of a loan exceed its costs.

The Final Rule

The Bureau now concludes, after consideration of the comments received, that when lenders make covered short-term loans without reasonably assessing whether the borrower has the ability to repay the loan according to its terms, lenders take unreasonable advantage of consumers' lack of understanding of the material risks, costs, and conditions of these loans, and also take advantage of their inability to protect their interests in selecting or using these loans.

The Bureau does not dispute the proposition that lenders may take reasonable advantage of their superior knowledge and bargaining power. Nonetheless, in the proposal the Bureau preliminarily found that many lenders who make such loans have crossed the threshold to take impermissible and unreasonable advantage of those to whom they lend. The suggestion that these lenders have little incentive to take advantage of borrowers who are likely to be repeat customers is unfounded—there is an enormous difference between a scenario in which a borrower successfully repays a loan and later returns to apply for another loan (i.e., a true “repeat customer”), as compared to a scenario in which a borrower is forced to re-borrow again and again to cope with the problems posed by an unaffordable loan. Given that such a large majority of covered loans (over 80 percent) consist of loans procured through re-borrowing, and given that this is the core of the business model, it is evident that lenders have very significant incentives to take advantage of consumers' lack of understanding of the material risks and their inability to protect themselves in the choice of the product. And once a consumer has taken a loan, lenders have at least equally significant incentives to take advantage of their inability to protect themselves with respect to the choice of the next loan in order to encourage re-borrowing. The factual background for the core elements of the Bureau's conclusion that the “taking unreasonable advantage” prong is met in these circumstances have been discussed at length in the section on unfairness and above in Market Concerns—Underwriting. For the sake of convenience, however, much of that analysis will be restated here.

First, many consumers may not be able to protect their interests or to understand either the likelihood or the extent of the risks and costs of loans made in accordance with the identified practice of failing to make a reasonable assessment of the borrower's ability to repay the loan according to its terms. In the face of these vulnerabilities, the general practice in this market is that lenders nonetheless make it their practice not to assess the borrower's ability to repay. As a result, they typically have a significant volume of loans that are unaffordable from the outset in accordance with their terms.

As discussed above in part II and in Market Concerns—Underwriting, this approach is in fact the core of the business model for most such lenders and reflects a deliberate decision on their part. Nothing in State or Federal law prohibits these lenders from engaging in meaningful underwriting on the loans they make. In this respect, the direction taken in this market is, in fact, out of step with traditional lender-borrower relationships in other loan markets, where the success of the lender is intertwined with the success of the borrower and determinations about loans that will be offered and accepted are preceded by underwriting assessments and determinations of this kind. Instead, the profitability of these lenders is built on, and depends upon, repeat re-borrowing by consumers.

This model of lending premised on very minimal underwriting—often limited to screening only for potential fraud—is exacerbated by another common practice of these lenders once the initial loan, often unaffordable according to its terms, has been made. At this point, these lenders typically provide the borrower with few or no repayment options other than either full repayment all at once or continued re-borrowing (which incurs another set of fees but provides no reduction of the loan principal). The array of repayment options provided in many other lending markets are virtually nonexistent here. Low-cost repayment or amortization options are typically not presented at all or are minimized or obscured in various ways. This again is a deliberate choice made by lenders in this market, not compelled by either State or Federal law. Indeed, the Bureau's close experience over the past five years from exercising its supervision and enforcement authority over this market indicates that, even when such options are supposed to be afforded under provisions of some State laws, lenders often find ways to mask or obscure them or otherwise impede borrowers from availing themselves of them. Indeed, even consumers who are delinquent and have further demonstrated their inability to repay the loan according to its terms are encouraged to re-borrow, which leads many consumers to engage in extensive re-borrowing even where they eventually wind up in default. For many re-borrowers, the upshot is that they end up making repeated payments that become increasingly unaffordable in the aggregate over time, even though a substantial number of them still will sustain the harms associated with default.

The Bureau also has observed other lender conduct that greatly increases the risks and harms to consumers in these circumstances. Covered short-term loans, in particular, involve a basic mismatch between how they appear to function as short-term credit and how they are actually designed and intended by lenders, as part of their business model, to function in long sequences of re-borrowing for a substantial population of consumers. Lenders present these loans as short-term, liquidity-enhancing products that consumers can use to bridge an income shortfall until their next paycheck. But in practice, across the universe of borrowers, these loans often do not operate that way. Lenders have designed the term of the loan, its balloon-payment structure, and the common use of leveraged payment mechanisms, including vehicle security, so as to magnify the risks and harms to the borrower. The disparity between how these loans appear to function and how they actually function increases the difficulties that consumers experience with these loans.

Once consumers have taken out a loan, they have no practical means to avoid the injuries that will occur if the loan proves to be unaffordable. Consumers who obtain a covered short-term loan that is beyond their ability to repay confront the harms of default, delinquency, re-borrowing, or the collateral consequences of making unaffordable payments that would cause them to forgo basic living expenses or major financial obligations. They can make choices among these competing harms but not avoid them. And as discussed above in Market Concerns—Underwriting, and below in Market Concerns—Payments, lenders engage in other practices that further increase the likelihood and degree of harm, for instance by encouraging additional re-borrowing and its attendant costs even for consumers who are already experiencing substantial difficulties as they are mired in extended loan sequences, and by engaging in payment collection practices that are likely to cause consumers to incur substantial additional fees beyond what they already owe on the terms of the existing loan. Further adverse effects can include expensive bank fees, the potential loss of their bank account, aggressive debt collection efforts, and, with title loans, the risks and costs of having their vehicle repossessed, causing them to lose their transportation to work or conduct their ordinary personal affairs.

As discussed earlier, this practice of making loans without regard to the consumer's ability to repay contrasts sharply with the regular practice of lenders in virtually every other credit market, and upends traditional notions of responsible lending enshrined in safety-and-soundness principles as well as in a number of other laws. The general principle of credit markets is that the interests of lenders and borrowers are aligned and lenders benefit only when their customers are successful in repaying their loans in accordance with the terms. For this reason, lenders in other markets, including other subprime lenders, typically do not make loans without first making an assessment that consumers have the capacity to repay the loan according to the loan terms.

Yet the set of effects found in the market for covered short-term loans has the cycle of indebtedness at its core, as intended and effectuated by lenders in this market. And it affects a large segment of borrowers: As described above in Market Concerns—Underwriting, half of all storefront payday loan sequences contain at least four loans. One-third contain seven loans or more, by which point consumers will have paid charges equal to 100 percent of the original amount borrowed and still owe the full amount of the principal. Almost one-quarter of loan sequences contain at least 10 loans in a row, and looking just at loans made to borrowers who are paid weekly, biweekly, or semi-monthly, more than one-fifth (21 percent) of those loans are in sequences consisting of at least 20 loans. For loans made to borrowers who are paid monthly, almost half (46 percent) of the loans are in sequences consisting of at least 10 loans. The figures for title loans are similar, and also are premised on a business model built around repeated re-borrowing: 56 percent of vehicle title loan sequences consist of more than three loans, 36 percent consist of at least seven loans, and almost one quarter—23 percent—consist of more than 10 loans.

Regardless of what the outer bounds of “taking unreasonable advantage” may be, the Bureau concludes that the ways lenders have structured their lending practices here fall well within any reasonable definition of that concept. Here the identified practice of making loans without reasonably assessing the borrower's ability to repay the loan according to its terms leads to unaffordable loans and all the harms that follow upon them. At a minimum, lenders take unreasonable advantage of borrowers when they develop lending practices that are atypical in the broader consumer financial marketplace, take advantage of particular consumer vulnerabilities, rely on a business model that is directly inconsistent with the manner in which the product is marketed to consumers, and eliminate or sharply limit feasible conditions on the offering of the product (such as underwriting and amortization, for example) that would reduce or mitigate harm for a substantial population of consumers. The Bureau now affirms that lenders take such unreasonable advantage in circumstances where they make covered short-term loans or covered longer-term balloon-payment loans without reasonably assessing the consumer's ability to repay the loan according to its terms.

The Bureau does not disagree with the commenters who noted that lenders do not take unreasonable advantage of consumers when they make loans to consumers with damaged credit or in need of cash, or they advertise their loans as quick or speedy to cater to borrower needs, or they offer terms that are readily and easily understood by borrowers. Neither in isolation nor taken together do these particular acts or practices constitute abusive behavior. The Bureau concludes instead that, by engaging in the identified practice, lenders take unreasonable advantage of consumer vulnerabilities.

Moreover, the rule does not substitute the Bureau's judgment and risk tolerance for those of consumers. Instead, it simply seeks to assure that lenders do not take unreasonable advantage of consumers' lack of understanding or inability to protect their interests through use of the identified practice. Even well-educated and sophisticated consumers can lack understanding of a loan product whose structural effects are complex and opaque, leading many of them to the negative consequences that flow from an extended cycle of indebtedness.

The Bureau disagrees with the commenters who noted that a lender cannot take unreasonable advantage of a borrower by failing to underwrite appropriately, such as by failing to ask for pay stubs or other verification evidence or failing to check with consumer reporting agencies for information about the borrower's credit history. The thrust of these comments is that the lender cannot “take unreasonable advantage” by seeking to reduce burdens and make life easier for consumers and, in particular, cannot do so by “acts of omission.” On the contrary, the Bureau has shown that lenders utilize these and related practices to position a substantial population of borrowers to take out unaffordable loans that lead directly to debt cycles of long-term re-borrowing. And as the law has long recognized in various contexts, there is no material distinction to be made between acts of omission and acts of commission, particularly here where these aspects of the identified practice take unreasonable advantage of consumer vulnerabilities.

With respect to the comments that a lender cannot take unreasonable advantage of a consumer when the benefits of a loan exceed its costs, as stated above in the unfairness section, the Bureau has concluded that the countervailing benefits of the identified practice, rather than of the product itself, do not outweigh the substantial injury. In determining whether the lender takes unreasonable advantage, the Bureau's focus is not on the variable experiences of the entire heterogeneous borrower universe, but rather on the adverse effects that the identified practice has on a substantial population of consumers where lenders are taking unreasonable advantage of their vulnerabilities by making unaffordable loans to them. Thus, for the sake of argument, even if it were true that a practice that is net beneficial for consumers cannot be found to take unreasonable advantage, that would not stand as an impediment to finding the practice at issue here to be abusive. Further, nothing in the final rule prevents any lender from offering loans whose benefits exceed their costs, regardless of the specific population for which that judgment is being made, as long as the lender does not engage in the identified practice of failing to make a reasonable assessment of ability to repay when making such loans.

In sum, the Bureau concludes that where a borrower lacks understanding of the material risks and costs of covered short-term loans, or where the borrower lacks an ability to protect his own interests by using or selecting these loans, the lender takes unreasonable advantage of these consumer vulnerabilities by making a covered short-term loan without reasonably assessing the borrower's ability to repay the loan according to its terms, where the natural result of that practice is that a substantial number of consumers will be caught up in extended loan sequences, with the adverse consequences that have been amply canvassed above and in Market Concerns—Underwriting. The Bureau does not take issue with the comment that it should take into consideration the array of State laws governing covered short-term loans. The Bureau has carefully considered the effects of those laws and concludes that the laws in those States that authorize such loans do not adequately protect consumers, because the negative effects for consumers that are described at length in Market Concerns—Underwriting continue to exist despite those State laws.

Having considered the comments submitted, the Bureau has concluded that there is substantial evidence and a sufficient basis to determine that the identified practice of making covered short-term and longer-term balloon-payment loans, without reasonably assessing the borrower's ability to repay the loan according to its terms, takes unreasonable advantage either of the borrower's lack of understanding of the material risks and costs of these loans or of the borrower's inability to protect his own interests by using or selecting these loans.

Section 1041.5 Ability-to-Repay Determination Required

General Approach in Proposed Rule

As discussed in the section-by-section analysis of § 1041.4 above, the Bureau tentatively concluded in the proposed rule that it is an unfair and abusive act or practice to make a covered short-term loan without reasonably determining that the consumer will have the ability to repay the loan. Section 1031(b) of the Dodd-Frank Act provides that the Bureau's rules may include requirements for the purpose of preventing unfair or abusive acts or practices. The Bureau thus proposed to prevent the abusive and unfair practice by including in proposed §§ 1041.5 and 1041.6 certain minimum requirements for how a lender may reasonably determine that a consumer has the ability to repay a covered short-term loan.

Proposed § 1041.5 set forth the prohibition against making a covered short-term loan (other than a loan that satisfies the protective conditions in proposed § 1041.7) without first making a reasonable determination that the consumer will have the ability to repay the covered short term loan. It also, in combination with proposed § 1041.6, specified the minimum elements of a baseline methodology that would be required for determining a consumer's ability to repay, using a residual-income analysis and an assessment of the consumer's prior borrowing history. In particular, proposed § 1041.6 would have required that a presumption of unaffordability applied if a consumer sought a new covered short-term loan within 30 days of a prior outstanding covered short-term loan, and applied a mandatory 30-day cooling-off period after the third such loan in a sequence.

The Bureau proposed similar ability-to-repay requirements for covered longer-term loans, including covered longer-term balloon-payment loans, in proposed §§ 1041.9 and 1041.10. Given the parallel nature of proposed §§ 1041.5 and 1041.6 for covered short-term loans and proposed §§ 1041.9 and 1041.10 for covered longer-term loans, the Bureau will generally refer just to proposed §§ 1041.5 and 1041.6 to describe the proposed ability-to-repay framework, but will note where proposed §§ 1041.9 and 1041.10 differed from the framework for covered short-term loans.

The baseline methodology in proposed § 1041.5 rested on a residual-income analysis—that is, an analysis of whether, given the consumer's projected income and major financial obligations, the consumer will have sufficient remaining (i.e., residual) income to cover the payments on the proposed loan and still meet basic living expenses. The proposal also would have required lenders to track the timing of inflows and outflows of funds to determine whether there would be periods of shortfall that might prompt consumers to re-borrow soon after a previous covered short-term loan. In the proposal, the Bureau recognized that, in other markets and under other regulatory regimes, financial capacity is more typically measured by establishing a maximum debt-to-income (DTI) ratio. DTI tests generally rest on the assumption that as long as a consumer's debt burden does not exceed a certain threshold percentage of the consumer's income, the remaining share of income will be sufficient for a consumer to be able to meet non-debt obligations and other expenses. By its nature, DTI must be calculated by dividing total income and total expenses for the relevant time period, and does not permit the tracking of a consumer's individual income inflows and major financial obligation outflows on a continuous basis over a period of time.

For low- and moderate-income consumers, the Bureau expressed concern in the proposal that a DTI ratio would not be sufficiently sensitive to determine re-borrowing risk in the markets for covered loans. In particular, the Bureau noted that a DTI ratio that might seem quite reasonable for the “average” consumer could be quite unmanageable for a consumer at the lower end of the income spectrum and the higher end of the debt burden range. Ultimately, the Bureau posited in the proposal, whether a particular loan is affordable will depend upon how much money the consumer will have left after paying existing obligations and whether that amount is sufficient to cover the proposed new obligation while still meeting basic living expenses.

The Bureau additionally stated in the proposal that, in contrast with other markets in which there are long-established norms for DTI levels that are consistent with sustainable indebtedness, the Bureau did not believe that there existed analogous norms for sustainable DTI levels for consumers taking covered short-term loans. The Bureau stated in the proposal that it thus believed that residual income was a more direct test of ability to repay than DTI and a more appropriate test with respect to the types of products covered in this rulemaking and the types of consumers to whom these loans are made.

The Bureau emphasized in the proposal that it had attempted to design the residual income methodology specified in proposed §§ 1041.5 and 1041.6 to ensure that ability-to-repay determinations can be made through scalable underwriting models. While it was proposing that the most critical inputs into the determination rest on documentation, the Bureau noted that its proposed methodology would allow for various means of documenting major financial obligations and also permit alternatives to documentation where appropriate. The Bureau recognized in particular that rent often cannot be readily documented and therefore would have allowed for estimation of rental expense based on the housing expenses of consumers with households in the locality of the consumer. The Bureau's proposed methodology also would not have mandated verification or detailed analysis of consumers' expenditures for basic living expenses. The Bureau stated in the proposal that it believed that such detailed analysis may not be the only method to prevent unaffordable loans and was concerned that it would substantially increase costs to lenders and consumers.

Finally, the Bureau emphasized that the proposed methodology would not dictate a formulaic answer to whether, in a particular case, a consumer's residual income is sufficient to make a particular loan affordable. For instance, the Bureau did not propose a specific minimum dollar threshold for adequate residual income. Instead, the proposed methodology would have allowed lenders to exercise discretion in arriving at a reasonable determination with respect to that question.

Proposed § 1041.5 outlined the methodology for assessing the consumer's residual income as part of the assessment of ability to repay. Proposed § 1041.5(a) set forth definitions used throughout proposed §§ 1041.5 and 1041.6.

Proposed § 1041.5(b) set forth the proposed requirement for a lender to determine that a consumer will have the ability to repay a covered short-term loan and set forth minimum standards for a reasonable determination that a consumer will have the ability to repay such a covered loan. In the standards in proposed § 1041.5(b), the Bureau generally proposed to require a lender to determine that the consumer's income will be sufficient for the consumer to make payments under a covered short-term loan while accounting for the consumer's payments for basic living expenses and major financial obligations.

Proposed § 1041.5(c) set forth standards for verification and projections of a consumer's income and major financial obligations on which the lender would be required to base its determination under proposed § 1041.5.

Proposed § 1041.6 would have augmented the basic ability-to-repay determination required by proposed § 1041.5 in circumstances in which the consumer's recent borrowing history or current difficulty in repaying an outstanding loan provides important evidence with respect to the consumer's financial capacity to afford a new covered short-term loan. For example, proposed § 1041.6 would have imposed a presumption of unaffordability in various circumstances suggesting that a consumer lacked the ability to repay a current or recent loan, so that a lender would have been permitted to extend a new covered short-term loan under proposed § 1041.5 only if there was particular evidence of a sufficient improvement in financial capacity. In addition, where a consumer took out a sequence of three covered short-term loans, each within 30 days of the prior outstanding loan, proposed § 1041.6 would have imposed a mandatory 30-day cooling-off period. The Bureau believed that these requirements would help consumers to avoid getting stuck in long cycles of debt. See section-by-section analysis for § 1041.5(d), below, for further discussion of proposed § 1041.6.

The Bureau explained in the proposal that as an alternative to the proposed ability-to-repay requirement, it had considered whether lenders should be required to provide disclosures to consumers warning them of the costs and risks of re-borrowing, default, and collateral harms from unaffordable payments associated with taking out covered short-term loans. However, the Bureau stated in the proposal that it believed that such a disclosure remedy would be significantly less effective in preventing the identified consumer harms, for three reasons. First, the Bureau stated that disclosures would not address the underlying incentives in the market for lenders to encourage consumers to re-borrow and take out long sequences of loans. As discussed in the proposal's section on Market Concerns—Short-Term Loans, the prevailing business model involves lenders deriving a very high percentage of their revenues from extended loan sequences. The Bureau stated in the proposal that while enhanced disclosures would provide additional information to consumers, the loans would remain unaffordable for consumers, lenders would have no greater incentive to underwrite more rigorously, and lenders would remain dependent for revenue on extended loan sequences of repeat re-borrowing by many consumers.

Second, the Bureau stated in the proposal that empirical evidence had led it to believe that disclosures would have only modest impacts on consumer borrowing patterns for short-term loans generally and negligible impacts on whether consumers re-borrow. In the proposal, the Bureau discussed evidence from a field trial of several disclosures designed specifically to warn of the risks of re-borrowing and the costs of re-borrowing that showed that these disclosures had a marginal effect on the total volume of payday borrowing. Further, the Bureau discussed in the proposal its analysis of the impact of a change in Texas law (effective January 1, 2012) requiring payday lenders and short-term vehicle title lenders to provide a new disclosure to prospective consumers before each payday loan transaction. The Bureau observed in the proposal that, using the Bureau's supervisory data, it had found that, with respect to payday loan transactions, there was an overall 13 percent decline in loan volume in Texas after the disclosure requirement went into effect, relative to the loan volume changes for the study period in comparison States. As discussed in the proposal, the Bureau noted that its analysis of the impacts of the Texas disclosures also showed that the probability of re-borrowing on a payday loan only declined by approximately 2 percent once the disclosure was put in place.

The Bureau stated in the proposal that this finding indicates that high levels of re-borrowing and long sequences of payday loans remain a significant source of consumer harm even with a disclosure regime in place. Further, the Bureau stated in the proposal that, as discussed in the proposal's section on Market Concerns—Short-Term Loans, the Bureau has observed that consumers have a very high probability of winding up in very long loan sequences once they have taken out only a few loans in a row. The Bureau stated in the proposal that the extremely high likelihood that a consumer will wind up in a long-term debt cycle after taking out only a few loans contrasts sharply with the nearly negligible impact on consumer re-borrowing patterns of a required disclosure, which the Bureau viewed as providing further evidence that disclosures tend to be ineffective in addressing what the Bureau considered to be the core harms to consumers in this credit market.

Third, the Bureau stated in the proposal that it believed that behavioral factors made it more likely that disclosures to consumers taking out covered short-term loans would be ineffective in warning consumers of the risks and preventing the harms that the Bureau sought to address with the proposal. The Bureau stated in the proposal that due to general optimism bias and the potential for tunneling in their decision-making, as discussed in more detail in the proposal's section on Market Concerns—Short-Term Loans, consumers are likely to dismiss warnings of possible negative outcomes as not applying to them, and not to focus on disclosures of the possible harms associated with outcomes—re-borrowing and default—that they do not anticipate experiencing themselves. The Bureau stated in the proposal that to the extent consumers have thought about the likelihood that they themselves will re-borrow or default (or both) on a loan, a general warning about how often people re-borrow or default (or both) is unlikely to cause them to modify their approach by revising their own expectations about what the chances are that they themselves will re-borrow or default (or both).

Legal Authority

As noted above in the section-by-section analysis for § 1041.4, the Bureau has authority to prescribe rules applicable to a covered person or service provider identifying as unlawful unfair, deceptive, or abusive acts or practices in connection with any transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service. The Bureau has done so in § 1041.4. Additionally, the Bureau may include in such rules requirements for the purpose of preventing such acts or practices. It is based on that authority that the Bureau issues § 1041.5.

A number of commenters, including several industry trade associations and lenders, challenged the Bureau's authority to enact a prescriptive ability-to-repay requirement because Congress did not specifically authorize such a requirement with respect to payday loans and other loans the Bureau proposed to cover, in contrast to the mortgage and credit card markets. Consumer advocates and some other commenters, however, argued that the Bureau had ample authority to impose the proposed ability-to-repay requirement under the UDAAP authority granted to the Bureau under the Dodd-Frank Act. These comments are addressed in the section-by-section analysis for § 1041.4, above (“Identification of Unfair and Abusive Practice—Covered Loans”).

More generally, the Bureau received a number of comments asserting that its proposed rule had exceeded its authority to prevent the unfair and abusive practice identified in § 1041.4, by prescribing more detailed underwriting requirements than would be required to avoid engaging in the identified unfair or abusive practice.

By its terms, section 1031 of the Dodd-Frank Act authorizes the Bureau not only to “prescribe rules applicable to a covered person or service provider identifying as unlawful unfair, deceptive or abusive acts of practices” but also provides that “Rules under this section may include requirements for the purpose of preventing such acts or practices.” This latter phrase would be surplusage if the Bureau's rulemaking authority were as circumscribed as these commenters suggest. Furthermore, as discussed above in part IV, courts have long held that rulemakings to remedy and prevent unfair acts and practices may include preventative requirements so long as those requirements have a “reasonable relation to the unlawful practices found to exist.” The Bureau believes that the final underwriting requirements as set forth in § 1041.5 are reasonably related to, and crafted adequately to prevent, the abusive and unfair practice identified in § 1041.4. The unfair and abusive practice is making covered short-term and longer-term balloon-payment loans without reasonably determining that consumers will have an ability to repay the loans according to their terms. Section 1041.5 sets forth a balanced approach, providing flexibility in some areas and bright-line guidance in others, that is aimed at ensuring that lenders account for net income, major financial obligations, and basic living expenses, and make a reasonable determination about whether a consumer will be able to repay the loan according to its terms, using those variables in a residual income or debt-to-income ratio calculation. And other provisions in § 1041.5, such as the cooling-off periods in paragraph (d), are likewise reasonably related to the identified practice in that they temporarily prohibit continued lending to consumers who have already received a sequence of three covered short-term loans or covered longer-term balloon-payment loans in quick succession, to both protect them from further unaffordable loans and potentially enable them to escape from a cycle of indebtedness.

General Comments Received

In this general section, before describing the details of proposed § 1041.5, comments, and changes in the final rule on specific paragraphs of § 1041.5 below, the Bureau is addressing comments about the Bureau's general proposed approach, including the overall burden of the proposed ability-to-repay requirements and general methodology proposed, the specificity of the rule, the comparison of the proposed approach to underwriting in other markets, the predictiveness of residual income methodologies, the decision not to adopt a disclosure-only remedy to the identified unfair and abusive practice, the decision not to permit a payment-to-income underwriting model and other alternatives suggested by commenters, and assertions that the rule will conflict with the interests of fair lending law.

The Bureau received a significant number of comments from a variety of stakeholders, including lenders of different types and sizes, industry trade associations, some service providers, some State and local elected officials, the SBA Office of Advocacy, a joint letter from five Members of Congress, and others asserting that the Bureau's proposed ability-to-repay regime would, in the aggregate, be too burdensome, rigid, and complicated. One commenter stated that one of the chief virtues of payday and other covered loans is their lack of underwriting, and if underwriting were required, it is unlikely that businesses would make nearly as many covered short-term loans. Many commenters believed that the burden would be so high that it would significantly reduce access to credit, including even to consumers who do have the ability to repay. One commenter stated that some in the industry have estimated an increase in cost for each loan of about $30, and several commenters asserted that lenders would need to increase prices to cover the additional costs. Others argued that while the more burdensome underwriting requirements proposed in the rule may be common for banks making other types of loans; they would be new and quite difficult for non-bank lenders to implement. Relatedly, some commenters noted that the small balances of covered loans, particularly covered short-term loans which often are $500 or less, might not allow lenders to offset the additional costs required to comply with the underwriting requirements. Some commenters suggested that only large lenders would be able to survive the additional compliance cost. Several commenters, including a SER and five Members of Congress, cited a presentation by representatives of four specialty consumer reporting agencies which appeared to suggest that the proposed ability-to-repay requirements would disqualify any consumer who earned under $40,000 per year, asserting that would effectively result in denial of credit access to 140 million Americans.

Some commenters also suggested that the burdensome and complex underwriting requirements would significantly increase the time needed to underwrite a loan, and did not agree with the Bureau that lenders would be able to automate sufficiently to keep origination times short. The Bureau received a number of estimates on the time it would take to originate a loan. For example, one commenter asserted that it would take more than 10 minutes. Another said it would take 15-20 minutes to originate a loan manually. One estimated that it would increase transaction time by 15-45 minutes, while another said it would increase the time by 6-25 minutes. Another commenter wrote that origination already takes 20 minutes, and the new documentation requirements would add to that timing. And one trade association asserted that it would take three hours.

Many of these commenters specifically focused on the Bureau's proposal to require a residual income underwriting requirement, which they argued was overly burdensome and prescriptive. Commenters argued that prescribing such an underwriting methodology would be a novel approach that is not common in other credit markets, and would be inconsistent with the general merits of preserving flexibility in underwriting models. Several commenters cited the preamble discussion to the Bureau's final ability-to-repay rule for mortgages as evidence of its novelty as an underwriting methodology. Several commenters asserted that the proposed residual income methodology would not prevent the default and re-borrowing injuries identified in the Bureau's analysis, relying on studies that the commenters believed showed that residual income is not predictive of such outcomes.

Commenters also stated that they believed that the proposed underwriting requirements were not specific enough with regard to such issues as estimates for basic living expenses, the general reasonableness standard for lenders' ability-to-repay analyses, the lack of a numeric threshold or other guidance for what constitutes sufficient residual income, and what kinds of loan performance patterns would be evidence that a lender's ability-to-repay analysis was inadequate. These commenters recognized that the Bureau had attempted to leave some amount of flexibility and discretion to lenders, but argued that more clarity was needed to reduce compliance risk associated with choices made in the “grey area.” One commenter noted that the underwriting model for mortgage loans from the U.S. Department of Veterans Affairs involves a more prescriptive methodology based on residual income that sets forth precise dollar figures for required residual income based on various variables, and that if a residual income approach was going to be adopted, the commenter believed this was a more workable model.

Relatedly, a number of commenters, including several lenders and industry trade associations, suggested the Bureau permit use of a debt-to-income ratio as an alternative to residual income, citing the Bureau's mortgage and credit card regulations (12 CFR 1026.43 and 12 CFR 1026.51, respectively) as precedent for that approach. They also discussed how the DTI ratio is a more familiar and time-tested concept for lenders across other credit markets. Some of these commenters argued that the Bureau should permit, instead of require, a residual income underwriting model, and also allow lenders to use a more traditional method premised on a DTI ratio.

A number of commenters, including several lenders and industry trade associations, argued that the proposed rule set forth ability-to-repay requirements that were more rigorous and burdensome than that set forth in the Bureau's ability-to-pay rules for credit cards (12 CFR 1026.51) and ability-to-repay rules for mortgages (12 CFR 1026.43), and asserted that the inconsistency was unwarranted. The Bureau's regulations under the CARD Act generally require underwriting that considers the consumer's ability to make the required minimum periodic payments under the terms of the account based on the consumer's income or assets and the consumer's current obligations; provides that card issuers must establish and maintain reasonable written policies and procedures to consider the consumer's ability to make the required minimum payments; and provides that reasonable policies and procedures include consideration of at least one of the following: The ratio of debt obligations to income; the ratio of debt obligations to assets; or the income the consumer will have after paying debt obligations. The Bureau's regulation on mortgage underwriting requires that a lender of covered transactions must make a reasonable and good faith determination at or before consummation that the consumer will have a reasonable ability to repay the loan according to its terms, and allows lenders to use either the consumer's monthly debt-to-income ratio or residual income in making that determination. These commenters argued that the Bureau's underwriting regulations for these other markets were more flexible than the regulation proposed here. Some commenters believed it was illogical and unjustified to impose more prescriptive and restrictive underwriting and verification requirements for small-dollar loans when the Bureau imposes, in their view, less prescriptive and restrictive underwriting and verification requirements for other loans of much larger size (e.g., mortgages). Several commenters noted that the proposal would require a determination of the consumer's ability to repay the entire principal amount while the credit card rules require a determination regarding the consumer's ability to make minimum payments, stating or implying that this was a difference in legal standards for ability to repay and questioning the basis for it; one commenter suggested the Bureau was imposing a different standard because it did not “trust” consumers in this market to make decisions for themselves. On a similar note, some commenters stated that the underwriting requirements would be greater than those in the student loan and automobile loan (for purchase money) markets.

Other commenters, including consumer advocates and at least some industry stakeholders (including several installment lenders), generally supported the underlying principle of the rule requiring lenders to make a reasonable determination that consumers have an ability to repay, noting that it is a fundamental, common-sense tenet of responsible lending in most loan markets. These commenters noted the precedent in the Bureau's regulations relating to mortgages and credit cards, as well as the other Federal precedent noted above in Market Concerns—Underwriting. Some consumer groups agreed that an underwriting methodology based on residual income was the most appropriate underwriting model for determining whether consumers have an ability to repay and asserted that alternative approaches were too permissive. Consumer advocates writing jointly suggested a number of specific changes to the proposal which in their view would strengthen elements of the ability-to-repay requirement, which are described in more detail below.

Some commenters argued that the Bureau should allow an approach that would permit lenders to lend up to a prescribed payment-to-income ratio (generally suggested by commenters as 5 percent) as an alternative to a residual income underwriting approach, an approach the Bureau had contemplated in the Small Business Review Panel Outline and on which it specifically solicited comment in the proposal. During inter-agency consultations on the final rule, a fellow financial regulator also expressed support for this concept. These commenters argued that a payment-to-income approach would provide a streamlined compliance option for lower-cost lenders for whom the proposed ability-to-repay requirements would prove too cumbersome and expensive. These commenters cited positively the Bureau's consideration of such a policy at the SBREFA process stage and criticized the Bureau's failure to include the option as an alternative in the proposed rule. One research and public policy organization discussed in its comment letter potential additional policy suggestions that it believed would address criticisms of the approach raised by other stakeholders, including restricting lenders from using the payment-to-income approach if they experience high default rates (over 10 percent) and limiting the total loan cost to 50 percent of the amount borrowed. This commenter also sent a separate comment letter in conjunction with a number of large and mid-sized banks and other stakeholders endorsing the payment-to-income concept, arguing it would provide a streamlined and more cost-effective approach for depository institutions to make small-dollar loans. That letter also provided a number of additional policy suggestions containing changes to the payment-to-income approach described in the Small Business Review Panel Outline, such as clarifying that evidence of regular deposits represents sufficient verification of income. The commenters also urged the Bureau to work with the federal prudential regulators to ensure sensible, streamlined regulatory oversight for small-dollar loans.

In contrast, a number of consumer groups and other commenters strongly urged the Bureau not to adopt a payment-to-income approach and supported the Bureau's decision not to propose it as an alternative. The consumer groups stated that they disagreed with a payment-to-income approach because it would not take into account consumer expenses, arguing that even a loan that is 5 percent of income could be unaffordable if the remaining income is allocated to expenses and emergency costs. One of these commenters noted that the Bureau's study found that more than 40 percent of loans made under a 5 percent payment-to-income ratio would still default or be re-borrowed.

The Bureau also received a number of comments objecting to its proposal to remedy the identified unfair and abusive practice through an underwriting requirement instead of disclosures alone. In particular, commenters stated that disclosure was a more appropriate remedy for any perceived lack of consumer understanding rather than complicated new underwriting requirements. They also argued that disclosures were a less restrictive alternative to the proposed ability-to-repay requirements and that the Bureau had not taken the disclosure option seriously. They pointed to model disclosures developed by industry trade associations as sufficient already to inform consumers of the high costs of using payday loans for an extended period. They also stated that the Bureau had not presented evidence that disclosures cannot adequately address the issue. One commenter specifically objected to the conclusions the Bureau derived from its analysis of the impact of the new Texas disclosures, which showed that following their introduction the disclosures decreased lending by 13 percent and the probability of re-borrowing by only 2 percent. The commenter argued that the appropriate conclusion is not that disclosure is ineffective, but rather, that consumers understand the costs and risks of payday loans and choose to take them out anyway. This commenter argued that the Bureau should have instead studied the impact the disclosures had on consumer understanding.

Commenters raised other substantive and procedural arguments related to a disclosure alternative. An industry trade association argued that the Bureau had failed to respond to the trade association's proposals to study and test enhanced disclosures, including a plan to partner with a firm that assisted the Bureau with the form design on the Bureau's Know Before You Owe mortgage rulemaking. Several industry commenters argued that the Bureau's discussion in the proposal of the marginal impacts of disclosures contradicted statements by the Bureau's own researchers who had analyzed the impact of the Texas disclosures, noting that they had stated at a research conference in 2015 that enhanced disclosures can have economically meaningful impacts and that consumers who are more likely to end up in long-term debt cycles may be more responsive to disclosures. A large non-bank lender commenter cited the Bureau's acknowledgment in a 2013 study that the Regulation E opt-in disclosures resulted in a majority of heavy over-drafters choosing not to opt-in to continued overdraft, as well as the lender's own data indicating that its customers use extended payment plans at a higher rate (17.25% vs. 5.67%) in States that require disclosure, as evidence that disclosure produces successful outcomes. This comment also suggested that the Bureau should use TILA authority to create disclosures comparing the “all in” cost of credit to other alternatives and to apply the requirement across all consumer loan products including overdrafts. A trade group criticized the reliance on “dubious theories of behavioral economics” as a reason for rejecting the efficacy of disclosures. Finally, a separate trade group suggested that a disclosure requirement could be dynamic and require consumers to fill out a form that would demonstrate how much residual income they have each month based on projected income and expenses.

Industry commenters, a joint letter from a number of State Attorneys General, letters from other attorneys general, SERs, and others argued that the Bureau had not considered as alternatives the less onerous approaches to regulating payday lending that many States have adopted. Commenters cited a variety of State laws, including laws about collection practices, disclosures, limits on the size and duration of loans, grace periods, limiting rollovers, principal repayment requirements, cooling-off periods, gross monthly income requirements, and even different ability-to-repay requirements. They also urged the Bureau to consider mixing and matching particular elements of the different State laws to find the right regulatory approach. Others argued that the Bureau should exempt entities operating in States that have payday laws.

Other commenters urged the Bureau to consider additional less restrictive alternatives to the proposed ability-to-repay requirements, such as requiring lenders to offer extended payment plans, implementing a nationwide licensing and registration system, using existing enforcement authority to continue addressing “bad actors” or focus on unregulated or online lenders, or addressing consumer demand for payday loans by adopting measures to encourage consumer savings, similar to the Bureau's “tools for saving.”

Lastly, the Bureau received a number of comments asserting that the proposed rule conflicts with the Equal Credit Opportunity Act. They asserted that the proposal would have a disparate impact on women and minorities because they are more likely to be paid in cash, which is less documentable and would mean, as a result, that women and minority applicants for covered loans would be less likely to qualify for the loans under the ability-to-repay requirements. Additionally, some commenters argued that the proposal would prevent non-working consumers, such as stay-at-home spouses, from receiving covered loans because they would not have their own individual income on which to rely for underwriting. They criticized the fact that the proposal did not permit consumers to rely on income from another person to which the consumer has a reasonable expectation of access, which may be considered under the Bureau's credit card ability-to-pay rules. They noted, additionally, that the Bureau had amended those ability-to-pay rules in 2013 specifically to address a similar policy concern regarding access to credit for stay-at-home spouses, and questioned why the Bureau would apply a different standard in the proposal. Commenters further argued that the proposal's allowance of estimates for rental housing expenses using locality-based data could create a disparate impact and look similar to more traditional “red-lining” discrimination. Commenters also argued that the proposal's definition of basic living expenses, which would have included expenses of any dependents of the consumer, would run afoul of Regulation B's prohibition on seeking information about the consumer's spouse. And more generally, some commenters argued that because covered loans are disproportionately used by minorities and women, the proposed rule would affect minority communities more significantly than other consumers.

Final Rule

As detailed below and in the discussion of specific parts of § 1041.5, the Bureau is finalizing the proposed ability-to-repay requirements for covered short-term loans and covered longer-term balloon-payment loans with substantial changes. These changes are designed to address various concerns raised by commenters, while still requiring lenders to engage in robust upfront underwriting procedures and providing targeted back-end protections to prevent consumers from getting stuck in long cycles of debt. In particular, the Bureau has made four substantial changes designed to make the final rule more flexible for both consumers and lenders, in order to facilitate efficient implementation and access to responsible credit: (1) The final rule permits use of a simplified underwriting calculation using either a residual income or debt-to-income methodology; (2) the final rule provides additional flexibility as to verification requirements, including permitting increased reliance by lenders on consumers' written statements in appropriate circumstances; (3) the final rule permits consideration of situations in which the consumer has a reasonable expectation of access to others' income or in which others regularly pay for certain of the consumer's expenses; and (4) the final rule does not apply presumptions that a consumer will not be able to repay the second or third covered short-term loan or covered longer-term balloon-payment loan within a sequence.

The final rule thus consolidates, with modifications, parts of proposed §§ 1041.5 and 1041.6 for covered short-term loans and §§ 1041.9 and 1041.10 for covered longer-term balloon-payment loans in final § 1041.5. The conditional exemption for covered short-term loans originated under the separate requirements contained in proposed § 1041.7 is thus now renumbered as § 1041.6 in the final rule, and discussed separately below. The Bureau details its analysis for the individual elements of § 1041.5 below, after providing an overview of its response to the high-level issues summarized above and discussing the overall balance struck in the final rule.

Burden, prescriptiveness, and complexity. As noted above, the Bureau received a significant number of comments from industry arguing that the underwriting requirements in the proposed rule would be too costly, take too much time to administer, be too restrictive, and require too much document verification. These commenters argued that the compliance burdens and underwriting restrictions would dramatically reduce loan origination volume, causing major impacts not only on lenders but on consumers as well through reduced access to credit, increased prices, and market consolidation. They also argued (as discussed separately further below) that the proposal unfairly imposed more rigorous underwriting requirements than the Bureau's rules for other credit markets.

As a general matter, the Bureau is sensitive to the concerns raised by many commenters regarding the burdens, prescriptiveness, and complexity of the proposal. The Bureau took some steps to address similar concerns that had been raised in response to the Small Business Review Panel Outline. For example, among the changes relative to the Outline, the proposal would have allowed lenders to use estimates of rental housing expenses instead of requiring verification of lease documents, and included a 30-day, rather than a 60-day, definition of loan sequence and cooling-off period after a three-loan sequence.

The Bureau also specifically sought comment in the proposal about automation and scalability, balancing the need for flexibility and innovation with the desire for regulatory certainty and related concerns. At the same time, the Bureau explained in the proposal that it believed that merely establishing a general requirement to make a reasonable determination that a consumer will have the ability to repay would provide insufficient protection for consumers and insufficient certainty for lenders. Rather, in light of stakeholder feedback to the Outline, Bureau experience, the experience with more general standards in some State laws, and the fact that lenders' current screening is designed for more limited purposes, the Bureau believed that it was important to specify minimum elements of a baseline methodology for evaluating consumers' individual financial situations.

After careful consideration, the Bureau continues to believe that specifying a baseline underwriting methodology is not just reasonably related to preventing the unfair and abusive practices identified above, but also is necessary to a successful regulatory regime, as are targeted back-end protections to prevent consumers from becoming stuck in long cycles of debt. By requiring common-sense underwriting steps that incorporate both certain activities that are routine in other credit markets and tailored measures for the specific market, the Bureau believes that the baseline methodology substantially reduces the risk that consumers will obtain an initial unaffordable loan and provides greater regulatory certainty to lenders. At the same time, in light of the back-end protections, concerns about impacts on consumers who may have difficulty documenting certain income sources, and the need to leave room for lenders to innovate and refine their methods over time, the Bureau believes that it possible to reduce the burdens, prescriptiveness, and complexity of the underwriting requirements in various ways relative to the proposal while still preserving the core of the essential consumer protections from the proposal. The four most significant changes to effectuate this revised framework, listed above, are summarized in the following discussion, with the section-by-section analysis of specific paragraphs within § 1041.5 below providing further elaboration and detail. Beyond the four significant areas of change from the proposal, the Bureau has also taken a number of smaller steps to calibrate the ability-to-repay analysis in ways that differ from the proposal, which are described in the more detailed section-by-section analysis.

First, as an initial matter, the Bureau agrees with commenters that the specific residual income methodology contained in the proposal for covered short-term loans would have been quite prescriptive in requiring lenders to track both the amount and timing of the consumer's receipt of net income and payment of major financial obligations, as well as to project the consumer's ability to cover major financial obligations and basic living expenses both during the loan term and for 30 days after the single highest payment. The proposal would not have required lenders to engage in detailed tracking of basic living expenses, but the analysis during the 30 days after the highest loan payment in particular would have required specific attention to the timing of the consumer's net income inflows and major financial obligation outflows. Upon further consideration, the Bureau believes it is appropriate to allow lenders a choice between residual income and debt-to-income methodologies, both of which would analyze the total amount of net income and major financial obligations during the month with the highest aggregate payments on the loan. Lenders can use this one-month snapshot to determine more generally whether the consumer has the ability to repay the loan without re-borrowing and can do so without having to track the specific timing of income receipts and major financial obligation payments. By simplifying the calculation to focus on the month in which the consumer is under the highest financial stress in connection with the covered short-term or covered longer-term balloon-payment loan, the final rule addresses concerns about compliance burden. The flexibility to use a debt-to-income methodology also allows lenders to use analyses that are more common in other credit markets, while maintaining appropriate tailoring in light of the variable payment structures and particular re-borrowing patterns evident in this market. See § 1041.5(a)(2) and (b)(2)(i) and the associated section-by-section analysis.

Second, the Bureau has also made a number of modifications to the proposed requirements regarding verification evidence for consumer's net income and major financial obligations. The final rule requires certain common-sense verification steps, such as requiring lenders generally to verify income, use a recent national consumer report to verify major financial obligations, and obtain a specialty consumer report from a registered information system in light of the fact that many covered loans are not reflected in national consumer reports. At the same time, the final rule reduces burden relative to the proposal and provides appropriate flexibility to consumers and lenders in cases in which verification is not reasonably available.

For example, the final rule does not require income verification in all instances, as the proposed rule would have required. In those circumstances where a lender determines that a reliable income record is not reasonably available—as, for example, when a consumer receives some income in cash and spends that money in cash—the lender can reasonably rely on the consumer's statements alone as evidence of income. See section-by-section analysis of § 1041.5(c)(2)(ii)(A) and associated commentary for further discussion.

In addition, the final rule also no longer requires lenders to obtain a national consumer report for every single new loan. Rather, lenders may rely on a national consumer report that was obtained for a previous loan if the lender did so within the last 90 days, unless during the previous 90 days the consumer had taken out a sequence of three loans and thereby triggered a cooling-off period since the previous report was obtained. See section-by-section analysis of § 1041.5(c)(2)(ii)(D) and associated commentary for further discussion. And with respect to evidence of rental housing expenses, the final rule does not require a lender to verify them with a lease or with estimates based on data about general housing expenses in the locality of the consumer, as the proposed rule would have required. Instead, lenders are able to reasonably rely on consumers' written statements for projecting rental housing expenses. See section-by-section analysis of § 1041.5(c)(2)(iii) and associated commentary for further discussion.

Third, unlike in the proposed rule, the final rule permits lenders and consumers to rely on income from third parties, such as spouses, to which the consumer has a reasonable expectation of access as part of the ability-to-repay analysis, as is generally true of the underwriting provisions for credit cards (although there are some distinctions described below, including that the lender must verify that the consumer has regular access to the funds). The final rule also permits the lender in certain circumstances to consider whether another person is regularly contributing to the payment of major financial obligations or basic living expenses. See section-by-section analysis of § 1041.5(a)(5), (b)(1), and (c)(1) and associated commentary for further discussion.

Fourth, the Bureau is not finalizing any of the presumptions of unaffordability from proposed § 1041.6 or § 1041.10. The Bureau had proposed presumptions of unaffordability during the period in which a consumer had a covered loan outstanding, or for 30 days thereafter, under the theory that one can presume a consumer who returns within 30 days after paying off a prior loan was unable to repay that loan while still meeting other expenses (and hence likely would not be able to afford to repay a new loan). In light of the complexity associated with implementing that presumption, the Bureau is not finalizing these provisions, and is instead leaving the determination of whether a consumer has the ability to repay a second or third loan in a sequence to the reasonable discretion of the lender consistent with the requirements under § 1041.5. The Bureau will, however, view extensive re-borrowing, as observed through the lender's performance metrics, as an indicator that the lender's ability-to-repay determinations may not be reasonable. See section-by-section analysis of § 1041.5(b)(1) and (d) and associated commentary for further discussion.

The Bureau has concluded that these significant changes will, collectively, reduce the upfront process burdens on lenders to underwrite these covered loans and provide more flexibility to consumers with regard to accounting for certain types of income, while maintaining the core elements of the proposal in reducing risks that consumers will become stuck in long cycles of unaffordable debt. The Bureau understands that any rule will impose some level of burden, especially for entities that have not previously had to comply with ability-to-repay standards. The Bureau is sensitive in particular to the concerns raised about the impacts on small lenders, by the SBA Office of Advocacy, the small entity representatives, and other stakeholders. The Bureau has analyzed these impacts in detail in the Regulatory Flexibility Analysis in part VIII, in addition to the compliance burdens on the industry in general in the Section 1022(b)(2) Analysis in part VII.

As discussed in more detail in those sections, the Bureau has found that the compliance burdens of § 1041.5 will not impose undue costs, particularly as those burdens have been modified from the proposal in the final rule. For instance, the Bureau continues to expect that underwriting in accordance with the rule can largely be automated and that the market will evolve toward greater automation to manage operational costs and the time it takes consumers to obtain loans. Rather, the Bureau believes that the main impacts to the industry—including with regard to consolidation—are likely to be driven primarily by the question of how many consumers are reasonably determined to have the ability to repay covered short-term and longer-term balloon-payment loans and by the impact of the 30-day cooling-off period after the third loan in a sequence. As set forth in the Section 1022(b)(2) Analysis, the Bureau acknowledges that those impacts will be substantial and will likely drive significant consolidation and/or product diversification, especially with respect to lenders who currently offer only short-term vehicle title loans. But putting limits on lending to consumers who lack the ability to repay is at the very heart of the rulemaking, as lenders' failure to make reasonable ability-to-repay determinations in the market today is the crux of the unfair and abusive practice identified by the Bureau. As described above, the Bureau has concluded that it is necessary to proscribe that practice and adopt substantive regulatory measures reasonably designed to prevent it. The substantial changes in the final rule are intended to reduce the impact on lenders so that they are able to make reasonable ability-to-repay determinations without unnecessary cost. But the Bureau maintains its view expressed in the proposal that a robust ability-to-repay requirement is necessary or appropriate to prevent the unlawful practice identified by the Bureau, which leads to harms to many consumers.

With regard to industry commenters who argued that the ability-to-repay requirements would have negative impacts on consumers in the form of increased time needed to obtain loans, increased prices, fewer lenders in close geographic proximity, and reduced access to credit in general, those issues are also addressed in greater detail in the Section 1022(b)(2) Analysis. As discussed in that section as well as with regard to specific elements of § 1041.5 below, the Bureau concludes that these impacts will generally be relatively modest. For example, as discussed above, the Bureau expects that the market will evolve toward automation in response to the rule, but for any lenders that choose to maintain an entirely manual system that loan processing time will be between 15 and 45 minutes. The Bureau also expects that compliance costs will not generally be passed through to consumers because many lenders are already charging the maximum amounts permitted by law, and that geographic impacts will be relatively modest in most areas. As described further below, the Bureau believes that a number of the modifications to final § 1041.5 will make it easier for consumers to access credit relative to the proposal, and consumers will also be able to access a limited number of covered short-term loans originated under § 1041.6 to deal with emergency situations or other needs. Indeed, the Bureau estimates that only six percent of current payday sequences would not be initiated due to the rule. Moreover, the Bureau disagrees with the commenters that argued that the proposal would preclude access to credit for any consumers who earn under $40,000 per year. As described in the Section 1022(b)(2) Analysis, the Bureau believes the analysis that underlies those comments rests on flawed assumptions and possible misunderstandings about the proposal.

The Bureau notes that in making the changes to § 1041.5 to reduce the prescriptiveness of the upfront origination process requirements, it is not adopting many policy suggestions suggested by consumer groups that would have further increased verification requirements and other compliance burdens as well as further limiting re-borrowing. For example, consumer groups argued that lenders should never be permitted to rely on consumers' written statements alone; that the Bureau should impose a cooling-off period after two loans in a sequence, rather than three; and that the final rule should impose an annual limit on all covered short-term loans of six loans or 90 days of total indebtedness. The treatment of the consumer groups' specific policy suggestions is discussed below in the relevant portions of the section-by-section for § 1041.5. At a broad level, however, the Bureau has concluded that the elements of the final rule as described further below will be sufficient to require lenders to engage in robust upfront underwriting and to provide targeted back-end protections to prevent consumers from getting stuck in long cycles of debt. In particular, the Bureau is finalizing a 30-day cooling-off period after a sequence of three covered short-term loans and applying it to sequences involving covered longer-term balloon-payment loans as well. The Bureau believes that the final rule as modified from the proposal will be sufficient to produce meaningful change in the incentives and practices of lenders in the affected markets, and that as long as those impacts are achieved it is appropriate to provide consumers and lenders with appropriate flexibility to meet individual circumstances under the rule.

Furthermore, the Bureau acknowledges that in some cases the final rule provides more flexibility with respect to the ability-to-repay requirements than the Bureau indicated in the proposal that it was comfortable providing. For example, the Bureau is permitting lenders to reasonably rely on consumers' written statements of net income if verification evidence is not reasonably available, in contrast to the proposal where it expressed concern about permitting loans to be made based on consumers' written statements of income alone. The Bureau remains concerned about the same policy issues expressed in the proposal, but also sees merit in the arguments made by many commenters about the challenges of documenting certain types of income or obligations. The Bureau concludes that it has been able to calibrate this exception in the final rule appropriately to apply to those limited circumstances. As discussed further below, the Bureau has also specifically emphasized that the ultimate reasonableness of lenders' ability-to-repay determinations in such cases will be determined primarily by the pattern of outcomes for consumers. The Bureau has taken a similar approach with regard to other places where it has relaxed certain elements of the final rule relative to the proposal. The Bureau has judged that these changes strike an appropriate balance to ensure that the final rule provides core consumer protections that are necessary to address the identified harms in these markets, while at the same time reducing the burdens, complexity, and prescriptiveness of the proposed ability-to-repay requirements.

Comparison to other markets. The changes described above in the final rule mean that relative to the proposal the rule is more consistent with underwriting practices in other consumer credit markets—whether specifically mandated by Federal law or as a matter of standard industry practice—while maintaining appropriately tailored requirements where the Bureau finds it appropriate to do so in light of the characteristics of the consumers who rely on covered short-term and longer-term balloon-payment loans, the product structures used in these markets, and the particular patterns of re-borrowing seen in these markets. The Bureau notes that different markets warrant different regulatory interventions, as demonstrated by the fact that Congress itself has established very different regimes for underwriting mortgages and credit cards, and believes that calibration is appropriate to address particular consumer risks, industry practices, and product structures.

At a basic conceptual level, the final rule requires lenders to assess both consumer income and expenses using either a residual income or debt-to-income analysis. This is broadly consistent with the Federal underwriting requirements for both mortgages and credit cards, although the three regimes vary as to certain details in light of the products' structure and the history of particular problems in their respective markets. For example, Congress specified a detailed regime for consideration of consumers' ability to repay mortgage loans, including verification of both income and current obligations, after substantial evidence that “no-doc” loans helped to fuel a crisis in that market. In the credit card market, Congress imposed an obligation to consider consumers' ability to make required payments on a credit card account, including heightened standards for consumers under the age of 21, in light of particular concerns that college students were being provided with amounts of debt that substantially exceeded their ability to make even minimum payments on their accounts. However, neither Congress nor the Federal Reserve Board, which was charged with implementing those requirements, chose to require specific verification requirements concerning income and expenses; the Board specifically noted that there had not been a record of the kinds of problems seen in the mortgage market and that certain market conditions created strong incentives for lenders to exercise appropriate diligence even in the absence of specific Federal requirements.

Similarly, the Bureau has tailored the details of the verification requirements and underwriting methodology in § 1041.5 based on the particular product structures and history of specific problems in the markets for covered short-term and longer-term loans. These include such factors as the frequency of lump-sum and irregular payment structures, the fact that many covered short-term and longer-term balloon-payment loans do not appear on national consumer reports, concerns that consumers who are in financial distress may tend to overestimate income or underestimate expenses, and lenders' strong incentives to encourage mistaken estimates to the extent that doing so tends to result in more re-borrowing. The resulting final rule takes a common-sense approach by generally requiring lenders to obtain what verification evidence is reasonably available, while allowing reliance on consumer statements where other evidence is not. In their details, the income and expense verification requirements of the final rule are somewhat less onerous than the Bureau's mortgage rules in 12 CFR 1026.43 and more onerous than the credit card rules for various groups of consumers in 12 CFR 1026.51. The final rule also has been modified in response to comments, discussed below, to allow consideration of situations in which consumers have a reasonable expectation of access to the income of other people and where another person regularly pays for certain expenses of a consumer, which is somewhat similar to the credit card rules but with more tailoring in light of the overall structure of § 1041.5 and general concerns about incentives to inflate income in the affected markets.

As noted above, the Bureau received many comments from industry stakeholders suggesting that it apply the same rules as for credit card ability-to-pay rules under Regulation Z. The Bureau believes the response to these comments merits more extensive discussion.

First, the Bureau disagrees with commenters that stated or implied that the proposed ability-to-repay requirement reflected a different legal standard for underwriting than the credit card ability-to-pay rule and questioned the basis for that difference, including the one commenter's argument that the Bureau was imposing a different standard because it did not “trust” consumers in this market to make decisions for themselves. It is true that the credit card rules focus only on a consumer's ability to make “required minimum payments,” which under credit card contracts are typically minimum monthly payments—typically finance charges, fees, and a small amount of principal—for however long it takes to pay off the principal. The ability-to-repay test set forth in the final rule requires the lender to determine whether the consumer can make “all payments on the loan.” As a legal standard, however, that is no different than the test under the CARD Act. That is, in both cases the rule requires that the lender assess the consumer's ability to repay the payments required under the contract. What differs in the two contexts is the structure of the loan and thus the size of the required payments under the contract.

Consumers under the typical covered short-term or longer-term balloon-payment loan have a legal obligation to repay the full amount of the loan when due in a single or large balloon payment, and the loans are presented to consumers as having a definite term. Consumers do not have the right to roll over or re-borrow; that is up to the discretion of the lender. Thus, to the extent that commenters implied that the Bureau should require that lenders inquire only about consumers' ability to pay finance charges, such an approach would be fundamentally inconsistent with the structure of these loans and would ignore the fact that at some point the principal must be repaid in a single or large balloon payment. Indeed, to apply the ability-to-repay test only to the finance charges would perpetuate one of the core concerns underlying this rule: that, as discussed in Market Concerns—Underwriting, these loans are presented to consumers as short-term loans to bridge until the next paycheck whereas in practice the loans operate quite differently. As discussed below in the 1022(b)(2) Analysis in more detail, there is substantial evidence that many consumers end up re-borrowing more than they expect and that consumers who end up in very long loan sequences in particular do not predict their usage patterns accurately.

The Bureau, furthermore, disagrees with commenters who asserted that the Bureau should follow the model of the credit card rules and not require verification of income. The Bureau believes that in view of the particular concerns about reliance on stated income in the market for covered short-term loans and covered longer-term balloon-payment loans, it is appropriate to include a baseline verification requirement in the final rule. Under the final rule, in § 1041.5(c)(2)(ii)(A), the lender must verify the consumer's net income amount if verification evidence is reasonably available. If verification evidence as to some or all of the net income is not reasonably available, the lender may reasonably rely on the consumer's statement of the amount. As described in the section-by-section analysis for § 1041.5(c)(2)(ii)(A) below, permitting lenders to reasonably rely on consumer statements of income in absence of verification evidence is a change from the proposal that addresses commenters' concerns that consumers paid in cash will not be able to receive a loan if they otherwise would pass the ability-to-repay requirements. The Bureau does not believe, however, that merely requiring consideration of consumers' stated amounts for net income and debt obligations as a baseline rule would provide sufficient consumer protections in this market. The Bureau notes that the income verification requirement in the final rule is generally aligned with current practices in the market for covered short-term loans (other than with regard to some vehicle title loans), where lenders typically request the consumer provide evidence of one pay cycle of income. Moreover, as discussed above, the Bureau understands that credit card issuers typically obtain a national consumer report for card applicants to ascertain “current obligations” under the credit card ability-to-repay rules, which is similar to the obligation under the final rule for lenders making covered short-term loans and covered longer-term balloon-payment loans to obtain a national consumer report to verify debt obligations.

Specificity. As discussed above in connection with the proposal and with regard to the final rule, the Bureau has attempted to balance the interests of specificity, which reduces uncertainty, with the interests of flexibility, which allows for innovation, competition, and diversification in business models. The Bureau received incompatible comments requesting that it shift further in both directions on the specificity-flexibility spectrum—sometimes from the same commenter when addressing different issues. Ultimately, as compared to the proposed rule, the Bureau found the commenters requesting more flexibility rather than additional prescriptiveness with regard to upfront underwriting procedures to raise the more compelling arguments, and decided to add more flexibility to the final rule as discussed generally above and with regard to individual elements below. At the same time, as discussed below, the Bureau has also refined the regulation text and commentary as appropriate in specific areas, for instance to provide clearer guidance on particular elements of the ability-to-repay analysis such as net income and estimation of basic living expenses and to discuss various fact patterns in examples.

With regard to commenters who criticized the general reasonableness standard, sought numerical thresholds or guidance on what constitutes sufficient residual income (or a specific debt-to-income ratio), or urged the Bureau to provide per se rules regarding what types of loan performance patterns indicate that a lender's ability-to-repay analysis was unreasonable, those issues are discussed in more detail below in connection with § 1041.5(b)(1). While this rule provides substantial specificity as to upfront procedures, the Bureau does not provide a formulaic residual-income threshold or debt-to-income ratio to answer the question of whether a consumer has the ability to repay. The same is true for the Bureau's mortgage and credit card ability-to-repay rules.⁷⁷⁸ The Bureau does not believe it is possible to eliminate lender judgment in making these determinations, and thus believes that the general reasonableness standard is a critical element of the rule. Reasonableness is a widely used legal concept in both State and Federal law, and is what Congress required with respect to the underwriting of mortgages. The Bureau believes the standard in the final rule—which has been revised to include a substantial amount of new commentary clarifying how the reasonableness of ability-to-repay determinations will be evaluated—should provide a sufficiently discernible standard.

As for loan performance, as discussed in final comments 5(b)-2.iii and 5(b)-2.iv, the Bureau will, among other things, use various outcome metrics on an aggregate basis to assess whether various underwriting models are indeed working as a practical matter to yield reasonable determinations of consumers' ability to repay. However, such metrics must also be evaluated in their specific context, particularly given that the harms that arise from unaffordable loans may play out in different ways depending on lender practices and other variables. For example, lenders might have higher patterns of re-borrowing relative to defaults depending on their particular sales and collection practices, so establishing a single set of thresholds for all situations would be difficult. As discussed below, the Bureau has provided more specific guidance on the types of potentially relevant loan performance metrics and more examples discussing particular fact patterns, but believes that it is not practicable to establish numeric performance thresholds that would definitively demarcate whether a lender's ability-to-pay determinations meet the reasonableness standard. See the discussion below regarding § 1041.5(b)(1) for more details.

Using Residual-Income Analysis to Predict and Prevent Harms. As described above, several industry commenters asserted that the proposed requirement to determine consumers' ability to repay is arbitrary because it will not actually predict and prevent the harms identified in the Bureau's UDAAP analysis, particularly default and re-borrowing. For example, an industry commenter cited a study that uses what the researchers said was the residual income methodology specified in the proposed rule to examine the relationship between such residual income and default. Applying the residual income methodology to a large sample of storefront payday loan borrowers, the study compares consumers deemed to have positive residual income to consumers deemed to have negative residual income with respect to whether they repaid or defaulted on a particular test loan. In one such analysis using the borrower's income most recently observed by the lender, loans in which the borrower had positive residual income had a default rate of 11 percent, compared with a default rate of 14.7 percent for loans in which the borrower had negative residual income. The study concluded that little difference in default rates exists between these two populations, and that the residual-income analysis is not highly predictive of default. On the basis of these results, the industry commenter inferred that the proposed rule's ability-to-repay requirement will not prevent consumers from defaulting.

Setting aside the issue of whether the difference in default rates among loans for which the borrowers did and did not have residual income was meaningful, the Bureau does not agree with the commenter's inference that an ability-to-repay requirement will not reduce the harms identified in the Bureau's unfairness and abusiveness analyses above. The study focuses only on defaults in isolation, despite the fact that as the Bureau has explained numerous times (both in the proposed rule and elsewhere in the final rule), when consumers are faced with an unaffordable covered short-term loan, their most frequent response is to roll over short-term loans (in States where doing so is permitted) or nominally repay the loans, only to have to re-borrow shortly thereafter. In its analysis, the Bureau found that only 28 percent of loan sequences consisted of single loans, with the remaining 72 percent of loan sequences consisted of at least one re-borrowing. For that 28 percent, 22 percent were repaid without re-borrowing, and only 6 percent defaulted. Where the lender has account access, such repayment is accomplished by a debit of the consumer's account. Where the lender has obtained a postdated check, such repayment is made either by way of that check or in light of the fact that the lender may deposit the check at any time. All of this explains why the default rate of covered short-term loans for which the consumer does not have the ability to repay is relatively low. Indeed, the commenter effectively conceded this point when it claimed that by imposing a cooling-off period after the third loan in a sequence, the proposed rule will drive default rates higher.

In addition, even if looking solely at default rates were a relevant metric, the study itself identifies a number of possible explanations for its finding of similar default rates for the two populations, including that account access may incentivize borrowers to prioritize paying the loan notwithstanding cash flow shortages affecting other expenses, which is one of the factors noted in the preceding paragraph.

A specialty consumer reporting agency commenter made a similar argument based on a study it conducted using its own borrowing data. At a high level of generality, the study found very similar default rates for loans made to consumers with positive residual income compared to consumers with negative or zero residual income (with default rates of 16.1 percent and 16.2 percent, respectively). However, a more detailed analysis that disaggregates these consumers into varying degrees of residual income, ranging from those with negative residual income of negative $2,500 or less to those with more than $2,500 in positive residual income, showed higher default rates among consumers who have the most negative residual income (20.0 percent) compared to those with far less negative or positive residual income (15-16 percent). Relatedly, the study reported that first-time borrowers with positive residual incomes had slightly lower default rates than first-time borrowers with residual incomes that were zero or negative. In addition, the study found that consumers who triggered any of the proposed 30-day cooling-off periods had markedly lower default rates than consumers that did not trigger the criteria. Like the industry commenter, this commenter concludes that residual income is not a good predictor of default. The commenter likewise forecasted that the proposed rule's restrictions on re-borrowing will drive up default rates. In addition, citing the study results, the commenter urged the Bureau to modify the rule in three respects: (1) Replace the ability-to-repay requirement with a propensity-to-repay requirement; (2) limit such an ability-to-repay requirement to first-time borrowers and those with low propensity to repay; and (3) eliminate all of the 30-day cooling-off periods.

Given the close similarity of this commenter's argument regarding the relationship between residual income and default to the argument of the industry commenter discussed above, the Bureau believes its response above to that argument applies equally to this one. For essentially the same reasons, the Bureau believes that the commenter's proposed modifications of the rule are unwarranted and would, in fact, result in perpetuating most of the harm experienced by consumers in the current market.

In addition to making the comment discussed above about default, the same industry commenter made a similar argument about re-borrowing: The commenter argued that ability to repay is no more predictive of re-borrowing than it is of default. In support of this claim, the commenter cited two studies. The first is the same study it cited in support of the “default” argument. In this instance, instead of describing the study as finding that there is a weak correlation between residual income and default, the commenter described it as finding that there is a weak correlation between ability to repay and repayment. The Bureau is not persuaded that this study provides such support. To be sure, if a study considers only default and repayment, its findings about default could be presented as findings about repayment, which is the mirror image of default in such a study. By the same token, however, given that such a study does not consider re-borrowing rates at all, it is unclear how findings about such rates can be derived from findings about default, or from mirror-image findings about repayment.

The second study, which predated the proposed rule, contained a number of slides that reference ability to repay, the most pertinent of which appears to be one that includes the claim that consumers with large amounts of residual income are as likely to roll over their loans as consumers with limited residual income. Just below that is what appears to be a screen shot of a portion of a database or spreadsheet with various numbers and percentages. On its face, the statement does not appear to provide support for the commenter's assertion. Nor does the commenter make any attempt to explain this page of the presentation.

Disclosure alternative. The Bureau disagrees with commenters that asserted that a disclosure remedy would be sufficient to prevent either the unfair or abusive practice itself or the risks and harms to consumers from such practice, that the Bureau is compelled as a matter of law to adopt disclosure remedies to address any unfair or abusive practices that involve a lack of understanding by consumers, and that the Bureau erred in proceeding with the rulemaking instead of delaying it to conduct further disclosure research. The Bureau notes that consumer disclosures can be an important and effective tool in different circumstances and indeed has adopted disclosures to communicate various pieces of information to consumers in connection with this final rule. But for the reasons discussed in the proposal and below, the Bureau concludes that disclosures would not be sufficient to prevent the unfair and abusive practices identified in this rule.

More generally, the Bureau concludes that it is not required to mandate disclosures to address any unfair or abusive practices that involve a lack of understanding by consumers, as opposed to adopting other approaches, such as the ability-to-repay provisions here, to prevent the unfair or abusive practices. Neither Congress nor other agencies nor the courts have adopted such a position. The Bureau is authorized by section 1031(b) of the Dodd-Frank Act to prescribe rules to identify unfair, deceptive, or abusive acts or practices and to include in such rules requirements for the purpose of preventing such acts or practices. The unfair and abusive practice the Bureau has identified in § 1041.4 is making covered short-term or longer-term balloon-payment loans without reasonably determining that consumers will have the ability to repay the loans according to their terms. No commenter claims that providing disclosures will prevent that practice. At most, effective disclosures could mitigate some of the harms from the failure to underwrite. In theory at least, disclosures could be so effective that any harms would be reasonably avoidable by the consumer and that consumers would no longer lack understanding of the material costs and risks of the product. However, as discussed below, the Bureau concludes that disclosures here would not have any such effect.

The Bureau agrees that informing consumers that covered short-term loans or covered longer-term balloon-payment loans have high risks of default, re-borrowing, or default avoidance harms or that lenders are not underwriting such loans using the same sorts of practices that are common to other credit markets may cause some consumers to be more generally cautious in taking out such loans. Indeed, the Bureau's analysis of the response by consumers to the new disclosure in Texas is consistent with this outcome. The Bureau finds it likely that the marginal difference in lending (around a 13 percent decrease in loan volumes) in fact resulted from consumers whose decisions were affected by the disclosures and decided not to borrow after better understanding the risks.

However, generalized or abstract information does not inform the consumer of the risks of the particular loan in light of the consumer's particular financial situation. Lenders would still have strong incentives, given their overall business models, to make loans to consumers who cannot in fact afford to repay them according to their terms, as long as such consumers do not default early in their loan sequences. Because consumers using these loans—or at least those who end up in extended loan sequences—are not good predictors of how long it will take them to repay their loans, generalized disclosures are particularly unlikely to position consumers effectively to appreciate the risks they themselves would face from their loans and to make their decisions accordingly. In light of these circumstances, the Bureau finds that generalized disclosures to consumers will not prevent the unfair and abusive practice identified above or equip consumers to avoid the harms it causes as effectively as prohibiting lenders from engaging in the unfair and abusive practice in the first instance.

The only disclosure that the Bureau could envision that could come close to positioning consumers to mitigate the unfair and abusive practice effectively would be an individualized forecast of whether the consumer could afford to repay the loan according to its term, and if not, a forecast of how long such repayment would be reasonably expected to take. While consumers are most familiar with their particular financial situations, lenders have the most information about their business models and the performance of their credit products over hundreds or thousands of individual cases. The Bureau notes, however, that no commenter has suggested such an approach, which would be unprecedented as a matter of mandatory disclosures under federal consumer financial law. Moreover, if anything, an individualized disclosure might require more compliance burden than the final rule to the extent that it would require a lender to forecast how many rollovers or re-borrowing might be required in the event that a consumer is not likely to repay the entire balance during the initial loan term.

Further, with disclosures in this specific context, the only option for a consumer warned about the risks of an unaffordable loan is simply not to take out the loan at all, since once a consumer takes out a loan that in fact turns out to be unaffordable the consumer's only options are to choose between the harms associated with default, re-borrowing, or forgoing other major financial obligations or basic living expenses. Thus, the Bureau believes that it is telling that while the Texas disclosures appear to have caused some consumers to seek different options altogether, in the first instance, once they had already taken out a loan, there was only a 2 percent decrease in the probability of re-borrowing.

The Bureau also addresses three other arguments commenters raised about disclosures. First, as to the specific trade group commenter's argument that the Bureau was wrong to reject a formal invitation to engage in a study to test enhanced disclosures, the Bureau notes that this commenter had engaged in outreach with the Bureau for several years during the course of the rulemaking, yet did not present the disclosure trial proposal until less than two weeks before the proposal was released and requested that the Bureau delay issuing a proposal or hold the comment period open during the pendency of the proposed study. Thus, in addition to the substantive reasons discussed above for why the Bureau concludes that generalized disclosures are insufficient to prevent the practice or harms identified, the Bureau rejected the request to delay the proposal in light of this strategic procedural posturing. The Bureau did indicate that it would be open to considering the results of any new research as part of the comment process, but no such evidence has been forthcoming.

Second, the Bureau finds that commenters overstate the degree to which the Bureau is relying on behavioral economics in rejecting a disclosure alternative. As discussed above, there are both theoretical and data-driven explanations for why the Bureau does not share the view that disclosures will sufficiently remedy the observed harms. Lastly, the Bureau does not view as a viable option one commenter's suggestion of requiring a new TILA disclosure that would potentially capture the “all-in” cost of credit. The Bureau finds that this disclosure would not be effective at preventing the unfair and abusive practice or rectifying the identified harms for the same reasons as described above.

Payment-to-income alternative. While the Bureau is now allowing lenders to choose between underwriting approaches based either on a debt-to-income ratio or on residual income, the Bureau is not adopting an alternative approach centered on a payment-to-income ratio. The Bureau recognizes that many commenters have expressed strong support for this approach, including depository institutions interested in making lower-cost small-dollar loans. However, the Bureau notes that the particular proposal under consideration at the SBREFA stage and which these commenters have elaborated upon in their comments—namely a safe harbor for loans with a payment that takes up 5 percent or less of a consumer's income—is far more relevant to the market for longer-term installment loans than for the loans covered by §§ 1041.4 and 1041.5, as those loans generally have lump-sum or other large irregular payments that far exceed a 5 percent payment-to-income ratio for the vast majority of consumers.

Consider, for example, a consumer making $2,000 per month. A 5 percent payment-to-income ratio safe harbor would mean the consumer is only eligible for a $100 loan, assuming all payments on the loan would be due in one month; for loans due in two weeks—as is common for payday loans—the maximum loan amount would be only $50. Accordingly, the Bureau does not believe that lenders or consumers would be likely to use a 5 percent payment-to-income option in the short-term space, particularly where it is permissible to make loans under § 1041.6 in amounts of up to $500. To the extent the Bureau engages in further study and potential future rulemaking on longer-term installment products, the Bureau will continue to consider whether a payment-to-income approach either in the specific form suggested by the commenters or in other forms would be a reasonable alternative to an ability-to-repay requirement.

State law regulatory approaches. As discussed above, many commenters argued that the Bureau failed to rigorously study existing State laws regulating small-dollar loans and consider more seriously whether one or more existing regulatory approaches in the States would be sufficient to address the concerns the Bureau identified in the market rather than the ability-to-repay requirements. The Bureau also notes that in some cases, State Attorneys General or other State or local officials in the States cited by the aforementioned commenters as having model State regulatory approaches wrote in support of the proposed ability-to-repay requirements and of the proposal in general, reflecting a diversity of opinion about the sufficiency of the laws in those States to address the identified harms at the Federal level.

The Bureau has over the past several years studied the regulatory approaches of many States carefully and, as discussed in part III, has engaged in outreach with a wide variety of stakeholders including elected officials and regulators in States that permit covered lending. The development of the proposal framework and the final rule has been informed by this understanding of these State laws. The Bureau provides more detail on State laws in part II, but some examples follow.

A number of States set rollover thresholds that are higher than those in this final rule. Delaware permits four rollovers on payday loans, Missouri permits six on payday loans, and New Hampshire permits 10 rollovers on short-term title loans. Idaho, on the other hand, sets their rollover cap at three, similar to this rule. Other States, like California and Kentucky, impose fewer restrictions but cap payday loans at, for example, $500 (Kentucky) or $300 (California).

Other commenters argued that States have imposed less onerous, but nonetheless effective, ability-to-repay frameworks that the Bureau should consider adopting instead of the proposed ability-to-repay requirements. For example, some commenters noted Utah as an example. Utah lenders must determine that a consumer has the ability to repay a loan based on one or more of the following sources: A consumer report from a consumer reporting agency, verification or proof of income, the borrower's self-affirmation of ability to repay, or prior payment history with the lender from its own records. In addition, lenders may not roll over loans beyond 10 weeks, and once a year consumers may request extended repayment plans. It appears one significant difference between Utah law and this rule is in how that State treats re-borrowing. In Utah a lender need only determine whether the consumer can repay the loan in the ordinary course, “which may include rollovers or extended payment plans,” and need not make a separate repayment determination on rollovers. To comply with § 1041.5(b), lenders will need to determine whether consumers have an ability to repay each loan according to its terms, without re-borrowing. And Utah law allows 10 weeks of re-borrowing, as opposed to the Bureau's cap of three loans in a sequence (under § 1041.5(d)), which would result in a shorter period for consumers taking out 14-day loans (approximately six weeks of re-borrowing), but a longer period for consumers taking out 30-day loans (approximately 12 weeks of re-borrowing).

Of course, the Bureau's approach is not more restrictive than that used by all the States. For example, only a minority of States, 19 by the Bureau's count, permit vehicle title lending with lump-sum (typically short-term) structures, and 15 States and the District of Columbia either ban payday loans or set fee or interest caps that payday lenders find too low to sustain the business model (see part II). Even in States that do allow payday lending, certain parts of their payday lending laws may be more restrictive. For example, the cooling-off period imposed by Virginia in certain circumstances lasts 45 or 90 days, while the Bureau's rule sets cooling-off periods, such as the one in § 1041.5(d), at 30 days.

Commenters also raised Colorado's laws as a model. However, following such an approach would involve banning covered short-term lending altogether since that State only allows loans of at least six months in term. To the extent the Bureau engages in further study and potential future rulemaking concerning longer-term installment products, the Bureau will continue to consider whether the Colorado model may provide additional insight.

Though the Bureau closely studied the various States' approaches as it developed this rule, the Bureau concludes that none of these State law frameworks, alone, would suffice to prevent the harms the Bureau has identified. As the Bureau noted in the proposal, above in Market Concerns—Underwriting and the section-by-section analysis for § 1041.4, and below in the Section 1022(b)(2) Analysis, the regulatory frameworks in most States do not appear to have had a significant impact on reducing re-borrowing and other harms that confront consumers of short-term loans.

For example, the Bureau's evidence shows that 24- and 48-hour cooling-off periods have a minimal impact on overall re-borrowing rates. As noted in the proposal, the Bureau studied re-borrowing rates from 2010-2011 in most of the States noted by commenters and found that, generally, over 80 percent of loans were re-borrowed regardless of the type of State restriction studied. This evidence suggests that the laws in those States at that time had not meaningfully prevented re-borrowing. Commenters have not rebutted these findings directly. Some instead challenge the premise that re-borrowing is an indicator of consumer harms. The Bureau addresses that issue above in Market Concerns—Underwriting and the section-by-section analysis for § 1041.4.

Thus, the Bureau continues to believe that there is a need to adopt minimum Federal standards that apply consistently across all of these States. In setting the parameters of this final rule, the Bureau sought to prevent the harms identified in § 1041.4 from continuing. For that reason, the Bureau declines to exempt entities operating in any given State on the basis of the given State's laws. The Bureau recognizes that States may wish to prevent more harms than are prevented by this rule, and they are free to do so because, as noted earlier, this rule should be considered a floor and not a ceiling. See part IV (discussing preemption under the Dodd-Frank Act and noting that State usury caps are an example of State consumer protections that may extend beyond the floor of Federal law).

Other alternatives. The Bureau does not believe that any of the other posited alternative approaches to regulating covered short-term or longer-term balloon-payment loans would be less onerous than, but as effective as, an ability-to-repay requirement. As noted in part II and Market Concerns—Underwriting sections and discussed at some length in the proposal, about 18 States require payday lenders to offer repayment plans to borrowers who encounter difficulty in repaying payday loans. The usage rate of these repayment plans varies widely, but in all cases it is relatively low. The Bureau believes the low take-up rate on these repayment plans may be due to lenders discouraging use of the plans or failing to promote their availability. At the very least, a rule that required only that lenders offer extended repayment plans would create significant evasion risk absent more complex provisions to try to prevent lenders from discouraging the use of repayment plans in order to make it more likely that such consumers will instead re-borrow. The Bureau is aware, from confidential information gathered in the course of statutory functions, that one or more payday lenders train their employees not to mention repayment plans until after the employees have offered renewals, and then only to mention repayment plans if borrowers specifically ask about them.

Another alternative posited by commenters was increased or sustained enforcement attention focusing on the worst market actors, or focused on specific sub-markets like unregulated or offshore online lenders. As noted in part III, the Bureau has already engaged in extensive enforcement and supervisory activity in this market focused on a wide variety of practices. But, as noted in Market Concerns—Underwriting, the identified unfair and abusive practice in § 1041.4 is a market-wide practice. Continued enforcement and supervisory activity focused on the worst actors would simply not prevent the market-wide harms identified by the Bureau. In addition, the Bureau is sometimes criticized for “regulation through enforcement.” Thus, while the Bureau could bring enforcement actions against individual lenders for engaging in the practices identified here as unfair and abusive, the Bureau believes that it provides more consistent protection for consumers and compliance guidance for industry to address market-wide harms through a detailed rulemaking that both defines the unfair and abusive practice, carefully outlines affirmative standards to prevent that practice, and provides a reasonable period for lenders to come into compliance with those standards.

With regard to implementing a nationwide licensing and registration system, the Bureau has authority under the Dodd-Frank Act to prescribe rules regarding registration requirements applicable to covered persons, including those covered by this rule. The Bureau also has authority under 12 U.S.C. 5514(b)(7)(C) to prescribe rules to ensure that lenders under the Bureau's nonbank supervision authority are legitimate entities and are able to perform their obligations to consumers, including by requiring background checks and bonding. Indeed, the Bureau has noted in its recent semi-annual regulatory agendas that it is evaluating stakeholder suggestions about creating such a system for these markets. But while such an action may assist with enforcement and supervision efforts (discussed above) and provide a better means of identifying lenders operating without State lending licenses, the Bureau does not believe that it would be effective in lieu of ability-to-repay requirements at remedying the identifying harms. A well-bonded lender with officers with a clean record, which is registered, would still be able to cause all of the identified harms noted in Market Concerns—Underwriting and the section-by-section analysis for § 1041.4 unless the Bureau took more substantive action (like adopting this rule).

In response to the comment urging the Bureau to forgo rulemaking and instead focus on consumer education initiatives, the Bureau does not find that this would be a viable option for significantly reducing the observed harms. While financial education is an important pillar of the Bureau's work, and it will continue those efforts, it does not believe that its financial education efforts would impact saving rates broadly enough to have a substantial impact on the need to borrow to cover cash shortfalls across all consumers. Nor does the Bureau believe that generalized financial education, even if it succeeded in reaching all would-be-borrowers, could enable consumers to accurately predict their own likelihood of re-borrowing or defaulting. The Bureau recognizes that there will continue to be demand for credit from consumers who lack the ability to repay covered short-term or longer-term balloon-payment loans. See the discussion in the section-by-section analysis for § 1041.4 regarding substitution to alternative products.

Fair lending. The Bureau expects that certain of the burden-reducing changes to the final rule will also address commenters' concerns relating to fair lending. For example, under the final rule, when a reliable record to verify income is not reasonably available, a lender may now rely on a consumer's statement of net income, provided such reliance is reasonable (see discussion of § 1041.5(c)(2)(ii)(A) and comment 5(c)(2)(ii)(A)-3 and -4, below). This change should reduce concern that members of protected classes would be denied access to credit solely because of the difficulty in verifying their income. Additionally, unlike the proposed rule, the final rule permits lenders to include in the consumer's net income any income of another person to which the consumer has a reasonable expectation of access if the consumer documents that he or she has regular, verifiable access to such income (see 1041.5(a)(5) and comment 5(a)(5)-3). In the final rule, the lender is also permitted to rely on the consumer's statement for rental housing expenses, provided such reliance is reasonable; this is a change from the proposal, which would have required a projection of rental housing expense using a reliable record or an estimate based on survey or other data with respect to the consumer's neighborhood (see § 1041.5(c)(2)(iii) and associated commentary). More generally, the Bureau notes that inquiries relating to dependents for purposes of estimating basic living expenses can be made consistent with Regulation B. For the foregoing reasons, the Bureau believes that the final rule is consistent with the requirements of ECOA and Regulation B.

5(a) Definitions

Proposed § 1041.5(a) would have provided definitions of several terms used in proposed §§ 1041.5 and 1041.6. Virtually identical definitions and commentary appeared in proposed § 1041.9(a) for covered longer-term loans (including covered longer-term balloon-payment loans), with minor adjustments to account for the difference in the term of the products. In the final rule, the Bureau has revised several of the six proposed definitions for substance or clarity, made them applicable to both covered short-term loans and covered longer-term balloon-payment loans, and has added two more definitions in part to effectuate the new underwriting methodology based on debt-to-income ratio. A discussion of the proposed definitions, the comments received on those definitions, and the final definitions follows.

5(a)(1) Basic Living Expenses

Proposed Rule

Proposed § 1041.5(a)(1) would have defined basic living expenses as a component of the ability-to-repay determination as established in the proposed rule. The Bureau proposed to define basic living expenses as expenditures, other than payments for major financial obligations, which a consumer makes for goods and services necessary to maintain the consumer's health, welfare, and ability to produce income, and the health and welfare of members of the consumer's household who are financially dependent on the consumer. Accordingly, the proposed definition of basic living expenses was a principle-based definition and did not provide a comprehensive list of all the expenses for which a lender must account. Proposed comment 5(a)(1)-1 provided illustrative examples of expenses that would be covered by the definition. It provided food and utilities as examples of goods and services that are necessary for maintaining health and welfare, and transportation to and from a place of employment and daycare for dependent children as examples of goods and services that are necessary for maintaining the ability to produce income.

Proposed comment 5(b)-2.i.C would have clarified that as part of the reasonable ability-to-repay determination, the lender's estimates of basic living expenses must be reasonable. Proposed comment 5(b)-4 would have provided examples of approaches to estimating basic living expenses that were reasonable or unreasonable. For discussion of how the final rule addresses the reasonableness of lender estimates of basic living expenses, see the section-by-section analysis of § 1041.5(b), where the commentary provisions relating to basic living expenses have been revised, as well as the immediately following discussion.

The Bureau's proposed definition gave lenders some flexibility in how lenders determine dollar amounts that meet the proposed definition, provided they do not rely on amounts that are so low that they are unreasonable for consumers to pay for the types and levels of expenses provided in the definition. The Bureau specifically noted in the proposal that a lender would not be required to verify or conduct a detailed analysis of every individual consumer expenditure. In contrast to major financial obligations, the Bureau explained that recent expenditures might not reflect the amounts a consumer needs for basic living expenses during the term of a prospective loan. The Bureau expressed concern that such a requirement could substantially increase costs for lenders and consumers while adding little protection for consumers.

The Bureau sought comment in the proposal on whether an alternative formulation focusing on expenses that are of the types that are likely to recur through the term of the loan and in amounts below which a consumer cannot realistically reduce them would be preferable; the Bureau had used similar concepts to define which expenses should be treated as major financial obligations as discussed further below in connection with § 1041.5(a)(3). The Bureau also sought comment on whether there are standards in other contexts that can be relied upon by the Bureau. The Bureau explained in the proposal that, for example, it was aware that the Internal Revenue Service (IRS) and bankruptcy courts have their own respective standards for calculating amounts an individual needs for expenses while making payments toward a tax delinquency or bankruptcy-related repayment plans.

Comments Received

The Bureau received many comments on the proposed definition of basic living expenses from a variety of stakeholders. In general, industry commenters criticized the proposed definition as overly vague and argued it would create uncertainty for lenders trying to comply with the proposed rule. A number of industry commenters asked for the Bureau to provide additional clarity on the definition. Some, including a trade association for payday lenders, suggested the Bureau include safe harbor amounts for basic living expenses due to the costs of having to establish a framework to estimate such expenses, particularly for smaller lenders. Some commenters argued that the standards were so vague that different lenders in good faith could apply different definitions. One State Attorney General expressed concern that the vagueness in the proposed definition would lead to inconsistent interpretation of the rule.

Industry commenters also raised a number of more discrete issues with the proposed definition. Some argued that the Bureau should let lenders assume that consumers could cut back on discretionary spending on items like restaurant meals, gym memberships, and the like, and that the proposed rule was not clear whether those types of expenses were included in the definition and whether lenders could assume that consumers would undertake some reductions in spending on those items for purposes of the basic living expenses estimates. Another commenter noted that the Bureau had not taken account of the fact that prices may change seasonally (as with back-to-school sales). Several commenters criticized the definition for including expenses for the health and welfare of the consumer's dependents when, they argued, consumers may have spouses or other persons paying a portion of the household expenses, including those of dependents. (These issues are noted above in the discussion of general comments regarding ECOA and Regulation B.) They argued that the definition should be modified to account for such sharing of expenses.

Most consumer advocates commenting on the rule expressed support for the concept of lenders having to estimate basic living expenses, but argued that the definition was under-inclusive. For example, they questioned why the Bureau only included four examples of specific expenses. They also expressed support for including within the definition any expense that is likely to recur. They also criticized what they viewed as too permissive provisions in commentary regarding reasonable estimates of basic living expenses. Some of these commenters suggested specific expenses that should be explicitly added to the definition, such as alimony, health insurance premiums other than those deducted from a consumer's paycheck, cell phone payments, car insurance payments, and a number of other categories. Another suggestion was to change the definition to include typical expenses based on geography, income, and household size.

In contrast, one organization generally supportive of the rule criticized the approach on this element of the financial analysis and argued that lenders should be expected to itemize basic living expenses because of the risk that estimates would be too low. The Bureau notes that it is responding to this comment in the discussion below of comment 5(b)-2.i.C. 1. A public policy and research organization argued that childcare expenses, including diaper costs for new parents, could consume a large percentage of a consumer's budget and therefore should be treated not as a basic living expense but as a major financial obligation to be verified.

Several commenters urged the Bureau to use the IRS Collection Financial Standards to define the ambit of basic living expenses. They argued that the proposed definition was too ambiguous and could lead to confusion and potentially lender evasion; they argued that the IRS Collection Financial Standards would provide needed clarity for all parties involved. A lender commenter, a SER, took a different view, arguing that the IRS Collection Financial Standards should not be used for either estimating basic living expenses or rental housing and citing the average housing cost in Orange County, California, as an example of the Standards being “unrealistic.”

Final Rule

The Bureau has decided to finalize the proposal's framing of the definition of basic living expenses as expenses that are “necessary” to maintain the consumer's health, welfare, and ability to produce income and the health and welfare of the members of the consumer's household who are financially dependent on the consumer. As such, the regulatory text is being finalized with only minor wording changes from the proposal for clarity. However, the Bureau in response to comments is making a number of modifications to the commentary clarifying the definition, as described in more detail below.

The Bureau concludes that the conceptual framework of the proposal remains the appropriate formulation for defining basic living expenses. The “necessary to maintain” language in the proposed definition is adapted largely from the IRS Collection Financial Standards, which set forth necessary expenses for repayment of tax delinquencies by taxpayers. The Bureau considered finalizing the alternative formulation on which it had sought comment (i.e., personal and household goods and services that are likely to recur and that are types of expenditures that the consumer cannot reasonably be expected to reduce or forgo during the term of the loan). However, while the focus on recurring obligations has been helpful in defining major financial obligations as discussed below, the Bureau is concerned about the complexity that would result from trying to differentiate recurring from non-recurring expenses and reducible from non-reducible expenses when it comes to more discretionary expenditures. To give an example, newspaper and magazine subscriptions and health club memberships are not typically thought of as necessary expenses, but they generally are recurring. And whether such expenses are reducible during the term of the loan generally and the relevant monthly period that is the focus of the residual-income or debt-to-income analysis in particular may depend on such factors as the term of the relevant contracts (for both the loan and the product or service), the method by which payments are made (e.g., automatic debit versus monthly bill pay), and the applicable termination policies and penalties (e.g., advance notice of termination). The Bureau also is not aware of data sources that categorize the types and amounts of recurring expenses as distinguished from non-recurring expenses, in contrast to the “necessary” expense formulation which as noted above is derived from the IRS Collection Financial Standards.

With regard to the commentary to § 1041.5(a)(1), the Bureau revised comment 5(a)(1)-1 and created a new comment 5(a)(1)-2. The revised comment 5(a)(1)-1 clarifies that estimating basic living expenses is part of the broader ability-to-repay determination under § 1041.5(b). The comment also clarifies that a lender may make a reasonable estimate of basic living expenses without making an individualized determination and includes a cross-reference to comment 5(b)-2.i.C. With regard to the amounts of basic living expenses, comment 5(b)-2.i.C has been revised in a number of ways to provide more guidance on how to reasonably estimate basic living expenses. Those changes are described below in the discussion of § 1041.5(b) and are to be read in tandem with the changes to commentary for the definition of basic living expenses in § 1041.5(a)(1).

Comment 5(a)(1)-2 expands the examples of basic living expenses described in the proposal with some additional clarification to six items, which are: (1) Food, (2) utilities not paid as part of rental housing expenses, (3) transportation, (4) childcare, (5) phone and Internet service, and (6) out-of-pocket medical expenses (which would include insurance premiums to the extent not deducted from consumer's paychecks as well as co-pays, prescriptions, and similar expenses). The comment also includes new language clarifying that basic living expenses do not include expenditures for discretionary personal and household goods or services and gives examples of newspaper subscriptions and vacation activities. Additionally, comment 5(a)(1)-2 notes that if the consumer is responsible for payment of household goods and services on behalf of the consumer's dependents, those expenditures are included in basic living expenses. The comment further clarifies that the lender may reasonably consider whether another person is regularly contributing toward the consumer's payment of basic living expenses when conducting a reasonable ability-to-repay determination (with a cross-reference to comment 5(b)-2.i.C. 2). The Bureau agrees with the commenters who suggested that, when a lender estimates basic living expenses on an individualized basis, the Bureau should permit lenders to take this fact into account given that the proposed definition of basic living expenses included members of the consumer's household who are financially dependent on the consumer.

The inclusion of additional examples of basic living expenses in comment 5(a)(1)-2 and the new language describing examples of items that are not included in the definition are in response to comments asking for more specificity on what expenses are included in and what are excluded from the definition of basic living expenses. Commenters had specifically asked about the status of the items now addressed. The categories of out-of-pocket medical expenses and phone and Internet service have been added in view of comments urging the Bureau either to clarify the status of the items or to include them because of the view by the commenters that they are necessary expenses. The category of utility payments also has been clarified to note that it includes utilities not paid as part of rental housing expense, in response to interagency comments from a Federal prudential regulator. The example of transportation as a basic living expense also has been broadened from the proposal, which included transportation to work as an example. The Bureau finds that transportation expenses for both personal and household use and for work is more consistent with the notion of “necessary” expenses for health, welfare, and the ability to work.

The Bureau concludes that the six categories of expenses provided as examples are sufficient for estimating basic living expenses. To this end, the Bureau has included language in comment 5(b)-2.i.C. 1 clarifying that a lender is not required to itemize the basic living expenses of each consumer but may instead arrive at estimates for the amount needed to cover the costs of food, utilities not paid as part of rental housing expenses, transportation, out-of-pocket medical expenses, phone and Internet services, and childcare. The comment also clarifies it would be reasonable for the lender to use data about these expenses from the Consumer Expenditure Survey of the Bureau of Labor Statistics or the IRS Collection Financial Standards, or a combination of the two data sources, to develop non-individualized estimates of basic living expenses for consumers seeking covered short-term or longer-term balloon-payment loans. The comment also clarifies that in using the data from those sources to estimate the amount spent on a particular category, the lender may make reasonable adjustments to arrive at an estimate of basic living expenses, for instance where a data source's information on a particular type of basic living expenses overlaps with a type of major financial obligation as defined in § 1041.5(a)(3). More explanation of the comment is provided in the section-by-section analysis for § 1041.5(b)(1), below.

With regard to the comments requesting that the Bureau should provide safe harbor categories and amounts for basic living expenses, the Bureau believes that the IRS Collection Financial Standards are a useful source for developing estimates of basic living expenses. As explained earlier, the “necessary” expense concept at the heart of the definition in § 1041.5(a) is derived from the Standards. Lenders can use the Standards to estimate both the amounts and categories of expenses, and the Bureau would view such an approach as reasonable. As described above, comment 5(b)-2.i.C. 1 now contains language recognizing that fact. At the same time, the Bureau recognizes that lenders may well want to make reasonable adjustments from that framework. The Bureau believes that in some cases the Standards may capture expenses that would not be relevant for a lender making a basic living expenses estimate for the relevant monthly period, which is the calendar month with the highest payments on the loan. And there also is overlap between some of the categories provided in the Standards and the items deemed in this rule as major financial obligations (such as automobile lease payments). A direct application of the Standards thus in some cases may create operational difficulty or result in an over-inclusive estimate for purposes of what is required under § 1041.5.

The Bureau also considered whether to use the Consumer Expenditure Survey of the Bureau of Labor Statistics (CEX) as a safe harbor. Like the Standards, the CEX is a useful source for information about consumers' household expenditures which could inform estimates of basic living expenses. As with the IRS Collection Financial Standards, comment 5(b)-2.i.C. 1 now clarifies that use of the CEX would be a reasonable method for estimating the categories and amounts of basic living expenses. However, because the CEX collects data at the household level, not the individual consumer level, and because of how it groups the categories of expenses, it too may be over-inclusive as to the amounts of the expenses, depending on whether the consumer has dependents or not match precisely the list of categories in comment 5(a)(1)-2.

Put another way, the Bureau views both data sources as reliable and useful for the purposes of estimating various categories of basic living expenses, and believes it would be reasonable for lenders to draw on one or both of them or on their own experience (or on a combination of the lenders' experience and these extrinsic data sources). But since the IRS Collection Financial Standards and the CEX each may be potentially over-inclusive or not match precisely the list of categories in comment 5(a)(1)-2, the Bureau expects that most lenders who use those sources will choose to make some reasonable adjustments or turn to supplemental sources.

The Bureau finds that, cumulatively, the changes to comments 5(a)(1)-2 and 5(b)-2.i.C. 1 described above will address commenters' concerns. To recap, the commentary now contains: (1) Additional examples of expense categories that are included in the definition; (2) clarification that it would suffice for lenders to estimate the six categories of expenses described in comment 5(a)(1)-2; (3) clarification around what is excluded from the definition; (4) new commentary language clarifying that use of particular government data sources (IRS Collection Financial Standards and/or CEX) would be reasonable methods of estimating expenses; and (5) commentary explaining that lenders have flexibility to make adjustments based on the lender's experiences and for other reasonable considerations. The Bureau recognizes that estimating basic living expenses will involve some complexity and burden, particularly initially while lenders are developing a system to comply with the rule's requirements. (This is discussed in the Section 1022(b)(2) Analysis.) The Bureau does expect that, at least in some cases, service providers would be positioned to provide software to permit lenders to develop this capability. Indeed, some commenters appear to have developed their own methodologies in the course of researching the affected markets and commenting on the proposal. The Bureau does not want to unduly restrict the flexibility of lenders and service providers to develop innovative methods of estimating basic living expenses, which a more prescriptive approach might do.

More generally, the Bureau emphasizes that at bottom the question will be whether the lender is acting reasonably in developing the estimates. The rule gives lenders substantial flexibility to develop estimates by consulting reliable data sources or developing reasonable estimates based on their own experience with similarly-situated consumers using at least the six categories of expenses provided as examples. Assuming a lender follows these procedural steps, the Bureau concludes that the strongest evidence of whether the estimations were in fact reasonable will be the performance of the loans in question; if a lender is consistently making unreasonable estimates of basic living expenses, the Bureau expects to see substantial re-borrowing and default activity.

In response to one commenter, the Bureau has declined to modify the commentary to address specifically whether a lender should take account of the fact that prices may change seasonally. The Bureau finds this to be adequately covered by the general reasonableness standard, such that a lender could choose to do so if there were reason to believe, for example, that the monthly averages that a lender is using in estimating basic living expenses are not representative of expenses during a particular term. At least in certain regions, a lender could make a reasonable determination based on historical and local trends that the estimated expense allocation for utilities declines in the spring and fall, when electricity and gas bills are lower.

The Bureau does not agree with the commenters who argued childcare expenses (including the costs of supplies for infant children) should not be basic living expenses and instead should be defined as major financial obligations and subject to verification. The Bureau believes that childcare expenses, particularly to the extent of including such items as diapers, could be difficult to verify and would not lend themselves to categorization as major financial obligations for which the primary source of verification is consumer reports from a nationwide consumer reporting agency. Therefore, the Bureau concludes that these expenses are better categorized as basic living expenses.

The Bureau has determined that the changes to the basic living expenses definition described above, along with revisions to comment 5(b)-2.i.C described below, appropriately balance the weight of the comments. The Bureau acknowledges that it has left some flexibility in the definition, but believes this flexibility will permit lenders to develop methodologies that work best for them consistent with the requirement that the estimates are reasonable.

5(a)(2) Debt-to-Income Ratio

The Bureau has added a new definition at § 1041.5(a)(2) for debt-to-income ratio in light of its decision, in response to the criticisms of the proposed residual income approach, to permit lenders to choose to use that underwriting methodology. Due to the addition of this new definition, the remaining subparagraphs of § 1041.5(a) are renumbered accordingly.

The final rule defines debt-to-income ratio as the ratio, expressed as a percentage, of the sum of the amounts that the lender projects will be payable by the consumer for major financial obligations during the relevant monthly period and the payments under the covered short-term loan or covered longer-term balloon-payment loan during the relevant monthly period, to the net income that the lender projects the consumer will receive during the relevant monthly period, all of which projected amounts are determined in accordance with § 1041.5(c). The Bureau has also added a definition for relevant monthly period in § 1041.5(a)(7), which consists of the calendar month in which the highest sum of payments under the loan is due. The section-by-section analysis for § 1041.5(a)(7) below describes why the Bureau chose this particular time period as the relevant monthly period.

The Bureau has added a new comment 5(a)(2)-1 to clarify aspects of the debt-to-income definition. Most notably, the comment clarifies that for covered longer-term balloon-payment loans, where the relevant monthly period may fall well into the future relative to the consummation of the loan, the lender must calculate the debt-to-income ratio using the projections made under § 1041.5(c) and in so doing must make reasonable assumptions about the consumer's net income and major financial obligations during the relevant monthly period compared to the period covered by the verification evidence. The comment clarifies that, for example, the lender cannot assume, absent a reasonable basis, that there will be a substantial increase in net income or decrease in major financial obligations between consummation and the relevant monthly period.

The addition of this new definition ties to the broader revision of § 1041.5(b)(2) in the final rule. The changes to § 1041.5(b)(2) are described in more detail in the associated section-by-section analysis below, but they bear some mention here given the interplay. As noted in the general § 1041.5 discussion above, under proposed § 1041.5(b)(2), the reasonable ability-to-repay determination would have required the lender to project both the amount and timing of the consumer's net income and major financial obligations, and to analyze the consumer's finances during two distinct time periods: First for the shorter of the term of the loan or 45 days after consummation of the loan, and then also for 30 days after having made the highest payment under the loan. For covered longer-term loans (including covered longer-term balloon-payment loans), the two periods would have been the month with the highest payments on the loan and also for 30 days after having make the single highest payment on that loan.

Upon further consideration of comments concerning the burdens involved in the proposed residual-income analysis and other factors, the Bureau has decided to streamline the calculations needed to support lenders' determination of consumers' ability to repay. Accordingly, the final rule simply requires lenders to make a projection about net income and major financial obligations and calculate the debt-to-income ratio or residual income, as applicable, during only a single monthly period, i.e., the relevant monthly period, which is the calendar month with the highest sum of payments on the loan. The debt-to-income ratio during this period is used as a snapshot of the consumer's financial picture to draw conclusions about the consumer's ability to pay, since it is the month in which the loan will cause the highest amount of financial strain. Specifically, under § 1041.5(b)(2), the lender uses this information to reach a reasonable conclusion about whether the consumer has the ability to repay the loan while meeting basic living expenses and major financial obligations during: (1) The shorter of the term of the loan or 45 days after consummation of the loan, for covered short-term loans, and the relevant monthly period, for covered longer-term loans, and (2) for 30 days after having made the highest payment under the loan. This simplified approach—which also has been incorporated into the definition of residual income in § 1041.5(a)(8) for purposes of making the standards for both alternatives consistent—dovetails with the inclusion of the debt-to-income ratio methodology as an alternative to residual income. As discussed above, a debt-to-income methodology does not track a consumer's individual income inflows and major financial obligation outflows on a continuous basis over a period of time.

Section 1041.5(b) requires that lenders using debt-to-income ratios leave a sufficiently large percentage of income to cover basic living expenses. Commentary to § 1041.5(b) elaborates on this reasonableness standard in more detail. Comment 5(b)-2.ii.B clarifies that it would be unreasonable for the lender to assume that the consumer needs an implausibly low percentage of income to meet basic living expenses. The comment also clarifies in an example that a 90 percent debt-to-income ratio would leave an implausibly low percentage of income to meet basic living expenses. The Bureau does not intend to require lenders to set individualized thresholds for each consumer; instead, a lender could set its own internal thresholds in its policies and procedures, which would then be applied to individual loan applications. Whether a lender would be able to rely on one debt-to-income threshold for all borrowers, or enact multiple thresholds based on income tiers or other characteristics, would depend on whether application of a single threshold or multiple thresholds resulted in reasonable ability-to-repay determinations in the run of cases, informed in part by the factors listed in comment 5(b)-2.iii.

Lenders using a debt-to-income ratio will, in essence, be taking an individualized accounting of the consumer's projected net income and major financial obligations within the relevant monthly period, which is the month in which a consumer will have to pay the most under the covered short-term or longer-term balloon-payment loan. The snapshot provided by the debt-to-income ratio, coupled with the lender's estimate of the consumer's basic living expenses during the relevant monthly period, will enable the lender to draw a reasonable conclusion about whether the consumer will be able to make payments for major financial obligations, make all payments under a covered longer-term balloon-payment loan, and meet basic living expenses during the loan term or 45 days following consummation (for covered short-term loans) or the relevant monthly period (for covered longer-term balloon-payment loans) and for 30 days after making the highest payment under the loan.

This accounting of the consumer's financial picture using a debt-to-income ratio is less granular than the proposed residual-income methodology, which would have required lenders to track the timing and amounts of net income and major financial obligations, and to analyze the consumer's finances for two separate periods in proposed § 1041.5(b)(2). The Bureau had expressed concern in the proposal that a debt-to-income approach might be problematic in the context of the market for covered loans, due to the lack of long-established debt-to-income norms in this market, and noted that debt-to-income ratios which might seem quite reasonable for an “average” consumer might be quite unmanageable for a consumer at the lower end of the income spectrum and higher end of the debt burden range. Upon further consideration of the comments focused on the complexity and burdens of the proposal, the Bureau concludes that it is appropriate to move to a simplified analysis that concentrates on the total inflows and outflows for the month in which the loan places the most financial strain on the consumer. In light of this change, the Bureau expects that lenders may be able to use either a debt-to-income ratio or a residual-income analysis, as long as they think carefully about the need for consumers to cover basic living expenses. For instance, lenders using a debt-to-income analysis may decide to set a more conservative ratio than lenders might use in other markets to account for the financial profiles of consumers in the markets for covered short-term loans or covered longer-term balloon-payment loans. Another option as referenced above may be to use different ratios for different subgroups of customers to account for differences in income, debt obligations, and other relevant factors.

As described below, in the discussion of § 1041.5(b), the Bureau has not set particular debt-to-income ratios for lenders to use. As with other aspects of the ability-to-repay requirements, lenders would be expected to be reasonable. Section 1041.5(b) commentary, as described below, has been revised extensively to include additional clarification and examples of the reasonableness of ability-to-repay determinations, in response to many comments urging the Bureau to provide additional clarity. See discussion of § 1041.5(b) for further elaboration.

5(a)(3) Major Financial Obligations

Proposed Rule

The Bureau proposed a definition for major financial obligations as a component of the ability-to-repay determination specified in proposed § 1041.5(b). Specifically, proposed § 1041.5(a)(2) would have defined the term to mean a consumer's housing expense, minimum payments and any delinquent amounts due under debt obligations (including outstanding covered loans), and court- or government agency-ordered child support obligations. In comment 5(a)(2)-1, the Bureau proposed to further clarify that housing expense includes the total periodic amount that the consumer applying for the loan is responsible for paying, such as the amount the consumer owes to a landlord for rent or to a creditor for a mortgage. It would have provided that minimum payments under debt obligations include periodic payments for automobile loan payments, student loan payments, other covered loan payments, and minimum required credit card payments.

The Bureau explained in the proposal that the obligations that it included in the proposed definition were obligations that are typically recurring; that can be significant in the amount of a consumer's income that they consume; and that a consumer has little or no ability to change, reduce, or eliminate in the short run, relative to their levels up until application for a covered short-term or longer-term balloon payment loan. The Bureau stated its belief that the extent to which a particular consumer's net income is already committed to making such payments was highly relevant to determining whether that consumer has the ability to make payments under a prospective covered short-term loan. As a result, the Bureau believed that a lender should be required to inquire about such payments, that they should be subject to verification for accuracy and completeness to the extent feasible, and that a lender should not be permitted to rely on income already committed to such payments in determining the consumer's ability to repay. The Bureau further elaborated in the proposal that obligations included in the proposed definition are roughly analogous to those included in total monthly debt obligations for calculating monthly debt-to-income ratio and monthly residual income under the Bureau's ability-to-repay requirements for certain residential mortgage loans, citing 12 CFR 1026.43(c)(7)(i)(A).

In the proposal, the Bureau noted that it had adjusted its approach to major financial obligations based on feedback from SERs and other industry stakeholders in the Small Business Review Panel Outline. In the SBREFA process, the Bureau stated that it was considering including within the category of major financial obligations “other legally required payments,” such as alimony, and had considered an alternative approach that would have included utility payments and regular medical expenses. However, the Bureau noted in the proposal that it believed that it would be unduly burdensome to require lenders to make individualized projections of a consumer's utility or medical expenses. With respect to alimony, the Bureau noted its belief that relatively few consumers seeking covered loans have readily verifiable alimony obligations and that, accordingly, inquiring about alimony obligations would impose unnecessary burden. The Bureau also noted that it did not include a category of “other legally required payments” because it believed that category, which was included in the Small Business Review Panel Outline, would leave too much ambiguity about what other payments are covered. The Bureau sought comment on whether to include alimony as a major financial obligation, as well as regarding other expenses such as telecommunication services.

Comments Received

The Bureau received a number of comments on its definition of major financial obligations. Some commenters argued that the proposal did not do enough to clarify the scope of obligations that are included in major financial obligations. For example, commenters questioned whether a medical debt would be included. Consumer advocates and some other commenters urged the Bureau to include additional expenses in the definition, like taxes, childcare, medical expenses, telecommunications services, health insurance premiums, and homeowners insurance. Some commenters, including a Federal financial regulator during interagency consultation, asked for clarification on the treatment of alimony or questioned why it was excluded from the definition while child support obligations were included. Other commenters interpreted the proposed definition to mean that the definition of major financial obligations did not include the payments on non-covered loans and urged the Bureau to include them.

Some industry commenters objected to the proposal to include delinquent amounts due on debt obligations in the definition of major financial obligations. They suggested that errors on credit reports often include defaulted debt, like medical debt, which could effectively halt the application process. Some commenters cited a Bureau report on the prevalence of consumers with outstanding medical debt in arguing that the proposal would impede credit access if medical debt was included as a major financial obligation. Others noted that, more generally, given how many consumers have accounts in collections on their credit reports, and the fact that the entire defaulted amount would need to be considered as a major financial obligation, this requirement would result in many consumers failing to demonstrate ability to repay and effectively being excluded from the market. Other commenters took a different view, arguing that delinquent amounts on non-covered loans should be part of the definition of major financial obligations.

Some commenters asked the Bureau to pinpoint the exact amount of time after which evidence on major financial obligations would become stale, and how long the calculations for major financial obligations remain valid. Similarly, commenters noted that it will be impossible to detect major financial obligations taken out the same day, or otherwise not reflected on national consumer reports because there is a delay between when a consumer takes out an obligation and when companies furnish to nationwide consumer reporting agencies.

Some commenters argued that where basic living expenses or major financial obligations were deducted from a paycheck, they would be deducted twice from residual income because they would count as major financial obligations or basic living expenses but would not be counted in the definition of net income. The commenters cited examples of such “double deductions” where consumers sign up directly for bill-pay from a paycheck or if the deduction is required under State law in connection with payment of child support obligations.

The Bureau received a comment suggesting that some of the categories of major financial obligations may not be able to be verified through national consumer reports, including escrowed amounts for property insurance and taxes. More broadly, industry commenters raised concerns about the accuracy of consumer reports, and being held accountable for inaccuracies in them.

One commenter, a State trade association, criticized the proposal for not clarifying how lenders should treat debts of non-applicant spouses, as well as their income, in a community property State where debt obligations are considered equally owned and are split equally upon dissolution of the marriage. The commenter argued that the proposed ability-to-repay requirements were significantly flawed because did not take into account the interplay with State community property laws. The commenter requested that the Bureau withdraw the proposal until it had adequately studied the issue.

Finally, one consumer suggested that the Bureau's identification of major financial obligations effectively prioritizes payment of other debts over covered loans. This commenter argued that the Bureau had not provided evidence that these debts were more important than covered loans.

Final Rule

The Bureau is finalizing the definition of major financial obligation at § 1041.5(a)(3) with certain substantive changes. The most significant change is that the Bureau has revised the reference to debt obligations to focus on “required payments under debt obligations (including, without limitation, outstanding covered loans).” In comment 5(a)(3)-1, the Bureau has provided further clarifications with regard to treatment of debt obligations to address commenters' concerns about treatment of medical debt and other issues.

First, comment 5(a)(3)-1 clarifies that the term “debt obligation” for purpose of § 1041.5(a)(3) does not include amounts due or past due for medical bills, utilities, and other items that are generally defined as basic living expenses under § 1041.5(a)(1). Second, the Bureau has provided a more robust definition of “required payments under debt obligations” drawing largely on language that was contained in proposed comments 5(a)(3)-1 and 5(c)(3)(ii)(B)-1. Third, the Bureau has added language to final comment 5(a)(3)-1 to include delinquent amounts on debt obligations within the concept of “required payments” only to the extent that such delinquent amounts are due as of the relevant monthly period, and not in cases in which an obligation on a covered short-term loan or a covered longer-term balloon-payment loan is no longer outstanding or where the obligation is listed as charged off on a national consumer report. The Bureau has also included an example of a creditor adding delinquent amounts on periodic payments to the consumer's next regularly scheduled periodic payment for an automobile loan payment.

The Bureau believes that these changes cumulatively will address a significant portion of commenters' concerns, particularly that resolving disputes about medical debts could effectively halt the application process. The Bureau has always intended that major financial obligations and basic living expenses be distinct categories, as evidenced by language in proposed and final § 1041.5(a)(1) defining the latter term, and the Bureau believes this further clarification will be helpful to reinforce the distinction. The Bureau recognizes that because of insurance and other factors, collections on medical bills can pose particular challenges for consumers. The Bureau believes that it may be appropriate for both consumers and lenders to exclude such irregular items from consideration. Because the general intent of the definition of major financial obligations generally is to capture recurring payments, the Bureau believes that a different rule is logical with regard to delinquent amounts on traditional consumer credit products by focusing on those amounts due in the relevant monthly period.

The Bureau made a few other changes to § 1041.5(a)(3) and comment 5(a)(3)-1. The Bureau specified in the text of the regulation that required payments under debt obligations could include, but are not limited to, outstanding covered loans, to address the impression expressed by commenters that non-covered loans are not considered debt obligations. The Bureau also added language to the commentary to reflect the new underwriting approach regarding timing—namely that the projections and calculations lenders will need to conduct will be in relation to the relevant monthly period, as defined in § 1041.5(a)(7). And the Bureau has clarified in comment 5(a)(3)-1 that the payments which must be included for a mortgage include principal, interest, and escrow if required.

Second, the Bureau has revised § 1041.5(a)(3) to include child support obligations and alimony obligations in general, rather than focusing solely on court- or government agency-ordered child support as in the proposal. As described above, at the SBREFA stage the Bureau had contemplated including both types of obligations generally within the definition of major financial obligations, but at the proposal stage decided to focus only on the obligations that were likely to be reflected in a national consumer report due to concerns that requiring lenders to verify other types of alimony or child support would be burdensome. Upon further consideration, the Bureau has concluded that the most reasonable approach is to include both types of expenses generally within the definition, and to permit lenders to rely on the information contained in consumers' written statements about such obligations to the extent that they are not listed on national consumer reports. The Bureau has added associated regulatory text and commentary to § 1041.5(c) to effectuate this requirement.

Finally, the Bureau has added a new comment 5(a)(3)-2 to specify that for purposes of the rule, motor vehicle leases shall be treated as a debt obligation. As explained in the Bureau's separate rulemaking to define larger participants in the market for automobile financing, automobile leases often function similarly to automobile loans. In the Bureau's experience, they are reported on national consumer reports—and, indeed, are often listed on such reports as installment loans—and the Bureau believes that it will promote more effective determinations of consumers' ability to repay a new covered short-term or covered longer-term balloon-payment loan to treat them as the equivalent of an automobile purchase loan.

Regarding the comments asking for a broader definition of major financial obligations, the general theory behind the distinction between major financial obligations and basic living expenses under the final rule is that a major financial obligation is something a lender will need to calculate individually and generally to verify, while a lender will not need to do so for basic living expenses. The Bureau's decision about what to include in the definition of major financial obligations has been influenced in part by considerations of administrability as well as size—all payments on debt obligations are included because they are generally both easily ascertained from a consumer report and tend to be large in amount. The other expenses that commenters recommended the Bureau include, such as childcare expenses, would not be ascertainable from a consumer report. Also, because housing is typically the largest recurring expense and is reflected on a credit report if the consumer has a mortgage, the Bureau thought it prudent for lenders to account specifically for that expense when performing their underwriting rather than including it in basic living expenses more generally.

The Bureau does not agree that the definition for major financial obligations should be vaguer and more flexible. It includes rental housing payments and payments on debt obligations. The Bureau has generally provided flexibility in this rule, but where lenders are required to itemize specific obligations, the Bureau concludes that it is more reasonable to prescribe the specific obligations for which the Bureau will expect heightened attention.

As to commenters that expressed concerns about duplicative deductions, the Bureau has added comments 5(c)(2)(ii)(B)-2 and 5(c)(2)(ii)(C)-2 to address this issue, both of which clarify the provisions on verification evidence for debt obligations and child support and alimony obligations. The comments provide that if verification evidence shows that a debt obligation or child support or alimony obligation is deducted prior to the receipt of take-home pay, the lender does not include the obligation in the projection of major financial obligations under § 1041.5(c). The Bureau also added an example to comment 5(c)(1)-1 relating to similar facts.

With regard to the comment that it would be difficult to verify some debt obligations on national consumer reports, the Bureau understands from its market monitoring that the nationwide consumer reporting agencies do in fact include most debt obligations in their national consumer reports, including payments necessary to cover escrowed items for mortgages. But, to the extent a consumer report does not include a debt obligation, lenders may reasonably rely on the information in the consumer's written statement. As described in final § 1041.5(c)(1), a lender must consider major financial obligations that are listed in a consumer's written statement even if they cannot be verified by the required sources.

If the national consumer report does not show a consumer's obligation because it is too recent or is not reported to a nationwide consumer reporting agency, and the consumer's statement does not include the payment on the obligation in listing major financial obligations, a lender would be reasonable in not accounting for that obligation in the lender's projection of major financial obligations and its residual income or debt-to-income calculation. Comment 5(c)(2)(ii)(B)-3 provides detailed guidance to lenders about how to reconcile inconsistent information as between a consumer's written statements and the verification evidence required under § 1041.5(c)(2)(ii)(B).

With regard to the commenter writing about State community property laws, the Bureau does not believe there is a fundamental tension between the proposed ability-to-repay requirements and State community property laws and declines the request to withdraw the proposal based on this issue. As an initial response to this comment, the Bureau notes that it has revised the final rule based on other commenters' input requesting that the final rule account for a consumer's reasonable expectation of access to spousal or third-party income, as well as the payment by another person of a consumer's major financial obligations or basic living expenses. Specifically, the Bureau has revised § 1041.5(a)(5), the definition of net income, and other provisions of § 1041.5 to provide that lenders may count as net income of the consumer any third party's income to which the consumer has a reasonable expectation of access, which must be verified. The Bureau has also added a comment that clarifies that lenders may factor into the projections of major financial obligations the regular contributions of third parties to those obligations (comment 5(c)(1)-2). Similarly, the Bureau has clarified that if a lender is individually itemizing a consumer's basic living expenses, the lender may consider whether other persons are regularly contributing to the consumer's payment of basic living expenses (comment 5(b)-2.i.C. 2). These changes are described in more detail in other parts of the section-by-section analysis for § 1041.5.

Thus, a consumer's access to spousal income or the spouse's contributions toward payment of a consumer's major financial obligations or basic living expenses may be accounted for by the lender under the final rule, regardless of whether the consumer lives in a community property State. The Bureau believes these changes would achieve for some consumers the same result as, for example, a rule that would permit a consumer to rely on the income of his spouse in a community property State.

The Bureau does not find it sensible to create separate ability-to-repay requirements for community property States and common law property States. This would add complexity to the rule, pose challenges for examination and uniform enforcement of the rule, and add compliance burdens on providers operating in multiple States with different family law regimes. Furthermore, such an adjustment would not fit with the final rule's orientation towards practical assessments of how much consumers pay in the short term for basic living expenses and major financial obligations, and practical access to income. For example, the final rule does not direct lenders to ascertain a consumer's legal entitlement to income where the consumer does not have practical access to the funds. Nor did the commenter present any evidence that lenders in the market today have been taking into account State community property laws in making lending decisions.

The Bureau disagrees with the commenter that argued that its identification of major financial obligations as obligations that must be itemized by category in underwriting suggests that the Bureau is prioritizing payment of other debt obligations over covered loans for which the lender is making an ability-to-repay determination. In fact, covered loans can also be major financial obligations (such as where a consumer has a concurrent loan outstanding). Rather, the Bureau is simply differentiating between major financial obligations that the consumer is already committed to and the obligation that would be incurred in connection with a new covered short-term or longer-term balloon-payment loan.

Finally, the Bureau declines the suggestion by commenters to include as major financial obligations property taxes and insurance that is not required to be paid in escrow to a mortgagee. The Bureau believes that the pool of consumers taking out covered short-term and longer-term balloon-payment loans who both own a home and who do not escrow their property taxes and insurance will be quite low. In the presumably small number of cases where consumers have a mortgage and do not pay taxes or insurance through a regular escrow arrangement, the Bureau also believes that the payments may be infrequent, particularly with regard to property taxes which, unless escrowed, are typically not paid monthly. Therefore, the Bureau believes it is unlikely in the vast majority of cases that these items would actually bear on the consumer's financial balance sheet for purposes of the ability-to-repay requirement for a covered short-term loan, and thus these items should not be treated as a major financial obligation. The Bureau also is not treating them as a basic living expense for similar reasons, as well as the difficulty lenders would have in developing a non-individualized estimate of property taxes.

5(a)(4) National Consumer Report

In proposed § 1041.5(a)(3), the Bureau defined national consumer report to mean a consumer report, as defined in section 603(d) of the Fair Credit Reporting Act (FCRA), 15 U.S.C. 1681a(d), obtained from a consumer reporting agency that compiles and maintains files on consumers on a nationwide basis, as defined in section 603(p) of the FCRA, 15 U.S.C. 1681a(p). In proposed § 1041.5(c)(3)(ii), the Bureau provided that a lender would have to obtain a national consumer report as verification evidence for a consumer's required payments under debt obligations and under court- or government agency-ordered child support obligations. Reports that meet the proposed definition are often referred to informally as a credit report or credit history from one of the three major nationwide consumer reporting agencies or bureaus. A national consumer report may also be furnished to a lender from a consumer reporting agency that is not a nationwide agency, such as a consumer reporting agency that is a reseller.

The Bureau did not receive comments on the specific definition of national consumer report, though it did receive comments on the requirement to obtain national consumer reports. The Bureau addresses those comments in the discussion regarding major financial obligations and § 1041.5(c). Therefore, the Bureau finalizes the definition as proposed, except renumbered as § 1041.5(a)(4).

5(a)(5) Net income

Proposed Rule

In proposed § 1041.5(a)(4), the Bureau set forth a definition for net income as a component of the calculation for the ability-to-repay determination specified in proposed § 1041.5(b). Specifically, the Bureau proposed to define the term as the total amount that a consumer receives after the payer deducts amounts for taxes, other obligations, and voluntary contributions, but before deductions of any amounts for payments under a prospective covered short-term loan or for any major financial obligation.

The Bureau explained in the proposal that the proposed definition was similar to what is commonly referred to as “take-home pay,” but is phrased broadly to apply to income received from employment, government benefits, or other sources. It would exclude virtually all amounts deducted by the payer of the income, whether deductions are required or voluntary, such as voluntary insurance premiums or union dues. The Bureau stated its belief that the total dollar amount that a consumer actually receives after all such deductions is the amount that is most instructive in determining a consumer's ability to repay. Certain deductions (e.g., taxes) are beyond the consumer's control. The Bureau further stated in the proposal that other deductions may not be revocable, at least for a significant period, as a result of contractual obligations into which the consumer has entered. Even with respect to purely voluntary deductions, most consumers are unlikely to be able to reduce or eliminate such deductions immediately—that is, between consummation of a loan and the time when payments under the loan would fall due. The Bureau also stated in the proposal that it believed that the net amount a consumer actually receives after all such deductions is likely to be the amount most readily known to consumers applying for a covered short-term loan (rather than, for example, periodic gross income) and is also the amount that is most readily verifiable by lenders through a variety of methods. The Bureau stated in the proposal that the proposed definition would clarify, however, that net income is calculated before deductions of any amounts for payments under a prospective covered short-term loan or for any major financial obligations. The Bureau stated that it was proposing the clarification to prevent double-counting of any such amounts when making the ability-to-repay determination.

Comments Received

The Bureau received a number of comments on its proposed definition of net income, raising a variety of issues. Several industry commenters argued that the Bureau should explicitly state that the definition includes a number of other sources of income that are paid at irregular times or in irregular amounts, including seasonal income, tips, bonuses, overtime pay, or commissions. Commenters also asked the Bureau to state explicitly that receipt of a number of other types of income should be included, such as child support, annuities, alimony, retirement, disability, prizes, jury awards, remittances, investment income, tax refunds, and legal settlements. A consumer advocate commenter took the opposite view, arguing that one-time lump-sum payments, tax refunds, legal settlements, or other income that is “not consistently reliable” should not be counted. This commenter argued that these income sources often are speculative and that consumers relying on them often take out payday or vehicle title loans in reliance on the expected funds only to see the payment delayed or to receive less funds than expected or not at all, leading to inability to repay and collateral consequences.

Other commenters argued that the Bureau should allow lenders to include in net income any third-party income, like spousal income, because many individuals' finances are managed on a household basis. Some suggested that the Bureau's failure to do so was inconsistent with CARD Act regulations, which permit card issuers to consider as the applicant's income the income of another person if the applicant has a reasonable expectation of access to the other person's income. The commenters argued that this created a disadvantage to stay-at-home spouses and would result in loss of credit access. They criticized the proposal for not addressing this issue in the same manner as the Bureau's rulemaking in 2013 amending the CARD Act regulations. (Commenters raised related Regulation B issues addressed in the general § 1041.5 discussion above.) One commenter made arguments similar to those it made regarding major financial obligations, discussed with regard to § 1041.5(a)(3) above, arguing that the Bureau should have taken into account spousal income in community property States.

Some commenters argued that the Bureau should use gross income instead of net income. One trade association argued that one of its members currently uses gross income, and that just this minor change would require training, systems updates, and changes to forms. Another noted that for Federal student loans, income-based repayment plans are assessed using adjusted gross income, and asserted that the Bureau's proposal to use net income was merely a method of ensuring that fewer consumers would meet the standard.

Some commenters argued that the Bureau should not require lenders to subtract voluntary deductions from the net income calculation, arguing that because these deductions are voluntary they thus could be diverted to cover basic living expenses, major financial obligations, or loan payments. Other commenters asked for further clarification of what “other obligations” and “voluntary contributions” would include. Still others argued that it would be very difficult in many instances to verify whether an employer was deducting for taxes or other items. Those commenters questioned whether lenders would be required to ascertain the consumer's tax liability or be held responsible if the take-home pay figure used for the projection of net income was found to be based on erroneous information about tax deductions. A small rural lender commented that the proposed definition would create an inconsistent standard, positing that a loan applicant who withholds the maximum permitted amount would be less likely to pass the ability-to-repay requirement than another applicant who withholds the minimum amount, even if they work at the same job and earn the same salary. Another commenter asked for clarification on the situation where the verification evidence does not identify the payee or purpose of a deduction; the commenter noted this would likely occur with deposit account transaction history.

Several industry commenters believed that the Bureau should allow lenders to include in net income the proceeds from the covered loan itself. These commenters argued that while it may make sense not to include proceeds in net income when a consumer is using those proceeds to pay for emergency expenses, it is conceptually inconsistent to exclude proceeds when they are being used to pay for basic living expenses or major financial obligations. For example, if a consumer uses proceeds to pay rent—which is a major financial obligation—commenters believed it would be unfair to have to treat rent as an obligation that the consumer would still have to pay in order to determine whether she would have the ability to repay the loan, unless the proceeds can be included in the net income calculation. They viewed this approach as improper “double-counting” of the major financial obligation or basic living expense paid with proceeds.

Final Rule

The Bureau is finalizing the definition of net income in § 1041.5(a)(5) with two changes from the proposal. The Bureau, moreover, has added three new comments to address various issues raised by the commenters.

The first change is a technical change that aligns with the change in scope of the final rule. The proposal defined net income as the total amount the consumer receives after the payor deducts amounts for taxes, other obligations, and voluntary contributions, qualified with a parenthetical phrase reading “but before deductions of any amounts for payments under a prospective covered short-term loan or for any major financial obligation.” The definition of net income in proposed § 1041.9(a)(5) contained similar language referring to covered longer-term loans. In light of its decision not to finalize the ability-to-repay requirements as to all covered longer-term loans and to consolidate into § 1041.5 provisions from § 1041.9 relating to covered longer-term balloon-payment loans, the Bureau has changed the language to refer to “but before deductions of any amounts for payments under a prospective covered short-term loan or covered longer-term balloon-payment loan or for any major financial obligation.”

Second, the Bureau agreed with commenters that it should allow lenders to include income from third parties where the consumer has a reasonable expectation of access to that income, and § 1041.5(a)(5) of the final rule allows lenders to do so. In new comment 5(a)(5)-3, the Bureau clarifies that a consumer has a reasonable expectation of access to a third party's income if the consumer has direct, practical access to those funds on a regular basis through a bank account in which the consumer is an accountholder. The Bureau also provided examples in comment 5(a)(5)-3 of what reasonable expectation of access would entail, including evidence of a joint bank account or of regular deposits from said third party into an account in the consumer's name.

A number of commenters had cited the Bureau's CARD Act regulations as precedent for the request to include the income of another person in net income. The Bureau notes that the CARD Act regulations in 12 CFR 1026.51(a)(1)(i) contain commentary including a number of examples of whether an applicant had a reasonable expectation of access to the income of another person. This commentary was added in the Bureau's amendments to the credit card ability-to-pay rules in 2013. The Bureau notes that it drew inspiration from this commentary in drafting the examples in comment 5(a)(5)-3, but the Bureau has not incorporated all of the examples. In particular, one example posited that the consumer has reasonable expectation of access where another person is regularly paying the consumer's expenses, and another comment cited above includes an example of where there is not reasonable expectation of access because, among other facts, no Federal or State statute or regulation grants the applicant an ownership interest in that income. The former example, in the Bureau's view, does not align well with the final rule insofar that the credit card example blends the distinction between income and expenses; as with the proposal, the final rule creates separate definitions for net income, major financial obligations, and basic living expenses. Accordingly, the Bureau has dealt with contributions toward basic living expenses and major financial obligations in comment 5(b)-2.i.C. 2 and comment 5(c)(1)-2, respectively, of the final rule rather than in connection with the definition of net income. Also, the Bureau is not adapting the language referencing Federal or State statutes or regulations granting an ownership interest in income for similar reasons to those described above with regard to State community property laws in connection with major financial obligations. For further discussion on the differences more generally between the final rule and the CARD Act ability-to-pay regulations, see general § 1041.5 discussion above.

Regarding the commenter that discussed State community property laws, similar to the treatment of this issue as applied to major financial obligations, the Bureau concludes that whether a consumer lives in a community property State does not change the consumer's practical access to income, and thus the regulation does not need to distinguish between how lenders should treat net income from one State to another. However, as noted above, in response to other comments the Bureau has decided to allow lenders to rely on third-party income, including income from a spouse, if the consumer has a reasonable expectation of access to that income (see discussion of § 1041.5(a)(5) and comment 5(a)(5)-3). This is consistent with the Bureau's general approach to whether a consumer has practical access to a spouse's (or other third party's) income. Given that this rule is closely focused on whether consumers will be able to meet their major financial obligations, make the payments on the loan, and pay basic living expenses in the near term, the Bureau determined that practical access to income was more important than legal entitlement to income. The Bureau also notes that attributing all community property to a consumer would not necessarily increase the odds that the consumer would be able to meet the ability-to-repay requirement relative to the final rule, because in community property States, liabilities are also imputed to the spouse. The Bureau also noted in the earlier discussion that creating separate underwriting regimes depending on the family law of the State would create added complexity and also challenges for examination, enforcement, and compliance.

The Bureau also agrees with commenters that the final rule should provide more clarity about and examples of what sources of income could be included in net income. The Bureau has added a detailed new comment, 5(a)(5)-1, addressing these issues. Specifically, the comment clarifies that net income includes income that is regularly received by the consumer as take-home pay, whether the consumer is treated as an employee or independent contractor, and also includes income regularly received by the consumer from other sources, such as court-ordered child support or alimony received by the consumer and any payments received by the consumer from retirement, social security, disability, or other government benefits, or annuity plans.

Comment 5(a)(5)-1 further clarifies that lenders may include in net income irregular or seasonal income, such as tips, bonuses, and overtime pay, and that net income does not include one-time payments anticipated to be received in the future from non-standard sources, such as legal settlements, tax refunds, jury prizes, or remittances, unless there is verification evidence of the amount and expected timing of such income. The Bureau has included the verification requirement with regard to future one-time payments because they generally are uncertain as to timing or amount. Before basing an ability-to-repay determination on a projection of this sort, the Bureau believes it is important to be confident that income will be received during the relevant monthly period in the expected amount. Of course, lenders must always collect verification evidence about net income where it is reasonably available (see § 1041.5(c)(2)(ii)(A) and comment 5(c)(2)(ii)(A)-3). Therefore, the effect of comment 5(a)(5)-1 is that when verification evidence is not reasonably available to project one-time income payment, then unlike with other sources of income, the lender cannot rely on the consumer's statement of the amount alone. The Bureau does not agree with the commenter requesting the rule prohibit inclusion of these types of one-time income sources altogether, because if verification evidence as described is available, the Bureau believes it is appropriate to include such types of income in the definition of net income.

The Bureau does not agree with commenters that it is more appropriate to calculate debt-to-income or residual income based on gross income than net income. The ability-to-repay determination is intended to capture the amount of money the consumer will actually have available to pay for major financial obligations, basic living expenses, and loan payments in the month with the highest sum of payments on the loan. Income that is automatically diverted to taxes or other deductions would not be available to cover any of those expenses. While it is true, as one commenter noted, that student loan income-driven repayment plans are based on gross income, that is because an income-driven repayment plan is a flat percentage of income and does not account for basic living expenses or major financial obligations (see the discussion above about why a payment-to-income approach has not been adopted in this rule).

At the same time, with regard to commenters that raised concerns about compliance burdens where they are relying on verification sources that do not clearly reflect whether deductions have been made from take-home pay, the Bureau believes it is not practicable to require lenders to engage in detailed inquiries and individual adjustments. Thus, the Bureau has clarified in comment 5(a)(5)-1 that the lender may draw reasonable conclusions from information provided by the consumer and is not required to inquire further about deductions for the consumer's taxes, other obligations, or voluntary contributions. This may mean that a lender could rely on gross income on a pay stub, if net income and/or deductions are not otherwise on the pay stub. Similarly, if a lender is verifying income via a bank statement, the lender may assume that the amount deposited is net of deductions.

The Bureau also is adding commentary language to address the comments asking for clarification on the meaning of voluntary contributions and whether the lender must, or can, assume that voluntary contributions will be discontinued during the term. The Bureau has added comment 5(a)(5)-2 to provide further clarification about what would be included as a voluntary contribution deducted from income, giving an example of a consumer's contribution to a defined contribution plan commonly referred to as 401K plans. In light of comments received, comment 5(a)(5)-2 also clarifies that a lender may inquire about and reasonably consider whether the voluntary contributions will be discontinued prior to the relevant monthly period, in which case deductions for those voluntary contributions would not need to be accounted for in the income calculation. New comment 5(a)(5)-2 also clarifies that an example of an “other obligation” is a consumer's portion of payments for premiums for employer-sponsored health insurance plans.

Treatment of loan proceeds. After careful consideration, the Bureau has decided not to include the loan proceeds in net income, or otherwise allow the lender to give a credit for or otherwise account for the proceeds in the estimation of basic living expenses or projection of major financial obligations. The Bureau acknowledges that some consumers use loan proceeds to cover basic living expenses or major financial obligations, but believes on balance that treating for loan proceeds as income is not appropriate for multiple reasons.

First, many consumers take out covered short-term or covered longer-term balloon-payment loans specifically to pay unusual, non-recurring or emergency expenses, or because covering such expenses in the recent past has left them without sufficient funds to cover basic living expenses or major financial obligations. The Bureau received many comments, including many from individual consumers, describing how consumers often use payday loans and other covered loans to cover emergency expenses. Payday lenders in their advertising also tend to cite this usage category as the primary purpose for using the product, and industry commenters noted it as a use case as well. Academic literature and surveys discussing usage patterns on payday loans have consistently found that a sizable number of consumers report using payday loans and other covered loans for non-recurring and emergency expenses. See part II and Market Concerns—Underwriting (citing a 2012 study by Center for Financial Services Innovation).

Because money is fungible, the Bureau is concerned that disentangling the interplay between regular and irregular expenses would create significant compliance and examination challenges. Lenders would be expected to adhere to different rules depending on the stated intended use of the loan proceeds. This would put the lenders in the position of having to inquire in detail about consumers' intended use for the loans, which consumers may feel is unduly intrusive. Such a provision would also be difficult to enforce given the fungible nature of the funds in question and raise questions about lender compliance burden and liability under the rule if they rely on a consumer's statement of intended use that does not prove accurate. It also would create incentives for evasion.

In addition, simply assuming that all consumers will use the loan proceeds to pay basic living expenses or major financial obligations would be as simple as the approach taken by the Bureau, but is a problematic approach on policy grounds. Because many consumers use loan proceeds for reasons other than payment of major financial obligations or basic living expenses, such a rule would lead to lenders making loans to many consumers who plan to use the funds to cover a non-recurring or emergency expense, and thus the ability-to-repay determinations would be inaccurate in the opposite direction. As a result, the harms identified in Market Concerns—Underwriting and the section-by-section analysis for § 1041.4 would continue to exist and would likely be prevalent.

Moreover, there is a question of timing. As referenced above and described in more detail below in connection with § 1041.5(a)(7) and (b)(2), the Bureau has decided to focus the calculation of debt-to-income or residual income on the relevant monthly period, which is the calendar month with the highest sum of loan payments. This snapshot is intended to focus on the month in which the loan places the greatest strain on the consumer's finances, which is then used in turn by the lender to forecast the consumer's ability to cover loan payments, major financial obligations, and basic living expenses both during the loan term and for 30 days after the single highest payment. To the extent that consumers use loan proceeds to cover major financial obligations or basic living expenses, that is likely to occur soon after consummation. Thus, except for loans with short terms made near the beginning of a calendar month, the Bureau believes that the proceeds will have been disbursed to cover expenses before the relevant monthly period and/or the 30 days after the single highest payment on the covered loan.

Indeed, in light of the concern about high risk of re-borrowing in the markets for covered short-term and longer-term balloon-payments, this is precisely why the Bureau has focused the analysis on the period of time in which the consumer is making the largest payment(s) on the loan and the major financial obligations and basic living expenses that are due soon thereafter.

5(a)(6) Payment Under the Covered Short-Term or Longer-Term Balloon-Payment Loan

Proposed Rule

The Bureau proposed to define payment under the covered short-term loan, which was a component of the calculation for the ability-to-repay determination as specified in proposed § 1041.5(b). Specifically, the proposed definition of payment under the covered short-term loan in proposed § 1041.5(a)(5)(i) and (ii) would have included all costs payable by the consumer at a particular time after consummation, regardless of how the costs are described in an agreement or whether they are payable to the lender or a third party. Proposed § 1041.5(a)(5)(iii) would have set special rules for projecting payments on lines of credit if they are provided for under a covered short-term loan for purposes of the ability-to-repay test, since actual payments for lines of credit may vary depending on usage.

Proposed § 1041.5(a)(5)(i) would have applied to all covered short-term loans. It defined payment under the covered short-term loan broadly to mean the combined dollar amount payable by the consumer in connection with the covered short-term loan at a particular time following consummation. The proposed definition further would have provided that, for short-term loans with multiple payments, in calculating each payment under the covered loan, the lender must assume that the consumer has made the preceding required payments and has not taken any affirmative act to extend or restructure the repayment schedule or to suspend, cancel, or delay payment for any product, service, or membership provided in connection with the covered loan. Proposed § 1041.5(a)(5)(ii) similarly would have applied to all covered short-term loans and clarified that payment under the covered loan included all principal, interest, charges, and fees.

The Bureau stated in the proposal that it believed that a broad definition was necessary to capture the full dollar amount payable by the consumer in connection with the covered short-term loan, including amounts for voluntary insurance or memberships and regardless of whether amounts are due to the lender or another person. The Bureau noted that it is the total dollar amount due at each particular time that is relevant to determining whether or not a consumer has the ability to repay the loan based on the consumer's projected net income and payments for major financial obligations. The amount of the payment is what is important, not whether the components of the payment include principal, interest, fees, insurance premiums, or other charges. In the proposal, the Bureau recognized, however, that under the terms of some covered short-term loans, a consumer may have options regarding how much the consumer must pay at any given time and that the consumer may in some cases be able to select a different payment option. The Bureau explained that the proposed definition would include any amount payable by a consumer in the absence of any affirmative act by the consumer to extend or restructure the repayment schedule, or to suspend, cancel, or delay payment for any product, service, or membership provided in connection with the covered short-term loan. Proposed comment 5(a)(5)(i) and 5(a)(5)(ii)-1 would have included three examples applying the proposed definition to scenarios in which the payment under the covered short-term loan includes several components, such as voluntary fees owed to a person other than the lender, as well as scenarios in which the consumer has the option of making different payment amounts.

Proposed § 1041.5(a)(5)(iii) included additional provisions for calculating the projected payment amount under a covered line of credit for purposes of assessing a consumer's ability to repay the loan. As explained in proposed comment 5(a)(5)(iii)-1, the Bureau believed such rules were necessary because the amount and timing of the consumer's actual payments on a line of credit after consummation may depend on the consumer's utilization of the credit (i.e., the amount the consumer has drawn down) or on amounts that the consumer has repaid prior to the payments in question. As a result, if the definition of payment under the covered short-term loan did not specify assumptions about consumer utilization and repayment under a line of credit, there would be uncertainty as to the amounts and timing of payments to which the ability-to-repay requirement applies. Proposed § 1041.5(a)(5)(iii) therefore prescribed assumptions that a lender must make in calculating the payment under the covered short-term loan. It would have required the lender to assume that the consumer will utilize the full amount of credit under the covered loan as soon as the credit is available to the consumer, and that the consumer will make only minimum required payments under the covered loan. The lender would then apply the ability-to-repay determination to that assumed repayment schedule.

Proposed § 1041.9(a)(5)(iii) would have included parallel provisions, with a supplemental provision to account for the fact that it applied to longer-term loan structures. In addition to the same two assumptions that a lender must make in calculating the payment under proposed § 1041.5(a)(5)(iii), proposed § 1041.9(a)(5)(iii) also would have required the lender to assume that, if the terms of the covered longer-term loan would not provide for a termination of access to the credit line by a date certain and for full repayment of all amounts due by a date certain, the consumer must repay any remaining balance in one payment on the date that is 180 days following the consummation date.

Comments Received

The Bureau received a number of comments that were generally supportive of the Bureau's definition of payment under the covered short-term loan.

A trade group representing open-end credit providers criticized this rule generally for reflecting what was, in the commenter's view, the Bureau's lack of understanding about open-end credit provisions. They specifically criticized the proposal for, in the commenter's view, not addressing how lines of credit with principal paydown requirements or with a specified duration would be treated. The Bureau also received a comment objecting to proposed § 1041.9(a)(5)(iii)(C), the parallel definition for the proposed underwriting section for covered longer-term loans, which would have provided that the whole balance of open-end longer-term credit should be considered to be due 180 days following the consummation date if there is not a date certain for termination of the line and repayment of any remaining balance. The commenter argued instead that the Bureau should use the maximum required payment under the terms of the agreement.

Final Rule

The Bureau has finalized the definition as proposed in § 1041.5(a)(6), with minor wording clarifications and the addition of references to payments for covered longer-term balloon-payment loans. The Bureau also has made minor adjustments to the examples in comment 5(a)(6)(i)-1 and 5(a)(6)(ii)-1 to reflect that the same definition applies to covered longer-term balloon-payment loans.

With regard to the rules for calculating payments on open-end loans, the Bureau has not imported the text from proposed § 1041.9(a)(5)(iii)(C) into this definition, which would have made a lender assume, for purposes of the ability-to-repay determination, that all advances under a longer-term open-end credit line would be due within 180 days of consummation if there is not a date certain for termination of the line and repayment of any remaining balance. Because the Bureau has decided to apply the ability-to-repay requirements only to covered longer-term balloon-payment loans that have the payment features as described in § 1041.3(b)(2), the Bureau does not believe that this provision is necessary to help lenders calculate potential loan payments. Put another way, if a loan without a date certain for termination of the line and repayment of any remaining balance qualifies as a covered longer-term balloon-payment loan under the rule, the Bureau believes the terms of the loan contract that create that balloon payment feature will be sufficient for lenders to calculate payments using the assumptions in § 1041.5(a)(6)(iii)(A) and (B).

In comment 5(a)(6)(iii)-1, in addition to corresponding technical updates, the Bureau added a description of how a lender should calculate the payment amount for open-end credit when underwriting for a new advance, including when there is an outstanding balance. The comment states that lenders should use the same test with the same assumptions when they make a new ability-to-repay determination under § 1041.5(b)(1)(ii) prior to an advance under the line of credit that is more than 90 days after the date of a prior ability-to-repay determination for the line of credit, in order to determine whether the consumer still has the ability to repay the current credit line.

The Bureau also disagrees with the commenter that argued the proposal reflects a lack of understanding of open-end credit provisions. The commenter's primary focus in asserting a lack of understanding appears to have been on certain assumptions about credit line usage and repayment that the proposal would have required lenders to use in periodically re-underwriting open-end loans. Those assumptions were admittedly complicated by the fact that the proposal would have applied to a broad range of product structures. However, the Bureau has since simplified and clarified those assumptions particularly in light of the narrowed scope of the final rule's ability-to-repay requirements, which now apply only to covered short-term loans and covered longer-term balloon-payment loans. The Bureau believes the remaining assumptions—that consumers draw the maximum amount allowed on the loan and make minimum payments for as long as permitted under the loan contract—are logical for assessing consumers' ability to repay and relatively simple to apply in conjunction with covered loans' contractual terms governing principal pay-down and other matters.

5(a)(7) Relevant Monthly Period

As described above, the Bureau has added a definition for relevant monthly period, which is the calendar month in which the highest sum of payments under the loan is due. This definition will be used as the period for which a lender will need to calculate residual income or a debt-to-income ratio. As noted in the discussion regarding debt-to-income ratio above, the concept of the relevant monthly period flows from the larger streamlining and reconceptualization of the requirements under § 1041.5(b)(2). The Bureau believes that instead of requiring lenders to make separate calculations to analyze consumers' ability to cover major financial obligations, basic living expenses, and payments on the covered loan both during the term of the loan and for 30 days after the highest payment on the loan, it would be more administrable to allow lenders to make a single monthly calculation that can then be used to evaluate more generally whether the consumer has the ability to cover all relevant expenses during the time periods described in § 1041.5(b)(2).

Because the month with the highest sum of payments on the covered short-term or covered longer-term balloon-payment loan will be the month in which the loan places the greatest strain on the consumer's finances, the Bureau believes that it is the logical period to use as a snapshot. Indeed, the Bureau had proposed to focus the underwriting analysis for covered longer-term balloon-payment loans on this specific period for this same reason. The Bureau considered starting the monthly clock on the date of the first of the loan payment(s), but ultimately concluded that a calendar month was easier to administer. Since billing cycles typically correspond to calendar months, the Bureau believes that it will be relatively straightforward for lenders to project income and major financial obligations based on consumer statements, income documentation, and national consumer reports. The Bureau also believes that calculating the residual income and debt-to-income ratio for a relevant monthly period defined by reference to a calendar month will generally give lenders a sense of total monthly inflows and outflows that can be projected to the time periods for which the lender must make a reasonable conclusion that, based on residual income or the debt-to-income ratio, the consumer can make payments for major financial obligations, make all payments under the loan, and meet basic living expenses. See discussion of § 1041.5(b)(2)(i) and (ii) and commentary for further information. The relevant monthly period is also the time period referenced under § 1041.5(b)(2)(i)(B) and (b)(2)(ii)(B).

The Bureau considered alternative time periods for the relevant monthly period, such as the 30-day period starting at consummation, the 30-day period ending on the contractual due date, or the calendar month in which consummation occurred. The Bureau chose the specific calendar month in which the highest sum of payments under the loan will be due for the reasons discussed above, because it believes that the residual income and debt-to-income ratio will only be demonstrative of ability to repay if they reflect the calendar month in which the loan will strain the consumer's monthly balance sheet the most. The Bureau notes that for covered longer-term balloon-payment loans, there may be challenges to projecting major financial obligations and net income, as the relevant monthly period may fall far into the future. Commentary in the definitions of debt-to-income ratio and residual income addresses this issue; see comments 5(a)(2)-1 and 5(a)(8)-1 which provide that for covered longer-term balloon-payment loans, lenders must make reasonable assumptions about that period compared to the period covered by the verification evidence, and gives examples.

5(a)(8) Residual Income

The Bureau proposed § 1041.5(a)(6) to define residual income as a component for the calculation of the ability-to-repay determination specified in proposed § 1041.5(b). It proposed to define the term as the sum of net income that the lender projects the consumer obligated under the loan will receive during a period, minus the sum of amounts that the lender projects will be payable by the consumer for major financial obligations during that same period. Proposed § 1041.5(b) would have generally required a lender to determine that a consumer will have sufficient residual income to make payments under a covered short-term loan and to meet basic living expenses.

The Bureau discussed above the comments that generally criticized its approach to requiring a residual-income analysis, which led the Bureau in the final rule to add the debt-to-income ratio as another option for lenders to use. Other comments about the Bureau's general ability-to-repay framework were also listed above, and will be discussed further in addressing § 1041.5(b).

The Bureau made a few changes to the definition of residual income as finalized in § 1041.5(a)(8). First, there were a number of technical edits, and the Bureau included “relevant monthly period” where appropriate to incorporate the revised approach to the timing of the underwriting calculations that must be made and thus parallel the definition of debt-to-income ratio. As discussed above, the Bureau has modified its approach to residual income calculations to allow lenders to calculate them on a net basis for the relevant monthly period, rather than focusing in detail on the timing of inflows and outflows within the time periods specified in § 1041.5(b)(2)(ii).

The Bureau has also added into the residual income calculation the payments under the covered short-term or longer-term balloon-payment loan. This was a shift in structure from the proposal, but not substance. In the proposed rule, residual income was net income minus major financial obligations, and the result was used to make sure a consumer could afford the loan payments and basic living expenses. Now residual income is net income minus major financial obligations and loan payments, and the results will be used to determine whether consumers can afford basic living expenses only. The Bureau thought it would be easier to reposition these variables so that the numbers for which the lender will need to make an individualized assessment—net income, major financial obligations, and loan payments—will all be used to come up with a single number. That will allow a lender to isolate the only estimated figure—basic living expenses. The Bureau notes that this “back-end” approach is consistent with the formulation in the Bureau's mortgage ability-to-repay requirements and the definition of debt-to-income ratio in § 1041.5(a)(2).

In addition, the Bureau added comment 5(a)(8)-1, which restates the definition of residual income and provides further clarification on how to project net income and major financial obligations for covered longer-term balloon-payment loans where the relevant monthly period may be well into the future. The Bureau states that the lender cannot assume, absent a reasonable basis, that there will be a substantial increase in income or decrease in major financial obligations between consummation and the relevant monthly period. As for all loans made under § 1041.5, lenders will generally be using figures verified by evidence of past payment amounts and income to project into the future. The Bureau recognizes that this projection will likely become somewhat less accurate as the time between verification evidence and the relevant monthly period lengthens, but notes that any further augmentations to amounts derived from verification evidence should be made only if a lender has a reasonable basis for doing so.

5(b) Reasonable Determination Required

Overview

The Bureau proposed to prohibit lenders from making covered short-term loans without first making a reasonable determination that the consumer will have the ability to repay the loan according to its terms, unless the loans were made in accordance with the conditional exemption in proposed § 1041.7. Specifically, proposed § 1041.5(b)(1) would have required lenders to make a reasonable determination of ability to repay before making a new covered short-term loan, increasing the credit available under an existing loan, or before advancing additional credit under a covered line of credit if more than 180 days have expired since the last such determination.

Proposed § 1041.5(b)(2) would have specified minimum elements of a baseline methodology that would be required for determining a consumer's ability to repay, using a residual-income analysis and an assessment of the consumer's prior borrowing history. It would have required the assessment to be based on projections of the consumer's net income, basic living expenses, and major financial obligations that are made in accordance with proposed § 1041.5(c). It would have required that, using such projections, the lender must reasonably conclude that the consumer's residual income will be sufficient for the consumer to make all payments under the loan and still meet basic living expenses during the shorter of 45 days or the term of the covered short-term loan. It would have further required that a lender must reasonably conclude that the consumer, after making the highest payment under the loan (typically, the last payment), will continue to be able to meet major financial obligations as they fall due, make any remaining payments on the loan, and meet basic living expenses for a period of 30 additional days. Finally, proposed § 1041.5(b)(2) would have required that, in situations in which the consumer's recent borrowing history suggests that she may have difficulty repaying a new loan as specified in proposed § 1041.6, a lender must satisfy the requirements in proposed § 1041.6 before extending credit (i.e., the proposed presumptions of unaffordability and prohibitions on lending contained therein).

As noted above in the general § 1041.5 discussion above, the Bureau received a significant number of comments asserting that the proposed ability-to-repay requirements were overly burdensome. Many commenters argued that they would lead to undue lost access to credit and excessive costs. The Bureau also received comments asserting that various aspects of the proposed ability-to-repay requirements were too restrictive and, on the other hand, too vague. Some commenters specifically argued that the reasonableness test animating the entirety of proposed § 1041.5 was overly vague and would lead to uncertainty about the Bureau's expectations for compliance and potential challenges for examination and enforcement. These commenters included a wide spectrum of parties, including industry stakeholders, State banking supervisors, and some State Attorneys General. Consumer advocates, on the other hand, generally supported the proposed requirements while suggesting various means of strengthening them in their view. These comments are discussed in more detail in the discussion of individual subparagraphs within § 1041.5(b).

As stated above, the Bureau has made a number of changes to § 1041.5(b) and its associated commentary in the final rule. As a general matter, these changes have been made in response to comments and have two primary purposes: To provide a streamlined set of requirements for evaluating the consumer's ability to repay, which the Bureau believes will reduce burden, and to clarify the “reasonableness” standard for ability-to-repay determinations, which the Bureau believes will reduce uncertainty about the standards for compliance. The specific changes to the rule and commentary to achieve these purposes are found in two areas: First, the Bureau has made substantial revisions to § 1041.5(b)(2), which sets forth the specific parameters of the general ability-to-repay determination in § 1041.5(b)(1), i.e., that the lender use the projections of net income and major financial obligations for the relevant monthly period and calculations of debt-to-income ratio or residual income for that same period to draw reasonable conclusions about the consumer's ability to make the loan payments, pay for major financial obligations, and meet basic living expenses during specified time periods as described in final § 1041.5(b)(2)(i) and (ii).

Second, the Bureau has substantially revised and expanded the commentary to § 1041.5(b) to provide additional clarity on the expected components of a “reasonable” ability-to-repay determination and how reasonableness will be evaluated through the lender's loan performance. Specifically, comment 5(b)-2.i has been revised to provide additional discussion of reasonable ability-to-repay determinations, in particular, additional clarification on reasonable estimates of basic living expenses. Comment 5(b)-2.ii now provides additional discussion of what constitutes an unreasonable ability-to-repay determination, including a new example involving a specific debt-to-income ratio. The final rule also significantly expands comment 5(b)-2.iii, which in the proposal described how evidence of the lender's objective and comparative loan performance (i.e., rates of delinquency, re-borrowing, and default) may be evaluated to assess the reasonableness of ability-to-repay determinations. The comment now contains a broader list of indicators than the proposal (including default rates, re-borrowing rates, patterns of lending across loan sequences, evidence of delinquencies and collateral effects, and patterns of lenders “bridging” covered loans with non-covered loans) and provides more detail on how the Bureau will use the loan performance metrics to evaluate lenders' ability-to-repay determinations. The final rule also contains a new comment 5(b)-2.iv, which complements the expanded comment 5(b)-2.iii and provides four detailed examples of whether the lender is making reasonable or unreasonable ability-to-repay determinations.

The Bureau also made several changes throughout § 1041.5(b) and its commentary to implement the decision to incorporate the part of proposed § 1041.9(b) that would have imposed similar ability-to-repay requirements for covered longer-term balloon-payment loans into § 1041.5.

Thus, as finalized, at a high level, § 1041.5(b)(1) provides that lenders must make reasonable determinations that the consumer will have the ability to repay the loan according to its terms. Section 1041.5(b)(1)(i) applies to covered short-term loans and covered longer-term balloon-payment loans generally, while § 1041.5(b)(1)(ii) imposes requirements to determine consumers' ability to repay periodically for open-end lines of credit. Finalized § 1041.5(b)(2) sets forth that a lender's determination is reasonable only if it uses a debt-to-income ratio methodology as set forth in § 1041.5(b)(2)(i), or a residual income methodology as set forth in § 1041.5(b)(2)(ii). Under § 1041.5(b)(2), both the residual income and debt-to-income methodologies are used to project the consumer's finances during the relevant monthly period so that the lender in turn can draw conclusions about the consumer's ability to repay covered short-term loans or covered longer-term balloon-payment loans without re-borrowing. This broader determination focuses for covered short-term loans on whether the consumer can make payments for major financial obligations, payments under the loan, and basic living expenses during the shorter of the loan term or 45 days following consummation, and for 30 days after the highest payment under the loan, and for covered longer-term balloon-payment loans, on whether the consumer can make the same payments during the relevant monthly period and for 30 days after the highest payment under the loan. However, as described in the general § 1041.5 discussion and the discussion of the debt-to-income ratio definition in § 1041.5(a)(2), above, the debt-to-income ratio and residual income would not need to be calculated for all of those periods. Rather, the lender only needs to project net income and major financial obligations and calculate debt-to-income ratio or residual income, as applicable, for one calendar month—the relevant monthly period.

The final rule reduces burden in at least two ways relative to the proposal, in addition to permitting use of a debt-to-income ratio as well as a residual-income analysis. Under proposed § 1041.5(b)(2), the reasonable ability-to-repay determination would have required the lender to project both the amount and timing of the consumer's net income and major financial obligations, as well as to make separate calculations about the consumer's finances during two distinct time periods: First for the shorter of the term of the loan or 45 days after consummation of the loan, and then also for 30 days after having made the highest payment under the loan. Under the final rule, however, lenders are instead required to make a projection about net income and major financial obligations and calculate the debt-to-income ratio or residual income, as applicable, during only the relevant monthly period, which is the calendar month with the highest payments on the loan. The debt-to-income ratio or residual income during this period is used as a snapshot of the consumer's financial picture to draw conclusions about the consumer's ability to pay. The lender then uses this information to make a reasonable conclusion that the consumer has the ability to repay the loan while meeting basic living expenses and major financial obligations during the two specified time periods (which are not necessarily the same as the relevant monthly period, but may often overlap).

The nature of the calculation has changed as well. While the proposal would have required lenders to pay particularly close attention to the timing of income and major financial obligations in the 30 days after the loan's highest payment, the final rule requires that the calculations for the relevant monthly period focus on the total amount of net income and major financial obligations. The Bureau also notes that this simplified approach dovetails with the inclusion of the debt-to-income ratio methodology as an alternative to residual income. As discussed above, a debt-to-income methodology does not permit the tracking of a consumer's individual income inflows and major financial obligation outflows on a continuous basis over a period of time. The same approach has also been incorporated into the definition of residual income in § 1041.5(a)(8) for purposes of making the standards for both alternatives consistent. As explained in more detail below, the Bureau believes that this approach will streamline the process for making the ability-to-repay determination required under 1041.5(b) because the lender will only be required to project net income and major financial obligations and make the calculation of debt-to-income ratio or residual income for one calendar month. The Bureau believes the revised approach will prove simpler for consumers as well.

5(b)(1)

Proposed Rule

In proposed § 1041.5(b)(1), the Bureau proposed generally that, except as provided in proposed § 1041.7, a lender must not make a covered short-term loan or increase the credit available under a covered short-term loan unless the lender first makes a reasonable determination of the consumer's ability to repay the covered short-term loan. The proposed provision would also have imposed a requirement to determine a consumer's ability to repay before advancing additional funds under a covered short-term loan that is a line of credit, if such advance would occur more than 180 days after the date of a prior required determination. Proposed § 1041.9(b)(1) would have included parallel provisions to proposed § 1041.5(b)(1) as applied to covered longer-term loans, except for certain conditional exemptions that are discussed above in connection with final § 1041.3(d)(7) and (8).

Proposed § 1041.5(b)(1) would have required the ability-to-repay determination before a lender actually takes one of the triggering actions. The Bureau recognized in the proposal that lenders decline covered loan applications for a variety of reasons, including to prevent fraud, avoid possible losses, and to comply with State law or other regulatory requirements. Accordingly, the requirements of proposed § 1041.5(b)(1) would not have required a lender to make the ability-to-repay determination for every covered short-term loan application it receives, but rather only before taking one of the enumerated actions with respect to a covered short-term loan. Similarly, the Bureau explained in the proposal that nothing in proposed § 1041.5(b)(1) would have prohibited a lender from applying screening or underwriting approaches in addition to those required under proposed § 1041.5(b) prior to making a covered short-term loan.

Proposed § 1041.5(b)(1)(ii) would have provided that, for a covered short-term loan that is a line of credit, a lender must not permit a consumer to obtain an advance under the line of credit more than 180 days after the date of a prior required determination, unless the lender first makes a new reasonable determination that the consumer has the ability to repay the covered short-term loan. As the Bureau wrote in the proposal, under a line of credit, a consumer typically can obtain advances up to the maximum available credit at the consumer's discretion, often long after the covered loan was consummated. Each time the consumer obtains an advance under a line of credit, the consumer becomes obligated to make a new payment or series of payments based on the terms of the covered loan. But when significant time has elapsed since the date of a lender's prior required determination, the facts on which the lender relied in determining the consumer's ability to repay may have changed significantly. As the Bureau explained in the proposal, during the Bureau's outreach to industry, the Small Dollar Roundtable urged the Bureau to require a lender to periodically make a new reasonable determination of ability to repay in connection with a covered loan that is a line of credit. The Bureau stated in the proposal that it believed that the proposed requirement to make a new determination of ability to repay for a line of credit 180 days following a prior required determination appropriately balanced the burden on lenders and the protective benefit for consumers.

Reasonable determination. Under § 1041.5(b)(1) of the proposed rule, a lender would have to make a reasonable determination that a consumer will be able to repay a covered short-term loan according to its terms. A consumer would have the ability to repay a covered short-term loan according to its terms, under the proposed rule, only if the consumer is able to make all payments under the covered loan as they fall due while also making payments under the consumer's major financial obligations as they fall due and continuing to meet basic living expenses during the shorter of the term of the loan or 45 days following consummation. The proposed rule would have also required that the lender determine if, for a period of 30 days after making the highest payment on the loan, the consumer will be able to pay major financial obligation as they fall due, make any remaining payments under the loan, and meet basic living expenses.

Proposed comment 5(b)-1 would have provided an overview of the baseline methodology that would be required as part of a reasonable determination of a consumer's ability to repay in proposed §§ 1041.5(b)(2) and (c) and § 1041.6.

As noted in the general discussion of proposed § 1041.5(b), above, proposed comment 5(b)-2 would have identified standards for evaluating whether a lender's ability-to-repay determinations under proposed § 1041.5 are reasonable. It would have clarified the minimum requirements of a reasonable ability-to-repay determination; identified assumptions that, if relied on by the lender, would render a determination not reasonable; and established that the overall performance of a lender's covered short-term loans is evidence of whether the lender's determinations for those loans are reasonable.

The Bureau explained in the proposal that the proposed standards would not have imposed bright-line rules prohibiting covered short-term loans based on fixed mathematical ratios or similar criteria. Moreover, the Bureau stated that it did not anticipate that a lender would need to perform a manual analysis of each prospective loan to determine whether it meets all of the proposed standards. Instead, the Bureau explained that each lender would be required under proposed § 1041.18 to develop and implement policies and procedures for approving and making covered loans in compliance with the proposed standards and based on the types of covered loans that the lender makes. The Bureau noted in the proposal that a lender would then apply its own policies and procedures to its underwriting decisions, which the Bureau anticipated could be largely automated for the majority of consumers and covered loans.

Minimum requirements. Proposed comment 5(b)-2.i set out some of the specific respects in which a lender's determination must be reasonable under the proposed rule with respect to covered short-term loans. For example, it noted that the determination must include the applicable determinations provided in proposed § 1041.5(b)(2), be based on reasonable projections of a consumer's net income and major financial obligations in accordance with proposed § 1041.5(c) and be based on reasonable estimates of a consumer's basic living expenses (which were further clarified under proposed comment 5(b)-4). It would also have to be consistent with the lender's written policies and procedures required under proposed § 1041.18(b) and must be grounded in reasonable inferences and conclusions in light of information the lender is required to obtain or consider.

Proposed comment 5(b)-2.i would have clarified that for a lender's ability-to-repay determination to be reasonable, the lender must appropriately account for information known by the lender, whether or not the lender is required to obtain the information under proposed § 1041.5, that indicates that the consumer may not have the ability to repay a covered short-term loan according to its terms. For example, the Bureau explained, proposed § 1041.5 would not have required a lender to inquire about a consumer's individual transportation or medical expenses, but if the lender learned that a particular consumer had a transportation or recurring medical expense that was dramatically in excess of the amount the lender used to estimate basic living expenses for consumers generally, proposed comment 5(b)-2.i would have clarified that the lender could not ignore that fact. The Bureau wrote in the proposal that, instead, it would have to consider the transportation or medical expense and then reach a reasonable determination that the expense did not negate the lender's otherwise reasonable ability-to-repay determination.

For covered longer-term loans, proposed comment 9(b)-2.i would have paralleled comment 5(b)-2.i in all respects except for the addition of proposed comment 9(b)-2.i.F, would have provided that for covered longer-term loans, the reasonable determination must include appropriately accounting for the possibility of volatility in the consumer's income and basic living expenses during the term of the loan, with a cross-reference to proposed comment 9(b)(2)(i)-2.

Determinations that are not reasonable. Proposed comment 5(b)-2.ii would have provided an example of an ability-to-repay determination that is not reasonable for covered short-term loans. The example, in proposed comment 5(b)-2.ii.A, was a determination that relies on an assumption that the consumer will obtain additional consumer credit to be able to make payments under the covered short-term loan, to make payments under major financial obligations, or to meet basic living expenses. The Bureau stated in the proposal that it believed that a consumer whose net income would be sufficient to make payments under a prospective covered short-term loan, to make payments under major financial obligations, and to meet basic living expenses during the applicable period only if the consumer supplements that net income by borrowing additional consumer credit is a consumer who, by definition, lacks the ability to repay the prospective covered short-term loan.

Similarly, proposed comment 9(b)-2.ii would have included two examples of unreasonable ability-to-repay determinations with respect to covered longer-term loans. The first example, proposed comment 9(b)-2.ii.A, was a parallel example to proposed comment 5(b)-2.ii.A. The second example, in proposed comment 5(b)-2.ii.B, would have clarified that an unreasonable ability-to-repay determination is one that relies on an assumption that a consumer will accumulate savings while making one or more payments under a covered longer-term loan and that, because of such assumed future savings, will be able to make a subsequent loan payment under a covered longer-term loan. The Bureau explained in the proposal that, like the prior comment, the Bureau is including this comment in an abundance of caution lest some lenders seek to justify a decision to make, for example, a multi-payment, interest-only loan with a balloon payment on the ground that during the interest-only period the consumer will be able to accumulate savings to cover the balloon payment when due. The Bureau explained further in the proposal that a consumer who finds it necessary to seek a covered longer-term loan typically does so because she has not been able to accumulate sufficient savings while meeting her existing obligations and expenses. The Bureau noted in the discussion in the proposal's Market Concerns—Longer-Term Loans section regarding the high incidence of re-borrowing and refinancing coinciding with balloon payments under longer-term loans strongly and stated that it suggests that consumers are not, in fact, able to accumulate sufficient savings while making lower payments to then be able to make a balloon payment. The Bureau wrote in the proposal that a projection that a consumer will accumulate savings in the future is purely speculative, and basing an ability-to-repay determination on such speculation presents an unacceptable risk of an erroneous determination. The Bureau explained that believed that basing a determination of a consumer's ability to repay on such speculative projections would not be reasonable.

Performance of covered loans as evidence. The Bureau stated in the proposal that in determining whether a lender has complied with the requirements of proposed § 1041.5, there is a threshold question of whether the lender has carried out the required procedural steps, for example by obtaining consumer statements and verification evidence, projecting net income and payments under major financial obligations, and making determinations about the sufficiency of a consumer's residual income. The Bureau explained that in some cases, a lender might have carried out these steps but still have violated § 1041.5 by making determinations that are facially unreasonable, such as if a lender's determinations assume that the amounts a consumer needs to meet basic living expenses are clearly insufficient for that purpose. The Bureau explained further in the proposal that, in other cases, the reasonableness or unreasonableness of a lender's determinations might be less clear. Accordingly, proposed comment 5(b)-2.iii provided that evidence of whether a lender's determinations of ability to repay for covered short-term loans are reasonable may include the extent to which the lender's determinations subject to proposed § 1041.5 result in rates of default, delinquency, and re-borrowing for covered short-term loans that are low, equal to, or high, as compared to the rates of other lenders making similar covered loans to similarly situated consumers.

The Bureau stated in the proposal that proposed comment 5(b)-2.iii would not mean that a lender's compliance with the requirements of proposed § 1041.5 for a particular loan could be determined based solely on the performance of that loan. Nor, the Bureau stated in the proposal, would this proposed comment mean that comparison of the performance of a lender's covered short-term loans with those of other lenders could be the sole basis for determining whether that lender's underwriting complies with the requirements of proposed § 1041.5. The Bureau wrote in the proposal that, for example, one lender may have default rates that are much lower than the default rates of other lenders because it uses aggressive collection tactics, not because its determinations of ability to repay are reasonable. The Bureau wrote that similarly, the fact that one lender's default rates are similar to the default rates of other lenders does not necessarily indicate that their determinations of ability to repay are reasonable; the similar rates could instead reflect that their respective determinations of ability to repay are similarly unreasonable. The Bureau wrote in the proposal that it believed, however, that such comparisons would provide important evidence that, considered along with other evidence, would facilitate evaluation of whether a lender's ability-to-repay determinations are reasonable.

The Bureau elaborated in the proposal that for example, a lender may use estimates for a consumer's basic living expenses that initially appear unrealistically low, but if the lender's determinations otherwise comply with the requirements of proposed § 1041.5 and otherwise result in covered short-term loan performance that is materially better than that of peer lenders, the covered short-term loan performance may help show that the lender's determinations are in fact reasonable. Similarly, the Bureau wrote, an online lender might experience default rates significantly in excess of those of peer lenders, but other evidence may show that the lender followed policies and procedures similar to those used by other lenders and that the high default rate resulted from a high number of fraudulent applications. The Bureau stated in the proposal that, on the other hand, if consumers experience systematically worse rates of default, delinquency, and re-borrowing on covered short-term loans made by one lender, compared to the rates of other lenders making similar loans, that fact may be important evidence of whether that lender's estimates of basic living expenses are, in fact, unrealistically low and therefore whether the lender's ability-to-repay determinations are reasonable.

With respect to covered longer-term loans, the discussion in the proposal's section-by-section analysis for proposed § 1041.9(b) and comment 9(b)-2.iii paralleled the discussion above.

Payments under the covered short-term loan. Proposed comment 5(b)-3 noted that a lender is responsible for calculating the timing and amount of all payments under the covered short-term loan. The Bureau explained in the proposal that the timing and amount of all loan payments under the covered short-term loan were essential components of the required reasonable determination of a consumer's ability to repay under proposed § 1041.5(b)(2)(i), (ii), and (iii). Calculation of the timing and amount of all payments under a covered loan was also necessary to determine which component determinations under proposed § 1041.5(b)(2)(i), (ii), and (iii) apply to a particular prospective covered loan. Proposed comment 9(b)-3 mirrored the discussion in comment 5(b)-3 with regard to payments under the covered longer-term loan.

Basic living expenses. A lender's ability-to-repay determination under proposed § 1041.5(b) would have been required to account for a consumer's need to meet basic living expenses during the applicable period, while also making payments for major financial obligations and payments under a covered short-term loan. The Bureau explained in the proposal that if a lender's ability-to-repay determination did not account for a consumer's need to meet basic living expenses, and instead merely determined that a consumer's net income is sufficient to make payments for major financial obligations and for the covered short-term loan, the Bureau believed the determination would greatly overestimate a consumer's ability to repay a covered short-term loan and would be unreasonable. The Bureau further explained that doing so would be the equivalent of determining, under the Bureau's ability-to-repay rule for residential mortgage loans, that a consumer has the ability to repay a mortgage from income even if that mortgage would result in a debt-to-income ratio of 100 percent. The Bureau stated in the proposal that it believed there would be nearly universal consensus that such a determination would be unreasonable.

However, the Bureau recognized in the proposal that in contrast with payments under most major financial obligations, which the Bureau stated it believes a lender can usually ascertain and verify for each consumer without unreasonable burden, it would be extremely challenging to determine a complete and accurate itemization of each consumer's basic living expenses. Moreover, the Bureau stated, a consumer may be somewhat more able, at least in the short-run, to reduce some expenditures that do not meet the proposed definition of major financial obligations. For example, the Bureau noted that a consumer may be able for a period of time to reduce commuting expenses by ride sharing.

Accordingly, the Bureau did not propose to prescribe a particular method that a lender would be required to use for estimating an amount of funds that a consumer needs to meet basic living expenses for an applicable period. Instead, proposed comment 5(b)-4 stated the principle that whether a lender's method complies with the proposed § 1041.5 requirement for a lender to make a reasonable ability-to-repay determination depends on whether it is reasonably designed to determine whether a consumer would likely be able to make the loan payments and meet basic living expenses without defaulting on major financial obligations or having to rely on new consumer credit during the applicable period.

Proposed comment 5(b)-4 provided a non-exhaustive list of methods that may be reasonable ways to estimate basic living expenses. The first method was to set minimum percentages of income or dollar amounts based on a statistically valid survey of expenses of similarly situated consumers, taking into consideration the consumer's income, location, and household size. The Bureau explained in the proposal that this example was based on a method that several lenders had told the Bureau they use in determining whether a consumer will have the ability to repay a loan and is consistent with the recommendations of the Small Dollar Roundtable. The Bureau noted that the Bureau of Labor Statistics conducts a periodic survey of consumer expenditures that may be useful for this purpose.

The second method was to obtain additional reliable information about a consumer's expenses other than the information required to be obtained under proposed § 1041.5(c) to develop a reasonably accurate estimate of a consumer's basic living expenses. The Bureau explained in the proposal that this example was not meant to suggest that a lender would be required to obtain this information, but was intended to clarify that doing so may be one effective method of estimating a consumer's basic living expenses. The Bureau wrote that the method described in the second example may be more convenient for smaller lenders or lenders with no experience working with statistically valid surveys of consumer expenses, as described in the first example. The third example was any method that reliably predicts basic living expenses. The Bureau wrote that it was proposing to include this broadly phrased example to clarify that lenders may use innovative and data-driven methods that reliably estimate consumers' basic living expenses, even if the methods are not as intuitive as the methods in the first two examples. The Bureau wrote that it expected to evaluate the reliability of such methods by taking into account the performance of the lender's covered short-term loans in absolute terms and relative to other lenders, as discussed in proposed comment 5(b)-3.iii.

Proposed comment 5(b)-4 also provided a non-exhaustive list of unreasonable methods of determining basic living expenses. The first example was a method that assumes that a consumer needs no or implausibly low amounts of funds to meet basic living expenses during the applicable period and that, accordingly, substantially all of a consumer's net income that is not required for payments for major financial obligations is available for loan payments. The second example was a method of setting minimum percentages of income or dollar amounts that, when used in ability-to-repay determinations for covered short-term loans, have yielded high rates of default and re-borrowing, in absolute terms or relative to rates of default and re-borrowing of other lenders making covered short-term loans to similarly situated consumers.

Proposed comment 9(b)-4 would have paralleled the language of proposed comment 5(b)-4, and the relevant discussion in the proposal's section-by-section analysis regarding this comment mirrored the discussion above.

Comments Received

The Bureau received a significant amount of comments on the standard set forth in § 1041.5(b)(1). The Bureau first addresses comments focused on the general ability-to-repay requirement itself, and then separately discusses comments received regarding the standards for assessing reasonableness of the ability-to-repay requirements, including proposed commentary in 5(b)-2.

General ability-to-repay requirement. A wide spectrum of commenters wrote in support of the ability-to-repay requirement as a general matter, including a group of United States Senators, a number of State Attorneys General, many local and State elected officials, civil rights organizations, faith groups and individual clergy members, other advocacy organizations, numerous individual consumers writing as part of organized comment campaigns, and other commenters. Relatedly, consumer groups agreed with the Bureau's basic premise in the proposal that true ability to repay on a covered loan is not determined merely by whether a consumer repays the loan, but rather by whether the consumer has the ability to repay the loan, major financial obligations, and basic living expenses without the need to re-borrow. In fact, some consumer groups urged Bureau to revise the general ability-to-repay requirement in § 1041.5(b)(1) to read “ability to repay the loan according to its terms while meeting other obligations and expenses and without re-borrowing” to more expressly reflect that the standard was not just focused on lenders' ability to collect payments from consumers no matter what the downstream consequences. These commenters cited statutory and regulatory language as precedent, such as language from HOEPA and the Federal Reserve Board's higher-priced mortgage loan rule.

Commenters who criticized the general reasonableness standard in proposed §§ 1041.5(b)(1) and 1041.9(b)(1) were split as to whether it was too vague, particularly as to the use of loan performance as a factor of the analysis, or too prescriptive, particularly in mandating specific upfront procedures. In one camp, several commenters objected generally to the use of a reasonableness standard, arguing that it is overly vague and would create uncertainty for compliance and examination. A group of State banking regulators commented that the proposed ability-to-repay requirement would be difficult to enforce because of the uncertain standards for making a reasonable determination. Other commenters criticized the proposal for not specifying the expected level of residual income that would be necessary for a determination to be reasonable. Some commenters referred to the lack of clarity on both front-end and performance standards as creating a “gotcha” regime.

On the other hand, some commenters argued that the final rule should be less prescriptive and designed to provide flexibility for innovation. A lender and a policy and research organization both argued that the Bureau's rule should embrace a “sandbox” or pilot approach to the ability-to-repay requirements that would test policy interventions in the market before enshrining them into specific rules. One of these commenters suggested that a sandbox could, for example, be used to “test out and `right-size'” a payment-to-income or payment-to-deposits approach to underwriting. The other suggested that the Bureau establish a process for approving data sources used in underwriting.

Relatedly, several commenters argued that the rule should embrace a principles-based approach to the ability-to-repay requirements which leaves more flexibility to lenders on the process and more closely scrutinizes the outcomes. One commenter cited its experience lending in the United Kingdom and discussed how the U.K. Financial Conduct Authority (FCA) in recent years has imposed regulations on small-dollar loans that are non-prescriptive. This lender described how it had successful implemented the FCA regulations and encouraged the Bureau to consider such an approach in this rulemaking.

A number of commenters argued that the Bureau should create an exception or safe harbor to the rule for various scenarios, including for unusual, non-recurring, or emergency expenses. A group of State Attorneys General writing in opposition to the proposal questioned the Bureau's reasoning for declining to create such an exemption. They argued that creating an exception for unusual circumstances—such as where a consumer has a documented medical emergency or a necessary furnace repair during the winter—would be no more difficult to implement than the proposal's other requirements such as income and expense verification. They argued that such an exemption would be invoked rarely, and also would provide States with more flexibility to impose their own requirements. They argued that failing to provide for an exception is “particularly incongruous” given that the proposal would require lenders to consider unusual expenses in determining a consumer's ability to repay, citing the section-by-section analysis describing proposed comment 5(b)-2.i.E.

Several commenters argued that the Bureau had failed to take into account a factor that lenders are currently using in their basic underwriting models—willingness to repay. These commenters argue that willingness to repay is often indicative of whether a consumer will default, and several commenters provided data regarding default rates.

Several commenters discussed proposed comment 5(b)-2.i.E, which would have clarified that a reasonable determination includes the lender appropriately accounting for information known to the lender indicating the consumer may not have the ability to repay, even if the lender is not required to obtain the information. Consumer advocates urged that this language be included in the regulatory text. They also asked that the language be broadened to provide that “information known to the lender” include the following: (1) Information on the national consumer report or registered information system reflecting delinquencies or defaults on covered loans, other forms of credit or debt obligations, basic living expenses within the past year; and (2) a pattern of re-borrowing known to the lender. A group of State Attorneys General commenting on the proposal interpreted this proposed comment to mean the rule would require lenders to consider unusual expenses in determining a consumer's ability to repay.

With regard to treatment of open-end lines of credit specifically under proposed § 1041.5(b)(1)(ii), consumer groups commenting on the rule also urged the Bureau to treat each advance on a covered loan that is an open-end line of credit as a new loan for purposes of the ability-to-repay requirement. They expressed concern about the risks of open-end credit lines that are covered loans and believed the rule should have stricter requirements to prevent evasion and debt traps.

One commenter, a State trade group representing open-end credit providers, took the opposite view. This commenter argued that the Bureau should exempt open-end lines of credit from the proposal and, in the alternative, that the Bureau should either address open-end lines of credit in a separate rulemaking along with credit cards or apply the requirements of the CARD Act in connection with open-end lines of credit that are covered in this rule. This commenter also argued that the condition under § 1041.5(b)(1)(ii) imposing a requirement to conduct an additional ability-to-repay determination after 180 days would contravene the definition of open-end credit under Regulation Z, 12 CFR 1026.2(a)(20), which has a replenishment element. This commenter also argued that the proposal did not address the parameters for when the open-end credit provider can increase the amount of the line or when the consumer no longer has the ability to repay amounts outstanding after 180 days due to a deterioration of the consumer's income or increase in expenses.

Performance of a lender's loans as evidence of ability to repay. As discussed briefly above, the Bureau received a substantial number of comments focusing specifically on proposed comment 5(b)-2.iii, which would have clarified that certain portfolio-wide backward-looking metrics of loan performance such as a lender's re-borrowing and default rates, may be indicative of whether a lender's determinations of ability to repay are reasonable.

Some commenters objected to the use of loan performance data, for instance by arguing that the use of performance metrics would unfairly penalize lenders for choices made by consumers. A number of commenters also argued that use of defaults or other metrics as measures of reasonableness could lead to unintended consequences, like creating a heightened incentive to aggressively collect delinquent loans. Several commenters also took particular issue with the Bureau's use of defaults as a performance metric.

Other commenters did not disagree that loan performance was potentially relevant to the question of whether a lender had made a reasonable determination of a consumer's ability to repay the loan, but urged the Bureau to provide more concrete guidance. Several commenters encouraged the Bureau to set objective performance metric standards rather than relying on clarifying principles in commentary. For instance, a group of consumer advocates wrote that the Bureau should set a 5 percent default rate for vehicle title loans and payroll deduction loans and a 10 percent default rate for payday loans as thresholds that, if exceeded by the lender on a portfolio basis, would trigger heightened scrutiny of the lender's practices to determine whether the ability-to-repay determinations are unreasonable. They also suggested that lenders whose loan performance exceeds those benchmarks would potentially be subject to enforcement actions or other required steps to mitigate such as refunding late fees, waiving back interest, or reducing loan principal. Another commenter similarly argued for the Bureau to treat lenders with a portfolio default rate on covered loans above 10 percent with heightened scrutiny. Other commenters argued that the Bureau should add more examples about the patterns of re-borrowing that would be indicative of unreasonable ability-to-repay determinations.

Some commenters actively advocated to use particular metrics. One commenter, a research and policy organization, generally supported the approach to use default data as a metric for evaluating ability to repay, stating that the clearest proof of effective underwriting processes should be found in consumer repayment outcome data rather than by assessing inputs into the product design alone. This commenter also argued that first-payment defaults would be a key indicator for the success of an underwriting model because absent fraud they clearly points to a mis-calibration in underwriting. Others argued that the Bureau should look to see whether consumers met expenses during the 30 or 60 days following the highest or last payment. Consumer groups also provided a list of additional performance metrics that they urged the Bureau to monitor as indicative of deficient ability-to-repay analyses, such as failed payments, late payments, requests for forbearance, aggressive collection practices, indications of consumers' overdrafting or having trouble paying other expenses, and the extent of consumer injury (which they argued was influenced by a number of factors including late fees, debt collection practices, the interest rate and for how long interest was charged, and whether the lender sells or sues on the debt).

In contrast, other commenters who generally supported the proposal and the reasonableness approach criticized the proposed comment 5(b)-2.iii for very different reasons and in particularly strong terms. These commenters objected to the language in the proposed comment suggesting that a review of the comparative performance metrics among lenders would be relevant to the evaluation of ability to repay. They suggested that this approach would perpetuate high default or delinquency rates by incentivizing lenders to achieve only marginally better results than their competitors rather than meaningfully improved performance. A group of consumer advocates wrote that this provision was “among the most dangerous parts of the proposal” and “strongly impl[ies] that the metric for evaluating loan performance is simply not to be the worst of the worst.” The commenters noted the Bureau's statements in the section-by-section analysis for the proposal that comparative performance metrics could not be the sole basis for a reasonableness determination and that factors such as aggressive collection efforts could be the reason for one lender's default rates to appear lower than another, rather than ability to repay, but they argued that such statements were cautionary and would “be exploited.” Other commenters, including a large number of individual commenters writing as part of organized commenter campaigns, expressed concern that this provision would be a “business as usual loophole.” However, one commenter expressed support for the language regarding comparative performance metrics, arguing that such an analysis of comparative loan performance would help control for macroeconomic shifts that could affect large groups of consumers similarly.

Final Rule

The Bureau finalized the text of § 1041.5(b)(1) with adjustments to apply it to covered longer-term balloon-payment loans and a change to the time period for re-underwriting open-end lines of credit from every 180 days to every 90 days. The justification for this latter change is discussed below in the context of the Bureau's response to comments asking for additional protections regarding open-end credit products covered by the proposal. The Bureau concluded that it was not necessary to further revise the regulation text in § 1041.5(b)(1) to refer expressly to consumers repaying the covered loan while meeting other obligations and expenses and without re-borrowing, as these elements are expressly addressed in various other parts of the regulation text and commentary.

The Bureau also made minor adjustments to the regulation text and commentary for clarity and conformity, such as to reflect policy decisions discussed elsewhere to permit lenders to analyze either a consumer's debt-to-income ratio or residual income for the relevant monthly period and to cross reference other relevant commentary. In addition, the Bureau is making several substantive changes to the commentary to address various concerns raised in comments on the proposal.

Specific elements of the ability-to-repay analysis. The Bureau made a number of substantive changes to the commentary for final § 1041.5(b)(1)(i) to address specific concerns about specific elements of the ability-to-repay test.

First, with regard to basic living expenses, the Bureau has significantly revised comment 5(b)-2.i.C to elaborate on the estimation methods posited in the proposal. The Bureau did so in part in response to comments and also because of the Bureau's decision to consolidate this comment with proposed comment 5(b)-4. The Bureau is not finalizing proposed comment 5(b)-4 because it believes it had some redundancy with other commentary language on basic living expenses, would have added complexity, and would have created some tension with comment 5(b)-2.i and -2.ii. The Bureau has chosen to harmonize the language regarding reasonable estimates of basic living expenses into one comment under § 1041.5(b).

Specifically, comment 5(b)-2.i.C now has two subparagraphs. Comment 5(b)-2.i.C. 1 emphasizes that the final rule does not specify a particular method that must be used to estimate basic living expenses, and that the lender is not required to itemize them for individual consumers. The comment goes on to clarify that a lender may instead arrive at estimates for the amount needed to cover the six categories of costs identified in § 1041.5(a)(1) based upon such sources as the lender's own experience in making covered short-term loans or covered longer-term balloon-payment loans to similarly-situated consumers, reasonably reliable information available from government surveys or other publications about the basic living expenses of similarly-situated consumers, or some combination thereof. The Bureau disagrees with commenters who argued that the Bureau should require itemization, as that would create potentially substantial burdens for lenders and consumers and make automation harder.

With regard to reliance on government sources, the comment also specifically clarifies that it would be reasonable for the lender to use data about the amounts spent on the six categories of basic living expenses identified in comment 5(a)(1)-2 from the IRS Collection Financial Standards or the CEX to develop non-individualized estimates of basic living expenses. However, the comment also notes that in using the data from those sources to estimate the amount spent on a particular category, the lender may make reasonable adjustments to arrive at an estimate of basic living expenses, for instance where a data source's information on a particular type of basic living expenses overlaps with a type of major financial obligation as defined in § 1041.5(a)(3) or where a source groups expenses into different categories than comment 5(a)(1)-2.

As discussed above in connection with the final commentary to § 1041.5(a)(1), the Bureau intends to make clear that lenders have flexibility to make reasonable non-individualized estimates of basic living expenses and that, in doing so, they can rely on their own experience in estimating basic living expenses for similarly-situated consumers or upon governmental survey or data sources, some of which are now listed as examples. At the same time, for the reasons discussed above, while the Bureau believes that it would be reasonable for lenders to rely on either the IRS Collection Financial Standards or the Consumer Expenditure Survey, there is reason to believe that both may be over-inclusive or reflect some differences as to expense categorization. The Bureau believes it is therefore appropriate to emphasize that further reasonable adjustments are permitted to estimates that are primarily based on such sources. These changes are in part responsive to comments asserting that the standards in proposed comment 5(b)-4, which were consolidated with this comment, were too vague.

The Bureau also has not finalized language in comment 5(b)-4 that would have referenced an example of reasonable basic living expense estimates being based on a survey taking into consideration a consumer's income, household size, and location. The Bureau received a number of questions and comments about these categories, including those suggesting that consideration of location and household size would implicate fair lending law issues. As noted earlier, the Bureau does not believe estimates based on these categories would raise fair lending law issues, and the Bureau believes it will be difficult for lenders to arrive at reasonable estimates that apply without regard to household size or, for lenders operating in multiple States, without regard to differences in living costs. However, the Bureau believes including commentary language of this sort might suggest that the final rule requires more precision in estimating than the Bureau intends.

The Bureau has also added a comment 5(b)-2.i.C. 2 regarding basic living expenses. This comment provides that if the lender is conducting an individualized estimate by itemizing the consumer's basic living expenses (which earlier commentary clarifies the lender is not required to do), the lender may reasonably consider other factors specific to the consumer that are not required to be projected under § 1041.5(c). The comment clarifies that this could include whether other persons are regularly contributing toward the payment of basic living expenses. The comment clarifies that the lender can consider such consumer-specific factors only when it is reasonable to do so, and further notes that it is not reasonable for the lender to consider whether other persons are contributing toward the consumer's payment of basic living expenses if the lender is also separately including in its projection of net income any income of another person to which the consumer has a reasonable expectation of access.

As discussed above, the Bureau has made these changes to this comment based on comments to the proposal arguing that lenders should be permitted to account for the fact that other persons besides consumers themselves sometimes contribute to pay basic living expenses. The Bureau notes that it is permitting consideration of consumer-specific factors only if the lender is making an individualized determination. The Bureau believes it would be unworkable operationally and also potentially create a loophole if consumer-specific factors were permitted to be considered when the lender makes non-individualized estimates of basic living expenses. For example, the Bureau would be concerned if lenders developed a model for estimating basic living expenses that applied to all of their consumers or relevant subsets of them, and the model assumed that a percentage of basic living expenses is always paid by persons other than the consumer. The comment also reflects the Bureau's policy concern that if lenders were able to count both the income of another person to which the consumer has a reasonable expectation of access and assume that the consumer's basic living expenses were being paid by that same person, it could result in a double-counting problem and an artificial inflation of net income (or deflation of basic living expenses); that is, the same income of another person to which the consumer claims access could be the income being used to pay for the consumer's expenses. The Bureau believes it is a reasonable response to the comments asking for flexibility on this point to permit lenders to do one or the other—consider payment of basic living expenses by another person toward the estimate, or count as net income the other person's income to which the consumer has a reasonable expectation of access.

The Bureau also has decided not to finalize comment 5(b)-2.i.E, which would have stated that for a reasonable determination of ability to repay, the lender must appropriately account for information known by the lender whether or not the lender is required to obtain the information. The Bureau believes that this language created potential tension with other commentary indicating that lenders need not individually analyze basic living expenses because it would potentially have required substantial individual follow up that would negate the decision to allow lenders to rely on survey data and other generalized sources. The Bureau believes there is even more potential for this risk under the final rule, given that it now also allows lenders to rely on their historical experiences. The Bureau is therefore not finalizing the comment, but notes that it has had added other commentary as discussed separately below clarifying that lenders must, for example, take into account major financial obligations that consumers list on their written statements even if those items are not reported on other sources. The Bureau believes that this more tailored guidance in particular circumstances will be more helpful to lenders in reconciling information from multiple sources. As such, the Bureau is declining the consumer groups' suggestion to embed concepts into the rule that were discussed in the proposal's section-by-section analysis for this proposed comment.

General reasonableness standard. More generally, with regard to comments that expressed broader concerns about prescriptiveness, vagueness, and flexibility under § 1041.5(b)(1)'s reasonableness standard, the Bureau has made a number of adjustments to the commentary. First, the Bureau has expanded comment 5(b)-2.ii to provide more examples of front-end underwriting that would not meet the reasonableness standard. In addition, as discussed separately below, the Bureau added substantial additional text to comments 5(b)-2.iii regarding consideration of loan performance and added a new comment 5(b)-2.iv with illustrative examples of how the factors in 5(b)-2.iii would be used to evaluate the reasonableness of ability-to-repay determinations on the back end. The latter two comments are discussed separately below.

With regard to comment 5(b)-2.ii, the Bureau has added a new subparagraph B to clarify that a lender's determination would not be reasonable if it assumed a consumer needs implausibly low amounts or percentages of funds to meet basic living expenses. In the proposal, this language appeared in proposed comment 5(b)-4.ii.A, but the Bureau moved it for purposes of the final rule and revised it to address an example where a lender makes an unreasonable ability-to-repay determination by making a loan to consumer with a 90 percent debt-to-income ratio. The Bureau is adding this example in part to address the comments that the proposal did not provide any indication of what thresholds would be considered sufficient for purposes of a reasonable ability-to-repay determination. The Bureau believes that a debt-to-income ratio in the range of 90 percent would not leave sufficient net income to cover consumers' basic living expenses for purposes of this requirement.

However, more generally, the Bureau is finalizing the general framework of considering whether an entity's ability-to-repay determinations are reasonable. Reasonableness is a widely used legal concept in both State and Federal law, and is what Congress required with respect to the underwriting of mortgages, and so the Bureau believes the standard in the final rule—which, again, has been revised to include a substantial amount of new commentary clarifying how the reasonableness of ability-to-repay determinations will be evaluated—should provide a sufficiently discernible standard.

The Bureau also declines to set more specific parameters about the level of residual income or debt-to-income ratio that would be considered reasonable or unreasonable for purposes of § 1041.5(b). Outside of extreme cases such as a 90 percent debt-to-income ratio, the Bureau believes that with regard to individual determinations of ability to repay, the acceptable level of residual income or debt-to-income ratio for a reasonable determination will depend on the circumstances. This question may also depend on whether lenders are using across-the-board DTI or residual income-thresholds or whether they are sorting their consumers into different categories and applying different thresholds for acceptable levels of DTI or residual income for consumers within those categories. There may be some debt-to-income thresholds that are sufficiently low that it would be reasonable to use a uniform debt-to-income threshold for all of the lender's customers, whereas as thresholds get higher it may be reasonable to apply the threshold to only subsets of the lender's customers (such as customers in higher income tiers). The overarching principle, of course, is that the lender must make reasonable determinations of consumers' ability to repay. Moreover, as discussed below, the Bureau believes that at least for lenders who follow the procedural requirements set forth in § 1041.5(c), the primary evidence with respect to the reasonableness of a lenders' determinations will be the pattern of outcomes for consumers found to have the ability to repay. That is why the Bureau is adding detailed commentary to 5(b)-2.iii and a new comment 5(b)-2.iv clarifying the performance factors that would be reviewed for purposes of assessing reasonableness and giving examples.

The Bureau declines the suggestion by some commenters to take a “sandbox” approach to components of the ability-to-repay requirement. The Bureau as a general matter supports innovation and policy experimentation through Project Catalyst and other initiatives. It simply does not believe this rulemaking is the best candidate for such an approach. Given the nature of the Federal rulemaking process and the particular history of this rulemaking—which has involved to date many years of study, outreach and deliberation, and where the compliance date of §§ 1041.2 through 1041.10, 1041.12, and 1041.13 will not be for another 21 months after publication in the Federal Register—the Bureau is concerned that failing to finalize necessary components of the rule, such as the ability-to-repay requirement, and instead testing ideas in the market would not prove a fruitful value proposition in view of the further delays in finalizing the rule. Any policy ideas emanating from the sandbox would have to be reintegrated into a rulemaking process in any event, further forgoing valuable consumer protections in the Bureau's view.

With regard to the commenters suggesting a principles-based approach where outcomes are more important that procedures, the Bureau notes that the final rule strikes a balance between a rules-based and an outcomes-based approach, with more emphasis than the proposal on the latter. First, the Bureau is taking a less prescriptive approach on certain key components of the ability-to-repay requirements, such as by permitting reasonable reliance on stated amounts for income in absence of reasonably available verification evidence. Second, as discussed below, the Bureau is expanding the discussion of how loan performance metrics will be used to evaluate ability-to-repay determinations. These changes reflect a greater emphasis on lender performance as a means of evaluating compliance with the ability-to-repay requirements.

As to commenters asserting that the Bureau should allow for exceptions to the ability-to-pay framework for consumers who are seeking loans to pay for non-recurring, unusual, and emergency expenses, the Bureau declines this suggestion for several reasons. First, lenders will already have an alternative to § 1041.5 by lending under § 1041.6 of the final rule, which is not subject to the ability-to-repay requirements. That approach is available for consumers up to six times per year and can be used in any of the circumstances—including emergency situations—that the commenters noted, unless the consumer is in a cooling-off period. Second, the Bureau continues to believe that the policy challenges described in the proposal with crafting such an exception are profound, such as the difficulty of defining, by rule, unusual and emergency expenses, and disagrees that this would pose the same or less challenges as with the implementation of other aspects of the rule.

Third, the Bureau believes that this type of exception would be extremely difficult to administer, for some the same reasons discussed in the section-by-section analysis for § 1041.5(a)(5) in connection with suggestions made by other commenters to count the proceeds of the loan toward net income or as a credit against major financial obligations or basic living expenses. As discussed in the section-by-section analysis for § 1041.5(a)(5), the Bureau believes it is difficult if not impossible to construct a workable rule that would carve out from the requirement one type of usage case for a consumer—here, emergency expenses—but include other usage cases, such as payment of basic living expenses, given the fungibility of money, the potential intrusiveness of asking about why the consumer is taking out the loan, and the challenges of policing such a rule. Lastly, the Bureau does not agree that this exception would be used sparingly. This assertion contravenes empirical evidence, assertions by other commenters including many individual consumers, and lender advertising about the purpose of the loans. Moreover, the difficulty of enforcing this type of provision would create an incentive for evasion, where consumers simply state a reason that would fall under the exception and lenders accept that reason without further inquiry.

Performance of a lender's loans as ability to repay. As noted above, the Bureau received many comments asking for additional guidelines and clarity on what constitutes a reasonable ability-to-repay determination, including in some cases numerical thresholds above which would trigger heightened scrutiny or even consumer remedies. The Bureau appreciates the concerns raised by the commenters and has substantially expanded the language in comment 5(b)-2.iii and added new comment 5(b)-2.iv to further clarify how it will use loan performance metrics and analysis in assessing whether a lender's determinations of consumers' ability to repay are reasonable. The specifics of the revised language are described in more detail below.

The Bureau is declining, however, to provide a prescriptive standard or exhaustive list of factors that would show reasonableness, or a set of numerical thresholds tied to the factors such as a specific default rate that would constitute a per se violation or grounds for closer scrutiny. While the Bureau understands that reasonableness tests and multi-factor back-end performance metrics, without specific numerical thresholds, may not give lenders perfectly clear direction on how exactly to underwrite, the Bureau believes that on balance the more prudent option at this time is to preserve the principles-based approach of the proposal but add detail and illustrations. The Bureau believes it may be challenging to set thresholds that would apply across the board, given that lenders who make unaffordable loans may experience different rates of default, re-borrowing, and other harms depending on collections practices and other factors. Furthermore, the Bureau also does not believe there is enough evidence at this time to codify specific numerical thresholds for default rates, re-borrowing rates, and the like, given that the practices identified in this rule are market-wide and that there is not currently a Federal ability-to-repay rule for this market. And the Bureau is concerned that setting particular benchmarks at this time would incentivize lenders to take steps to manage their rates aggressively through enhanced debt collection or even to manipulate the metrics to fall just beneath the threshold, neither of which would be a beneficial result.

Further, to the extent that consumer group commenters urged the Bureau to establish numeric thresholds for enhanced scrutiny of particular lenders rather than outright thresholds for per se violations, such as 5 percent default rates for vehicle title loans and employer-based loans and 10 percent threshold for payday loans, such a policy decision would not be made as part of a rulemaking, but rather, in the Bureau's prioritization decisions regarding supervision or enforcement activity as the market evolves over time in response to the rule and other business developments. As noted above, comment 5(b)-2.iii does state that default rates can provide evidence that a lender's ability-to-pay determinations were not reasonable.

The Bureau also declines some commenters' request to change the ability-to-repay standard to one focused on willingness or propensity to pay. The Bureau recognizes that many lenders today already employ predictive underwriting tools to screen out those with a propensity to default, a point noted in some comments. However, the Bureau's core concern in this rulemaking is the determination of whether consumers have the ability to repay, i.e., the financial capacity to make the loan payments, pay for major financial obligations, and meet basic living expenses. The Bureau expects that lenders will continue to utilize in their underwriting models various methods for detecting fraud or willingness to repay, and nothing in the final rule precludes that from happening as long as they comply with the requirements of this rule.

The assertion made by some commenters that default and re-borrowing are caused simply by consumer choice and not at all by lender practices—including the identified unfair and abusive practice that is the Bureau's focus in this rule—runs counter to the analysis provided above in Market Concerns—Underwriting and seems to contradict their own comments that their customers are often living paycheck to paycheck.

Regarding the comments about the use of comparative performance metrics and how that would create a “business as usual loophole,” as an initial matter the Bureau agrees with the concern voiced by consumer advocates, individual consumers, and others about a rule that would judge the reasonableness of ability-to-repay determinations based solely (or primarily) on a comparison of loan performance across lenders. The Bureau did not intend to promulgate a standard that would evaluate loan performance simply on not being “the worst of the worst.” The Bureau expressly noted in the proposal that comparative metrics are not the sole basis of judging compliance, that lenders cannot rely on comparative performance to excuse poor loan performance as measured more objectively, and that comparatively lower default rates could be caused by factors extrinsic to ability-to-repay determinations (such as aggressive debt collection).

To further underscore and memorialize this intent, the Bureau has revised comment 5(b)-2.iii to state specifically that evidence about comparative performance is not dispositive as to the evaluation of a lender's ability-to-repay determinations. Additionally, this comment has been revised more generally to provide a more expansive discussion of the types of performance metrics used to evaluate the reasonableness of ability-to-repay determinations, along with several examples in comment 5(b)-2.iv showing lending patterns that indicate either reasonable or unreasonable ability-to-repay determinations. The combination of these changes provides more clarity that the reasonableness of ability-to-repay determinations are to be measured over a variety of dimensions (e.g., default rates, re-borrowing rates, patterns of lending across loan sequences, and delinquency-related harms such as late fees); non-comparative measures of loan performance will be primary; and comparative performance metrics will be complementary. These changes are discussed in detail below.

However, the Bureau has decided not to eliminate reference to comparative performance metrics altogether, as requested by the consumer advocates and other commenters. Although as noted above the fact that a lender's outcomes are not among the worst of its peers is not sufficient to establish that the lender is making reasonable ability-to-repay determinations, outlier outcomes surely are probative of the unreasonableness of a particular lender's ability-to-repay determinations. That is the import of comment 5(b)-2.iii and 5(b)-2.iv.

The Bureau agrees with the consumer advocates that evaluating the ability-to-repay determinations should involve looking at indicators beyond default rates. Again, revised comment 5(b)-2.iii provides additional clarification on the types of performance metrics that will be evaluated. The list of factors has been expanded from the proposal. The commentary states that a variety of factors may be relevant, including rates of default, patterns of re-borrowing within loan sequences, patterns of re-borrowing across loan sequences, rates of delinquency-related harms (e.g., late fees and failed presentments), and patterns of lenders making non-covered loans that bridge gaps between sequences of covered loans. The Bureau has also clarified that loan performance may be evaluated across the lender's entire portfolio of covered short-term or longer-term balloon-payment loans, as well as with respect to particular products, geographic regions, time periods during which the loans were made, or other relevant categorizations. Finally, the Bureau provides several new illustrative examples of lending patterns that would indicate reasonable or unreasonable ability-to-repay determinations in comment 5(b)-2.iv. More discussion and explanation of these revised commentary provisions are found below.

Comment 5(b)-2.iii has been revised and expanded in a number of important ways. First, it now states that evidence that a lender's determinations of ability to repay are not reasonable may include, without limitation, the factors described under paragraphs (A) through (E) of the comment. This change refers to how the comment now lists the factors in separate paragraphs rather than the main body of the comment for organizational purposes and due to the additional level of detail provided. Second, comment 5(b)-2.iii now clarifies that these factors may be evaluated across a lender's entire portfolio of covered short-term loans or covered longer-term balloon-payment loans or with respect to particular products, geographic regions, particular time periods during which the loans were made, or other relevant categorizations, and clarifies that other relevant categorizations would include, without limitation, loans made in reliance on consumer statements of income in the absence of verification evidence. The Bureau believes that this approach is important to identify potential troublesome patterns insofar as lenders could not simply blend the categories of covered loans evidencing poor performance with other types of covered loans made by the lender with better performance. Third, the comment now clarifies that the factors may be considered either individually or in combination with one another; that the factors are not absolute in their application and instead exist on a continuum and may apply to varying degrees; and that each of the factors is viewed in the context of the facts and circumstances relevant to whether the lender's ability-to-repay determinations are reasonable. Finally, the comment clarifies that relevant evidence may also include a comparison of the factors listed in the comment on the part of the lender to that of other lenders making covered short-term loans or covered longer-term balloon-payment loans to similarly situated consumers, but that such evidence about comparative performance is not dispositive as to the evaluation of a lender's ability-to-repay determinations. This revised language above is a response to the criticisms of the proposed comment 5(b)-2.iii language regarding comparative performance metrics as evaluative tools, as discussed above.

Comment 5(b)-2.iii is then organized into five sub-paragraphs elucidating the factors that will be evaluated. Comment 5(b)-2.iii.A addresses default rates, clarifying that this evidence includes defaults during and at the expiration of covered loan sequences as calculated on a per sequence or per consumer basis. The Bureau believes that a per-loan basis for calculating default rates would not be as accurate for purposes of evaluating whether reasonable ability-to-repay determinations are being made, because then a lender's re-borrowing rate would substantially distort the metric. For example, on a per loan basis, a consumer who re-borrows twice and then defaults would have one-third the impact on the default rate that a consumer who defaults after the first loan would, even though both loan sequences end the same way. The Bureau also notes that the consumer advocates in their joint comment letter urged that any default rate metric that is used should be a per-customer or per-sequence default rate, for similar reasons.

Comment 5(b)-2.iii.B addresses re-borrowing rates, which the comment clarifies as including the frequency with which the lender makes consumers multiple covered short-term loans or covered longer-term balloon-payment loans within a loan sequence as defined in § 1041.2(a)(14), i.e., consecutive or concurrent loans taken out within 30 days of a prior loan being outstanding. As discussed in many places in the final rule, including Market Concerns—Underwriting and the section-by-section analysis for § 1041.4, the Bureau has identified repeat re-borrowing as a problem in this market meriting intervention and is requiring lenders to determine whether consumers have the ability to repay a covered short-term or longer-term balloon-payment loan without the repayment triggering a need to re-borrow over the ensuing 30 days. Thus, within-sequence re-borrowing rates will be critical in evaluating compliance with the ability-to-repay determination, as that is one of the core consumer harms that the requirements of the final rule are aiming to prevent.

Comment 5(b)-2.iii.C lists patterns of lending across loan sequences as a third factor and clarifies that this evidence includes the frequency with which the lender makes multiple sequences of covered short-term loans or covered longer-term balloon-payment loans to consumers. The comment clarifies that this evidence also includes the frequency with which the lender makes new covered short-term loans or covered longer-term balloon-payment loans immediately or soon after the expiration of a cooling-off period under § 1041.5(d)(2) or the 30-day period that separates one loan sequence from another, referencing the loan sequence definition in § 1041.2(a)(14). As noted in the section-by-section analysis for § 1041.4, while the Bureau has established a 30-day period as the measure for determining whether a consumer is likely to be re-borrowing the prior loan, there are circumstances in which new loans beyond the 30-day period would also be the result of the unaffordability of a prior loan rather than the result of a new borrowing need. For example, if a consumer does not have funds to pay major financial obligations or basic living expenses as they come due because the consumer used income that would pay those obligations to pay off a covered short-term loan, and the consumer falls behind on an obligation during the month after repaying a short-term loan and then returns to obtain a new loan 31 days after the prior loan was repaid, that would effectively mean that the prior loan was not affordable. A pattern of consumers frequently returning to take out a new loan immediately after the end of a cooling-off period would thus be relevant in assessing whether the lender's ability-to-repay determinations were reasonable.

Comment 5(b)-2.iii.D lists a fourth factor, rates of delinquencies and collateral impacts. The comment clarifies that this evidence includes the proportion of consumers who incur late fees, failed presentments, delinquencies, and repossessions. The Bureau believes that evaluating the rates of late fees, failed presentments, delinquencies, and repossessions is highly relevant to the evaluation of ability-to-repay determinations because those metrics would indicate that consumers are struggling to repay their loans, even if they do not necessarily wind up in default. The Bureau discusses the consumer harms associated with failed presentments in § 1041.7.

Comment 5(b)-2.E lists a fifth factor, patterns of non-covered lending. The comment clarifies that this evidence includes the frequency with which the lender makes non-covered loans shortly before or shortly after consumers repay a covered short-term loan or covered longer-term balloon-payment loan, and the non-covered loan bridges all or a substantial part of either the time period between two loans that otherwise would be part of a loan sequence or of a cooling-off period. The comment lists an example where the lender, its affiliate, or a service provider frequently makes 30-day pawn loans to consumers shortly before or soon after repayment of covered short-term loans made by the lender, and where the lender then makes additional covered short-term loans to the same consumers soon after repayment of the pawn loans. The Bureau included this factor as a way to address concerns, discussed by the Bureau in the proposal, about the possibility of lenders using non-covered loans as a way of “bridging” gaps between the making of covered loans in order to evade the cooling-off period and other aspects of the proposal. The proposal attempted to address this issue more directly through rule provisions justified under the Bureau's Dodd-Frank Act anti-evasion authority, but as described in the discussion below of §§ 1041.5(d) and 1041.6(d), the Bureau is not finalizing these provisions due to concerns about their efficacy and complexity and to the Bureau's decision to significantly streamline the re-borrowing restrictions that had been in proposed § 1041.6 based on public comments. Upon further consideration, however, the Bureau has realized that if lenders are making these “bridge” loans on a frequent basis, it may be an indication that the consumers are struggling to repay the preceding covered short-term or covered longer-term balloon-payment loan and therefore the underlying ability-to-repay determination on the earlier loan may have been unreasonable.

The Bureau believes that revised comment 5(b)-2.iii provides a relatively comprehensive list of factors that broadly capture the types of ascertainable outcomes that would be useful in evaluating the reasonableness of lenders' ability-to-repay determinations. As such, the Bureau declines to include all of the factors urged to be added by the consumer advocates, including the loan's interest rate and the “extent and aggressiveness of the lender's debt collection practices.” At least some of the examples suggested by the consumer groups would be very difficult if not impossible to measure quantitatively; others may be more aptly described as potential examples of evasion rather than indicators of unreasonable ability-to-repay determinations; and still others in the Bureau's view are overly restrictive, such as the suggestion regarding interest rates.

Other commenters' suggestions about which metrics would be most indicative of a failure to make a reasonable ability-to-repay determination, such as first-payment defaults absent those due to fraud, are helpful and may help inform Bureau analyses once the rule takes effect. However, the Bureau is not at this time rank-ordering the metrics because it believes that, depending on the facts and circumstances, any one of the factors, or multiple factors working in tandem, may be indicative of whether an ability-to-repay methodology is unreasonable.

As a complement to revised comment 5(b)-2.iii, the Bureau has also added a new comment 5(b)-2.iv. This comment contains four detailed examples of fact scenarios illustrating how the factors in comment 5(b)-2.iii might constitute evidence about whether lenders' ability-to-repay determinations are reasonable under § 1041.5(b). The Bureau is including these examples as a further response to criticisms that proposed comment 5(b)-2.iii, and § 1041.5(b) more broadly, did not provide sufficient guidance on how reasonableness on ability-to-repay determinations would be evaluated. These examples are non-exhaustive. The examples focus on fact scenarios where lenders' portfolios include multiple factors from comment 5(b)-2.iii and where the factors are present to varying degrees, thus illustrating how the factors will be evaluated in combination.

The first example, in comment 5(b)-2.iv.A, describes a scenario in which a significant percentage of consumers who obtain covered short-term loans from a lender under § 1041.5 re-borrow within 30 days of repaying their initial loan, re-borrow within 30 days of repaying their second loan, and re-borrow shortly after the end of the cooling-off period that follows the initial loan sequence of three loans, and how, based on the combination of these factors, this evidence suggests that the lender's ability-to-repay determinations are not reasonable. This example illustrates a pattern where the lender's consumers experience frequent re-borrowing—specifically, where a significant percentage of the lender's consumers take out a full sequence of three covered short-term loans and then return to borrow shortly after the end of the cooling-off period, beginning another sequence. This would implicate the factors in both comment 5(b)-2.iii.B and 5(b)-2.iii.C.

The second example, in comment 5(b)-2.iv.B, describes a scenario in which a lender frequently makes at or near the maximum number of covered short-term loans permitted under the conditional exemption in § 1041.6 to consumers early within a 12-month period (i.e., the loans do not require ability-to-repay determinations) and then makes a large number of additional covered short-term loans to those same consumers under § 1041.5 (i.e., the loans require ability-to-repay determinations) later within the 12-month period. The example assumes that the loans made under § 1041.5 are part of multiple loan sequences of two or three loans each and the sequences begin soon after the expiration of applicable cooling-off periods or 30-day periods that separate one loan sequence from another. The example clarifies that this evidence suggests that the lender's ability-to-repay determinations for the covered short-term loans made under § 1041.5 are not reasonable. The example notes further that the fact that some of the loans in the observed pattern were made under § 1041.6 and thus are conditionally exempted from the ability-to-repay requirements does not mitigate the potential unreasonableness of the ability-to-repay determinations for the covered short-term loans that were later made under § 1041.5.

This example is intended to illustrate the potential interaction of the provisions under §§ 1041.5 and 1041.6 and how the reasonableness of the lender's ability-to-repay determinations for loans made under § 1041.5 would be evaluated if the lender makes a combination of loans under the different provisions to consumers during a given time period. Here, the lender is making loans to many consumers more or less continuously throughout the year (i.e., long loan sequences, borrowing shortly after cooling-off periods expire), with the § 1041.6 loans made toward the beginning of the year and § 1041.5 loans made later in the year. This pattern suggests that the lender is not making reasonable ability-to-repay determinations for the loans made under § 1041.5. This is the case even though some of the loans in the pattern did not require such an ability-to-repay determination. Put another way, the mere fact that the first set of loans in the pattern did not require an ability-to-repay determination does not insulate the lender from scrutiny if the subsequent loans show a pattern of long loan sequences and frequent borrowing shortly after cooling-off periods expire.

The third example, in comment 5(b)-2.iv.C, is a variation of the preceding example. The facts are that a lender frequently makes at or near the maximum number of loans permitted under § 1041.6 to consumers early within a 12-month period and then only occasionally makes additional covered short-term loans to those same consumers under § 1041.5 later within the 12-month period, and that very few of those additional loans are part of loans sequences longer than one loan. The example clarifies that absent other evidence that the ability-to-repay determination is unreasonable (i.e., presence of the factors in comment 5(b)-2.iii.A through E), this evidence suggests that the lender's ability-to-repay determinations for the loans made under § 1041.5 are reasonable. In contrast to the preceding example where the lender made a large number of § 1041.6 loans and a large number of § 1041.5 loans within a given time period and the latter loans were made in long sequences and close in time (broken up only by the cooling-off periods), under this example the vast majority of loans are made under § 1041.6, and there is little to no evidence of re-borrowing on the § 1041.5 loans. Therefore, this pattern reflects the permissible maximization of lending under § 1041.6 and the incidental making of additional § 1041.5 loans within the given time period, a pattern that is not suggestive of unreasonableness.

Comment 5(b)-2.iv.D contains the final example. The pattern described is that within a lender's portfolio of covered short-term loans, a small percentage of loans result in default; consumers generally have short loan sequences (fewer than three loans); the consumers who take out multiple loan sequences typically do not begin a new loan sequence until several months after the end of a prior loan sequence; and there is no evidence of the lender or an affiliate making non-covered loans to consumers to bridge cooling-off periods or the time periods between loan sequences. The example clarifies that this evidence suggests that the lender's ability-to-repay determinations are reasonable. Although this example does indicate the presence of two factors from comment 5(b)-2.iii (i.e., defaults and re-borrowing), it illustrates that the degree to which these factors are present is germane to the overall evaluation. The re-borrowing is typically less than a full loan sequence, defaults are infrequent, and while there are some consumers who borrow multiple sequences, they are spread further apart, suggesting that new borrowing needs are driving the re-borrowing rather than the spillover effects of the prior loans. Therefore, this pattern does not indicate potentially unreasonable ability-to-repay determinations.

Re-underwriting of open-end credit. Finally, with regard to the special rule requiring re-underwriting of open-end credit on a periodic basis under § 1041.5(b)(1)(ii), the Bureau is concerned that the consumer group commenters' suggestion to require lenders to underwrite each individual advance separately would be unduly burdensome particularly as to small advances. However, the Bureau has further considered the timeline it proposed, and decided to adjust the final rule to require in § 1041.5(b)(1)(ii) that the lender must make a new ability-to-repay determination prior to an advance on an open-end line of credit if more than 90 days has elapsed since the initial determination, rather than every 180 days as proposed. The Bureau believes it is reasonable to require a new ability-to-repay determination once a quarter for an open-end line of credit, which for example would mean that a consumer would be re-underwritten after taking a monthly advance three times in a row. This revised time period also aligns with the revised requirement in § 1041.5(c)(2)(ii)(D), which as discussed below generally exempts lenders from the requirement to obtain a new national consumer report to verify debt obligations, child support obligations, and alimony obligations if the lender or its affiliates has previously obtained such a report in the prior 90 days (unless the consumer had triggered a cooling-off period since the report was last obtained).

The Bureau disagrees with the commenter that argued that the Bureau should exempt open-end lines of credit from the proposal or, in the alternative, should address open-end lines of credit in a separate rulemaking along with credit cards or apply the requirements of the CARD Act in connection with open-end lines of credit that are covered in this rule. The Bureau notes that while open-end products are not as common in the affected markets as closed-end products, the Bureau did conduct substantial research as part of this rulemaking concerning deposit advance products, which can be structured as open-end credit. The Bureau believes that consumers can be harmed just as much by unaffordable open-end credit as unaffordable closed-end credit, and that both products are therefore appropriately subject to the final rule. With regard to why the Bureau is not imposing the same rules for open-end products as the CARD Act regulations—an alternative approach suggested by the commenter—see the general discussion above for § 1041.5 about the comparison between the two rules. The Bureau also disagrees with the more technical arguments made by the same commenter about the proposed requirement to assess consumers' ability to repay an open-end line of credit where the consumer requests a new advance more than 180 days after the lender's last assessment of the consumer's ability to repay.

5(b)(2)

Proposed Rule

Proposed § 1041.5(b)(2) set forth the Bureau's specific proposed methodology for making a reasonable determination of a consumer's ability to repay a covered short-term loan. Specifically, it would have provided that a lender's determination of a consumer's ability to repay is reasonable only if, based on projections in accordance with proposed § 1041.5(c), the lender reasonably makes the applicable determinations provided in proposed § 1041.5(b)(2)(i), (ii), and (iii). Proposed § 1041.5(b)(2)(i) would have required an assessment of the sufficiency of the consumer's residual income during the term of the loan, and proposed § 1041.5(b)(2)(ii) would have required an assessment of an additional 30-day period after having made the highest payment on the loan in light of the harms from loans with short-term structures. In proposed § 1041.5(b)(2)(iii), the Bureau would have required compliance with further requirements in proposed § 1041.6 in situations where consumers' borrowing history suggests that they may have difficulty repaying additional credit. Proposed § 1041.9(b)(2) would have imposed similar requirements on covered longer-term balloon-payment loans.

More specifically, proposed § 1041.5(b)(2)(i) would have provided that for any covered short-term loan subject to the ability-to-repay requirement of proposed § 1041.5, a lender must reasonably conclude that the consumer's residual income would be sufficient for the consumer to make all payments under the covered short-term loan and to meet basic living expenses during the shorter of the term of the loan or for 45 days following consummation. The Bureau believed that if the payments for a covered short-term loan would consume so much of a consumer's residual income that the consumer would be unable to meet basic living expenses, then the consumer would likely suffer injury from default or re-borrowing, or suffer collateral harms from having to make unaffordable payments. The parallel provision in § 1041.9(b)(2)(i) applicable to covered longer-term loans would have provided for a reasonable conclusion about the sufficiency of the residual income during the loan term. Proposed comment 9(b)(2)(i)-1.i would have clarified that for covered longer-term loans, a reasonable conclusion about the sufficiency of the residual income for the month in which the highest sum of payments were due on the loan would have satisfied this requirement.

In proposing § 1041.5(b)(2)(i), the Bureau recognized that, even when lenders determine at the time of consummation that consumers will have the ability to repay a covered short-term loan, some consumers may still face difficulty making payments on these loans because of changes that occur after consummation. The Bureau noted in the proposal that, for example, some consumers would experience unforeseen decreases in income or increases in expenses that would leave them unable to repay their loans. Thus, the fact that a consumer ended up in default is not, in and of itself, evidence that the lender failed to reasonably assess the consumer's ability to repay the loan ex ante. The Bureau explained that proposed § 1041.5(b)(2)(i) would instead have looked to the facts that were reasonably knowable prior to consummation and prohibited a lender from making a covered short-term loan if the lender lacked a reasonable basis at consummation to conclude that the consumer would be able to repay the covered loan while also meeting basic living expenses and major financial obligations.

The Bureau further explained in the proposal that while some consumers may have so little (or no) residual income as to be unable to afford any loan at all, for other consumers the ability to repay will depend on the amount and timing of the required repayments. Thus, the Bureau noted, even if a lender concludes there is no reasonable basis for believing that a consumer can pay a particular prospective loan, proposed § 1041.5(b)(2)(i) would have not prevented a lender from making a different covered loan with more affordable payments to such a consumer, provided that the loan is consistent with State law and that the more affordable payments would not consume so much of the consumer's residual income that she would be unable to meet basic living expenses.

Proposed comment 5(b)(2)(i)-1 would have provided more detailed guidance on the calculations needed for the applicable period under § 1041.5(b)(2)(i), explaining that a lender complies with the requirement in § 1041.5(b)(2)(i) if it reasonably determines that the consumer's projected residual income during the shorter of the term of the loan or the period ending 45 days after consummation of the loan will be greater than the sum of all payments under the covered short-term loan plus an amount the lender reasonably estimates will be needed for basic living expenses during the term of the covered short-term loan. The Bureau explained in the proposal that this method of compliance would have allowed the lender to make one determination based on the sum of all payments that would be due during the term of the covered short-term loan, rather than having to make a separate determination for each respective payment and payment period in isolation in cases where the short-term loan provide for multiple payments.

Under the proposed rule, the lender would have had to make the determination for the actual term of the loan, accounting for residual income (i.e., net income minus payments for major financial obligations) that would actually accrue during the shorter of the term of the loan or the period ending 45 days after consummation of the loan. The Bureau wrote that it believed that for a covered loan with short duration, a lender should make the determination based on net income the consumer will actually receive during the term of the loan and payments for major financial obligations that will actually be payable during the term of the loan, rather than, for example, based on a monthly period that may or may not coincide with the loan term. The Bureau explained that when a covered loan period is under 45 days, determining whether the consumer's residual income will be sufficient to make all payments and meet basic living expenses depends a great deal on, for example, how many paychecks the consumer will actually receive during the term of the loan and whether the consumer will also have to make no rent payment, one rent payment, or two rent payments during that period.

Proposed comment 9(b)(2)(i)-1 contained similar content but also emphasized that determination of whether residual income will be sufficient for the consumer to make all payments and to meet basic living expenses during the term of a covered longer-term loan (including covered longer-term balloon-payment loans) requires a lender to reasonably account for the possibility of volatility in the consumer's residual income and basic living expenses over the term of the loan. The Bureau further stated in that proposed comment that a lender reasonably accounts for the possibility of volatility in income and basic living expenses by reasonably determining an amount (i.e., a cushion) by which the consumer's residual income must exceed the sum of the loan payments under the loans and the amount needed for basic living expenses.

Proposed comment 5(b)(2)(i)-2 clarified what constitutes “sufficient” residual income for a covered short-term loan, explaining that residual income is sufficient as long as it is greater than the sum of payments that would be due under the covered loan plus an amount the lender reasonably estimates will be needed for basic living expenses. Proposed comment 9(b)(2)(i)-2 was identical.

The proposal also would have required lenders who make covered short-term loans and covered longer-term balloon-payment loans to assess consumers' finances for a second, distinct time period under §§ 1041.5(b)(2)(ii) and 1014.9(b)(2)(ii), respectively. Specifically, those sections would have required that before making such loans, a lender must reasonably conclude that the consumer will be able to make payments required for major financial obligations as they fall due, make any remaining payments under the loan, and meet basic living expenses for 30 days after having made the highest payment under the loan on its due date.

Proposed comment 5(b)(2)(ii)-1 noted that a lender must include in its determination under proposed § 1041.5(b)(2)(ii) the amount and timing of net income that it projects the consumer will receive during the 30-day period following the highest payment, in accordance with proposed § 1041.5(c). Proposed comment 5(b)(2)(ii)-1 also included an example of a covered short-term loan for which a lender could not make a reasonable determination that the consumer would have the ability to repay under proposed § 1041.5(b)(2)(ii). The Bureau noted in the proposal that it proposed to include the requirement in § 1041.5(b)(2)(ii) for covered short-term loans because research showed that these loan structures are particularly likely to result in re-borrowing shortly after the consumer repays an earlier loan. As discussed in the proposal, when a covered loan's terms provide for it to be substantially repaid within 45 days following consummation, the fact that the consumer must repay so much within such a short period makes it especially likely that the consumer will be left with insufficient funds to make subsequent payments under major financial obligations and meet basic living expenses. The Bureau noted that the consumer may then end up falling behind in paying major financial obligations, being unable to meet basic living expenses, or borrowing additional consumer credit. Such consumers may be particularly likely to borrow new consumer credit in the form of a new covered loan.

The Bureau further elaborated in the proposal that this shortfall in a consumer's funds is most likely to occur following the highest payment under the covered short-term loan (which is typically but not necessarily the final payment) and before the consumer's subsequent receipt of significant income. The Bureau noted, however, that depending on the regularity of a consumer's income payments and payment amounts, the point within a consumer's monthly expense cycle when the problematic covered short-term loan payment falls due, and the distribution of a consumer's expenses through the month, the resulting shortfall may not manifest itself until a consumer has attempted to meet all expenses in the monthly expense cycle, or even longer. The Bureau noted that indeed, many payday loan consumers who repay a first loan and do not re-borrow during the ensuing pay cycle (i.e., within 14 days) nonetheless find it necessary to re-borrow before the end of the expense cycle (i.e., within 30 days).

The Bureau noted in the proposal that in the Small Business Review Panel Outline, the Bureau described a proposal under consideration to require lenders to determine that a consumer has the ability to repay a covered short-term loan without needing to re-borrow for 60 days, consistent with the proposal in the same document to treat as part of the same loan sequence a loan taken out within 60 days of having a prior covered short-term loan outstanding. The Bureau noted in the proposal that several consumer advocates had argued that consumers may be able to juggle expenses and financial obligations for a time, so that an unaffordable loan may not result in re-borrowing until after a 30-day period. The Bureau proposed a 30-day period for both purposes.

The Bureau wrote that it believed that the incidence of re-borrowing caused by such loan structures would be somewhat ameliorated simply by determining that a consumer would have residual income during the term of the loan that exceeds the sum of covered loan payments plus an amount necessary to meet basic living expenses during that period. But if the loan payments consume all of the consumer's residual income during the period beyond the amount needed to meet basic living expenses during the period, the Bureau wrote in the proposal, then the consumer will have insufficient funds to make payments under major financial obligations and meet basic living expenses after the end of that period, unless the consumer receives sufficient net income shortly after the end of that period and before the next set of expenses fall due. The Bureau noted that often, though, the opposite is true: A lender schedules the due dates of loan payments under covered short-term loans so that the loan payment due date coincides with the consumer's receipt of income. The Bureau noted that this practice maximizes the probability that the lender will timely receive the payment under the covered short-term loan, but it also means the term of the loan (as well as the relevant period for the lender's determination that the consumer's residual income will be sufficient under proposed § 1041.5(b)(2)(i)) ends on the date of the consumer's receipt of income, with the result that the time between the end of the loan term and the consumer's subsequent receipt of income is maximized.

Thus, in the proposal, the Bureau wrote that even if a lender made a reasonable determination under proposed § 1041.5(b)(2)(i) that the consumer would have sufficient residual income during the loan term to make loan payments under the covered short-term loan and meet basic living expenses during the period, there would remain a significant risk that, as a result of an unaffordable highest payment (which may be the only payment, or the last of equal payments), the consumer would be forced to re-borrow or suffer collateral harms from unaffordable payments. The Bureau wrote that the example included in proposed comment 5(b)(2)(ii)-1 was intended to illustrate just such a result.

In proposed § 1041.5(b)(2)(iii), the Bureau would have required the lender to determine that the requirements of proposed § 1041.6 are satisfied when making a covered short-term loan for which a presumption of unaffordability under proposed § 1041.6 applies.

Comments Received

The Bureau received a number of comments on proposed § 1041.5(b)(2), and specifically the time period and sufficiency of the residual income model. Many of the comments pertaining to this section were already discussed above in the discussion of comments received pertaining to § 1041.5 more generally and § 1041.5(a) and (b)(1).

On the time period, several consumer advocate commenters suggested that residual income should be assessed under § 1041.5(b)(2)(ii) for 60 days following the highest payment. Other commenters argued that the time period in question should run from the last payment instead of the highest payment, arguing that this would ensure that the consumer does not need to re-borrow throughout the entirety of the loan term and thereafter. As articulated by the commenters, if a consumer's highest payment came more than 30 days before the end of the loan term, then under the Bureau's proposed requirement, the lender would only need to make a reasonable conclusion about whether the consumer could repay until the end of the loan term (and there would not be a 30-day period after to assess for re-borrowing).

Industry commenters asserted that forecasting for income and expenses as they come due, including the timing of those payment and expenses, during the various overlapping proposed time periods would be infeasible. Others made the opposite argument, asserting that lenders should at least be encouraged to assess actual basic living expenses during the two time periods specified in proposed § 1041.5(b)(2).

As discussed above, a number of commenters asserted that the residual income model was unduly restrictive or otherwise inadequate for assessing whether a consumer has the ability to repay. Some argued that if the Bureau is using a residual income approach, it should model its test after the Department of Veterans Affair's residual income test, which includes objective numerical standards. Many other commenters, as noted in the general § 1041.5 discussion above, asserted that a debt-to-income ratio was a more well-accepted and time-tested underwriting model. Other commenters argued, as noted above, for a loan-to-income or payment-to-income approach instead. Others argued, also as noted above, that a residual income test would be too burdensome. Still other commenters pointed to data showing that residual income is not indicative of whether a consumer will default. These comments are discussed in more detail in the introduction to § 1041.5 and the summary of § 1041.5(b)(1) above.

The Bureau also received a number of comments relating to how proposed § 1041.9(b) would have required lenders to include a cushion to account for income volatility over the course of a covered longer-term loan, arguing that to do so would be purely speculative.

Final Rule

As described in the general § 1041.5 discussion and in the discussion of the debt-to-income ratio definition in § 1041.5(a)(2) above, the Bureau has made a substantial number of changes to § 1041.5(b)(2) of the final rule.

To summarize, as described in the general § 1041.5 discussion above, under proposed § 1041.5(b)(2) the reasonable ability-to-repay determination would have required the lender to project both the amount and timing of the consumer's net income and major financial obligations and draw reasonable conclusions about the consumer's ability to repay during two distinct time periods: First for the shorter of the term of the loan or 45 days after consummation of the loan, and then also for 30 days after having made the highest payment under the loan. This requirement is being streamlined in the final rule. Lenders are instead required to make a projection about net income and major financial obligations and calculate the debt-to-income ratio or residual income, as applicable, during only a single monthly period, i.e., the relevant monthly period. The Bureau has defined that term in § 1041.5(a)(7) as the calendar month with the highest payments on the loan, which is generally consistent with the analysis that the Bureau proposed to use for covered longer-term balloon payment loans under proposed § 1041.9(b)(2)(i) and focuses on the time in which the loan places the greatest strain on the consumer's finances.

Lenders can use the debt-to-income ratio or residual income during this relevant monthly period as a snapshot of the consumer's financial picture to draw conclusions about the consumer's ability to repay the covered short-term loan or covered longer-term balloon-payment loan without re-borrowing. Specifically, under § 1041.5(b)(2), the lender uses this information to make a reasonable conclusion that the consumer has the ability to repay the loan while meeting basic living expenses and major financial obligations during: (1) The shorter of the term of the loan or 45 days after consummation of the loan, for covered short-term loans, and the relevant monthly period, for covered longer-term balloon-payment loans, and (2) for 30 days after having made the single highest payment under the loan. This simplified approach also dovetails with the inclusion of the debt-to-income ratio methodology as an alternative to residual income. As discussed above, a debt-to-income methodology does not permit the tracking of a consumer's individual income inflows and major financial obligation outflows on a continuous basis over a period of time.

In response to commenters arguing that forecasting the timing of income flow and payment obligations over the applicable period will be difficult, the Bureau has adjusted the rule. While § 1041.5(b)(2) still requires the lender to generally make a reasonable conclusion about whether the consumer can pay major financial obligations, loan payment amounts, and basic living expenses for the loan term and 30 days after the largest payment, the Bureau has adjusted the rule such that the lender does not need to specifically project both the amount of the payments and the timing of the payments during those periods. Rather, the lender is required to account only for the amounts of such payments—and not the timing of them—during a single calendar month, the relevant monthly period. The relevant monthly period is defined in § 1041.5(a)(7) as the calendar month in which the payments on the loan are highest.

The Bureau has also revised commentary to § 1041.5(b)(2) to discuss how lenders are to use the projections of net income and major financial obligations during the relevant monthly period as a baseline of information to then make reasonable inferences and draw a reasonable conclusion about the time periods described in § 1041.5(b)(2).

As noted above, § 1041.5(b)(2) has been revised and expanded largely as a way of accommodating the inclusion in the final rule of an option for lenders to use a debt-to-income methodology in lieu of a residual income methodology. Although some of the revisions are substantive and are described below, most of the changes reflect the creation of a parallel set of provisions to apply to the debt-to-income methodology. Thus § 1041.5(b)(2) of the final rule is now split so that paragraph (b)(2)(i) addresses the debt-to-income ratio methodology, and paragraph (b)(2)(ii) addresses the residual income methodology. Lenders will only have to comply with one or the other subparagraph depending on which methodology they choose.

The Bureau described the debt-to-income ratio methodology above in the discussion of § 1041.5(a), but, to recap, a lender may determine whether a consumer will have a high enough percentage of net income remaining to pay for basic living expenses after paying major financial obligations and the loan payments during the relevant monthly period. As discussed earlier, the Bureau has not set the threshold for how high a percentage would meet the test and will allow lenders to use their reasoned judgment. The Bureau believes that a lender may find that different thresholds are effective for consumers with different income levels and family sizes. However, a lender could conceivably use a single threshold, and lenders that choose to vary the thresholds will almost surely develop different approaches of doing so. The test will be whether the thresholds deployed by any given lender lead to reasonable determinations of whether consumers have the ability to repay their loans according to the loan terms. Of course, if lenders set thresholds based on reasoned judgment, but then find they do not work in practice, the Bureau will expect them to adjust accordingly.

The Bureau has not imported the requirement under proposed comment 9(b)(2)(i)-2 (also cross-referenced in proposed comment 9(b)-2.i.F) that lenders must allow a cushion for income volatility. The proposal did not include a requirement to account for income volatility for covered short-term loans, and the Bureau sees no reason to add one in the final rule. The Bureau is skeptical that such a requirement is needed for covered short-term loans due to their shorter duration.

Moreover, the Bureau is not finalizing this comment as to covered longer-term balloon-payment loans, which are included in the scope of § 1041.5(b)(2). The Bureau proposed the cushion requirement with respect to covered longer-term loans because installment loans would have predominated that category. For those loans, the proposed ability-to-repay requirement would have focused on the affordability of the regular periodic payment. The Bureau believed that if a consumer had only just enough money to cover that payment in a “normal” month, the loan would prove unaffordable over its term due to income or expense volatility. The final rule, however, covers only longer-term loans with a balloon payment and requires underwriting such loans to assess whether the consumer will be able to make the payments in the month with the highest sum of payments. Therefore, the Bureau does not believe it is necessary to add a cushion to that calculation.

In addition to substantially revising the text of § 1041.5(b)(2) in light of these major changes, the Bureau has also revised the comments. Comment 5(b)(2)-1 reiterates the general methodology, and notes that if there are two payments that are equal to each other in amount and higher than all other payments, the highest payment under the loan is considered the later in time of the two. Comments 5(b)(2)(i)-1 and -2 explain how the relevant monthly period for calculating the debt-to-income ratio is not identical to the periods for which a lender is assessing ability to repay in § 1041.5(b)(2)(i), and explains that in fact they may overlap. Comment 5(b)(2)(i)-2 explains that the lender uses the projections about the consumer's net income and major financial obligations during the relevant monthly period and the calculation of the consumer's debt-to-income ratio as a baseline of information on which to make reasonable inferences and draw a reasonable conclusion about whether the consumer will be able to pay major financial obligations, make the payments on the loan, and meet basic living expenses during the periods specified in § 1041.5(b)(2)(i). The comment further states that the lender cannot assume, for example, in making those reasonable inferences, that the consumer will defer payment on major financial obligations or basic living expenses until after the 30-day period that follows the date of the highest payment on the loan, or assume that the obligations and expenses will be less than in the relevant monthly period. The Bureau provides examples of this dynamic in comment 5(b)(2)(i)-3. Comments 5(b)(2)(ii)-1 through -3 provide parallel guidance as to covered longer-term balloon-payment loans.

Lastly, the Bureau did not finalize the content in proposed § 1041.5(b)(2)(iii), which would have required lenders to satisfy further requirements under proposed § 1041.6 before making a covered short-term loan in circumstances where the consumer's recent borrowing or current difficulties paying off an existing loan suggested that they did not have the ability to repay a new loan. As discussed below, the Bureau has instead finalized certain elements of proposed § 1041.6 as final § 1041.5(d).

5(c) Projecting Consumer Net Income and Payments for Major Financial Obligations

Overview

Proposed § 1041.5(c) specified the requirements for obtaining information directly from consumers as well as various forms of verification evidence for use in projecting consumers' net income and major financial obligations for purposes of the ability-to-repay requirements under proposed § 1041.5(b). Following the Bureau's review and consideration of the comments to the proposal, the Bureau is finalizing § 1041.5(c) with substantial changes to provide more flexibility with regard to verification requirements and to provide more detailed guidance for how lenders should treat discrepancies between consumers' written statements and verification evidence. The Bureau has carefully balanced the final rule to require substantial improvements in current industry verification practices, while providing appropriate flexibility for lenders and consumers in situations in which verification evidence is not reasonably available.

Specifically, the Bureau had proposed § 1041.5(c) in the following manner: Paragraph (c)(1) set forth the general evidentiary standards for reasonably projecting net income and major financial obligations and the standards for addressing inconsistencies between the consumers' stated amounts for such items and verification evidence; paragraph (c)(2) addressed one narrow way in which lenders could deviate from information in verification evidence; and paragraph (c)(3) governed how and when lenders must obtain verification evidence for net income and major financial obligations. The Bureau is not finalizing much of the content in paragraph (c)(2), as described below, and, for increased clarity, the Bureau is now placing the content from paragraph (c)(2), to the extent that content is being finalized or amended, into paragraph (c)(1). Accordingly, final § 1041.5(c)(1) describes the general evidentiary standards, the standards for addressing inconsistencies between the consumers' stated amounts for net income and major financial obligations and the verification evidence, and the process for when lenders can deviate from the information in verification evidence; and § 1041.5(c)(2) governs how and when lenders must obtain verification evidence for net income and major financial obligations.

5(c)(1) General

Proposed Rule

With regard to covered short-term loans, in proposed § 1041.5(c)(1), the Bureau provided that for a lender's projection of the amount and timing of net income or payments for major financial obligations to be reasonable, the lender must obtain both a written statement from the consumer as provided for in proposed § 1041.5(c)(3)(i) and verification evidence as provided for in proposed § 1041.5(c)(3)(ii). Proposed § 1041.5(c)(1) further provided that for a lender's projection of the amount and timing of net income or payments for major financial obligations to be reasonable, it may be based on a consumer's statement of the amount and timing only to the extent the stated amounts and timing are consistent with the verification evidence.

As the Bureau explained in the proposal, the Bureau believed verification of consumers' net income and payments for major financial obligations was an important component of the reasonable ability-to-repay determination. Consumers seeking a loan may be in financial distress and inclined to overestimate net income or to underestimate payments for major financial obligations to improve their chances of being approved. Lenders have an incentive to encourage such misestimates to the extent that as a result consumers find it necessary to re-borrow. The Bureau further stated in the proposal that this result is especially likely if a consumer perceives that, for any given loan amount, lenders offer only a one-size-fits-all loan repayment structure and will not offer an alternative loan with payments that are structured to be within the consumer's ability to repay. As the Bureau noted, an ability-to-repay determination that is based on unrealistic factual assumptions will yield unrealistic and unreliable results, leading to the very consumer harms that the Bureau's proposal was intended to prevent.

Accordingly, proposed § 1041.5(c)(1) would have permitted a lender to base its projection of the amount and timing of a consumer's net income or payments for major financial obligations on a consumer's written statement of amounts and timing under proposed § 1041.5(c)(3)(i) only to the extent the stated amounts and timing are consistent with verification evidence of the type specified in proposed § 1041.5(c)(3)(ii). Proposed § 1041.5(c)(1) also provided that in determining whether and the extent to which stated amounts and timing are consistent with verification evidence, a lender may reasonably consider other reliable evidence the lender obtains from or about the consumer, including any explanations the lender obtains from the consumer.

In the proposal, the Bureau stated its belief that the proposed approach would appropriately ensure that the projections of a consumer's net income and payments for major financial obligations will generally be supported by objective, third-party documentation or other records. The Bureau further stated, however, that the proposed approach also recognized that reasonably available verification evidence may sometimes contain ambiguous, out-of-date, or missing information. For example, the net income of consumers who seek covered loans may vary over time, such as for a consumer who is paid an hourly wage and whose work hours vary from week to week. In fact, a consumer is more likely to experience financial distress, which may be a consumer's reason for seeking a covered loan, immediately following a temporary decrease in net income from more typical levels. Accordingly, the Bureau stated that the proposed approach would not have required a lender to base its projections exclusively on the consumer's most recent net income receipt shown in the verification evidence. Instead, it allowed the lender reasonable flexibility in the inferences the lender draws about, for example, a consumer's net income during the term of the covered loan, based on the consumer's net income payments shown in the verification evidence, including net income for periods earlier than the most recent net income receipt. At the same time, the proposed approach would not have allowed a lender to mechanically assume that a consumer's immediate past income as shown in the verification evidence will continue into the future if, for example, the lender has reason to believe that the consumer has been laid off or is no longer employed.

The Bureau stated in the proposal, that in this regard, the proposed approach recognized that a consumer's own statements, explanations, and other evidence can be important components of a reliable projection of future net income and payments for major financial obligations. Proposed comment 5(c)(1)-1 included several examples applying the proposed provisions to various scenarios, illustrating reliance on consumer statements to the extent they are consistent with verification evidence and how a lender may reasonably consider consumer explanations to resolve ambiguities in the verification evidence. It included examples of when a major financial obligation in a consumer report is greater than the amount stated by the consumer and of when a major financial obligation stated by the consumer does not appear in the consumer report at all.

The Bureau stated in the proposal that it anticipated that lenders would develop policies and procedures, in accordance with proposed § 1041.18, for how they project consumer net income and payments for major financial obligations in compliance with proposed § 1041.5(c)(1) and that a lender's policies and procedures would reflect its business model and practices, including the particular methods it uses to obtain consumer statements and verification evidence. The Bureau stated its belief that many lenders and vendors would develop methods of automating projections, so that for a typical consumer relatively little labor would be required.

In proposed § 1041.5(c)(2), the Bureau proposed an exception to the requirement in proposed § 1041.5(c)(1) that projections must be consistent with the verification evidence that a lender would be required to obtain under proposed § 1041.5(c)(3)(ii). As discussed below, the required verification evidence would have normally consisted of third-party documentation or other reliable records of recent historical transactions or of payment amounts. Proposed § 1041.5(c)(2) would have permitted a lender to project a net income amount that is higher than an amount that would otherwise be supported under proposed § 1041.5(c)(1), or a payment amount for a major financial obligation that is lower than an amount that would otherwise be supported under proposed § 1041.5(c)(1), only to the extent and for such portion of the term of the loan that the lender obtains a written statement from the payer of the income or the payee of the consumer's major financial obligation of the amount and timing of the new or changed net income or payment.

As the Bureau explained in the proposal, the exception was intended to accommodate situations where a consumer's net income or payment for a major financial obligation will differ from the amount supportable by the verification evidence. For example, a consumer who has been unemployed for an extended period of time, but who just accepted a new job, may not be able to provide the type of verification evidence of net income that generally would have been required under proposed § 1041.5(c)(3)(ii)(A). Proposed § 1041.5(c)(2) would have permitted a lender to project a net income amount based on, for example, an offer letter from the new employer stating the consumer's wage, work hours per week, and frequency of pay. The lender would have been required to retain the statement in accordance with proposed § 1041.18.

Proposed § 1041.9(c) included parallel requirements applicable to covered longer-term loans.

Comments Received

The Bureau received many comments on the proposed verification requirements from a variety of stakeholders. Many of these commenters argued that the verification requirements were overly burdensome, too prescriptive, and not appropriate to this credit market in contrast to the mortgage and credit card markets. Other industry commenters asked the Bureau to provide more specificity around verification requirements to reduce uncertainty. These commenters included both industry stakeholders and other parties, such as several State Attorneys General and the SBA Office of Advocacy. Many individual consumers, often commenting as part of letter-writing campaigns, also criticized aspects of the verification requirements, particularly the requirement for lenders to obtain a national consumer report for each loan to verify debt obligations. Consumer advocates, on the other hand, generally argued that the verification requirements were calibrated appropriately or, in some places, were too permissive. Some of these arguments are described in the general § 1041.5 discussion at the outset of the section-by-section analysis for this section. These arguments are also described with more particularity in discussion below of paragraphs of this overall section, such as the requirements under § 1041.5(c)(2)(ii)(A) and (B) (verification evidence for net income and major financial obligations, respectively).

Commenters generally argued that there are many consumers who have an ability to repay, but who cannot verify income, and that they would be harmed by the verification requirements. Specifically, many commenters cited consumers who work in the cash economy or who had seasonal or sporadic work as consumers who would be unable to access credit under the proposal because of the income verification requirements. One industry trade group representing community banks argued that some consumers use cash to pay for basic living expenses, so deposit account records would not provide accurate verification evidence. These comments are addressed in the discussion of § 1041.5(c)(2).

One commenter argued that the Bureau should not impose any verification evidence requirements until the Bureau could prove that consumers were harmed by lenders failing to collect evidence to verify consumer claims.

A number of industry commenters asserted that the Bureau had failed to explain why it was applying more vigorous verification requirements to payday loans than to mortgages and credit cards. Some of these arguments are described in the general § 1041.5 discussion above. Some commenters argued that requiring similar verification requirements undermined the business model of payday and title loan companies, which they argued are built around speed, convenience, and lack of intrusive underwriting, and that consumers desire these features of the business model. Many individual consumers, often writing as part of organized letter-writing campaigns made similar comments. They described favorably their experience with payday loans based on the lack of a credit check requirement, the ease of the application process, and the respect they feel they receive from the origination process at payday lenders (in contrast to their experience at banks, which they argued was more intrusive and impersonal).

Other commenters argued that the Bureau could and should provide safe harbors or exceptions for certain lenders who meet various criteria. For example, one commenter, an online lender, argued that the Bureau should not impose any income verification requirements on short-term lenders with below market average charge-offs and that the Bureau should set a safe harbor loss rate of under 15 percent for first-time customers.

A trade group representing vehicle title lenders commented that income verification is incompatible with the business model for the vehicle title loan product and its customer base. The commenter argued that vehicle title lenders would have difficulty obtaining the information from consumers; that the time it would add to the process is disproportionate for this type of loan; and that it would undermine the value and competitiveness of the product.

A number of commenters argued that the more rigorous underwriting requirements would involve personal questions that many consumers would believe violate their privacy and so would resist answering, or viewed such questions as too intrusive for a small-dollar loan as opposed to a much larger extension of credit. Similarly, many individual commenters expressed concerns about providing their personal information to lenders, and were concerned about their privacy and also the risk of data breach. Some industry commenters provided similar comments, stating that the need to create real-time, centralized databases for obtaining information on consumers during underwriting would increase consumers' exposure to data breach risk.

A number of commenters, including several lenders and consumer reporting agencies, argued that the Bureau should adopt a validation instead of a verification model, in which lenders could compare statements about income, basic living expenses, or major financial obligations to various third-party data sources or data models, and perform manual processing and verification only when the validation process identifies an anomaly. Some of these commenters noted that the U.K. Financial Conduct Authority guidelines on small-dollar lending permit such an approach. Another provided data comparing deviations from historical 12-month average stated income to default rates, finding that the further a consumer's stated income deviated from that consumer's historic average, the higher the default rate (with significantly higher default rates as consumers' stated income is multiples higher than the historic average).

More broadly, commenters argued that the proposed verification requirements did not take into consideration shared payment of major financial obligations by consumers and other persons, such as expenses shared with spouses and cohabitants. Consumer advocates argued, alternatively, that claims of shared major financial obligations should be allowed only with verification evidence. The issues raised in these comments in some cases overlap with the issues discussed in the section-by-section analysis for § 1041.5(a)(1) (definition of basic living expenses) and § 1041.5(a)(3) (definition of major financial obligations).

The Bureau received a number of comments relating to how proposed § 1041.5(c)(1) and (2) would have addressed inconsistencies between the consumers' stated amounts and the verification evidence, when deviation from the stated amounts would have been permitted, and what additional steps would have been required in those circumstances. Consumer advocates argued that lenders should not be allowed to rely on consumer statements that are inconsistent with verification evidence unless relying on the consumer statements would result in a projection of a lower income amount or a higher major financial obligations amount. Others expressed concern that the ability to deviate from amounts in the verification evidence based on explanations from the consumer would be an easy way to skirt the verification requirements in the proposal. On the other hand, industry commenters suggested that lenders should be able to deviate from amounts in verification evidence based on borrower statements. Specific to proposed § 1041.5(c)(2), a number of industry commenters argued that a requirement to procure statements from payors or payees would pose significant privacy concerns for consumers.

Online lenders and their trade groups expressed concerns about the practicality and burdens on both the consumer and the lender with respect to the verification requirements. They argued that document verification disadvantages online lenders because documents submitted by fax, mobile image capture, or email scan are frequently illegible or easily misinterpreted; mobile image capture does not work for pay stubs; and even if the customers could submit the documents via mobile app, lenders would need to manually process them on the back end. They also expressed concerns about the fraud and security risks related to consumers taking photos of sensitive documents to submit to online lenders via a smartphone.

Lastly, some commenters noted concerns about potential double-deductions, where a national consumer report identifies a debt obligation or child support obligation that may have already been deducted from the consumer's gross income prior to the consumer's receipt of take-home pay. The concern was that the portion of the gross income deducted for this obligation would not be included in net income but would still be counted as a major financial obligation.

Final Rule

After carefully considering the comments received, the Bureau has finalized the core elements of § 1041.5(c)(1) to require lenders to obtain consumers' written statements and various forms of verification evidence in order to reasonably project net income and major financial obligations for the relevant monthly period as required by § 1041.5(b). However, the Bureau has adopted a number of changes to the proposed approach to provide lenders with greater flexibility to rely on consumers' written statements in appropriate circumstances and to clarify how lenders should address situations in which there are inconsistencies between consumers' written statements and consumer reports or other verification evidence. The Bureau has also incorporated some elements of proposed § 1041.5(c)(2) into the commentary on § 1041.5(c)(1), but is not adopting a categorical requirement that lenders may only project increases in net income or decreases in major financial obligations if they obtain a written statement from the payer of the income or the payee of the obligation.

Specifically, final § 1041.5(c) specifies that a lender must obtain the consumer's written statement in accordance with § 1041.5(c)(2)(i), obtain verification evidence as required by § 1041.5(c)(2)(ii), assess information about rental housing expense as required by § 1041.5(c)(2)(iii), and make a reasonable projection of the amount of a consumer's net income and payments for major financial obligations during the relevant monthly period. As described in more detail in connection with final § 1041.5(c)(2) below, each of those provisions has been modified in turn to allow lenders more flexibility in reasonably relying on information in consumers' written statements where particular income or major financial obligations cannot be verified through reasonably available sources. For example, § 1041.5(c)(2)(ii)(A) allows lenders to reasonably rely on consumers' written statements with regard to income that cannot be verified through pay records, bank account records, or other reasonably available sources. Section 1041.5(c)(2)(iii) also allows lenders to reasonably rely on consumers' written statements with regard to rental housing expense, but not with regard to mortgages that can be verified from a national consumer report.

The Bureau also revised § 1041.5(c)(1) to address different types of potential inconsistencies between consumers' written statements and verification evidence in more detail. Thus, final § 1041.5(c)(1) specifically requires lenders to consider major financial obligations that are listed in a consumer's written statement, even if they cannot be verified by the sources provided for as verification evidence under § 1041.5(c)(2)(ii)(B). This requirement is consistent with various Bureau statements in the proposal and with proposed comment 5(c)(1)-1.G, which included an example in which a consumer's child support payment did not appear on a national consumer report, but the Bureau has concluded that the requirement implicit in the example should be reflected in a more direct statement in the regulation text. With regard to other types of inconsistencies between the consumer's written statement and verification evidence, the final rule provides that a lender may base the amounts of net income or major financial obligations on the consumer's written statement only as specifically permitted under § 1041.5(c)(2) or to the extent the stated amounts are consistent with the verification evidence. Consistent with the proposal, § 1041.5(c)(1) states that in determining consistency with verification evidence, the lender may reasonably consider other reliable evidence the lender obtains from or about the consumer, including any explanations the lender obtains from the consumer.

While the basic elements of proposed § 1041.5(c)(1) remain intact in the final rule, the Bureau has made a number of significant changes to § 1041.5(c)(1). First, as discussed above in connection with § 1041.5(a) and (b), the Bureau is not requiring lenders to project the specific timing of major financial obligations or income. Thus, the Bureau has eliminated all references to the need to verify timing throughout this provision.

Second, the Bureau is not finalizing proposed § 1041.5(c)(2). That section would have required a lender to obtain a written statement from a payor of income or a payee of major financial obligations in order to project income in a higher amount, or to project major financial obligations in a lower amount, than would otherwise have been supported by the verification evidence. The Bureau upon further consideration believes this requirement would be too onerous and inflexible, and may also raise privacy concerns if a consumer had to explicitly ask for a written statement from an employer. Because the Bureau is not finalizing proposed § 1041.5(c)(2), it is renumbering proposed § 1041.5(c)(3), which is being finalized (as described in further detail below), as § 1041.5(c)(2).

The Bureau believes that the final rule strikes an appropriate balance that will require substantial and reasonable improvements in current industry verification procedures while also addressing concerns that the proposal would be too burdensome to implement and would deny consumers access to credit in situations in which their finances are difficult to verify. The Bureau agrees with consumer advocates that verifying net income and major financial obligations is important to ensure the soundness of ability-to-repay determinations. But the Bureau also found the concerns raised by industry commenters regarding the burden of the verification requirements to be compelling in some instances, as noted below.

In response to commenters asserting that the Bureau must first determine that lack of verification evidence is causing harms to consumers before imposing verification requirements, the Bureau notes that it has found harms associated with failing to make reasonable determinations that a consumer has the ability to repay the loan, and had identified the practice as unfair and abusive (as discussed in the section-by-section analysis for § 1041.4 of the final rule). To make a reasonable determination that a consumer has the ability to repay, lenders must satisfy certain reasonable verification requirements, which have been loosened somewhat in light of the concerns raised by commenters. In other words, the verification requirements are reasonably related to preventing the identified unfair and abusive practice in § 1041.4. As discussed above, this is the legal standard for exercise of the Bureau's prevention authority under section 1031(b) of the Dodd-Frank Act.

Moreover, as consumer groups noted and as the proposal stated, there are particular concerns in this market that that consumers who are in financial distress may tend to overestimate income or underestimate expenses, and lenders have strong incentives to encourage misestimates to the extent that doing so tends to result in more re-borrowing. Thus, the Bureau believes that the practice of making loans without verification evidence is a contributing cause of the harms previously discussed. This premise was further validated by data submitted by a commenter, on 1.2 million covered loan applicants in 2014 to support arguments on a different issue. The analysis tracked the degree to which consumers' stated income deviated from a 12-month historical average for that consumer and compared it to default rates. The data showed that default rates increased as a consumer's stated income deviated from that same consumer's 12-month average. Some of this could be due of course to unexpected changes in income after the point of prediction, but it may also suggest that the stated income predictions were inaccurate in the first instance. Indeed, the commenter's data suggests that 35 percent of the 1.2 million applicants studied provided stated income that was 1.5 or more times higher than their own 12-month averages and that those borrowers saw significantly higher default rates than other applicants.

The Bureau disagrees with arguments that the proposal would have imposed more rigorous verification requirements than it has in the mortgage market under Regulation Z, but in any event as discussed in detail in the introduction to § 1041.5 above, the Bureau believes that the final rule's income and expense verification requirements are somewhat less onerous than the Bureau's mortgage rules in 12 CFR 1026.43 and more onerous than the credit card rules for various groups of consumers in 12 CFR 1026.51. The Bureau recognizes that the Regulation Z rules for credit cards do not impose similar verification requirements for income, although pulling consumer reports is a widespread industry practice. As noted above, each credit market is different and warrants different regulations. For further explication on this issue, see the discussion at the beginning of the section-by-section analysis for § 1041.5.

The Bureau does not agree with comments requesting the Bureau grant safe harbors regarding the verification requirements for lenders meeting certain criteria such as below-market average charge-off rates. The Bureau does not believe the comments provided adequate data or justification for the particular safe harbors suggested. These changes also would add certain amounts of operational complexity. Additionally, the Bureau is not convinced that, as finalized, the verification requirements are so onerous as to warrant a safe harbor; see discussion elsewhere in this section of the various ways in which the requirements are being relaxed from the proposal. Allowing lenders to collect any less information, for example, through a safe harbor, would significantly undermine the lender's ability-to-repay determinations under § 1041.5(b), which rely on a reasonable projection of net income and major financial obligations which is grounded in relevant evidence concerning the consumer's current or recent income and obligations.

The Bureau is not revising the final rule to allow lenders to rely on validation or modeling of income or expenses in lieu of verification, as suggested by a number of commenters. As described in the section-by-section analysis for § 1041.5(c)(2), the final rule relaxes the verification requirement in a variety of ways, such as not requiring verification of rental housing expenses and permitting reliance on stated amounts of income where verification evidence is not reasonably available. Thus, one of the reasons for expressly permitting the validation or modeling of income and expenses in the final rule as a broad alternative to verification—that it would permit lenders to make loans to consumers with undocumented cash income—has been addressed in a different manner. Furthermore, the rule permits income verification to be done electronically via transaction account data or payroll data, which may be particularly useful to online lenders.

Additionally, the Bureau does not have reason to believe that income validation or modeling is a viable option in many contexts covered by § 1041.5, at least as an across-the-board substitute for income verification. The loans covered by § 1041.5 are, for the most part, short-term loans and the rule requires the lender to project net income for the relevant monthly period. Whatever the reliability of income validation or income estimation modeling may be in assessing a consumer's average monthly income or annual income, the Bureau does not believe that these techniques provide an adequate substitute for obtaining verification evidence, when reasonably available, of the consumer's current income or income in the recent past. However, the Bureau has no objection to lenders using validation or modeling methods as a backstop in situations in which consumers' income cannot be verified through traditional means or continuing to experiment with them in addition to traditional verification methods in order to develop a more complete picture of the strengths and weaknesses of those methods. The Bureau will continue to monitor developments in this area.

As noted in Background and Market Concerns—Underwriting, the Bureau understands that obtaining verification evidence for income is a common practice in most of the covered markets (except with regard to some vehicle title lending), and thus, the Bureau's requirement to verify income is unlikely to upend current norms in those markets. The Bureau notes that the Small Dollar Roundtable, including several lenders, supported an income verification requirement.

The Bureau agrees with commenters representing vehicle title lenders who argued that requiring income verification would present more of an adjustment for vehicle title lenders than payday lenders. However, the Bureau is not convinced that this is a compelling reason to not require income verification for vehicle title lenders. Commenters' arguments are essentially that because a vehicle title lender has security for the loan, the lender's business model is to forgo underwriting, and not obtain evidence of income, and that the Bureau's rule should permit that business model to continue as is. But the Bureau has identified particular consumer harms associated with this business model (see Market Concerns—Underwriting), and that is precisely why the Bureau believes it is important that vehicle title lenders be required to underwrite the loans based on consumers' ability to repay and not rely on the asset value as a substitute for underwriting. Were the Bureau to exclude vehicle title lenders from the verification provisions of the rule, it would be antithetical to one of the goals of this rule, which is to require reasonable determinations that consumers have the ability to repay loans according to their terms.

More broadly, the Bureau added comment 5(c)(1)-2 as one of several steps taken to address commenters who urged the Bureau to allow lenders to recognize situations in which other persons regularly contribute to a consumer's income or regularly pay a consumer's expenses. Specifically, this comment clarifies that, when it is reasonable to do so, a lender may take into account consumer-specific factors, such as whether other persons are regularly contributing toward paying the consumer's major financial obligations. Comment 5(c)(1)-2 also notes, however, that it is not reasonable for the lender to consider whether other persons are regularly contributing toward the consumer's payment of major financial obligations if the lender is separately including in its projection of net income any income of another person to which the consumer has a reasonable expectation of access. As discussed also in connection with § 1041.5(a)(1) and (5) concerning others' contributions to basic living expenses and net income, respectively, this clarification is intended to avoid double-counting.

Regarding comments by online lenders and their representatives that the proposed verification requirements would disadvantage and prove impractical to online lenders and would raise fraud or security risks, the Bureau believes that these comments are largely overstated or mooted in view of the scope and substance of the final rule's ability-to-repay requirements. First, the Bureau understands that online lenders generally fund the loans they make by depositing those loans into consumers' checking accounts and collect payment by debiting those accounts. Thus, consumers obtaining online loans have transaction accounts that can be used to verify income electronically. As discussed below in the section-by-section analysis, comment 5(c)(2)(ii)(A)-3 has been added to clarify that the consumer's recent transaction account deposit history is a reliable record (or records) that is reasonably available if the consumer has such an account and to note that that with regard to such bank account deposit history, the lender could obtain it directly from the consumer or, at its discretion, with the consumer's permission via an account aggregator service that obtains and categorizes consumer deposit account and other account transaction data. Furthermore, in the rare case in which a consumer without a transaction account seeks an online loan, the consumer may be able to provide verification evidence through online payroll records or by electronically transmitting a picture of a pay stub from her smart phone. Thus, the concern of commenters that the income verification requirement will require a scanner or fax machine, or will implicate widespread issues around data transmission or fraudulent documentation, seems misplaced. The Bureau also notes that the commenters' concerns are moot to the extent that they were focused primarily on longer-term loans without balloon payments, given that such loans are not covered by the ability-to-repay requirements in the final rule.

In light of the significant revisions it has made to the proposed rule, the Bureau has re-written many of the examples in the commentary for § 1041.5(c)(1). In response to the comments received, the Bureau has also added commentary in both § 1041.5(c)(1) and (2) to clarify exactly when lenders can deviate from verification evidence. As discussed further below with regard to specific types of information, the Bureau recognizes that there is some risk of evasion, as consumer groups noted, but has decided to allow lenders to rely on consumers' written statements in limited circumstances to augment the picture painted by verification evidence, as long as those statements are consistent and reasonable. The Bureau does so in recognition of the evident fact that many borrowers of covered loans have cash income that they spend in cash rather than deposit in a transaction account, and thus would be adversely affected by an overly rigid income verification requirement. For example, in comment 5(c)(1)-1.iii, the Bureau notes that it would be reasonable to rely on consumers' written statements to supplement verified income (by, for example, identifying and explaining a separate source of cash income in a reasonable amount), so long as there is no reasonably available evidence to verify that other source (like deposit account statements). Additionally, and consistent with the proposal, comment 5(c)(1)-1.iv states that a lender acts reasonably in relying on a consumer's explanation to project income where there is inconsistent verification evidence such as, for example, where a consumer explains that she was sick and missed two days of work, and thus made less income than usual in the most recent period covered by the verification evidence and that the prior period covered by the evidence is more representative of the consumer's income.

Similarly, other examples in the commentary address inconsistencies between a consumer's written statement and verification evidence with regard to major financial obligations. Specifically, comment 5(c)(1)-1.vi emphasizes that lenders must consider major financial obligations that are listed on the consumer's written statement but not on a national consumer report or other verification sources, while comment 5(c)(1)-1.vii addresses a situation in which a national consumer report lists a debt obligation that does not appear on the consumer's written statement. Lastly, the Bureau added comment 5(c)(1)-1.viii, to provide an example clarifying that a lender can deduct from major financial obligations the child support payments that a lender reasonably determines, based on a combination of verification evidence and an explanation from the consumer, have already been deducted from net income, a concept that is further described in § 1041.5(c)(2).

5(c)(2) Evidence of Net Income and Payments for Major Financial Obligations

Overview

Proposed § 1041.5(c)(3) provided more detailed requirements for collection of a written statement from the consumer concerning the amount and timing of net income and required payments for various major financial obligations, as well as various types of verification evidence for particular categories of major financial obligations. As explained above in connection with proposed § 1041.5(c)(1) and (2), proposed § 1041.5(c)(3) generally would have required lenders to base their projections on amounts shown in the verification evidence, with only limited reliance on the written statements. In light of the challenges in documenting housing expenses where a consumer does not have a formal mortgage or lease, however, proposed § 1041.5(c)(2)(ii)(D) would have permitted lenders to use a reliable estimate of rental housing expenses for consumers with households in the same locality as the consumer, based either on a source such as the American Community Survey of the United States Census Bureau or a lender's own applicants, provided that the lender periodically reviewed the reasonableness of its estimates by comparing them to statistical survey data or other reliable sources. The Bureau had proposed that more permissive approach to rental housing expense following feedback during the SBREFA process and other outreach about a stricter verification approach to rental housing expense.

The Bureau is finalizing proposed § 1041.5(c)(3) as § 1041.5(c)(2) of the final rule, with a number of modifications to the proposal that are intended to relieve unnecessary burdens of verification and to provide greater flexibility and clarity to lenders and consumers in situations in which a source of net income or a major financial obligation cannot be verified through the sources that lenders are required to obtain under the final rule. The Bureau has also modified the final rule to reflect policy decisions addressed in more detail above, including the decision to relax proposed requirements for lenders to project the timing of individuals' net income and major financial obligations as part of the broader ability-to-repay determination, the decision to include alimony as a major financial obligation, and the decision to allow lenders to account for situations in which the consumer has a reasonable expectation of access to others' income or in which other parties regularly pay for a consumer's major financial obligation.

5(c)(2)(i) Consumer Statements

Proposed Rule

Proposed § 1041.5(c)(3)(i)—which is being finalized, with adjustments, in § 1041.5(c)(2)(i) of the final rule—would have required a lender to obtain a consumer's written statement of the amount and timing of net income, as well as of the amount and timing of payments required for categories of the consumer's major financial obligations (e.g., credit card payments, automobile loan payments, housing expense payments, child support payments, and the like). The lender would then use the statements as an input in projecting the consumer's net income and payments for major financial obligations during the term of the loan. The lender would also have been required to retain the statements in accordance with proposed § 1041.18. These statements were intended to supplement verification evidence because verification evidence may sometimes contain ambiguous, out-of-date, or missing information.

Proposed comment 5(c)(3)(i)-1 would have clarified that a consumer's written statement includes a statement that the consumer writes on a paper application or enters into an electronic record, or an oral consumer statement that the lender records and retains or memorializes in writing and retains. It further would have clarified that a lender complies with a requirement to obtain the consumer's statement by obtaining information sufficient for the lender to project the dates on which a payment will be received or will be paid through the period as required under proposed § 1041.5(b)(2). This proposed comment included the example that a lender's receipt of a consumer's statement that the consumer is required to pay rent every month on the first day of the month is sufficient for the lender to project when the consumer's rent payments are due. Proposed § 1041.5(c)(3)(i) did not specify any particular form or even particular questions or particular words that a lender must use to obtain the required consumer statements.

Comments Received and Final Rule

The Bureau received few comments about the written statements in their own right, and is finalizing the proposed regulation and commentary as § 1041.5(c)(2)(i) in the final rule. The Bureau has revised the regulation text slightly for clarity and to reflect the decision to allow consideration of the amount of any income of another person to which the consumer has a reasonable expectation of access, as discussed above in connection with § 1041.5(a)(5) (definition of net income). The regulation text and commentary have also been edited to omit references to the timing of particular income and major financial obligation payments, in light of the final rule's changes with regard to use of debt-to-income ratios and revisions to the residual-income analysis as discussed above in connection with § 1041.5(a)(2) (debt-to-income ratio definition) and § 1041.5(b)(2) (ability-to-repay determination methodologies). Comments concerning lenders' ability to rely on written statements in the absence of verification evidence are discussed in more detail below.

5(c)(2)(ii) Verification Evidence

In proposed § 1041.5(c)(3)(ii), the Bureau would have required a lender to obtain verification evidence for the amounts and timing of the consumer's net income and payments for major financial obligations for a fixed period prior to consummation. It separately specified the type of verification evidence required for net income and each component of major financial obligations. The Bureau explained in the proposal that the requirements were designed to provide reasonable assurance that lenders' projections of consumers' finances were based on accurate and objective information, while also allowing lenders to adopt innovative, automated, and less burdensome methods of compliance.

5(c)(2)(ii)(A)

Proposed Rule

In proposed § 1041.5(c)(3)(ii)(A), the Bureau specified that for a consumer's net income, the applicable verification evidence would be a reliable record (or records) of an income payment (or payments) covering sufficient history to support the lender's projection under proposed § 1041.5(c)(1). It did not specify a minimum look-back period or number of net income payments for which the lender must obtain verification evidence. The Bureau explained in the proposal that it did not believe it was necessary or appropriate to require verification evidence covering a look-back period of a prescribed length. Rather, the Bureau indicated that the sufficiency of the history for which a lender would obtain verification evidence may depend on the source or type of income, the length of the prospective covered longer-term loan, and the consistency of the income shown in the verification evidence that the lender initially obtains, if applicable.

Proposed comment 5(c)(3)(ii)(A)-1 would have clarified that a reliable transaction record includes a facially genuine original, photocopy, or image of a document produced by or on behalf of the payer of income, or an electronic or paper compilation of data included in such a document, stating the amount and date of the income paid to the consumer. It further would have clarified that a reliable transaction record also would include a facially genuine original, photocopy, or image of an electronic or paper record of depository account transactions, prepaid account transactions (including transactions on a general purpose reloadable prepaid card account, a payroll card account, or a government benefits card account), or money services business check-cashing transactions showing the amount and date of a consumer's receipt of income.

The Bureau explained in the proposal that the proposed requirement was designed to be sufficiently flexible to provide lenders with multiple options for obtaining verification evidence for a consumer's net income. For example, the Bureau noted that a paper pay stub would generally satisfy the requirement, as would a photograph of the pay stub uploaded from a mobile phone to an online lender. In addition, the Bureau noted that the requirement would also be satisfied by use of a commercial service that collects payroll data from employers and provides it to creditors for purposes of verifying a consumer's employment and income. Proposed comment 5(c)(3)(ii)(A)-1 would also have allowed verification evidence in the form of electronic or paper bank account statements or records showing deposits into the account, as well as electronic or paper records of deposits onto a prepaid card or of check-cashing transactions. Data derived from such sources, such as from account data aggregator services that obtain and categorize consumer deposit account and other account transaction data, would also generally satisfy the requirement. During outreach, service providers informed the Bureau that they currently provide such services to lenders.

The Bureau explained in the proposal that this approach was designed to address concerns that had been raised during the SBREFA process and other industry outreach prior to the proposal. In particular, some SERs and industry representatives had expressed concern that the Bureau would require outmoded or burdensome methods of obtaining verification evidence, such as always requiring a consumer to submit a paper pay stub or transmit it by facsimile (fax) to a lender. Others questioned requiring income verification at all, stating that many consumers are paid in cash and therefore have no employer-generated records of income. The Bureau explained in the proposal that proposed § 1041.5(c)(3)(ii)(A) was intended to respond to many of these concerns by providing a wide range of methods to obtain verification evidence for a consumer's net income, including electronic methods that can be securely automated through third-party vendors with a consumer's consent. The Bureau explained that in developing the proposal, Bureau staff met with more than 30 lenders, nearly all of which stated they already use some method—though not necessarily the precise methods the Bureau was proposing—to verify consumers' income as a condition of making a covered loan. The Bureau stated that its proposed approach thus would accommodate most of the methods they described and that the Bureau was aware of from other research and outreach. It was also intended to provide some accommodation for making covered loans to many consumers who are paid in cash. For example, under the Bureau's proposed approach, a lender would have been able to obtain verification evidence of net income for a consumer who is paid in cash by using deposit account records (or data derived from deposit account transactions), if the consumer deposits income payments into a deposit account. The Bureau explained in the proposal that lenders often require consumers to have deposit accounts as a condition of obtaining a covered loan, so the Bureau believed that lenders would be able to obtain verification evidence for many consumers who are paid in cash in this manner.

The Bureau recognized in the proposal that there would be some consumers who receive a portion of their income in cash and do not deposit it into a deposit account or prepaid card account. For such consumers, a lender may not be able to obtain verification evidence for that portion of a consumer's net income, and therefore generally could not base its projections and ability-to-repay determinations on those amounts. The Bureau stated in the proposal that where there is no verification evidence for a consumer's net income, the Bureau believed the risk would be too great that projections of net income would be overstated and that payments under a covered short-term loan consequently would exceed the consumer's ability to repay, resulting in all the harms from unaffordable covered loans identified in the proposal.

For similar reasons, the Bureau did not propose to permit the use of predictive models designed to estimate a consumer's income or to validate the reasonableness of a consumer's statement of her income. The Bureau noted that it had received recommendations from the Small Dollar Roundtable, comprising a number of lenders making the kinds of loans the Bureau was considering whether to cover in this rulemaking and a number of consumer advocates, urging the Bureau to require income verification.

Comments Received

Many commenters, particularly industry stakeholders, were generally concerned that the income verification requirements would create inaccurate portrayals of consumers' income because many types of income would not be verifiable. These commenters specifically focused on consumers who are paid in cash, noting that these consumers would likely not have a way, except account statements, to verify income. One trade group commenter said even then, some consumers use cash income directly to pay basic living expenses (without depositing it in an account). Commenters similarly argued that the Bureau's verification regime had not accounted for consumers who have seasonal or irregular income, such as tips, bonuses, and overtime pay. Commenters also asked for clarity on how income earned in amounts and from sources other than regular payroll would be handled under the rule, and expressed concern with strict verification requirements that would make it difficult for consumers with these types of income to prove future income with past documentation. Commenters argued that these consumers who work in the “cash economy” make up a substantial portion of the customer base for covered lenders, and cited numerous examples of occupations such as restaurant workers, hair stylists, or day laborers who are routinely paid in cash. Others argued that the Bureau should allow stated income based on consumer statements, noting that credit card issuers do not need to verify income.

Consumer groups generally supported the income verification requirements and urged the Bureau not to permit lenders to rely on stated income in any circumstances. They argued that variations from verification evidence based on the consumer statements should be permitted only if they result in a lower projection of income (i.e., a more conservative estimate).

Also, as stated earlier, many commenters argued that the Bureau had not established a way to account for income from third parties to which a lender has a reasonable expectation of access (or even a legal right), like spousal income. These comments are described in the section-by-section analysis for § 1041.5(a)(5).

Some commenters argued that consumers of online loans would need a fax machine or scanner to submit evidence of income, something that many of their customers do not own. These comments are described in more detail above in the section-by-section analysis for § 1041.5(c)(1).

Commenters asked for further detail about what constitutes a “sufficient history” of net income for purposes of the verification requirement, a phrase appearing in the proposed regulation text without corresponding commentary. These commenters asked how long a lender should look back (e.g., for how many pay stubs) to establish a sufficient history. One trade group asked for a safe harbor of two pay cycles of verification evidence for covered longer-term loans, citing NCUA requirements. Other lenders asked whether they could look far back into the past, for example, at the bonus payment from last year, to help establish whether the borrower is likely to receive one this year. Consumer advocates argued that for longer-term loans with a duration of longer than six months, “sufficient history” should correspond to the length of the loan.

Final Rule

The Bureau has carefully considered the comments received and has concluded that it is appropriate to make two significant modifications to proposed § 1041.5(c)(3)(ii)(A). First, while the Bureau continues to believe that it is critical for lenders to obtain reliable records of net income if they are reasonably available, the Bureau has decided to permit lenders discretion to reasonably rely on consumers' written statements of net income where such records cannot be obtained. Second, with regard to situations in which the consumer has a reasonable expectation of access to the income of another person, the Bureau has decided to permit lenders discretion to reasonably rely on such income but only if they have obtained verification evidence of regular access to that income, such as documentation of a joint account.

Specifically, in the final rule, § 1041.5(c)(2)(ii)(A)(1) has been revised to provide that the lender must obtain a reliable record (or records) of an income payment (or payments) directly to the consumer covering sufficient history to support the lender's projection under § 1041.5(c)(1) if a reliable record (or records) is reasonably available. Section 1041.5(c)(2)(ii)(A)(1) has also been revised in the final rule to provide that if a lender determines that a reliable record (or records) of some or all of the consumer's net income is not reasonably available, then the lender may reasonably rely on the consumer's written statement described in § 1041.5(c)(2)(i)(A) for that portion of the consumer's net income.

The Bureau has added two comments in the final rule to accompany these changes in the regulation text. First, comment 5(c)(2)(ii)(A)-3 clarifies the meaning of “reasonably available” records. The comment clarifies that a reliable record of the consumer's net income is reasonably available if, for example, the consumer's source of income is from her employment and she possesses or can access a copy of her recent pay stub. The comment clarifies that the consumer's recent transaction account deposit history is a reliable record (or records) that is reasonably available if the consumer has such an account. The comment further clarifies that with regard to such bank account deposit history, the lender could obtain it directly from the consumer or, at its discretion, with the consumer's permission via an account aggregator service that obtains and categorizes consumer deposit account and other account transaction data. The comment also clarifies that in situations in which income is neither documented through pay stubs or transaction account records, the reasonably available standard requires the lender to act in good faith and exercise due diligence as appropriate for the circumstances to determine whether another reliable record (or records) is reasonably available.

Second, comment 5(c)(2)(ii)(A)-4 clarifies when a lender can reasonably rely on a consumer's statement if a reliable record is not reasonably available. The comment clarifies that § 1041.5(c)(2)(ii)(A) does not permit a lender to rely on a consumer's written statement that the consumer has a reasonable expectation of access to the income of another person. The comment further clarifies that a lender reasonably relies on the consumer's written statement if such action is consistent with a lender's written policies and procedures required under § 1041.12 and there is no indication that the consumer's stated amount of net income on a particular loan is implausibly high or that the lender is engaged in a pattern of systematically overestimating consumers' income. The comment clarifies that evidence of the lender's systematic overestimation of consumers' income could include evidence that the subset of the lender's portfolio consisting of the loans where the lender relies on the consumers' written statements to project income in absence of verification evidence perform worse, on a non-trivial level, than other covered loans made by the lender with respect to the factors noted in comment 5(b)-2.iii indicating poor loan performance (e.g., high rates of default, frequent re-borrowings). The comment also clarifies that if the lender periodically reviews the performance of covered short-term loans or covered longer-term balloon-payment loans where the lender has relied on consumers' written statements of income and uses the results of those reviews to make necessary adjustments to its policies and procedures and future lending decisions, such actions indicate that the lender is reasonably relying on consumers' written statements. The comment provides an example of how such necessary adjustments could include, for example, the lender changing its underwriting criteria for covered short-term loans to provide that the lender may not rely on the consumer's statement of net income in absence of reasonably available verification evidence unless the consumer's debt-to-income ratio is lower, on a non-trivial level, than that of similarly situated applicants who provide verification evidence of net income. Finally, the comment clarifies that a lender is not required to consider income that cannot be verified other than through the consumer's written statement.

The Bureau emphasizes four points relating to the changes in the final rule permitting lenders to reasonably rely on consumer statements of net income where reliable records for verification are not reasonably available. First, the test for whether a reliable record is reasonably available is not whether the consumer brings it with him to the store, but rather is akin to whether such records could have been brought because they do, in fact, exist. Pay stubs and transaction account history records documenting income are considered reliable records as clarified by comment 5(c)(2)(ii)(A)-3. If the consumer possesses or can access these types of records, the consumer has to provide them as needed to verify the consumer's written statement and the lender cannot merely rely on the consumer's written statement.

Second, the Bureau expects that such reliance on consumers' written statements will occur in relatively narrow circumstances. These would include situations where a consumer has a primary job where she receives a traditional pay stub but has a side business or job where the consumer is paid in cash and cannot document the income, and the small number of cases where a consumer is paid entirely in cash for her primary job and has no transaction account or deposits only a portion of cash wages in the account. In the vast majority of cases, the Bureau expects that the consumer will have a pay stub or transaction account history that can serve as a reliable record to verify the relevant net income.

Third, as stated in comment 5(c)(2)(ii)(A)-4, lenders are not required to consider income that cannot be verified other than through the consumer's written statement (i.e., where a reliable record is not reasonably available). However, if they do so they are still subject to a reasonableness standard. The comment specifically notes that a lender reasonably relies on the consumer's written statement only if such action is consistent with a lender's written policies and procedures required under § 1041.12 and there is no indication that the consumer's stated amount of net income on a particular loan is implausibly high or that the lender is engaged in a pattern of systematically overestimating consumers' income. The comment also discusses what types of performance patterns might constitute evidence of a lender's systematic overestimation of income and ways in which lenders could monitor and make adjustments to their policies and future lending decisions in the face of such evidence. The Bureau thus expects to monitor lenders for systematic overestimation of income where lenders are relying on consumers' stated income amounts. The Bureau will look at whether lenders themselves are monitoring such loans and making appropriate adjustments to their underwriting policies and procedures and lending decisions.

Fourth, the Bureau recognizes that, generally, the current practice among storefront payday lenders (but not vehicle title lenders) is to verify at least one pay stub of income for an initial loan. The Bureau thus believes that lenders have strong incentives to continue that practice rather than shift toward a widespread model of relying on stated income. With vehicle title lenders there are greater incentives for lenders to forgo verification and rely on the asset value of the vehicle. But under the final rule, even for vehicle title lenders, the lender can only reasonably rely on the consumer's statement of income when a reliable record is not reasonably available.

The Bureau believes this approach responds appropriately to the comments from industry and other stakeholders about how the proposed verification requirements would not have accounted for, and potentially would have disadvantaged, individuals who are paid in cash and could afford to repay the loan but may not have the necessary documentation. At the same time, the Bureau believes that the final rule's requirements that lenders' reliance on consumers' written statements of income must be reasonable and that lenders can only rely on such written statements when the records are not “reasonably available”—along with the detailed guidance in commentary about the meaning of those terms and the expectations around lender monitoring—will provide guardrails against lender overreliance on consumers' written statements of income and the potential for abuse of this provision. For these reasons, as well as those noted in the several paragraphs above, the Bureau disagrees with the suggestion by the consumer group commenters that lenders should not be permitted to rely on consumers' written statements of income in any circumstances or that they should only be permitted to use a more conservative estimate.

The other significant change is in response to statements by commenters that some consumers rely on income from third parties such as spouses or partners. The Bureau has added § 1041.5(c)(2)(ii)(A)(2) which permits consumers to rely on third party income, but only when the lender obtains verification evidence to support the fact that the consumer has a reasonable expectation of access to that income. The Bureau recognizes that many consumers either pool their income in households or rely on third-party income, such as contributions from siblings or from parents to adult children. Given this fact, the Bureau in finalizing the rule is allowing lenders to rely on third-party income when calculating net income. However, the Bureau is adopting a different approach with regard to verification of such income relative to income received directly by the consumer. As described above, for a consumer's income, a lender must obtain verification evidence unless it is not reasonably available. For third-party income, a lender must obtain verification evidence that the consumer has a reasonable expectation of access to that income for such income to be included in the ability-to-repay analysis. Comment 5(c)(2)(ii)(A)-1 clarifies that such evidence could consist of bank account statements indicating that the consumer has an account into which the other person's income is regularly deposited. With regard to income that is not the consumer's own income, the Bureau judges it is important for lenders to obtain objective evidence of regular access. The Bureau acknowledges that in this regard the rule imposes a more demanding verification requirement than applies under the CARD Act with respect to “accessible income” but notes again that, as explained earlier, differences between the credit card market and the market for short-term and balloon-payment loans warrant the differences in treatment; see the general discussion of § 1041.5 and the discussion of § 1041.5(a)(5) and comment 5(a)(5)-3 for further detail.

In response to commenter requests for clarification about what constitutes “sufficient history” for purposes of projecting income, the Bureau has added a new comment 5(c)(2)(ii)(A)-2 to provide general guidance. The comment states that: For covered short-term loans, one pay cycle would typically constitute sufficient history; and for longer-term balloon payment loans, two pay cycles generally would constitute sufficient history. However, the comment also clarifies that additional verification evidence may be needed to resolve inconsistency between verification evidence and consumers' written statements, and depending on the length of the loan.

For covered longer-term balloon-payment loans, a national trade association for online lenders suggested a safe harbor for sufficient history of two pay stubs, citing National Credit Union Administration requirements for certain loans. In contrast, consumer groups argued that for covered longer-term loans greater than six months in duration, the final rule should require a look-back period of the length of the loan. The Bureau declines to adopt the consumer groups' suggestion, because such a long look-back period would impose significant burdens on lenders and consumers to provide many months of pay stubs or bank statements, at least for loans of significant length. At the same time, the Bureau does not believe a safe harbor of two pay cycles would be appropriate, given that in some circumstances more income history might be necessary to project future income. The Bureau has structured comment 5(c)(2)(ii)(A)-2 to take into account these competing considerations.

In response to a comment to the proposal seeking clarification on how far back lenders may look to make reasonable projections of future net income, specifically citing the issue of annual bonuses, § 1041.5(c)(2)(ii)(A), as clarified by new comment 5(c)(2)(ii)(A)-2, does not preclude the lender from requesting additional verification evidence dating back to earlier periods where needed to make the lender's projection of income reasonable.

5(c)(2)(ii)(B), (C), and (D)

Proposed Rule

The Bureau proposed separate provisions to detail the verification requirements for different types of major financial obligations in proposed § 1041.5(c)(3)(ii)(B) (debt obligations), § 1041.5(c)(3)(ii)(C) (child support), and § 1041.5(c)(3)(ii)(D) (rental housing expense), respectively. Specifically, in proposed § 1041.5(c)(3)(ii)(B) the Bureau specified that for a consumer's required payments under debt obligations, the applicable verification evidence would be a national consumer report, the records of the lender and its affiliates, and a consumer report obtained from an information system currently registered pursuant to § 1041.17(c)(2) or (d)(2), if available. The Bureau believed that most typical consumer debt obligations other than covered loans would appear in a national consumer report. Many covered loans are not included in reports generated by the nationwide consumer reporting agencies, so the lender would also be required to obtain, as verification evidence, a consumer report from consumer reporting agency that specifically registers with the Bureau under part 1041. As discussed above, proposed § 1041.5(c)(1) would have permitted a lender to base its projections on consumer statements of amounts and timing of payments for major financial obligations (including debt obligations) only to the extent the statements are consistent with the verification evidence. Proposed comment 5(c)(1)-1 included examples applying that proposed requirement in scenarios where a major financial obligation shown in the verification evidence is greater than the amount stated by the consumer and where a major financial obligation stated by the consumer does not appear in the verification evidence at all.

Proposed comment 5(c)(3)(ii)(B)-1 would have clarified that the amount and timing of a payment required under a debt obligation are the amount the consumer must pay and the time by which the consumer must pay it to avoid delinquency under the debt obligation in the absence of any affirmative act by the consumer to extend, delay, or restructure the repayment schedule. To the extent the national consumer report and the consumer report from a registered information system omit information for a payment under a debt obligation stated by the consumer, the Bureau explained in the proposal that the lender would simply base its projections on the amount and timing stated by the consumer.

The Bureau also emphasized in the proposal that proposed § 1041.5(c)(3)(ii)(B) would not have required a lender to obtain a consumer report unless the lender is otherwise prepared to make a loan to a particular consumer. Because obtaining a consumer report adds some cost, the Bureau assumed in the proposal that lenders would order such reports only after determining that a consumer otherwise satisfied the ability-to-repay test so as to avoid incurring costs for applicants who would be declined without regard to the contents of the report.

Similarly, in proposed § 1041.5(c)(3)(ii)(C), the Bureau specified that for a consumer's required payments under court- or government agency-ordered child support obligations, the applicable verification evidence would be the same national consumer report that serves as verification evidence for a consumer's required payments under debt obligations under proposed § 1041.5(c)(3)(ii)(B). To the extent the national consumer report omitted information for a required payment, the Bureau explained in the proposal that the lender could simply base its projections on the amount and timing stated by the consumer, if any.

Comments Received

Many industry commenters and many individual consumer commenters objected broadly to the proposed requirements to collect verification evidence on major financial obligations on the grounds of burden, efficacy, and negative consequences for consumers. For example, many individual consumer commenters and several lenders and industry trade groups argued that requiring a credit check for every loan will harm consumers' credit by lowering their credit scores. Others stated that many consumers do not have a credit history, and so the credit check will not work. Still others claimed that the credit check and requirement to obtain a report from a registered information system would be costly for lenders. The SBA Office of Advocacy encouraged the Bureau to eliminate the credit check requirement because they argued it is an unnecessary hurdle based on feedback from small business roundtable participants. They also noted the costs to small businesses, citing the Bureau's estimate in the proposal that a consumer report will cost approximately $2.00 for small lenders versus $0.55 for larger lenders. They also reported that SERs stated that the actual cost of a consumer report may be as high as $12.00. Commenters more specifically asked the Bureau to require that registered information systems only charge lenders a fee if a report is actually obtained (as opposed to an inquiry that generates no hits). Other commenters asked for a safe harbor when they rely on information from a consumer report, noting that the information in a consumer report may be inaccurate.

A specialty consumer reporting agency commenting on the proposed provision requiring lenders to obtain a national consumer report to verify debt obligations and child support obligations wrote that it agreed with the Bureau's assumption that lenders will stage the ordering of credit reports. The commenter wrote that it expected lenders will have a “two-step process” for obtaining national consumer reports—they would first order the separate required report from the registered information system to determine the borrowing history on covered loans and would conduct a preliminary underwriting assessment, and that only if the applicant passed that first phase would the lender then order the national consumer report as part of the final ability-to-repay determination.

Commenters noted that credit report information is for the past, and not the future for which the lender would need to project major financial obligations. The commenters asked for clarification on whether in these instances a lender can trust a consumer's statements regarding future payments, or how the lender will be able to project for any changes to the obligation in the future.

Final Rule

After careful consideration of the comments, the Bureau is finalizing proposed § 1041.5(c)(3)(ii)(B) and (C) as final § 1041.5(c)(2)(ii)(B) and (C), respectively, to address verification evidence for debt obligations and for alimony and child support.

With regard to debt obligations, the final rule is consistent with the proposal in that it generally requires that lenders search their own records and those of affiliates and obtain consumer reports from both a nationwide consumer reporting agency and from an information system that has been registered for 180 days or more pursuant to § 1041.11(c)(2) or is registered pursuant to § 1041.11(d)(2), if available. However, in recognition of commenters' concerns about the burdens on lenders with regard to the requirement to obtain a national consumer report (particularly on small lenders as described by the SBA Office of Advocacy) and the possibility of small negative impacts on some consumers' credit scores as discussed further below, the Bureau has adopted new § 1041.5(c)(2)(ii)(D) to permit lenders and their affiliates to rely on a national consumer report that was obtained within the prior 90 days, provided that the consumer did not complete a three-loan sequence and trigger the mandatory 30-day cooling-off period under § 1041.5(d)(2) since the prior report was obtained.

Even with this change, the Bureau acknowledges that there will be some costs associated with obtaining consumer reports from nationwide consumer reporting agencies, and costs associated with obtaining a report from a registered information system. The Bureau has estimated, in its Section 1022(b)(2) Analysis below, that the cost of obtaining a report from a registered information system will likely be around $0.50 “per-hit,” and has estimated that the cost of pulling a consumer report from a nationwide consumer reporting agency will run somewhere between $0.50 and $2.00 each, depending on the report. The Bureau agrees that these are not small costs. However, they are essential to making sure that the lender can adequately determine that a borrower has an ability to repay, and are essential to the proper administration of the cooling-off period found in § 1041.5(d). In particular, given the importance of tracking consumers' borrowing patterns with regard to covered short-term loans and covered longer-term balloon-payment loans under § 1041.5 in order to comply with § 1041.6 and with the cooling-off period provisions of § 1041.5(d), the Bureau believes it is important to require that lenders obtain new reports from registered information systems for each such loan where available.

Further, as noted in the section-by-section analysis for § 1041.4, the Bureau believes that any impact on consumer's credit scores will be minimal as a result of the requirements under § 1041.5(c)(2)(ii), for several reasons. First, as discussed above, the final rule in general only requires a credit check no more than once every 90 days, rather than for every loan. Second, as discussed in the proposal, the Bureau expects that lenders making loans under § 1041.5 will only order national consumer reports after determining that the consumer otherwise satisfies the rule's eligibility requirements and the ability-to-repay test using a consumer report from a registered information system so as to avoid incurring these costs for applicants who would be declined without regard to the contents of the national consumer report. In this regard, the Bureau notes the comment described earlier from a specialty consumer reporting agency which predicted that lenders would develop a “two-step process” for obtaining credit reports—they would first order the report from the registered information system and would determine the borrowing history on covered loans, along with a preliminary underwriting assessment, and that only if the applicant passed that first phase would the lender then order the national consumer report as part of the final ability-to-repay determination. Thus, the Bureau expects that many consumers who apply for loans but are denied based on information reflected in a report from a registered information system will have no negative impacts on their credit scores. Third, as discussed in the 1022(b)(2) Analysis, the Bureau is projecting that the majority of covered short-term loans that would be made under the final rule would be made under § 1041.6, not § 1041.5, so this particular requirement may affect only a small number of consumers.

Moreover, as a more general matter, the impact that any credit check with a nationwide consumer reporting agency will have on a borrower's overall credit profile is limited and uncertain, given that every consumer report differs and different creditors use different credit scoring models. One of the most experienced scoring companies, FICO, says the following about the impact of credit inquiries on a consumer's score: “The impact from applying for credit will vary from person to person based on their unique credit histories. In general, credit inquiries have a small impact on one's FICO Scores. For most people, one additional credit inquiry will take less than five points off their FICO Scores. For perspective, the full range of FICO Scores is 300-850.” Through the Bureau's market monitoring and outreach it also understands that such a decrease in credit score may only be reflected on consumer reports for up to 12 months or could be fixed during that time period. For these reasons, the Bureau believes that the negative impacts claimed by commenters resulting from lenders having to obtain national consumer reports will be minimal.

The Bureau recognizes, as commenters note, that consumer reports always include historical information. Thus, in projecting forward to the relevant monthly period, there will be times when lenders will have to make reasonable adjustments based on the consumer's written statement and other sources as discussed in § 1041.5(c)(1) and (2) and related commentary.

In addition, the Bureau reconsidered, as commenters noted, whether it was inconsistent to count child support but not alimony as a major financial obligation, especially where alimony is court- or government agency-ordered, and thus, likely reported on a consumer report. (Commenters also had questioned why receipt of alimony or child support was not included as net income, as discussed in the section-by-section analysis for § 1041.5(a)(5)). In light of the fact that, like other major financial obligations, alimony could potentially appear on a consumer report, or alternatively, a lender could rely on a written statement from the consumer about alimony, and the fact that alimony meets the general definition of a major financial obligation, the Bureau has decided to adjust § 1041.5(c)(2)(ii)(C) and the corresponding commentary to state that both alimony and child support obligations should be verified where possible from a national consumer report and that lenders may otherwise reasonably rely on information provided in a consumer's written statement for purposes of verification.

In addition, in response to commenters asking for a safe harbor for instances where information in a consumer report is inaccurate, the Bureau has added comment 5(c)(2)(ii)(B)-3 to clarify more specifically how lenders should resolve conflicting information about major financial obligations as between a consumer's written statement and various forms of verification evidence. The comment also clarifies that a lender is not responsible for information about a major financial obligation that is not owed to the lender, its affiliates, or its service providers if such obligation is not listed in a consumer's written statement, a national consumer report, or a consumer report from an information system that has been registered for 180 days or more pursuant to § 1041.11(c)(2) or is registered pursuant to § 1041.11(d)(2). A similar provision addressing inaccurate or incomplete information in consumer reports from an information system that has been registered for 180 days or more pursuant to § 1041.11(c)(2) or is registered pursuant to § 1041.11(d)(2) has been included in the commentary for § 1041.6.

With regard to the privacy concerns raised by commenters, the lender need only obtain information about the borrower's individual income, information that is on consumer reports (including a report from a registered information system), and information contained in the borrower's written statement. In the modern era, it is quite typical for creditors to have access to consumer reports, and many other parties, including employers, often do as well. The Bureau expects lenders to act in accordance with permissible use restrictions as prescribed in the Fair Credit Reporting Act and other privacy laws and regulations to the extent applicable. Lenders will also ask consumers questions about, and receive verification evidence on, income. In the payday market, this will likely make only a marginal difference with respect to privacy because the payday market typically already collects this information. It will have a more significant impact for vehicle title lending borrowers, who would now have to obtain income verification. The Bureau recognizes that some consumers will be troubled by the increased scrutiny into borrowers' private information, as noted by many individual commenters, but believes that these concerns have been somewhat reduced by changes to the final rule and in any event are worth the benefits of requiring income verification.

The Bureau has made a number of technical and structural, as well as substantive, changes to § 1041.5(c)(2)(ii) and the related commentary to implement the policy changes discussed above, and the policy changes found throughout other paragraphs in § 1041.5.

Lastly, in response to commenters' concerns that lenders may “double-count” certain major financial obligations if they are deducted from income, the Bureau notes that it has added comment 5(c)(2)(ii)(B)-2 and comment 5(c)(2)(ii)(C)-2, which specify that if verification evidence shows that a debt obligation, child support obligation, or alimony obligation is deducted from the consumer's income, the lender does not include those amounts in the projection of major financial obligations. This change and the comments underlying the change are discussed in more detail in the section-by-section analysis for § 1041.5(a)(3) (definition of major financial obligations), above.

5(c)(2)(iii)

Proposed Rule

The Bureau proposed a more flexible approach with regard to rental housing expenses in proposed § 1041.5(c)(3)(ii)(D) than with regard to other major financial obligations. Specifically, proposed § 1041.5(c)(3)(ii)(D) specified that for a consumer's housing expense (other than a payment for a debt obligation that appears on a national consumer report obtained by the lender under proposed § 1041.5(c)(3)(ii)(B)), the applicable verification evidence would be either a reliable transaction record (or records) of recent housing expense payments or a lease, or an amount determined under a reliable method of estimating a consumer's housing expense based on the housing expenses of consumers in the same locality.

Proposed comment 5(c)(3)(ii)(D)-1 described each of the options for verification evidence in more detail. Most importantly, proposed comment 5(c)(3)(ii)(D)-1.iii provided examples of situations in which a lender used an amount determined under a reliable method of estimating a consumer's share of housing expense based on the individual or household housing expenses of similarly situated consumers with households in the same locality, such as relying on the American Community Survey of the U.S. Census Bureau to estimate individual or household housing expense in the locality (e.g., in the same census tract) where the consumer resides. In the alternative, the comment also provided that a lender may estimate individual or household housing expense based on housing expense and other data (e.g., residence location) reported by applicants to the lender, provided that it periodically reviews the reasonableness of the estimates that it relies on using this method by comparing the estimates to statistical survey data or by another method reasonably designed to avoid systematic underestimation of consumers' shares of housing expense. It further explained that a lender may estimate a consumer's share of household expense by reasonably apportioning the estimated household housing expense among the people sharing the housing expense as stated by the consumer, or by another reasonable method.

The Bureau explained in the proposal that this approach was designed to address concerns that had been raised in the SBREFA process and other industry outreach prior to the proposal. In particular, the Small Business Review Panel Outline had referred to lender verification of a consumer's rent or mortgage payment using, for example, receipts, cancelled checks, a copy of a lease, and bank account records. As discussed in the proposal, some SERs and other lender representatives stated that many consumers would not have these types of documents readily available. Few consumers receive receipts or cancelled checks for rent or mortgage payments, they stated, and bank account statements may simply state the check number used to make a payment, providing no way of confirming the purpose or nature of the payment. Consumers with a lease would not typically have a copy of the lease with them when applying for a covered loan, they stated, and it would be unduly burdensome, if not impracticable for them to locate and transmit or deliver a copy of the lease to a lender.

Comments Received

Several commenters argued that the Bureau's standards around verifying housing expenses were unfair and would lead to a significant number of “false negatives” (i.e., unintended denials of credit) for consumers who can, and do regularly, pay for rental housing expense but do not possess the requisite verification evidence. Commenters claimed that many consumers have non-traditional living arrangements where there is no documented lease, or live rent-free with a relative, and thus would not have any verification evidence of rent. Some commenters argued that asking consumers for verification of rental housing expense would be considered intrusive, particularly for those consumers living in informal rooming arrangements. The Bureau also received a number of comments arguing that the proposal had not accounted for consumers who share rental housing expense and where the formal documentation does not reflect the arrangement. For example, if two roommates pay rent on the same lease, the verification evidence would indicate that only one of them may have to pay the full rent.

Other commenters claimed that rental agreements were difficult to procure, and thus, it would be impractical to require one. Commenters also argued that bank statements would not be sufficient to verify housing expenses because they might not show the names of the recipients of the rental payments.

A number of commenters raised issues with the provision in proposed § 1041.5(c)(3)(ii)(D) that lenders could estimate rental housing expenses by using a reliable method (either locality-based data or data on their own customers) as an alternative to collecting a reliable record of rental housing expense such a lease. As explained earlier, the Bureau had included the alternative in response to feedback during the SBREFA process and outreach that the Small Business Review Panel Outline took too strict of an approach to verification of rental housing expense. Commenters were critical of this proposed provision on a number of grounds. Some argued it would be burdensome for lenders, particularly small lenders, to develop statistical estimates. Other commenters argued that using census tract data, as given in a proposed commentary example, could substantially overstate housing expenses by failing to account for the greater amount of shared living arrangements among payday borrowers or the demographics of this borrowing population. One trade group argued that, at minimum, the Bureau should allow “validation” of housing expenses based on a consumer's stated history and circumstances. Some commenters also raised concerns that taking into account locality-based information on housing expenses in underwriting decisions could violate ECOA and Regulation B (see discussion of these issues in the more general § 1041.5 discussion above).

Consumer groups, on the other hand, commented that the proposal's treatment of rental housing expenses was too permissive. They argued that rental housing expense should be verified wherever possible, and that if verification evidence is not available, the lender should have to use the larger of the locality-based average or the consumer's statement. They also argued that if there is a shared arrangement, lenders should obtain verification evidence (such as a lease or checking account activity) or reliable third-party evidence (like a co-tenant statement). They expressed concern about proposed commentary language permitting lenders to apportion household expense based solely on the consumer's statement. And they argued that the Bureau should consider providing “portfolio-level guardrails” that indicate whether housing estimates not based on verification evidence and lender assertions of shared housing expense are more likely to be unreasonable, and subjecting lenders whose portfolios have those indicators to higher scrutiny.

Final Rule

The Bureau is finalizing proposed § 1041.5(c)(3)(ii)(D) as final § 1041.5(c)(2)(iii) with a number of significant changes as discussed below. In response to the many comments criticizing the Bureau for proposing to require, for rental housing, either a reliable record or an estimate based on the housing expenses of consumers with households in the same locality (including concerns about fair lending interests discussed above), the Bureau has adjusted § 1041.5(c)(2)(iii) to provide that lenders may reasonably rely on the consumer's written statement to project rental housing obligations. New comment 5(c)(2)(iii)-1 states that a lender reasonably relies on the consumer's written statement if such actions are consistent with a lender's policies and procedures, there is no evidence that the stated amount on a particular loan is implausibly low, and there is no pattern of the lender underestimating consumers' rental housing expense. The Bureau views these clarifications as analogous to those in comment 5(c)(2)(ii)(A)-4 regarding reasonable reliance on stated amounts for net income, and refers to the explanatory explanation above.

The Bureau recognizes that there are likely a significant number of consumers, as noted by commenters, that have non-traditional living situations, live with roommates without being on the lease, rent on a month-to-month basis without a lease or a current lease, sublet, or live with a third party (like parents). The Bureau also recognizes that requiring consumers with a lease to present those documents to obtain a loan could prove burdensome, especially for consumers applying online. For these reasons, the proposal did not require applicants to provide a lease even where one existed. Instead, the proposal allowed lenders instead to rely on verification evidence consisting of data that could be used to validate the reasonableness of a consumer's statement of rental housing expenses. However, the Bureau is persuaded by the weight of the comments suggesting that the proposal's approach to estimation of expenses raised a number of challenges.

Specifically, the Bureau is persuaded by commenters who argued that data on the median or average rental expenses for households in the same locality may not accurately reflect the median or average demographic or housing expenses of customers of covered short-term and longer-term balloon-payment loans and would thus potentially overstate the amount of rental housing expense for prospective borrowers. Furthermore, the Bureau is persuaded that even if it were possible to determine the average or median rental expense for these consumers, such data would not be useful in validating the reasonableness of any individual consumer's statement of her rental housing expenses, which could be vastly different from the average or median consumer. Finally, the Bureau agrees with commenters who noted that small lenders would be at a disadvantage in obtaining statistical validation evidence. The Bureau continues to recognize the risks entailed in permitting lenders to rely on stated rental expenses—including the risk that consumers will misstate or be induced to misstate their expenses—which are concerns echoed by the consumer groups in their comment. But the Bureau nonetheless is persuaded that the available alternatives are not practical and therefore is permitting lenders to rely on consumers' written statements of rental housing expense where it is reasonable to do so.

5(d) Additional Limitations on Lending—Covered Short-Term Loans and Covered Longer-Term Balloon-Payment Loans

Proposed § 1041.6 would have augmented the basic ability-to-repay determination in proposed § 1041.5 in circumstances in which the consumer's recent borrowing history or recent difficulty repaying an outstanding loan provides important evidence with respect to the consumer's financial capacity to afford a new covered short-term loan. In particular, proposed § 1041.6 would have imposed a presumption of unaffordability when a consumer returned for a covered short-term loan within 30 days of a prior covered short-term or covered longer-term balloon-payment loan being outstanding. Presumptions would also have been imposed in particular circumstances indicating that a consumer was having difficulty repaying an outstanding covered or non-covered loan outstanding that was made or was being serviced by the same lender or its affiliate. Under the proposed approach, lenders would have been able to overcome a presumption of unaffordability only in circumstances where there was a sufficient improvement in financial capacity. This would have applied, for instance, where there was evidence that the prior difficulty with repayment was due to an income shock that was not reasonably expected to recur or where there was a reasonable projected increase of income or decrease in major financial obligations during the term of the new loan. However, after the third covered short-term loan in a sequence, proposed § 1041.6 would have imposed a mandatory 30-day cooling-off period. The proposed section also contained certain additional provisions that were designed to address concerns about potential evasion and confusion if consumers alternated in quick succession between covered short-term loans under proposed § 1041.5 and other types of credit products.

Similarly, proposed § 1041.10 would have applied parallel presumptions of unaffordability to new covered longer-term loans based on consumers' recent borrowing history on certain types of covered loans or difficulty repaying a current covered or non-covered loan, that was made or was being serviced by the same lender or its affiliate, although it would not have imposed a mandatory cooling-off period after a three loan sequence. Proposed § 1041.10 also would have imposed certain restrictions to address concerns about potential evasion and confusion if consumers alternated in quick succession between a covered short-term loan under proposed § 1041.7 and other types of credit products.

After consideration of the comments received as discussed further below, the Bureau has decided to finalize only selected elements of proposed §§ 1041.6 and 1041.10, consolidated as § 1041.5(d) of the final rule. Specifically, the Bureau is finalizing a 30-day mandatory cooling-off period after a consumer has completed a three-loan sequence of covered short-term loans, covered longer-term balloon-payment loans, or a combination thereof. It is also finalizing restrictions on certain re-borrowing within 30 days of a covered shorter-term loan made under final rule § 1041.6 (which was § 1041.7 in the proposal) being outstanding. As explained below in detail, the Bureau is not finalizing several provisions, including any of the proposed presumptions of unaffordability. Thus, the Bureau is finalizing adjusted portions of proposed § 1041.6(a)(2), (f), and (g) and proposed § 1041.10(a)(2) and (e) on a combined basis in § 1041.5(d) for both covered short-term and longer-term balloon-payment loans as discussed further below.

Proposed Rule

In proposed § 1041.6, the Bureau proposed to require the lender to factor evidence about the consumer's recent borrowing history and difficulty in repaying an outstanding loan into the ability-to-repay determination and, in certain instances, to prohibit a lender from making a new covered short-term loan to the consumer under proposed § 1041.5 for 30 days. The Bureau proposed the additional requirements in § 1041.6 for the same basic reason that it proposed § 1041.5: To prevent the unfair and abusive practice identified in proposed § 1041.4 and the consumer injury that results from it. The Bureau explained in the proposal that it believed that these additional requirements would be needed in circumstances where proposed § 1041.5 alone might not suffice to prevent a lender from making a covered short-term loan that the consumer would lack the ability to repay.

Proposed § 1041.6 would have generally imposed a presumption of unaffordability on continued lending where evidence suggested that the prior loan was not affordable for the consumer, indicating that the consumer could have particular difficulty repaying a new covered short-term loan. Specifically, such a presumption would have applied in three circumstances: (1) Under proposed § 1041.6(b), when a consumer sought a covered short-term loan during the term of a covered short-term loan made under proposed § 1041.5 and for 30 days thereafter; (2) under proposed § 1041.6(c), when a consumer sought a covered short-term loan during the term of a covered longer-term balloon-payment loan made under proposed § 1041.9 and for 30 days thereafter; and (3) under proposed § 1041.6(d), when a consumer sought to take out a covered short-term loan when there were indicia that the consumer was already struggling to repay an outstanding loan of any type—covered or non-covered—with the same lender or its affiliate.

The Bureau explained in the proposal that a central component of the preventive requirements in proposed § 1041.6 was the concept of a re-borrowing period—a period following the payment date of a prior loan during which a consumer's borrowing of a covered short-term loan is deemed evidence that the consumer is seeking additional credit because the prior loan was unaffordable. When consumers have the ability to repay a covered short-term loan, the loan should not cause consumers to have the need to re-borrow shortly after repaying the loan. As discussed in the proposal, including in the proposal's discussion of Market Concerns—Short-term Loans, however, the Bureau believed that the fact that covered short-term loans require repayment so quickly after consummation makes such loans more difficult for consumers to repay consistent with their basic living expenses and major financial obligations without needing to re-borrow. Moreover, as the Bureau explained, most covered short-term loans—including payday and vehicle title loans—also require payment in a single lump sum, thus exacerbating the challenge of repaying the loan without needing to re-borrow.

For these loans, the Bureau stated in the proposal that it believed that the fact that a consumer returns to take out another covered short-term loan shortly after having a previous covered short-term loan outstanding frequently indicates that the consumer did not have the ability to repay the prior loan and meet the consumer's basic living expenses and major financial obligations. This also may provide strong evidence that the consumer will not be able to afford a new covered short-term loan. The Bureau further explained that a second covered short-term loan shortly following a prior covered short-term loan may result from a financial shortfall caused by repayment of the prior loan. The Bureau noted that evidence shows that re-borrowing for short-term loans often occurs on the same day that a loan is due, either in the form of a rollover of the existing loan (where permitted by State law) or in the form of a new loan taken out on the same day that the prior loan was repaid. Some States require a cooling-off period between loans, typically 24 hours, and the Bureau found that in those States, if consumers take out successive loans, they generally do so at the earliest time that is legally permitted. The Bureau interpreted these data to indicate that these consumers could not afford to repay the full amount of the loan when due and still meet their basic living expenses and major financial obligations.

In the proposal, the Bureau stated that it is less facially evident whether a particular loan is a re-borrowing that was prompted by the unaffordability of a prior loan when that new loan is taken out after some time has elapsed since a consumer has repaid the prior loan (and after the expiration of any State-mandated cooling-off period). The fact that consumers may cite a particular income or expense shock is not dispositive, since a prior unaffordable loan may be the reason that the consumer cannot absorb the new change. The Bureau stated in the proposal that on balance, the Bureau believed that for new loans taken out within a short period after a prior loan ceases to be outstanding, the most likely explanation is the unaffordability of the prior loan—i.e., the fact that the size of the payment obligation on the prior loan left these consumers with insufficient income to make it through their monthly expense cycle.

The Bureau explained in the proposal that to provide a structured process that accounts for the likelihood that the unaffordability of an existing or prior loan is driving re-borrowing and that ensures a more rigorous analysis of consumers' individual circumstances, the Bureau believed that an appropriate approach would be to impose presumptions when new loans fall within a specified re-borrowing period, rather than engaging in an open-ended inquiry. The Bureau thus proposed to delineate a specific re-borrowing period, during which a new loan will be presumed to be a re-borrowing. In determining the appropriate length of the re-borrowing period, the Bureau described how it had considered several different possible periods. The Bureau proposed a 30-day period, but also considered periods of 14, 45, 60, or 90 days in length. The Bureau also considered an option that would tie the length of the re-borrowing period to the term of the preceding loan.

In evaluating the alternative options for defining the re-borrowing period (and, in turn, the definition of a loan sequence), the Bureau described in the proposal how it was seeking to strike a balance between two alternatives. The first would be a re-borrowing period that is too short, thereby not capturing substantial numbers of subsequent loans that are in fact the result of the spillover effect of the unaffordability of the prior loan and inadequately preventing consumer injury. The second would be a re-borrowing period that is too long, thereby covering substantial numbers of subsequent loans that are in fact the result of a new need for credit, independent of such effects. The Bureau further described how this concept of a re-borrowing period is also intertwined with the definition of loan sequence. Under proposed § 1041.2(a)(12), the Bureau would have defined loan sequence as a series of consecutive or concurrent covered short-term loans in which each of the loans is made while the consumer currently has an outstanding covered short-term loan or within 30 days after the consumer ceased to have such a loan outstanding.

The Bureau explained in the proposal that the Bureau's 2014 Data Point analyzed repeated borrowing on payday loans using a 14-day re-borrowing period reflecting a bi-weekly pay cycle, the most common pay cycle for consumers in this market. For the purposes of the 2014 Data Point, a loan was considered part of a sequence if it was made within 14 days of the prior loan. The Bureau stated in the proposal that it had adopted this approach in its early research in order to obtain a relatively conservative measure of re-borrowing activity relative to the most frequent date for the next receipt of income. However, the 14-day definition had certain disadvantages, including the fact that many consumers are paid on a monthly cycle, and a 14-day definition thus does not adequately reflect how different pay cycles can cause somewhat different re-borrowing patterns.

The Bureau stated in the proposal that upon further consideration of what benchmarks would sufficiently protect consumers from re-borrowing harm, the Bureau turned to the typical consumer expense cycle, rather than the typical income cycle, as the most appropriate metric. The Bureau noted that consumer expense cycles are typically a month in length with housing expenses, utility payments, and other debt obligations generally paid on a monthly basis. Thus, where repaying a loan causes a shortfall, the consumer may seek to return during the same expense cycle to get funds to cover downstream expenses.

The proposals under consideration in the Small Business Review Panel Outline relied on a 60-day re-borrowing period, based on the premise that consumers for whom repayment of a loan was unaffordable may nonetheless be able to juggle their expenses for some time so that the spillover effects of the loan may not manifest themselves until the second expense cycle following repayment. As explained in the proposal, upon additional analysis and extensive feedback from a broad range of stakeholders, the Bureau tentatively concluded that the 30-day definition incorporated into the proposal may strike a more appropriate balance between the competing considerations, chiefly because so many expenses are paid on a monthly basis.

The Bureau stated its belief that loans obtained during the same expense cycle are relatively likely to indicate that repayment of a prior loan may have caused a financial shortfall. Similarly, in analyzing supervisory data, the Bureau found that a considerable segment of consumers who repay a loan without an immediate rollover or re-borrowing nonetheless return within the ensuing 30 days to re-borrow. The Bureau stated in the proposal that accordingly, if the consumer returned to take out another covered short-term loan—or, as described in proposed § 1041.10, certain types of covered longer-term loans—within the same 30-day period, the Bureau believed that this pattern of re-borrowing indicated that the prior loan was unaffordable and that the following loan may likewise be unaffordable. On the other hand, the Bureau stated its belief that for loans obtained more than 30 days after a prior loan, there is a higher likelihood that the loan is prompted by a new need on the part of the borrower, and is not directly related to potential financial strain from repaying the prior loan. The Bureau further explained that while a prior loan's unaffordability may cause some consumers to need to take out a new loan as many as 45 days or even 60 days later, the Bureau believed that the effects of the previous loan are more likely to dissipate once the consumer has completed a full expense cycle following the termination of a prior loan that has been fully repaid.

For these reasons, the Bureau believed at the time it developed the proposed rule that a 45-day or 60-day definition would be too broad. The Bureau also stated in the proposal that a re-borrowing period that would vary with the length of the preceding loan term would be operationally complex for lenders to implement and, for consumers who are paid either weekly or bi-weekly, may also be too narrow.

Accordingly, using this 30-day re-borrowing window, the Bureau proposed a presumption of unaffordability for covered short-term loans made while a prior loan is outstanding or within a 30-day period after the end of the term of the prior loan. As proposed, however, the presumption could have been overcome in various circumstances suggesting that there is sufficient reason to believe the consumer would, in fact, be able to afford the new loan even though she is seeking to re-borrow during the term of or shortly after a prior loan. The Bureau recognized, for example, that there may be situations in which the prior loan would have been affordable but for some unforeseen disruption in income that occurred during the prior expense cycle and which is not reasonably expected to recur during the term of the new loan. The Bureau also recognized that there may be circumstances, albeit less common, in which even though the prior loan proved to be unaffordable, a new loan would be affordable because of a reasonably projected increase in net income or decrease in major financial obligations.

To effectuate these policy decisions, proposed § 1041.6(a) would have set forth the general requirement for lenders to obtain and review information about a consumer's borrowing history from the records of the lender and its affiliates, and from a consumer report obtained from an information system currently registered pursuant to proposed § 1041.17(c)(2) or (d)(2), if available, and to use this information to determine a potential loan's compliance with the requirements of proposed § 1041.6.

Proposed § 1041.6(b) through (d) would have defined the set of circumstances in which the Bureau believed that a consumer's recent borrowing history makes it unlikely that the consumer can afford a new covered short-term loan, including concurrent loans. In such circumstances, a consumer would be presumed not to have the ability to repay a covered short-term loan under proposed § 1041.5. Specifically, the presumption of unaffordability would have applied: (1) Under proposed § 1041.6(b), when a consumer sought a covered short-term loan during the term of a covered short-term loan made under proposed § 1041.5 and for 30 days thereafter; (2) under proposed § 1041.6(c), when a consumer sought a covered short-term loan during the term of a covered longer-term balloon-payment loan made under proposed § 1041.9 and for 30 days thereafter; and (3) under proposed § 1041.6(d), when a consumer sought to take out a covered short-term loan when there are indicia that the consumer is already struggling to repay an outstanding loan of any type—covered or non-covered—with the same lender or its affiliate. Proposed § 1041.6(e) would have defined the additional determinations that a lender would be required to make in cases where the presumption applies in order for the lender's ability-to-repay determination under proposed § 1041.5 to be reasonable despite the unaffordability of the prior loan.

The presumption of unaffordability in proposed § 1041.6(c) would have provided that a consumer is presumed not to have the ability to repay a covered short-term loan under proposed § 1041.5 during the time period in which the consumer has a covered longer-term balloon-payment loan made under proposed § 1041.9 outstanding and for 30 days thereafter. The Bureau stated in the proposal that it believed that when a consumer seeks to take out a new covered short-term loan that would be part of a loan sequence, there is substantial reason for concern that the need to re-borrow is being triggered by the unaffordability of the prior loan. Similarly, covered longer-term balloon-payment loans, by definition, require a large portion of the loan to be paid at one time. The Bureau described its research suggesting that the fact that a consumer seeks to take out another covered longer-term balloon-payment loan shortly after having a previous covered longer-term balloon-payment loan outstanding will frequently indicate that the consumer did not have the ability to repay the prior loan and meet the consumer's other major financial obligations and basic living expenses. The Bureau stated that it had found that the approach of the balloon payment coming due is associated with significant re-borrowing. However, the need to re-borrow caused by an unaffordable covered longer-term balloon is not necessarily limited to taking out a new loan of the same type. The Bureau explained that if the borrower takes out a new covered short-term loan in such circumstances, it also is a re-borrowing. Accordingly, in order to prevent the unfair and abusive practice identified in proposed § 1041.4, the Bureau proposed a presumption of unaffordability for a covered short-term loan that would be concurrent with or shortly following a covered longer-term balloon-payment loan.

In proposed § 1041.6(d), the Bureau would have established a presumption of unaffordability when a lender or its affiliate sought to make a covered short-term loan to an existing consumer in which there are indicia that the consumer cannot afford an outstanding loan with that same lender or its affiliate. The triggering conditions would have been a delinquency of more than seven days within the preceding 30 days, expressions by the consumer within the preceding 30 days that he or she cannot afford the outstanding loan, certain circumstances indicating that the new loan is motivated by a desire to skip one or more payments on the outstanding loan, and certain circumstances indicating that the new loan is solely to obtain cash to cover upcoming payments or payments on the outstanding loan. The Bureau believed that the analysis required by proposed § 1041.6(d) would have provided greater protection to consumers and certainty to lenders than requiring that such transactions be analyzed under proposed § 1041.5 alone. Proposed § 1041.5 would have required generally that the lender make a reasonable determination that the consumer will have the ability to repay the contemplated covered short-term loan, taking into account existing major financial obligations that would include the outstanding loan from the same lender or its affiliate. However, the presumption in proposed § 1041.6(d) would have provided a more detailed roadmap as to when a new covered short-term loan would not meet the reasonable determination test.

In proposed § 1041.6(f), the Bureau also would have established a mandatory cooling-off period prior to a lender making a fourth covered short-term loan in a sequence. As stated in the proposal, the Bureau believed that it would be extremely unlikely that a consumer who twice in succession returned to re-borrow during the re-borrowing period, and who seeks to re-borrow again within 30 days of having the third covered short-term loan outstanding, would be able to afford another covered short-term loan. Because of lenders' strong incentives to facilitate re-borrowing that is beyond the consumer's ability to repay, the Bureau believed it appropriate, in proposed § 1041.6(f), to impose a mandatory 30-day cooling-off period after the third covered short-term loan in a sequence, during which time the lender cannot make a new covered short-term loan under proposed § 1041.5 to the consumer. This period was intended to ensure that after three consecutive ability-to-repay determinations have proven inconsistent with the consumer's actual experience, the lender could not further worsen the consumer's financial situation by extending additional unaffordable debt to the consumer.

In its discussion of proposed § 1041.6(f), the Bureau stated that the ability-to-repay determination required by proposed § 1041.5 is intended to protect consumers from what the Bureau believes may be the unfair and abusive practice of making a covered short-term loan without making a reasonable determination of the consumer's ability to repay the loan. If a consumer who obtains such a loan seeks a second loan when, or shortly after, the payment on the first loan is due, that suggests that the prior loan payments were not affordable and triggered the new loan application, and that a new covered short-term loan will lead to the same result. The Bureau stated that it believes that if a consumer has obtained three covered short-term loans in quick succession and seeks to obtain yet another covered short-term loan when or shortly after payment on the last loan is due, the fourth loan will almost surely be unaffordable for the consumer.

In the proposal, the Bureau described how the Bureau's research underscores the risk that consumers who reach the fourth loan in a sequence of covered short-term loans will wind up in a long cycle of debt. Most significantly, the Bureau found that 66 percent of loan sequences that reach a fourth loan end up having at least seven loans, and 47 percent of loan sequences that reach a fourth loan end up having at least 10 loans. For consumers paid weekly, bi-weekly, or semimonthly, 12 percent of loan sequences that reach a fourth loan end up having at least 20 loans during a 10-month period. And for loans taken out by consumers who are paid monthly, more than 40 percent of all loans to these borrowers were in sequences that, once begun, persisted for the rest of the year for which data were available.

The Bureau explained in the proposal, further, that the opportunity to overcome the presumption for the second and third loan in a sequence means that by the time that the mandatory cooling-off period in proposed § 1041.6(f) would apply, three prior ability-to-repay determinations will have proven inconsistent with the consumer's actual experience. If the consumer continues re-borrowing during the term of or shortly after repayment of each loan, the pattern suggests that the consumer's financial circumstances do not lend themselves to reliable determinations of ability to repay a covered short-term loan. After three loans in a sequence, the Bureau stated that it believes it would be all but impossible under the proposed framework for a lender to accurately determine that a fourth covered short-term loan in a sequence would be affordable for the consumer.

The Bureau stated in the proposal that in light of the data described above, the Bureau believed that by the time a consumer reaches the fourth loan in a sequence of covered short-term loans, the likelihood of the consumer returning for additional covered short-term loans within a short period of time warrants additional measures to mitigate the risk that the lender is not furthering a cycle of debt on unaffordable covered short-term loans. To prevent the unfair and abusive practice identified in proposed § 1041.4, the Bureau stated the belief that it may be appropriate to impose a mandatory cooling-off period for 30 days following the third covered short-term loan in a sequence.

The Bureau's overall approach to the re-borrowing restrictions in proposed § 1041.6 was fairly similar to the framework included in the Small Business Review Panel Outline, but contained some adjustments in response to feedback from the SERs, agency participants, and other stakeholders. For instance, the Bureau proposed a 30-day definition of loan sequence and a 30-day cooling-off period rather than a 60-day definition of loan sequence and a 60-day cooling-off period which was in the Small Business Review Panel Outline. The Bureau also proposed to provide greater specificity and flexibility about when a presumption of unaffordability would apply, for example, by proposing in § 1041.6(b)(2) certain exceptions to the presumption of unaffordability for a sequence of covered short-term loans where the consumer is seeking to re-borrow no more than half the amount that the consumer has already paid on the loan. In those instances, the Bureau explained, the predicate for the presumption of unaffordability may no longer apply. The proposal also provided somewhat more flexibility about when a presumption of unaffordability could be overcome by permitting lenders to determine that there would be sufficient improvement in the consumer's financial capacity for the new loan, under proposed § 1041.6(e). This standard would have included both documented increases in income or decreases in expenses since the prior borrowing (the Small Business Review Panel Outline standard of “changed circumstances”) plus where reliable evidence indicated that the need to re-borrow was caused by a specific income decline that would not recur. The Bureau also continued to assess potential alternative approaches to the presumptions framework, as outlined in the proposal, and specifically sought comment in response to the Small Business Review Panel Report on whether a loan sequence should be defined with reference to a period shorter or longer than 30 days.

Proposed § 1041.10 would have applied a parallel set of presumptions of unaffordability to new covered longer-term loans where consumers had had a covered short-term or covered longer-term balloon-payment loan outstanding within the last 30 days or where there were indicia that consumers were having difficulty repaying a current loan of any type from the same lender or its affiliates. The Bureau's logic in proposing to apply these presumptions was the same as described above with regard to proposed § 1041.6: Because covered longer-term balloon-payment loans also involve lump-sum or other large irregular payments that appear to exacerbate the challenge of repaying such loans without needing to re-borrow, there is substantial reason for concern that the need to re-borrow within a short time period is being triggered by the unaffordability of the prior loan. The Bureau did not specifically propose to impose a mandatory cooling-off period after a sequence of covered longer-term loans (whether they had a balloon payment or not), but sought comment on the general issue of whether a consumer's intensity of use during a defined period of time warranted additional protections.

Finally, proposed §§ 1041.6 and 1041.10 would also have established certain rules with regard to the prospect that consumers might switch back and forth between different types of covered or non-covered loans over time. In particular, proposed §§ 1041.6(g) and 1041.10(e) would have prohibited lenders under certain circumstances from making a covered short-term loan or a covered longer-term loan, respectively, while a prior covered short-term loan to the same consumer made under the conditional exemption in proposed § 1041.7 was outstanding or for 30 days thereafter. Because loans under that exemption are subject to certain principal reduction requirements over a sequence of three loans, the Bureau was concerned that the protections provided by that provision could be abrogated if a consumer were induced instead to take out a different kind of covered loan.

Also, proposed §§ 1041.6(h) and 1041.10(f) would have suspended the 30-day count for purposes of determining whether a loan was subject to a presumption of unaffordability or the mandatory cooling-off period for short-term loans if a lender or its affiliate made a non-covered bridge loan within 30 days of a prior outstanding covered short-term loan or covered longer-term balloon-payment loan. The Bureau would have defined non-covered bridge loan in proposed § 1041.2(a)(13) as a non-resource pawn loan made by the same lender or its affiliate that is substantially repayable within 90 days of consummation. In the proposal, the Bureau described how this provision would address the concern that these types of loans could be used by lenders or their affiliates to bridge gaps between the making of covered loans, creating a continuous series of loans as a way of evading the proposed re-borrowing restrictions.

Comments Received

The Bureau received numerous comments on the proposed re-borrowing restrictions. Stakeholders generally supportive of the rule criticized the restrictions for not going far enough, and stakeholders generally critical of the rule thought these restrictions went too far in a number of ways.

Many consumer groups and other commenters argued that the Bureau should adopt a 45, 60, or 90 day cooling-off and re-borrowing period instead of a 30-day period, asserting that it takes longer than 30 days for a consumer to reach financial equilibrium. These arguments were based largely on arguments that had already been raised in response to the Small Business Review Panel Outline. The consumer advocates raised additional arguments for why the 30-day period was too short, including evidence from the U.S. Financial Diaries project and from national delinquency data on unsecured debt that they interpreted to suggest that consumers who take covered loans have monthly expense cycles greater than 30 days, and often in excess of 60 days. A State Attorney General urged that if the Bureau were not to adopt a 60-day cooling-off period, the Bureau should consider a 45-day cooling-off period as a more restrictive alternative to the proposed 30-day cooling-off period.

Consumer groups and a broad spectrum of other commenters—including a group of U.S. Senators, several State Attorneys General, faith leaders, civil rights organizations, and other stakeholders generally supportive of the proposal—asked that the Bureau limit covered short-term lending overall to 6 loans per year and 90 days per year. As discussed in the section-by-section analysis for § 1041.6, these stakeholders opposed the inclusion of the exemption for covered short-term loans, which contained these loan and time-in-debt limits as conditions of the proposed exemption. They argued that those same limits should apply to the making of all covered short-term loans, in addition to the ability-to-repay requirements applicable to each loan and the various presumptions of unaffordability. The consumer groups asserted that these limits are “rooted in significant precedent” such as the FDIC's 2005 guidelines on payday lending and State loan limits in Washington and Delaware.

Consumer advocates also argued that that the Bureau should adopt a two-loan cap instead of a three-loan cap, because they believed that after two loans the ability-to-repay analysis already will have proven to be flawed. They argued that the rationale for imposing the three-loan limit in proposed § 1041.6(f) was equally applicable after two loans, i.e., it is extremely unlikely that a consumer attempting to borrow a third loan within a short period of time will be able to repay that loan given the prior re-borrowing.

A number of commenters urged the Bureau to adopt additional restrictions under proposed § 1041.6. Several commenters raised concerns about the potential ability of consumers to take out multiple loans at a time, or to switch back-and-forth either between covered and non-covered loans or between short-term and longer-term loans, which could be ways of evading the proposed rule's requirements. One commenter argued that the Bureau should consider any type of loan to be a non-covered bridge loan—rather than just non-recourse pawn loans of 90 days or fewer in duration—if it is used to bridge a gap between two sequences (or through a cooling-off period). Similarly, a number of other commenters argued that the Bureau should make the intra-sequence presumptions stronger, arguing that lenders would likely still lend, and allow some amount of re-borrowing, unless there were stronger restrictions after the first and second loan. Consumer groups argued that tighter verification requirements should apply to loans being made that overcome the presumption of unaffordability. One State Attorney General expressed concern about consumers taking out short-term and longer-term loans in quick succession as a way of evading the proposal and urged the Bureau to place greater restrictions on this type of lending pattern. Several commenters argued that the presumptions should apply in other scenarios, such as whenever a loan went delinquent, or when a consumer had repaid a loan made by an unaffiliated lender within 30 days. Others asked whether lenders can rely on consumer statements to determine whether a consumer had a prior loan with an unaffiliated lender.

Consumer advocates also criticized the proposed exception to the presumption of unaffordability when the amount being borrowed was no more than half of the amount paid on the prior loan. They argued that this would incentivize lenders to make loans larger than consumers could initially afford at the outset and “then flip the clearly unaffordable portions, extracting excess costs each time.”

Industry commenters, along with some other stakeholders, generally criticized the re-borrowing restrictions in proposed § 1041.6. Many of them focused specifically on the proposed presumptions of unaffordability. Several industry commenters argued that the specific standards for overcoming presumptions provided too little flexibility or that they were vague and needed to be clarified. One trade group commenter argued that lenders essentially would have to become “financial planners” to determine whether a consumer had a “sufficient improvement in financial capacity”—the standard for overcoming the presumption—which the commenter viewed as untenable. Others asked for exceptions to the presumptions in various scenarios. Some commenters offered alternatives, such as off-ramps or exemptions for consumers who were taking out smaller or less expensive loans than they had previously.

A State trade association for lenders also criticized the exception to the presumption of unaffordability. The commenter argued that it would harm a more responsible consumer who borrowed a smaller amount initially but then developed a need for additional funds in excess of 50 percent of the initial loan amount.

Several commenters argued that the Bureau should eliminate the presumptions against unaffordability and the cooling-off periods because consumers who have previously repaid are the most likely to repay in the future. One commenter, a specialty consumer reporting agency, discussed its analysis of data which it interpreted to show that a consumer who triggered the cooling-off period was more likely to repay than a consumer who had not, citing default rates. Similarly, commenters argued that consumers who pay off a loan have factually proven that they have an ability to repay, and thus there should be no limitation on future lending. Still other commenters argued that under the proposal consumers would be penalized twice for taking out a new loan while another loan remains outstanding, because the other loan would already be considered a major financial obligation. One lender commented that it was generally supportive of the proposed ability-to-repay requirements and viewed those requirements as sufficient, mitigating the need for additional re-borrowing restrictions.

More broadly, many commenters argued that the cooling-off period should trigger after more loans have been made, or should be shorter, primarily arguing that the cooling-off periods as proposed would have a substantial impact on revenue, and would prevent consumers from obtaining credit when they need it. One commenter argued that the cooling-off period alone would reduce revenue by 71 to 76 percent. Others claimed that a cooling-off period would bar consumers from access to credit, and consumers cannot control when they might need it. A small entity representative criticized the cooling-off period and the impacts it would have on this person's small business. Several commenters argued that setting loan limits would cause consumers to over-borrow in order to tide themselves through the period when they would be restricted from borrowing.

Commenters suggested a number of alternatives to the cooling-off period proposed, arguing that these alternatives would be less restrictive. Some commenters recommended that the Bureau create an off-ramp or repayment plan as an alternative to a cooling-off period, or alternatively, provide for exceptions where a consumer can prove that a new need has arisen. And some commenters asked the Bureau to take a more flexible approach when setting cooling-off periods, which would allow lenders to fluidly set their own thresholds based on outcomes, or give safe harbors while various industry participants try out different options. Some commenters called this a “sandbox” regulatory approach.

A group of State Attorneys General opposed the proposed approach and asked the Bureau to allow the States to set their own restrictions, such as rollover caps, limits on the number of loans that may be taken out in a given timeframe, and cooling-off periods, to better reflect local conditions and allow for experimentation. They argued that States that impose rollover or annual limits, such as Washington and Missouri, should be allowed to continue that practice within a broader minimum Federal regulatory framework.

The SBA Office of Advocacy encouraged the Bureau to reconsider the proposed cooling-off period and suggested that, if one were deemed necessary, it should be shortened from 30 days. The SBA Office of Advocacy noted that small entity representatives had criticized the cooling-off period based on its negative revenue impacts. It also passed along feedback from small entities attending roundtables that some of their clients do not operate on a 30-day billing cycle, including some who pay their rent on a weekly basis; the 30-day cooling-off period would prevent these consumers from obtaining funds that may be needed for essential expenses. In its comment letter, the SBA Office of Advocacy acknowledged and expressed appreciation for the fact that the Bureau had shortened the period from the Small Business Review Panel Outline, which contemplated a 60-day period, but nonetheless argued that 30-days was too restrictive.

An industry trade group criticized what it perceived as the proposal setting a blanket limit of six loans in a 12-month period for all covered short-term loans, not just exempt loans. The commenter argued the number was arbitrary and not backed by data. The commenter wrote that a more “appropriate limit that strikes the balance” between preventing consumers from relying too much on short-term loans and allowing the market for these loans to continue would be to limit covered short-term loans to eight loans during a 12-month consecutive period. The Bureau discusses substitutes and general considerations of access to credit in the Section 1022(b)(2) Analysis, as well as in the section-by-section analysis for § 1041.4.

The Bureau received a significant number of comments from individual consumers who wrote as part of organized letter-writing campaigns. Among the more common themes in the letters was opposition to loan limits and cooling-off periods. Many individual consumers of such loans argued vehemently that these measures would intrude on consumer choice, would harm consumers who had no other credit options, and would cause consumers to turn to unsavory lending options. A number of them were concerned specifically about the burden and length of the 30-day cooling-off period, noting that it ignored the urgency of the need for immediate funds. Some were concerned that the re-borrowing limitations would result in loan denials and impede their ability to access needed funds easily and quickly. These commenters specifically noted the need for funds for unexpected emergencies, like car repairs. Some simply declared these limits “unwarranted”. Many of these commenters believed the proposal to be setting firm annual limits on the making of all types of covered short-term loans.

Lastly, the Bureau received some comments on the requirement to review borrowing history under proposed § 1041.6(a) by obtaining and reviewing information about a consumer's borrowing history from a consumer report obtained from a registered information system. Consumer groups argued that a lender should have to check a State registry, if available, when a registered information system is unavailable. Others asked whether lenders would need to establish a backup registered information system in anticipation of potential periods in which the one the lender regularly uses may be unavailable.

Final Rule

After carefully considering the comments, the Bureau has decided to finalize only selected elements of §§ 1041.6 and 1014.10 in final § 1041.5(d). In particular, the Bureau has decided not to adopt the presumptions framework specified in the proposal, but rather rely primarily on the mandatory 30-day cooling-off period after the third loan in a sequence of covered short-term loans, covered longer-term balloon-payment loans, or a combination thereof. As specified below, the Bureau believes that this “circuit breaker,” when combined with the front-end ability-to-repay determination required under final § 1041.5(a) through (c), will protect consumers from long cycles of debt and strongly incentivize lenders to adopt more consumer-friendly business models rather than relying on extensive consumer re-borrowing. At the same time, the Bureau believes that this shift will substantially simplify the final rule relative to the proposal, giving consumers more flexibility to manage their finances within short sequences and reducing burden on lenders. The Bureau is also adopting certain other parts of proposed §§ 1041.6 and 1014.10 concerning the basic obligation to review consumers' borrowing history to determine whether a cooling-off period is triggered, and the restrictions on making covered short-term loans or covered longer-term balloon-payment loans under § 1041.5 within 30 days after an outstanding covered short-term loan under § 1041.6. The Bureau has made conforming changes to the commentary, as well as adding examples and other clarifications as discussed further below.

Presumptions of unaffordability. The Bureau continues to believe the basic premise articulated in the proposal, as summarized above, that re-borrowing shortly after a previous covered short-term loan or covered longer-term balloon-payment loan can be important evidence that a consumer lacked the ability to repay the initial loan and that a consumer likely will not be able to afford a similar subsequent loan. When consumers have the ability to repay a covered short-term or covered longer-term balloon-payment loan, the loan should not cause consumers to have the need to re-borrow soon after repaying the balance, or when the prior loan is outstanding. Thus, the Bureau believes that the most likely explanation for a consumer returning to re-borrow shortly after paying off a previous covered short-term loan or covered longer-term balloon-payment loan is that the prior loan's payment obligation left the consumer with insufficient income to make it through the balance of their expenses.

However, the Bureau also recognizes that there are occasional situations in which a consumer may experience an income or expense shock while a loan is already outstanding, and that the proposed presumptions framework did not provide a simple method of distinguishing such cases. In particular, the Bureau recognizes that defining the standard for overcoming the presumption would have either required extremely detailed inquiries of consumers, risked substantial evasion, or both. The Bureau agrees with the commenters who criticized the vagueness and workability of that standard contained in the proposal. As a result, the presumptions framework both would have imposed substantial compliance burdens on lenders and would have risked denying credit in some situations to consumers who had experienced an intervening borrowing need while a loan was already outstanding and would have been able to repay a second or third loan.

Upon further consideration, the Bureau believes that the general ability-to-repay analysis under § 1041.5 in combination with a mandatory cooling-off period under § 1041.5(d)(2) provides a more appropriate way to balance the competing considerations with regard to re-borrowing. The Bureau concludes that if a lender appropriately complies with § 1041.5(b) and (c) and makes a reasonable determination that the consumer will have the ability to repay the loan, the separate presumptions of unaffordability should be unnecessary to prevent re-borrowing in cases where the re-borrowing is attributable to the unaffordability of the prior loan. Of course, the presumptions were intended to be triggered in instances where it appeared that the lender was not making reasonable determinations of ability to repay. In the final rule, the Bureau has instead decided to rely on the reasonableness of ability-to-repay determinations. The determination of reasonableness will be based on whether a lender complies with the reasonable determination and verification requirements in § 1041.5(b) and (c), including whether the outcome-related factors listed in comment 5(b)-2.iii indicate that the lender's ability-to-repay determinations are reasonable as required in § 1041.5(b). Those factors include the frequency with which a lender makes multiple covered short-term or longer-term balloon-payment loans within a sequence. The Bureau believes that these requirements and measures will ensure that lenders shift their approach away from relying on extended loan sequences, and that lenders will appropriately factor in consumers' prior borrowing history in making ability-to-pay determinations, especially with respect to loans that would constitute second or third loans in a sequence. If a lender fails to do so, the lender's determinations would not be considered reasonable under § 1041.5(b).

For the same reasons, the final rule does not include the presumptions framework of the proposal to address circumstances where there are indicia that consumers are struggling to repay a current loan—whether covered or non-covered or made by the same lender or its affiliate—as had been proposed in §§ 1041.6(d) and 1041.10(c), respectively. Here, too, the Bureau believes that the combination of the ability-to-pay requirements coupled with a 30-day cooling-off period applied after the third covered short-term loan or covered longer-term balloon-payment loan in a sequence will be sufficient to prevent the unfair and abusive practice identified in § 1041.4.

Cooling-off period. As noted above, a significant number of commenters objected to the cooling-off period, which the Bureau is finalizing largely as proposed for covered short-term loans and extending to covered longer-term balloon-payment loans in § 1041.5(d)(2). Thus, under the final rule, a lender cannot make a covered short-term loan or covered longer-term balloon-payment loan during the time period in which the consumer has one of those types of loans outstanding or for 30 days thereafter if the new loan would be the fourth loan in a sequence of covered short-term loans, covered longer-term balloon-payment loans, or a combination thereof.

Some commenters argued that consumers who have repaid a previous loan (or two or three loans in a sequence) and come back to borrow again within 30 days are consumers who are able to repay because they did not previously default, and thus, the Bureau should not impose cooling-off periods based on patterns of re-borrowing. But this ignores one of the central premises of §§ 1041.4 and 1041.5 of the final rule, which is that when a consumer avoids default by re-borrowing, it does not reflect that the consumer has the ability to repay the loan according to its terms. The industry's current underwriting models do not account for re-borrowing risk because such re-borrowing helps to ensure that the lenders' business model produces consistent revenue. But the very purpose of this rule is to ensure that lenders determine whether a consumer will be able to repay the loan and pay basic living expenses and major financial obligations without the need to re-borrow, thereby avoiding a significant harm identified above in Market Concerns—Underwriting and in the section-by-section analysis of § 1041.4.

The Bureau's decision to finalize the cooling-off period is also tied to its decision not to finalize the presumptions for the first or second loan in a sequence, as described above. The Bureau continues to believe that most consumers who return for a new loan within 30 days of paying off a previous loan had trouble meeting their obligations and needed to take out a new loan to cover the deficit left by paying off the old loan. For these consumers, such an “early return” suggests the consumer is beginning or continuing a cycle of re-borrowing, and the prior ability-to-repay determination was insufficient in some way. But there are other consumers who did have an ability to repay, but who simply encountered an independent need for borrowing again within 30 days of paying off a prior loan, such as an unexpected car repair. The Bureau did not finalize the presumptions, in part, because the high bar for overcoming the presumptions would have prevented such consumers from obtaining additional credit that they can repay. But when a consumer returns to take out a fourth loan in a sequence, the Bureau concludes that is sufficient evidence to suggest that the consumer is not borrowing because of an independent need for funds, such as a non-recurring, unusual, or emergency expense. After all, at that point, the consumer would have had four such “new needs” during a relatively short period of time, each within 30 days of each other. Rather, it is much more likely that a cycle of re-borrowing has become manifest and the need for additional borrowing is due to the spillover effects of the prior borrowing.

This conclusion is borne out in the Bureau's data. The data show that consumers who take out more than three loans in a row are significantly more likely to be in a cycle of indebtedness that leads to 10 or more loans in a sequence than they are to repay that fourth loan and not re-borrow. Relatedly, the Bureau reiterates the data points noted in the proposal as support for this conclusion. The Bureau found that 66 percent of loan sequences that reach a fourth loan end up having at least seven loans, and 47 percent of loan sequences that reach a fourth loan end up having at least 10 loans. For consumers paid weekly, bi-weekly, or semimonthly, 12 percent of loan sequences that reach a fourth loan end up having at least 20 loans during a 10-month period. And for loans taken out by consumers who are paid monthly, more than 40 percent of all loans to these consumers were in sequences that, once begun, persisted for the rest of the year for which data were available. The Bureau thus concludes that though it is not finalizing the presumptions, it is appropriate to finalize the cooling-off period after three loans in a sequence to prevent the unfair and abusive practice identified in § 1041.4, and that doing so will still leave room for consumers who experience a new need to obtain credit via a second and even third loan in a sequence.

Additionally, as the Bureau first stated in the proposal, if a lender's ability-to-repay determinations resulted in re-borrowing three consecutive times in a sequence, the Bureau believes that is sufficient to suggest that either the lender's ability-to-repay determinations are generally not reasonable, or the lender's underwriting methodology does not work for the specific consumer's circumstances. Of course, even well-underwritten credit includes some consumer defaults. But if a consumer returns to re-borrow three times in a sequence, that would likely suggest that the determinations are coming to erroneous results. Again, the Bureau believes that if a lender's ability-to-repay determinations lead to the need to re-borrow three times in a row, it is unlikely that the fourth loan will produce a better outcome. The Bureau is finalizing a three-loan cap, instead of a different threshold such as a two-loan cap as suggested by certain consumer groups. As discussed above, a consumer's taking three loans in a row is very strong evidence that the consumer did not have the ability to repay the prior loans and likely would not be able to repay another loan. It is not as apparent whether a consumer's taking two loans in a row would provide such clear evidence.

Furthermore, the Bureau notes that by including covered longer-term balloon-payment loans, it has also changed the additional limitations on lending for longer-term balloon-payment loans as compared to what was in proposed § 1041.10. Again, in proposed § 1041.10(b), the Bureau proposed a rebuttable presumption that a consumer would not have the ability to repay a longer-term loan (including a longer-term balloon-payment loan) if taken out while a covered short-term loan made under § 1041.5 or a longer-term balloon-payment loan made under § 1041.9 was outstanding and for 30-days thereafter. In the same way and for the same reasons that the Bureau is not finalizing the presumptions for covered short-term loans, the Bureau is not finalizing the presumptions for longer-term balloon-payment loans in proposed § 1041.10. However, after three longer-term balloon-payment loans in a sequence, or a combination of three covered short-term and longer-term balloon-payment loans in a sequence, there will now be a 30-day cooling-off period for all covered short-term and longer-term balloon-payment loans. Because the Bureau views covered short-term and longer-term balloon-payment loans as having similar risks, as noted above in the section-by-section analysis for § 1041.4, the Bureau's analysis on why cooling-off periods are warranted for short-term loans made under § 1041.5 is applicable to longer-term balloon-payment loans made under § 1041.5. Three longer-term balloon-payment loans in a sequence, or a combination of three covered short-term or longer-term balloon-payment loans in a sequence, indicates both that the lender's ability-to-repay determinations have not been reasonable, and that the consumer has begun a cycle of re-borrowing.

Relatedly, the Bureau is not finalizing proposed comment 6(f)-1, which clarified that the cooling-off period did not limit a lender's ability to make covered longer-term loans. That is still the case for most longer-term loans, because the cooling-off period only applies to loans made under §§ 1041.5 and 1041.6. However, as § 1041.5 now includes covered longer-term balloon-payment loans, the cooling-off period now prohibits that subset of longer-term loans. Again, as noted above, the Bureau is concerned that covered longer-term balloon-payment loans, where a large amount of funds are due at once and can potentially drive consumers to need to re-borrow, may be joined together, or joined with covered short-term loans to form a re-borrowing sequence. For this reason, the Bureau believes covered short-term loans and covered longer-term balloon-payment loans should be treated the same with regard to the cooling-off period.

In crafting the preventive remedy to the unfair and abusive practice identified, the Bureau is attempting to maintain a significant amount of flexibility and not unduly restrain access to credit. And the Bureau recognizes that, as one commenter put it, “life happens.” There are likely to be a number of consumers who have an ability to repay when they take out the first loan, and who do repay the loan, but then encounter a new emergency expense or other independent borrowing need, and seek to take out a second loan to cover it (though as stated earlier, the Bureau continues to believe that most will in fact be re-borrowing even after the first loan due to the spillover effects of that loan). That this would happen again, two times in a row, is much less likely, but in the interest of maintaining access to credit and flexibility, the Bureau does not wish to categorically prevent such loans where there are likely to be at least some of these instances. There may even be a few instances where this would occur three times in a row, but the Bureau has made the judgment that at this point the likelihood that the consumer is instead re-borrowing is overwhelmingly more likely. The Bureau believes that very few consumers who return for a fourth loan in row would have the ability to repay that loan.

With regard to comments about the negative revenue impacts of the cooling-off period for lenders, the Bureau recognizes that this cooling-off period will reduce revenue for covered lenders. The Bureau has accounted for that revenue reduction in the costs, benefits, and impacts analysis below. As the Bureau has previously noted, the Bureau's data suggest that many payday lenders rely on continuous re-borrowing for a substantial amount of their revenue. While a majority of consumers currently finish their payday loan sequences within the first three loans in a sequence, the majority of loans, and thus revenue, comes from loans made in sequences of 10 or more in a row. And as noted in the proposal, 21 percent of payday loans made to borrowers paid weekly, bi-weekly, or semi-monthly are in loan sequences of 20 loans or more. It is this very business model that is at the core of the unfair and abusive act or practice identified in § 1041.4, and thus, the Bureau cannot prevent the identified unfair and abusive practice without significantly impacting revenue made by lenders with this kind of business model.

The Bureau is sensitive to the comments from many individual consumers who expressed concern and frustration over the proposed cooling-off period. The Bureau has carefully considered these comments, as well as related comments from consumers and other stakeholders about whether consumers affected by the cooling-off period will have available credit alternatives, and whether the rule will cause these consumers to seek out loans from more expensive or less reputable sources. And the Bureau recognizes that consumers who have obtained three covered short-term or longer-term balloon-payment loans in a sequence will be unable to obtain a fourth for 30 days, and that these consumers may be at risk of defaulting on their loans, or alternatively, defaulting on other expenses or obligations. However, the Bureau concludes that by requiring an ability-to-repay determination for each loan in a sequence, it is unlikely that many consumers will obtain a third loan in a sequence and not be able to repay that loan. Moreover, the cooling-off period will create an incentive that would not otherwise exist for lenders to offer no-cost payment plans to consumers who come to the end of a sequence and cannot afford to repay since otherwise the lender may face a default. In contrast, the Bureau believes that the risk of perpetuating cycles of unaffordable loans would be far greater without a cooling-off period.

Further, the Bureau declines commenters' suggestions to create an exception to the cooling-off period where a consumer can individually prove an independent borrowing need. As discussed in detail above in connection with § 1041.5(a)(5) and (b)(1), differentiating between re-borrowing that is prompted by a prior unaffordable loan and a new need can be complicated in practice, such that an exception would be very difficult to administer and would introduce significant risks of evasion. Where consumers are already three loans into a sequence, the Bureau believes for the reasons stated above that there is a substantial risk that they have become trapped in what would otherwise become a long-term cycle of debt. Further, such an approach would effectively turn the cooling-off period into a presumption, which the Bureau now disfavors for the reasons noted above.

Some industry commenters believed that requiring lenders to offer an off-ramp option after a certain number of loans would be more advisable than a prohibition on new loans during a cooling-off period. As discussed in Market Concerns—Underwriting and in the introduction to the section-by-section analysis for § 1041.5, the Bureau is concerned, however, that if lenders remained free to continue loan sequences, they would find ways to do so and discourage consumers from using an off-ramp. Thus, the Bureau does not believe that an off ramp can substitute for a cooling-off period. The Bureau notes, however, that under the rule a lender may offer a no-cost off ramp after a consumer hits a cooling-off period and, indeed, may be required to do so under some State laws. These further protections are not prohibited by the rule, and the Bureau encourages lenders to find ways to work with their customers on repayment plans within the boundaries of the rule.

Similarly, the Bureau does not agree with the comment by a group of State Attorneys General that the Bureau should allow the States to set their own re-borrowing restrictions to better reflect local conditions and that the Bureau should exempt from the requirements of this section any State that has extended repayment plans. As discussed in Market Concerns—Underwriting and in the introduction to the section-by-section analysis for § 1041.5, the Bureau has considered various policy alternatives suggested by commenters as well as current State laws, both of which include extended repayment plans, but the Bureau has concluded that a Federal rule is necessary to protect consumers and that extended repayment plans imposed at the State level would not be adequate to prevent the unfair and abusive practice identified by the Bureau in this rulemaking, in part because evidence suggests low take rates for State mandated off-ramps or extended repayment plans.

The Bureau does not believe that the suggestion by some commenters of a more flexible “sandbox” approach to the cooling-off periods, or safe harbors while industry participants experiment with different cooling-off periods, is warranted. The Bureau's rulemaking process has involved several years of analysis and experience and the Bureau does not believe that the potential benefits from a period of further experimentation warrant delaying the consumer protection that would be provided by this rule. The Bureau set the length of the cooling-off period for the reasons described herein and in the proposed rule. This final rule does, however, take a more flexible approach than the proposal in prescribing how lenders must make ability-to-repay determinations, which the Bureau accomplished, in part, by not finalizing the proposed presumptions after each loan in a three-loan sequence as described above. Given that those presumptions are not being finalized, the Bureau believes that the remaining bright-line backstop of a strict cooling-off period is warranted.

Length of Cooling-off Period. The Bureau concludes that, when a consumer has borrowed three covered short-term or longer-term balloon-payment loans in a sequence, the cooling-off period before the consumer can take out another such loan should be set at 30 days rather than some longer or shorter period of time. The Bureau believes that a 30-day cooling-off period strikes the appropriate balance and accordingly is finalizing that duration in § 1041.5(d).

The Bureau's rationale for doing so is largely the same as the reasons the Bureau chose a 30-day period to define the parameters of a loan sequence: Namely, that major financial obligations generally are due on a monthly basis. During the SBREFA process, and in considering the comments on the proposal, including from the SBA Office of Advocacy, the Bureau heard examples of some consumers who paid for major financial obligation on a different cycle—like weekly rent. However, that does not change the fact that the traditional billing cycle in the United States is monthly. The Bureau has concluded that a consumer who returns to a lender to borrow again after paying a loan within a period consisting of a 30-day billing cycle is very likely to have shifted money around to pay the loan instead of expenses. Again, the Bureau's test for whether a consumer has the ability to repay is whether the consumer has the ability to repay the loan as well as major financial obligations and still meet basic living expenses. By contrast, if a consumer makes it through an entire billing cycle without needing to re-borrow, then it is more likely that she reached equilibrium and if the consumer then returns to borrow that may well reflect a new and independent borrowing need. As noted in the proposal, there is always some chance that a consumer will have a new need for a new loan within any re-borrowing period, no matter what time period it is based on. There also is some chance that the spillover effects of repaying an unaffordable loan will be felt for a prolonged period of time after the payment. Nonetheless, the Bureau has concluded that a 30-day re-borrowing period is the appropriate threshold for the definition of a sequence—accounting for one billing cycle, but not extending so far as to capture a significant number of genuine new credit needs. Similarly, the Bureau believes that a 30-day cooling-off period is the appropriate length of time to ensure that a consumer who has just re-borrowed twice in a row is sufficiently free from the spillover effects of those unaffordable loans before she borrows additional covered short-term or longer-balloon-payment loans.

The Bureau is also aligning the length of the cooling-off periods with the length of the re-borrowing period for purposes of greater simplicity and practicality. Extending the cooling-off period to 60 or 90 days, as some commenters recommended, would reduce access to credit to a significant extent. The Bureau does not judge that approach to be warranted at this time. The Bureau notes that it has considered whether to impose a cooling-off period of a different length than the re-borrowing period, and also has considered whether to impose a graduated cooling-off period, an alternative on which the Bureau sought comment (e.g., 30 days after the first full loan sequence, 60 days after the second, 90 days after the third). The Bureau has judged these alternatives to be too complex to administer. The Bureau again believes that the logic for setting the re-borrowing period at 30 days is applicable here as well, and that in addition setting the cooling-off period and re-borrowing period at the same length is the simplest and most intuitive approach.

Treatment of Covered Longer-Term Balloon-Payment Loans. As noted above, the Bureau proposed to subject covered longer-term balloon-payment loans to the same presumptions that would have applied to covered short-term loans in situations in which the consumer's re-borrowing or struggles to repay a current loan suggested that they may not have the ability to repay a new loan. The Bureau did not specifically propose to impose a 30-day cooling-off period after the third longer-term balloon-payment loan in a sequence, but did seek comment on whether particular patterns of re-borrowing within a particular timeframe warranted additional protections. Consumer groups responded with proposals to strengthen the presumptions for longer-term loans, or add to the number of facts that would trigger a presumption.

After additional consideration, the Bureau has concluded that covered longer-term balloon-payment loans should be treated in the same manner as covered short-term loans where there is a sequence of three loans (i.e., where the loans are each taken out within 30 days of each other). In such circumstances, three prior ability-to-repay determinations will have proven inconsistent with the consumer's actual experience. For consumers who reach that point, the Bureau believes that terminating a loan sequence may assist the consumer to escape from the cycle of indebtedness. Particularly for loans with terms that slightly exceed the limits for a covered short-term loan and that have very large end payments—such as a 46-day lump-sum loan structure—the Bureau believes that the risks of consumers becoming stuck in a long cycle of borrowing absent a mandatory cooling-off period would be similar to those for covered short-term loans.

Borrowing history. As in the proposal, a lender will need to obtain a report from a registered information system to assess whether a consumer has or had loans from other lenders that would make a new loan violate either § 1041.5(d)(2) or (3). The Bureau received comments about what happens (or should happen) if no registered information system is available. Section 1041.5(d)(1) requires that a lender obtain a consumer report from a registered information system only if such a report is available. If no report is available, either because no entity has been registered as an information system for 180 days or more or because no registered information system is capable of producing a report at the time the lender is contemplating making a covered loan (for example, due to temporary system outage), a lender does not violate § 1041.5 if it makes a covered loan without obtaining a consumer report from a registered information system.

Regarding the comment from consumer groups that the rule should provide for mandatory checking of State databases when no report from a registered information system is available, the Bureau declines to impose this requirement because it does not believe it would be useful for compliance with this part. The Bureau also does not believe such a requirement is necessary; State laws already require such activity, and this rule would not preempt any such requirements. With regard to comments asking whether lenders must obtain a consumer report from another registered information system in the event the registered information system from which the lender regularly obtains reports is unavailable for some reason (e.g., a temporary system outage), the Bureau believes that it is reasonable and appropriate to impose such a requirement given the importance of the information contained in a registered information system report in assessing whether the lending limitations contained in § 1041.5(d) are triggered. The Bureau notes that lenders are required to furnish information to every registered information system and thus a lender should not experience difficulty in maintaining a backup purchasing relationship with a registered information system other than the one from which the lender regularly obtains reports.

Annual loan limits. The Bureau addresses the comments it received regarding annual loan limits. At the outset, the Bureau finds it necessary to address a common misperception in the comments, including those submitted by many individual commenters and a trade group commenter described above. Some commenters perceived that the restrictions in proposed § 1041.7 (now § 1041.6 of the final rule) on the number of exempt covered short-term loans and the time of indebtedness on such loans within a 12-month period applied to all covered short-term loans. However, under the proposal, if consumers took out the maximum number of covered short-term loans under proposed § 1041.7 in a 12-month period and therefore could no longer obtain an exempt covered short-term loan under that provision, the proposal still would have permitted them to obtain a covered short-term loan within the 12-month period as long as they met the ability-to-repay requirements under proposed § 1041.5.

The final rule contains a similar framework. Section 1041.6 permits a consumer to obtain loans under that provision so long as the consumer has not taken out six covered short-term loans or become indebted on covered short-term loans for 90 days within a 12-month period. After reaching either of those caps, a consumer could continue obtaining loans under § 1041.5, subject to the requirements of § 1041.5, including the ability-to-repay determination and the cooling-off period that applies after three loans in a sequence.

The Bureau received many comments from stakeholders who were supportive of the proposal in general, including consumer advocates, elected officials, and others, but who urged the Bureau to impose a cap on covered short-term lending of six loans or 90 days of indebtedness in a 12-month period. The Bureau declines to impose such a limit. The Bureau has imposed such a cap on loans made under § 1041.6 because such loans can be made without assessing the consumer's ability to repay. As explained in the discussion of that section, the Bureau is concerned about the risks of making such loans to consumers who have demonstrated a pattern of extensive borrowing. However, that same logic does not extend to § 1041.5 since loans made under that section do require an ability-to-repay determination.

The Bureau is concerned that blanket caps limiting all consumers to no more than six covered short-term loans in a 12-month period and to 90 days of indebtedness within a 12-month period would unduly restrict access to credit. A consumer may have several unusual and non-recurring borrowing needs over the course of a 12-month period, with several months in between any loan sequence. A cap of this sort would deny access to credit to such consumers later in the year, regardless of their particular circumstances, even if they have the ability to repay. This restriction also would mean that a consumer who takes the maximum number of permitted exempt covered short-term loans under § 1041.6 could not take out another covered short-term loan during the 12-month period—even one for which they have the ability to repay. The Bureau is also mindful of the high number of individual consumers who commented on the concerns they had about potential restrictions on access to credit. The provisions in § 1041.5 of the final rule requiring ability-to-repay underwriting according to specific criteria directly address the risks and harms created by the identified unfair and abusive practice. That practice of making loans without reasonably determining the borrower's ability to repay the loan according to its terms enables lenders to make unaffordable loans that mire many consumers in extended loan sequences through repeat re-borrowing—or else leads them to experience default, delinquency, or the collateral consequences of forgoing basic living expenses or major financial obligations to avoid defaulting on their unaffordable loans. Without moving to the stricter specification of an overall loan cap, the Bureau believes that the measures in § 1041.5 are sufficiently calibrated to prevent consumers from experiencing the risks and harms associated with the unfair and abusive practice.

Furthermore, the Bureau has eliminated the specific regulatory requirements around non-covered bridge loans—in proposed §§ 1041.6(h) and 1041.10(f)—because it has determined that these requirements would be too complex to implement. At the same time, the Bureau recognizes, as noted by consumer groups, that any kind of non-covered loan could be used as a means to bridge over a re-borrowing period or cooling-off period. Thus, the Bureau is addressing the concerns animating these proposed provisions by adding an example in comment 5(b)-2.iv.E, noting that frequent instances of using any kind of non-covered loans to bridge between loan sequences could indicate that the ability-to-repay determinations are not reasonable.

In § 1041.5(d)(3), the Bureau has finalized the prohibition against making covered short-term loans or longer-term balloon payment loans under § 1041.5 within 30 days of a loan made under § 1041.6 (as was proposed in proposed §§ 1041.6(g) and, to a certain extent, 1041.10(e)). These provisions were designed to ensure that protections in proposed § 1041.7 requiring a step-down of the amount of principal over three loans in a sequence worked as intended, and is otherwise based on the same rationale as was in the proposal.

5(e) Prohibition on Evasion of § 1041.5

The Bureau is also adding a new § 1041.5(e), which states that a lender must not take any action with the intent of evading the requirements of § 1041.5 of the final rule. The Bureau had proposed a general anti-evasion provision in proposed § 1041.19, and is finalizing that more generalized anti-evasion provision at § 1041.13 of the final rule. Nonetheless, the Bureau has decided to add this more specific paragraph to § 1041.5 so that it can provide guidance on anti-evasion within the specific context of that section. Comment 5(e)-1 clarifies that the standard for what constitutes evasion is the same as that in the broader provision, § 1041.13 of the final rule, which is applicable to part 1041 in its entirety. The Bureau addresses comments about that more general standard below in the section-by-section analysis of § 1041.13.

For illustrative purposes, the Bureau provided one example at comment 5(e)-2, which is a particular fact pattern that may be considered an evasion of § 1041.5. Modified in response to comments received, the substance of the example in comment 5(e)-2 is based on the illustrative example that had been presented in proposed comment 19-2.ii. For ease of reference, it has been moved here. Consumer groups requested that the Bureau alter the example to clarify that late fees are considered rollovers or re-borrowing, and that the example was not viewed as exhaustive, meaning other scenarios could lack elements from this fact pattern and still constitute possible evasions. The Bureau does not believe these clarifications are necessary. The example is not exhaustive. All late fees would not be considered rollovers or re-borrowing, but as noted in the example, when combined with other features, may prove intent to evade the rule. The final comment 5(e)-2 consists, among other things, of a covered short-term or longer-term balloon-payment loan structure that requires a consumer to accrue a late fee for every two weeks of non-payment, in an amount that meets or exceeds the normal finance charge. The comment further explains that depending on the relevant facts and circumstances, including the lender's prior practices, the lender may have taken these actions with the intent of evading its obligations in § 1041.5(b) (underwriting) and § 1041.5(d) (cooling-off period, if the late fees accrue beyond the time when the cooling-off period would begin if the late fees instead were new loans) and as a result the lender may have violated § 1041.5(e). The explanation of how the conduct may violate § 1041.5(e) was not contained in the proposed comment, but was added to provide more clarity on specific actions that may indicate an intent to violate the provision and thereby support a possible violation of § 1041.5(e) of the final rule.

Section 1041.6 Conditional Exemption for Certain Covered Short-Term Loans

Proposed § 1041.7 would have exempted covered short-term loans that satisfy certain conditions from proposed §§ 1041.4, 1041.5, and 1041.6. The Bureau is finalizing the proposed conditional exemption for certain covered short-term loans, largely as proposed, but with several substantive adjustments and renumbered as § 1041.6 in light of other changes to the rule. This section first describes the Bureau's general approach to the exemption in the proposed rule, the Bureau's legal authority for the exemption, some comments received on the general approach to the exemption, and a high-level summary of the final rule. Then the Bureau will discuss each portion of § 1041.6, the comments received, and the final rule in turn.

General Approach in the Proposed Rule

The Bureau proposed to exempt covered short-term loans under proposed § 1041.7 from proposed §§ 1041.4, 1041.5, and 1041.6. Because loans made under proposed § 1041.7 would not have been subject to the underwriting criteria in proposed § 1041.5 and the additional borrowing limitations in proposed § 1041.6, proposed § 1041.7 would have included a number of screening and structural provisions to protect consumers in place of those other requirements. The Bureau believed that these protections would reduce the likelihood and magnitude of the kinds of risks and harms to consumers from unaffordable payments on covered short-term loans that were discussed in the section in the proposal on Market Concerns—Short-Term Loans, including the harms that result to consumers from extensive re-borrowing in long sequences of short-term loans.

In the proposal, the Bureau recognized, based on its own research and that of others, that even where lenders do not engage in any meaningful underwriting, some consumers are in fact able to repay a short-term loan when it comes due without further re-borrowing. These consumers thus avoid at least some, if not all, of the risks and harms with which the Bureau is concerned. For example, as described in the CFPB Report on Supplemental Findings, approximately 22 percent of new payday loan sequences do not result in any re-borrowing within the ensuing 30 days. While the Bureau believed that most of these consumers would be able to demonstrate their ability to repay and thus could continue to obtain loans under the proposal, the Bureau recognized there may be a subgroup of consumers for whom this is not true and who would be denied loans even though they could, in fact, afford to repay them.

The proposal noted that some of these consumers may take out a payday or title loan, repay it on the contractual due date, and never again use such a loan. Others may return on another occasion, when a new need arises, likely for another single loan or a short sequence. Further, even among those who do re-borrow, the Bureau's research indicated that about 16 percent of payday sequences ended with final repayment within three loans, without either defaulting or re-borrowing within 30 days after the last payment has been made.

In addition, the proposal noted that the Bureau's research suggested that even consumers who re-borrow many times might have shorter loan sequences if they were offered the option of taking out smaller loans each time they returned to re-borrow—instead of being presented only with the binary option of either rolling over the loan without paying down any principal (in States where rollovers are permitted) or repaying the full amount of the loan plus the finance charge, which often leads the borrower to take out another loan in the same amount.

Finally, the Bureau recognized that the verification and other underwriting criteria in proposed §§ 1041.5 and 1041.6 would have imposed compliance costs that some lenders, especially smaller lenders, may have found difficult to absorb for covered short-term loans, particularly for those loans that are relatively small in amount.

In light of these considerations, the Bureau believed that it would further the purposes and objectives of the Dodd-Frank Act to provide a simpler alternative to the specific underwriting criteria in proposed §§ 1041.5 and 1041.6 for covered short-term loans, but with robust alternative protections against the harms that consumers experience from loans with unaffordable payments. Proposed § 1041.7 would have permitted lenders to extend to consumers a sequence of up to three loans, in which the principal is reduced by one-third at each stage and certain other conditions are met, without following the underwriting criteria specified in proposed § 1041.5 and without satisfying the limitations of proposed § 1041.6.

The Bureau's approach to a conditional exemption for covered short-term loans garnered discussion from stakeholders even before the proposal was issued. During the SBREFA process and the Bureau's outreach following its release of the Small Business Review Panel Report, many lenders and other industry stakeholders argued that the alternative requirements for covered short-term loans presented in the Report would not provide sufficient flexibility to sustain a lender's profitability in making covered short-term loans. In contrast, during the Bureau's outreach before and after the release of the Report, many consumer advocates argued that permitting covered short-term loans to be made without meeting specified underwriting criteria would weaken the overall framework of an ability-to-repay rule, and urged the Bureau not to adopt any alternatives that would sanction a series of repeat loans.

The Bureau carefully considered this feedback in developing the proposed rule and in particular in developing proposed § 1041.7. With regard to the industry argument that the approach described in the Report would not allow lenders to remain profitable, the Bureau believed that reflected the heavy reliance of many lenders on revenue from borrowers who experience long sequences of covered short-term loans. Since the Bureau began studying the market for payday, vehicle title, and similar loans several years ago, it has noted its significant concern with the amount of long-term re-borrowing observed in the market, and the apparent dependence of many lenders on such re-borrowing for a significant portion of their revenues. The Bureau was sensitive to the impact that the proposed rule would have had on small entities, but to the extent they are relying on repeated re-borrowing and long loan sequences for a substantial portion of their revenues, the Bureau had the same concerns here about significant harm to consumers that it found to exist more generally with this market. Proposed § 1041.7 would have permitted consumers with emergencies or occasional shortfalls to receive a limited number of covered short-term loans without having to meet the underwriting criteria in proposed §§ 1041.5 and 1041.6, but would have addressed the risks and harms to consumers from such loans by providing them with an alternative set of protective requirements.

The Bureau acknowledged in the proposal that a substantial number of loans currently being made in the marketplace would not qualify for the exemption under proposed § 1041.7 because they are part of extended cycles of re-borrowing that are very harmful to many consumers. The Bureau noted that some lenders may be able to capture scale economies and build a business model that relies solely on making loans under proposed § 1041.7, with their approach to underwriting such loans likely having to be adjusted to take account of substantial declines in re-borrowing revenue. For other lenders, the Bureau expected that loans made under proposed § 1041.7 would become one element of a business model that would also incorporate covered short-term and longer-term loans, loans that are not covered by this rule, and perhaps other financial products and services as well.

As for the consumer advocates that disfavored any alternatives to requiring lenders to meet specified underwriting criteria for covered short-term loans, the Bureau issued its proposal because it did not believe that providing a carefully constructed alternative to the specific underwriting criteria proposed in §§ 1041.5 and 1041.6 would significantly undermine consumer protections. The Bureau noted that the proposed exemption would provide a simpler means of obtaining a covered short-term loan for consumers where the loan is likely to prove less harmful. That was so, the Bureau noted, because proposed § 1041.7 included a number of safeguards, including the principal step-down requirements and the fixed limit on the number of loans in a sequence of such loans, to ensure that consumers cannot become trapped in long-term debt on an ostensibly short-term loan. The Bureau believed that those safeguards also would reduce the risk of harms from default, delinquency, re-borrowing, and the collateral consequences of making unaffordable loan payments while forgoing basic living expenses or major financial obligations during a short sequence of these loans. The proposal reflected the Bureau's view that the requirements in proposed § 1041.7 would appropriately balance the goal of providing strong consumer protections with the goal of permitting access to less risky credit on less prescriptive terms.

The Bureau noted that by including an alternative set of requirements under proposed § 1041.7, the Bureau was not suggesting that regulation of covered short-term loans at the State, local, or Tribal level should encompass only the provisions of proposed § 1041.7. On the contrary, proposed § 1041.7(a) would not have provided an exemption from any other provision of law. The Bureau noted that many States and other non-Federal jurisdictions have made and likely will continue to make legislative and regulatory judgments about how to treat such loans, including usury limits, prohibitions on making high-cost covered short-term loans, and other strong consumer protections under legal authorities that in some cases extend beyond those conferred on the Bureau. The proposed regulation would have coexisted with—rather than supplanted—State, local, and Tribal regulations that impose a stronger framework that is more protective of consumers, as discussed in part IV. In the same vein, the Bureau noted that proposed § 1041.7 also would not have permitted loans to servicemembers and their dependents that would violate the Military Lending Act and its implementing regulations.

The Bureau requested comment generally on whether to provide an alternative to the requirement that lenders meet the specific underwriting criteria in proposed §§ 1041.5 and 1041.6 for covered short-term loans that satisfy certain requirements. The Bureau also sought comment on whether proposed § 1041.7 would appropriately balance the considerations regarding consumer protection and access to credit that presents a lower risk of harm to consumers. The Bureau sought further comment on whether covered short-term loans could be made in compliance with proposed § 1041.7 in States and other jurisdictions that permit covered short-term loans. In addition, the Bureau sought comment on the appropriateness of each of the proposed requirements in proposed § 1041.7, and more generally on the costs and other burdens that would be imposed on lenders, including small entities, by proposed § 1041.7.

General Comments Received

The Bureau here is addressing the general comments that it received on the conditional exemption in proposed § 1041.7, and discusses the comments pertaining to its more specific components when addressing them below.

A significant number of industry members and trade associations opposed the Bureau's proposed conditional exemption. Several argued that the conditions in the proposed exemption are too restrictive and would severely reduce revenue, profits, and access to credit. A number of State Attorneys General similarly argued that the exemption in proposed § 1041.7 was not workable and would generate too little revenue to allow lenders to remain in business. Some industry commenters argued that the Bureau had not adequately justified the conditions of the proposed exemption, arguing that there was no data supporting the structural limitations of the exemption. One commenter, in connection with its argument that the Bureau had not shown that payday loans cause consumer harm, contended that the Bureau has provided no justification for providing the exemption in proposed § 1041.7.

Several industry commenters opposed § 1041.7 as proposed because, they argued, the conditionally exempt loans would fail to meet the needs of borrowers, especially those who needed a loan for an emergency expense. Commenters argued that the requirements of proposed § 1041.7 would reduce the speed and convenience of the product, diminishing its value and therefore harming borrowers who are currently able to repay. Some commenters argued that the Bureau had underestimated how much its proposed approach would reduce lending volumes and thus the availability of credit, citing either their own studies or the studies of others.

One industry commenter argued that the disclosures that would have been required by proposed § 1041.7(e) for loans made under § 1041.7 demonstrate that disclosures can be effective and maintained that the rule as a whole should focus on disclosures rather than on imposing more restrictive provisions such as ability-to-repay requirements. Another industry commenter argued that instead of offering an exemption under proposed § 1041.7, the rule should consider setting limits on the number of consecutive transactions a consumer may obtain under proposed § 1041.5 or requiring an “off-ramp” after a certain period of indebtedness.

Some commenters argued that the exemption in proposed § 1041.7 was not broad enough and that it should exempt lenders from other requirements. For example, several commenters affiliated with banks or credit unions urged the Bureau to expand the exemption. Commenters asserted that even conditionally exempt loans would require banks or credit unions to comply with other portions of the rule, and this compliance would impose significant costs, causing them to leave the market.

Some State officials took a different tack, urging the Bureau to further limit the extent of the exemption in proposed § 1041.7 and arguing that if the exemption existed at all, it should be limited to loans with APRs below 25 percent because loans with higher interest rates risk being unaffordable to consumers. Another commenter urged the Bureau to require lenders to refund finance charges if the borrower paid back a loan early. The commenter asserted that requiring a partial refund of fees when a borrower paid back a loan sequence early would encourage borrowers to make earlier payments and would reduce the amount of money that borrowers ultimately paid over the course of the loan sequence.

Consumer groups and many individual commenters urged the Bureau to eliminate the conditional exemption in proposed § 1041.7. They argued that ability-to-repay determinations are necessary to prevent the identified unfair or abusive practice, and thus there should be no exemptions from those portions of the rule. A coalition of consumer groups argued that the exemption would not prevent substantial payments from coming due in a short amount of time, which would not be affordable to borrowers. Another commenter argued that lenders making covered short-term loans will exploit any loophole, and thus lenders would exploit the exemption. Some commenters also argued that the exemption would allow for unaffordable loans and that unaffordable loans cause substantial harm. Others pointed to data suggesting that conditionally exempt loans would be unaffordable for borrowers. They argued that even small payments are often unaffordable and that even one unaffordable loan can cause substantial harm. Because the exemption would allow loans to be made without meeting specific underwriting criteria, they argued that it would increase the incidence of these harms.

Consumer groups also urged the Bureau not to adopt the exemption in proposed § 1041.7 because they viewed it as inconsistent with the rest of the rule. They said the Bureau had persuasively demonstrated in proposed § 1041.4 that loans made without an ability-to-repay determination cause substantial harm. Because the exemption would allow loans that did not meet that standard, they argued that it was inconsistent with the rest of the rule. These commenters also suggested that the proposal's reasoning about why conditionally exempt loans under proposed § 1041.7 should not be permitted to include a security interest in an auto title applies to payday loans as well. And they stated that they were unaware of any precedent from other regulators for adopting a similar exemption.

A non-profit group argued that the exemption was likely to be ineffective because lenders would make more money on longer-term loans and therefore would not offer conditionally exempt loans under proposed § 1041.7. It also argued that the exemption would not allow lower-cost lenders to make loans.

Several State Attorneys General argued that the rule should not include any exemption from the ability-to-repay requirements, though one stated that if the Bureau were to retain an exemption, it should be structured as in proposed § 1041.7. One attorney general urged the Bureau to monitor the effectiveness of the exemption periodically in order to ensure that it did not permit lenders to continue to make unaffordable loans on a regular basis.

Some consumer groups criticized proposed § 1041.7 because it would not have required lenders to verify income for conditionally exempt loans, which they argue is necessary for all loans. Others also urged the Bureau not to adopt the proposed exemption because it could risk undermining State laws that restrict payday lending if lenders were to cite the exemption as evidence that payday loans are deemed to be safe.

Both consumer group and industry commenters asked the Bureau to clarify how the requirements of the proposed rule would interact with existing State law. One commenter noted that some cities allow loans to roll over three times—for a total of four loans—while the proposed rule would only allow two rollovers. This commenter also urged the Bureau to promulgate a definition to clarify when the provisions of the rule would provide “greater consumer protection” than other measures, especially State laws for purposes of preemption under the Dodd-Frank Act. Industry commenters similarly expressed concerns about interactions with State law, asserting that many States mandate extended payment plans, and arguing that the Bureau does not have the authority to displace those State laws.

Final Rule

The Bureau is finalizing proposed § 1041.7 as § 1041.6 of the final rule to provide for conditionally exempt loans, with several technical changes to accommodate other changes in the rule, and with one more substantive change that is summarized below and explained in more detail in the section-by-section analysis of § 1041.6(d).

Proposed § 1041.7(d) would have required that, for the purpose of calculating the period for determining whether loans made under proposed § 1041.7 would be part of the same loan sequence, a lender or its affiliate must not count the time when it had a non-covered bridge loan (as defined in proposed § 1041.2(a)(13)) outstanding with the consumer. As discussed in more detail in the section-by-section analysis of § 1041.6(d), in the final rule, the Bureau has replaced the “tolling” provision in proposed § 1041.7(d) relating to non-covered bridge loans with § 1041.6(d), which prohibits a lender or its affiliate from making any covered or non-covered loans (other than a loan under § 1041.6) within 30 days of a loan made under § 1041.6 of the final rule.

The Bureau is finalizing the exemption substantially as proposed based on the grounds set forth in the proposal and discussed above. As described and explained further in § 1041.6(c)(3) and (d) below, the exemption has been carefully designed to minimize the risk of borrowers becoming trapped in cycles of re-borrowing. In § 1041.4 of the final rule, the Bureau has identified the substantial risks and harms to consumers associated with lending without making reasonable determinations that borrowers have the ability to repay—default, delinquency, re-borrowing, and other harms associated with avoiding default. Because loans made under § 1041.6 would not be required to meet the specific underwriting criteria in § 1041.5, the specific features of this conditional exemption are designed to mitigate those harms. Certain requirements for loans made under § 1041.6 (and described in more detail below), including the 3-loan cap, the cooling-off period, and the specific limitation on indebtedness in a 12-month period, are all intended to prevent extended re-borrowing. Other requirements for loans made under § 1041.6, including the principal-reduction requirements, the prohibition on security interests in vehicle titles, and the limits on loan amounts, are intended to prevent re-borrowing, and prevent or reduce the risks and harms associated with default, delinquency, and forgoing basic living expenses or major financial obligations to avoid default.

The Bureau also has concluded that, compared to specific alternatives suggested by certain commenters, the exemption in § 1041.6 is likely to be more effective at balancing the need for consumer protections with preservation of access to credit. As noted above, an industry commenter argued that instead of offering an exemption under proposed § 1041.7, the rule should consider setting limits on the number of consecutive transactions a consumer may obtain under proposed § 1041.5 or requiring an “off-ramp” after a certain period of indebtedness. The Bureau agrees that prescribing certain limits on sequential borrowing would help limit the harms that result from repeated re-borrowing and has prescribed certain limits in § 1041.6(c)(2) for conditionally exempt loans made under § 1041.6, as well as in § 1041.5(d) for loans made under the ability-to-repay requirements in § 1041.5. However, as discussed in the section-by-section analysis for §§ 1041.5 and 1041.6, the Bureau has concluded that additional protections are necessary to protect consumers against the risks and harm from unaffordable loans.

The Bureau is not persuaded by the commenter's argument that because the disclosures proposed for these conditionally exempt loans under § 1041.6 can be effective; it follows that the entire substance of this rule can therefore be replaced with a disclosure-only rule. The Bureau recognizes that disclosures like those finalized in § 1041.6(e) can be valuable and effective in educating consumers on how their choices may be affected by the restrictions prescribed in the final rule. Yet the Bureau does not believe that prescribing disclosures to explain the provisions of § 1041.6 is inconsistent with the conclusion that disclosures alone do not suffice to protect consumers against the harms targeted in this rulemaking. As discussed above in the section-by-section analysis for § 1041.5, the Bureau has concluded that disclosures alone are not enough to protect consumers against the risks and harms of unaffordable loans.

With respect to the recommendation to require off-ramps instead of providing for a conditional exemption, the Bureau concludes that off-ramps alone would not provide sufficient protection to consumers. As discussed in the section-by-section analysis of § 1041.6(b) through (e), the Bureau believes those provisions offer important protections against harms from default, delinquency, re-borrowing, and forgoing basic living expenses or major financial obligations to avoid default. While off-ramps likely would help consumers who are struggling to repay their loans by giving them additional time and reducing their payments, they would not mitigate the potential harms as effectively as the suite of protections in § 1041.6. Moreover, as some commenters noted, lenders frequently have managed to find ways to discourage consumers from taking advantage of off-ramp options under existing State laws, and therefore the Bureau has determined that off-ramps would be less effective at improving the chances that consumers will be able to repay covered short-term loans without becoming mired in extended loan sequences.

As noted above, the Bureau has concluded that the structural requirements of the exemption are well-designed to prevent or mitigate the harm that results from unaffordable short-term loans, but the Bureau also has concluded that making the requirements of the exemption more demanding would restrict its value to consumers and lenders. A range of commenters argued that the exemption should be limited to loans with certain APRs, that conditionally exempt loans should remain subject to income verification, or that lenders should be required to pay back finance charges if borrowers repay early. While the requirements in § 1041.5 of the final rule are designed to prevent the harms identified in § 1041.4, the Bureau has recognized that those requirements may be burdensome to some lenders and consumers, and thus finds it prudent to offer a less restrictive alternative to address the identified harms.

As noted above, some industry commenters argued that the underwriting requirements in proposed §§ 1041.5 and 1041.6 would be unworkable and that the exemption in proposed § 1041.7 would not provide a feasible alternative. The Bureau has endeavored to substantially address the concerns raised about the complexity and burdens of the underwriting requirements, as adopted in § 1041.5, through revisions to those requirements as discussed above. Section 1041.6 was intended to reduce burden and allow for a more feasible alternative to loans made under § 1041.5. In particular, it does not require lenders to meet the specific underwriting criteria set out in § 1041.5. It does, however, still impose some restrictions, which in turn involve some burden. The Bureau acknowledges this, but considers each of the restrictions imposed in § 1041.6 necessary or appropriate to ensure that the exemption does not allow significant amounts of harms to continue under the exemption.

Having said that, the Bureau recognizes, as commenters noted, that allowing lenders to continue making covered short-term loans without requiring the loans to meet the underwriting criteria specified in § 1041.5 poses some risk, even with the protections that are built into the exemption. Those risks include the likelihood that at least some loans meeting the conditions under § 1041.6 may be unaffordable at least to some consumers. The Bureau acknowledges these concerns, and agrees that finalizing § 1041.5 without this exemption would create a more rigid framework that would more completely prevent the risks and harms identified in § 1041.4. But a significant animating influence in the Bureau's decision to include this exemption was the aim of acting prudently in fashioning its first underwriting rule for this market, while recognizing as noted above that some borrowers that likely cannot satisfy the ability-to-repay test may still be able to repay their loans without re-borrowing.

As some commenters suggested, the Bureau will monitor how lenders use conditionally exempt loans to see if the risks and harms identified in this rule are being perpetuated, and stands ready to take action if it sees this occurring. Of course, lenders will also need to comply with more restrictive State laws as applicable, which is consistent with the notion that this rule is a floor and not a ceiling on consumer protections, both in general and for purposes of preemption as discussed in part IV. Additionally, the Bureau judges it likely that lenders will find it in their self-interest to engage in additional underwriting before making conditionally exempt loans given that the re-borrowing restrictions with respect to such loans will mean that lenders cannot count on revenue from extended loan sequences to cover the costs of defaults. Put differently, the distinct conditions for these loans will likely lead to modifications in the lending practices of those lenders choosing to utilize the provisions of § 1041.6. Those conditions are likely to prompt more caution in making such loans, because the costs incurred by making unaffordable loans cannot be offset by heavy volumes of re-borrowing fees.

The Bureau also disagrees with the claim made by some commenters that after having identified as an unfair and abusive practice the making of covered short-term loans without reasonably determining that the borrower has the ability to repay the loans according to their terms, the Bureau must prohibit all such loans in all circumstances. As explained further below, the Bureau has express legal authority to issue exemptions from its rules. The Bureau agrees that the measures intended to mitigate the harms caused by the practice identified as unfair and abusive in § 1041.4 may not entirely mitigate those harms when lenders make conditionally exempt loans without underwriting according to the criteria laid out in § 1041.5. At this time, however, the Bureau deems it prudent to accept that level of risk in light of the positive effects that § 1041.6 will have on reducing burden and providing access to credit while continuing to mitigate most of the harms caused by the practice identified in § 1041.4.

Both consumer and industry commenters asked the Bureau to clarify how the requirements of § 1041.6 would interact with existing State law. The provisions to which the commenters objected are merely conditions for loans to satisfy the § 1041.6 exemption, not new requirements that the Bureau is imposing on all loans. If a lender cannot legally offer a loan meeting such conditions in the State or city where a conflicting requirement exists, then that lender simply cannot offer loans that qualify for the § 1041.6 exemption, though it always can underwrite loans under the provisions of § 1041.5 where State law permits such loans to be made. To be clear, however, nothing in this rule categorically prohibits extended repayment plans. To the extent that some jurisdictions presently allow loans to be rolled over three times, the cap of two partial rollovers (subject to the prescribed limits on the amounts that can be rolled over) in § 1041.6 nevertheless must be met for loans to qualify for the conditional exemption.

Legal Authority

Section 1041.6 establishes an alternative set of requirements for covered short-term loans that, if complied with by lenders, conditionally exempts them from § 1041.4 and the specific underwriting criteria in § 1041.5. The requirements of § 1041.6 have been developed pursuant to section 1022(b)(3)(A) of the Dodd-Frank Act, which authorizes the Bureau to grant conditional exemptions in certain circumstances from its rules. With respect to § 1041.6(e), the Bureau developed the proposed disclosures by relying on its authority under section 1032(a) of the Act, which allows it to prescribe rules to ensure that the features of a consumer financial product or service are fully, accurately, and effectively disclosed to consumers, and section 1032(b) of the Act, which provides for the use of model forms. These sources of legal authority for § 1041.6 of the final rule are explained more fully below.

Section 1022(b)(3)(A) of the Dodd-Frank Act—Exemption Authority

Section 1022(b)(3)(A) of the Dodd-Frank Act authorizes the Bureau, by rule, to “conditionally or unconditionally exempt any class of . . . consumer financial products or services” from any provision of Title X of the Act or from any rule issued under Title X as the Bureau determines “necessary or appropriate to carry out the purposes and objectives” of Title X. The purposes of Title X are set forth in section 1021(a) of the Act, which provides that the Bureau shall implement and, where applicable, enforce Federal consumer financial law consistently “for the purpose of ensuring that all consumers have access to markets for consumer financial products and services and that [such markets] are fair, transparent and competitive.”

The objectives of Title X are set forth in section 1021(b) of the Dodd-Frank Act. This section authorizes the Bureau to exercise its authorities under Federal consumer financial law for five specified purposes, two of which are relevant here. In particular, the Bureau may exercise its authorities under Federal consumer financial law for the purposes of ensuring that, with respect to consumer financial products and services: (1) Consumers “are provided with timely and understandable information to make responsible decisions about financial transactions;” (2) consumers “are protected from unfair, deceptive, or abusive acts and practices and from discrimination;” (3) “outdated, unnecessary, or unduly burdensome regulations are regularly identified and addressed in order to reduce unwarranted regulatory burdens;” (4) “Federal consumer financial law is enforced consistently, without regard to the status of a person as a depository institution, in order to promote fair competition;” and (5) “markets for consumer financial products and services operate transparently and efficiently to facilitate access and innovation.”

When issuing an exemption under section 1022(b)(3)(A) of the Dodd-Frank Act, the Bureau is required under section 1022(b)(3)(B) of the Act to take into consideration, as appropriate, three factors: (1) The total assets of the class of covered persons; (2) the volume of transactions involving consumer financial products or services in which the class of covered persons engages; and (3) existing provisions of law which are applicable to the consumer financial product or service and the extent to which such provisions provide consumers with adequate protections.

The conditional exemption for covered short-term loans in § 1041.6 is appropriate to carry out the purposes and objectives of Title X of the Dodd-Frank Act, for three primary reasons. First, § 1041.6 is consistent with the Bureau's statutory purposes and its statutory objective under section 1021(b)(5) of the Dodd-Frank Act: Seeking to implement Federal consumer financial law consistently to ensure that consumers have access to fair, transparent, and competitive markets for consumer financial products and services; and ensuring that such markets operate transparently and efficiently to facilitate access to consumer financial products and services. Section 1041.6 will help preserve access to credit by providing lenders with an option for making covered short-term loans that is an alternative to—and a conditional exemption from—the requirements of § 1041.5. Because lenders making these conditionally exempt loans under proposed § 1041.6 will be conditionally exempt from complying with the specific underwriting criteria under § 1041.5, making loans under § 1041.6 will reduce the compliance costs for lenders that make covered short-term loans relative to the costs of complying with the underwriting requirements under § 1041.5. This reduction in compliance costs will help facilitate access to credit.

Second, the conditional exemption for covered short-term loans is consistent with the Bureau's statutory objective under section 1021(b)(2) of the Dodd-Frank Act, which is to ensure that consumers are protected from unfair or abusive acts and practices. In § 1041.4, the Bureau has stated that it is an unfair and abusive practice for a lender to make covered short-term loans without making a reasonable determination that consumers have the ability to repay the loans according to their terms. In § 1041.5, the Bureau prevents this unfair and abusive practice by prescribing specific underwriting criteria for lenders making certain covered loans. Although lenders making conditionally exempt loans are not required to satisfy these same requirements, they will be required to satisfy the alternative requirements for the conditional exemption under § 1041.6. These alternative requirements are designed to protect consumers from the harms that result from lenders making covered short-term loans that are unaffordable—namely, default, delinquency, repeat borrowing, and collateral harms from making unaffordable loan payments. These are the same kinds of harms that the requirements in § 1041.5 were designed to address.

Third, the conditional exemption in § 1041.6 is consistent with the Bureau's statutory objective under section 1021(b)(1) of the Dodd-Frank Act to ensure that consumers are provided with timely and understandable information to make responsible decisions about financial transactions. Under § 1041.6(e), the Bureau is prescribing a series of disclosure requirements in connection with the making of these conditionally exempt loans. The disclosures notify the consumer about important aspects of how these transactions operate, and are designed to contribute significantly to consumers having timely and understandable information about taking out these conditionally exempt loans.

The Bureau also considered the statutory factors listed in section 1022(b)(3)(B) of the Dodd-Frank Act, as appropriate. The first two factors are not materially relevant because they pertain to exempting a class of covered persons, whereas § 1041.6 conditionally exempts a class of transactions from certain requirements of the rule. Nor did the Bureau base the conditional exemption on the third factor. Certain requirements under § 1041.6 are similar to requirements under certain applicable State and local laws. However, the Bureau is not aware of any State or locality that has combined all the elements that the Bureau has concluded are necessary or appropriate to adequately protect consumers from the risks and harms associated with unaffordable loans when covered short-term loans are not underwritten under the terms of § 1041.5.

The Bureau emphasizes that the conditional exemption in § 1041.6 is a partial exemption. That is, these conditionally exempt loans are still subject to all of the requirements of the Bureau's proposed rule other than the specific underwriting criteria in § 1041.5.

Sections 1032(a) and (b) of the Dodd-Frank Act—Disclosures

In § 1041.6(e), the Bureau is requiring disclosures related to covered short-term loans made under § 1041.6. The Bureau is doing so pursuant to its authority under section 1032(a) and (b) of the Dodd-Frank Act. Section 1032(a) of the Act provides that the Bureau may prescribe rules to “ensure that the features of any consumer financial product or service,” both initially and over the term of the product or service, are “fully, accurately, and effectively disclosed to consumers” in a manner that “permits consumers to understand the costs, benefits, and risks associated with the product or service, in light of the facts and circumstances.” This authority is broad, and it empowers the Bureau to prescribe rules on disclosures about the features of consumer financial products and services generally. Accordingly, the Bureau may prescribe disclosure requirements for particular features even if other Federal consumer financial laws do not specifically require such disclosures. Specifically, the Bureau is requiring lenders to provide notices before making the first and third loan in a sequence of conditionally exempt loans, which would inform consumers of the risk of obtaining such a loan and restrictions on taking out further conditionally exempt loans in a sequence.

Under section 1032(b)(1) of the Dodd-Frank Act, “any final rule prescribed by the Bureau under [section 1032] requiring disclosures may include a model form that may be used at the option of the covered person for provision of the required disclosures.” Any model form must contain a clear and conspicuous disclosure which, at a minimum, must use plain language comprehensible to consumers, contain a clear format and design, and succinctly explain the information that must be communicated to the consumer. Section 1032(b)(3) of the Act provides that any model form the Bureau issues shall have been validated through consumer testing. Accordingly, in developing the model forms for the proposed notices, the Bureau conducted two rounds of qualitative consumer testing in September and October of 2015, contracting with Fors March Group (FMG) to conduct qualitative user testing of the forms, which presented its results in the FMG Report. Dodd-Frank Act section 1032(d) provides that, “Any covered person that uses a model form included with a rule issued under this section shall be deemed to be in compliance with the disclosure requirements of this section with respect to such model form.”

6(a) Conditional Exemption for Certain Covered Short-Term Loans

Proposed Rule

In proposed § 1041.7(a), the Bureau proposed to establish a conditional exemption for certain covered short-term loans. Under proposed § 1041.7(a), a covered short-term loan that is made in compliance with the requirements set forth in proposed § 1041.7(b) through (e) would have been exempt from §§ 1041.4 through 1041.6. The Bureau also proposed in § 1041.7(a) to require the lender, in determining whether the proposed requirements in paragraphs (b), (c), and (d) are satisfied, to obtain information about the consumer's borrowing history from the records of the lender or its affiliates, and a consumer report from an information system registered under proposed § 1041.17(c)(2) or (d)(2).

Proposed comment 7(a)-1 explained that a lender could make a covered short-term loan without making the ability-to-repay determination under proposed § 1041.5, provided it complied with the requirements set forth in proposed § 1041.7(b) through (e). Proposed comment 7(a)-2 clarified that a lender cannot make a covered short-term loan under proposed § 1041.7 if no information system is both registered under proposed § 1041.17(c)(2) or (d)(2) and available when the lender seeks to make the loan. Proposed comment 7(a)-2 also clarified that a lender may be unable to obtain a report on the consumer's borrowing history if, for example, information systems are not yet operational or are temporarily unavailable.

Comments Received

Commenters urged the Bureau not to adopt the prohibition on making these conditionally exempt loans if no registered information system is operational and available. They argued that this requirement would be unfair or irrational because, even if a lender complied with all of the regulatory requirements under the alternative approach, the lender would still have to rely on a third-party reporting agency's compliance with the new and untested rules. One commenter observed that this was especially problematic given that most lenders will come to depend primarily on the approach to lending provided in the conditional exemption, and hence this restriction will reduce access to credit for consumers.

Consumer groups supported the requirement that a lender check a registered information system before making a conditionally exempt loan. They asserted that restrictions based on borrower history are the primary limit on conditionally exempt loans and that without this requirement the exemption would only work on a lender-by-lender basis. Because of the risk of multiple lenders making loans to the same borrower absent the requirement, the commenters argued that this requirement is appropriate.

Several commenters requested a safe harbor from the requirements in the rule where the lender relies on information from a registered information system where the information turns out to be incorrect. For example, if a borrower were to have previously taken out three consecutive conditionally exempt loans under proposed § 1041.7 at a different lender, and applied for a fourth such loan within 30 days at a new lender, and those prior three loans did not appear on the report obtained from the registered information system, one commenter believed the new lender should not be held liable for failing to comply with the requirements in proposed § 1041.7 when it makes the loan in accordance with the erroneous information that the registered information system had provided to it.

Final Rule

The final rule adopts § 1041.7(a) as proposed, renumbered in this final rule as § 1041.6(a), with some technical edits and one addition—that the information system from which the lender obtains a consumer report must have been registered for 180 days or more pursuant to § 1041.11(c)(2) or registered pursuant to paragraph (d)(2). In addition, the final rule clarifies that the lender must use this borrowing history information to determine a potential loan's compliance with the requirements in § 1041.6(b) and (c); the reference to § 1041.6(d) is removed. Lenders will not need to obtain a separate report from a registered information systems to comply with § 1041.6(d), which prohibits a lender from making a loan within 30 days of a conditionally exempt loan made by that lender itself (other than another conditionally exempt loan following the conditions of § 1041.6). And § 1041.6(c), as well as § 1041.5(d), restrict covered short-term loans made by other lenders, as well as loans made by the same lender and its affiliates.

The Bureau added the provision specifying that, when a lender is relying on a report from an information system registered pursuant to § 1041.11(c)(2) to satisfy § 1041.6, the registered information system must have been registered for 180 days or more. Under § 1041.10(b), a lender is not required to begin furnishing information to registered information systems registered pursuant to § 1041.11(c)(2) until 180 days after they are registered. A consumer report obtained from an information system registered for less than 180 days would not contain any information about borrowers' use of covered short-term and longer-term balloon payment loans.

In the final rule, the Bureau is retaining the proposed requirement that, prior to making a covered short-term loan under § 1041.6, a lender must review the consumer's borrowing history in its own records, the records of the lender's affiliates, and a consumer report from a registered information system. The Bureau concludes that lenders should not be permitted to make conditionally exempt loans under § 1041.6 if lenders do not obtain and review a report from a registered information system, even in instances where a report from a registered information system is unavailable. The Bureau maintains its view that reports from registered information systems are important for ensuring that the protections put in place by § 1041.6 are fully realized, and, based on outreach during the rulemaking process, the Bureau expects to register at least one information system sufficiently in advance of the compliance date of §§ 1041.5 and 1041.6 that reports from a registered information system will be available and may be relied upon on such date.

If no report from a registered information systems is available and a lender is therefore unable to obtain reliable information about a consumer's borrowing history with other lenders, the Bureau is concerned that conditionally exempt lending could result in consumers continuing to experience extended cycles of re-borrowing. Consumers could refinance a loan under § 1041.6 from one lender with another lender, and repeat continuously, severely undermining many of the protections contained in § 1041.6. In the unlikely circumstance that no information system has been registered for at least 180 days as of the compliance date of §§ 1041.5 and 1041.6, the Bureau will consider its options at that time, but does not at this time wish to leave open the possibility of § 1041.6 lending without lenders first obtaining borrower history from a registered information system. If lenders are unable to make loans under § 1041.6 absent a report from a registered information system, the Bureau has concluded that lenders will have an incentive to ensure that there is at least one registered information system that has been registered for at least 180 days as of the compliance date of §§ 1041.5 and 1041.6. If the Bureau were to allow lenders to make § 1041.6 loans without obtaining a report from a registered information system, the opposite could be true—industry would have an incentive to impede or slow the development of registered information systems.

The Bureau is finalizing comment 6(a)-1 as proposed, with the addition of citations of §§ 1041.8 and 1041.9 to clarify the meaning of “other applicable laws” (which in essence means that these conditionally exempt loans are still subject to the payment-related provisions of this rule). The Bureau has adjusted comment 6(a)-2 to clarify the requirement that the registered information system from which the lender obtains a consumer report must have been registered under § 1041.11(c)(2) for 180 days or more or must be registered under § 1041.11(d)(2).

The Bureau has added comment 6(a)-3 in response to commenters requesting a safe harbor when they rely on information obtained from a registered information system to make a loan determination and the information they are provided later turns out to have been erroneous. This comment clarifies that a lender is not responsible for inaccurate or incomplete information contained in a consumer report from a registered information system. If a lender relies on information obtained from a registered information system that is inaccurate, and based on that inaccurate information makes a loan that does not comply with the requirements of § 1041.6 because of inaccurate information in that report, the loan nonetheless qualifies for the exemption in § 1041.6.

6(b) Loan Term Requirements

In proposed § 1041.7(b), the Bureau proposed to require a covered short-term loan that is made under proposed § 1041.7 to comply with certain requirements as to the loan terms and structure. The requirements under proposed § 1041.7(b), in conjunction with the other requirements set forth in proposed § 1041.7(c) through (e), were presented as an alternative to the underwriting criteria specified in § 1041.5, and were likewise intended to reduce the likelihood that consumers who take out these conditionally exempt loans would suffer the competing harms of default, delinquency, re-borrowing, or the collateral harms from making unaffordable loan payments to avoid default. These proposed requirements were also intended to limit the harm to consumers if they are unable to repay the loan as scheduled.

6(b)(1)

Proposed Rule

In proposed § 1041.7(b)(1), the Bureau proposed certain principal amount limitations for a conditionally exempt loan. Specifically, proposed § 1041.7(b)(1)(i) would have required that the first loan in a sequence of conditionally exempt loans have a principal amount that is no greater than $500. Proposed § 1041.7(b)(1)(ii) would have required that the second loan in a sequence of conditionally exempt loans have a principal amount that is no greater than two-thirds the principal amount of the first loan in the sequence. Proposed § 1041.7(b)(1)(iii) would have required that the third loan in a sequence of conditionally exempt loans have a principal amount that is no greater than one-third of the principal amount of the first loan in the sequence.

Proposed comment 7(b)(1)-1 cross-referenced the definition and commentary for loan sequences. Proposed comment 7(b)(1)-2 clarified that the principal amount limitations apply regardless of whether the loans are made by the same lender, an affiliate, or unaffiliated lenders. Proposed comment 7(b)(1)-3 noted that the principal amount limitations under proposed § 1041.7 apply to both rollovers of an existing loan when they are permitted under State law and new loans that are counted as part of the same loan sequence. Proposed comment 7(b)(1)-4 gave an example of a loan sequence in which the principal amount is stepped down or amortized in increments of one-third.

The Bureau believed that the principal cap and principal reduction requirements under proposed § 1041.7(b)(1) were critical to reducing both the risk of extended loan sequences and the risk that the loan payments over a limited, shorter loan sequence would prove unaffordable for consumers. Because proposed § 1041.7 would not require the borrower to meet the underwriting criteria set forth in proposed § 1041.5 for a covered short-term loan, some consumers may not be able to repay these loans as scheduled. Absent further protections, these consumers would be in the position of choosing among the harms that borrowers confront when they have to make the payments on an unaffordable loan—default on the loan, or re-borrow, or fail to meet basic living expenses or other major financial obligations in an effort to avoid default as the loan comes due. As discussed in the proposal, the Bureau found that in this predicament, consumers in the market today generally re-borrow for the same amount as the prior loan, rather than pay off a portion of the principal and reduce their debt burden. As a result, consumers may face a similar situation when the next loan comes due and all succeeding loans after that, except that they have paid substantial fees for re-borrowing with every additional loan. The Bureau has found that this lack of principal reduction, or “self-amortization,” over the course of a loan sequence is correlated with higher rates of re-borrowing and default.

Proposed § 1041.7(b)(1) was designed to work in tandem with proposed § 1041.7(c)(3), which proposed to limit a loan sequence of these conditionally exempt loans to no more than three loans. The proposed requirements together would ensure that a consumer may not receive more than three consecutive covered short-term loans under proposed § 1041.7 and that the principal would decrease from a maximum of $500 on the first loan over the course of a loan sequence. The proposed principal reduction feature was intended to steadily reduce consumers' debt burden and permit them to pay off the original loan amount in its entirety in more manageable increments over the course of a loan sequence with three loans.

The Bureau believed that the proposed $500 limit for the first loan was appropriate in light of current State regulatory limits and would reduce the risks that unaffordable payments would cause consumers to default, re-borrow, or fail to meet basic living expenses or other major financial obligations during a loan sequence. Many State statutes authorizing payday loans impose caps on the loan amount, with $500 being a common limit. In States that have lower limits on loan amounts, those lower limits would prevail. In addition, the Bureau's empirical research found that average loan sizes are well under this threshold. Finally, without applying the underwriting criteria under proposed § 1041.5, the Bureau believed that loans with a principal amount larger than $500 would carry a significant risk of unaffordable payments.

The Bureau also gave extensive consideration to proposing an “off-ramp” for consumers who are struggling to repay a covered short-term loan, in lieu of the principal reduction structure. Under this approach, lenders would be required to provide a no-cost extension of the third loan in a sequence (the off-ramp) if a consumer is unable to repay the loan according to its terms.

The Bureau believed that the off-ramp approach would have three significant disadvantages relative to the principal reduction structure outlined above. First, an off-ramp, which began after a sequence of three loans, would delay the onset of the principal reduction and compel consumers to carry the burden of unaffordable payments for a longer time, increasing the likelihood of default and collateral harms from making unaffordable loan payments. Second, the Bureau believed that an off-ramp provision likely could not be designed in a way so as to ensure that consumers actually receive the off-ramp. The Bureau's analysis of State regulatory reports indicated that even where off-ramps are made available under State law, actual consumer use of available off-ramps has been quite limited. Third, to make an off-ramp approach less susceptible to such defects, additional provisions would be necessary, including disclosures alerting consumers to their rights to take the off-ramp and prohibitions on false or misleading information regarding off-ramp usage and collections activity prior to completion of the full loan sequence. These measures would be of uncertain effectiveness and would increase complexity, burdens on lenders, and challenges for enforcement and supervision.

Comments Received

Several industry commenters urged the Bureau not to adopt the $500 cap in proposed § 1041.7(b)(1) because it is too low. These groups argued that the Bureau had not sufficiently demonstrated that $500 was a large enough amount of money to meet consumer demand and that consumers routinely needed more money, especially for potential emergencies. One commenter was concerned that the $500 cap was inconsistent with the definition of small-dollar loans in some States and could lead to compliance problems and costs, causing lenders to leave the market and producing a reduction in available credit.

In contrast, consumer groups urged the Bureau not to adopt the $500 cap in the proposed rule because it is too high. The group argued that the median loan amount for current borrowers is $350 to $375 and this smaller median loan amount did not support the $500 cap.

Several commenters supported the principal reduction requirements in proposed § 1041.7(b)(1). An academic commenter suggested this feature would benefit borrowers by helping them make incremental progress on their loans, and argued that a 3-loan sequence would help provide borrowers with sufficient time to repay their loans.

Several consumer groups urged the Bureau not to adopt the conditional exemption, yet supported the 3-loan framework with an amortizing structure if the exemption was part of the final rule. Some commenters argued that roughly two-thirds of borrowers are unable to pay off these kinds of loans in three payments or less, so the provision would likely be ineffective, but stated that it may be worth trying nonetheless.

Several consumer groups and a legal services organization supported the Bureau's choice to use principal reduction and amortization instead of using off-ramps. These commenters asserted that consumers often are not informed about or are discouraged from using off-ramps, which makes them ineffective. In contrast, some industry commenters wrote in support of adding an off-ramp option. One said it would be more in keeping with existing approaches by the States and would adequately address the Bureau's concerns about the number of consecutive transactions in extended loan sequences.

Some industry commenters urged the Bureau not to adopt the proposed structure of three loans with amortization. They asserted that emergency expenses are not predictable, and so a rigid 3-loan schedule with amortization would not meet borrower needs.

Several industry commenters urged the Bureau to allow more conditionally exempt loans in order to reduce the size of the step-down between each loan, and thus reduce the amount that the borrower would be unable to re-borrow after each loan, which would also reduce the burden and impact on lenders by allowing more re-borrowing. A number of State Attorneys General similarly noted that some States have implemented smaller principal-repayment requirements that permit more rollovers and more time for consumers to repay. One commenter suggested that five step-down loans was a better limit than three because it would allow for smaller and more affordable payments. Another recommended a 4-loan sequence with an indebtedness limit of 104 days during a 12-month period.

In contrast, consumer groups urged the Bureau not to extend the number of loans. These commenters argued that increasing the number of loans from the proposed level of three loans even to four loans would result in more harm to borrowers because of the longer payment period.

Final Rule

The Bureau has considered the comments and is adopting proposed § 1041.7(b)(1), renumbered in this final rule as § 1041.6(b)(1), as proposed. The Bureau adopts proposed comments 7(b)(1)-1 through 7(b)(1)-4 as proposed, renumbered in this final rule as comments 6(b)(1)-1 through 6(b)(1)-4, with only technical modifications.

The Bureau does not agree with the industry commenters that urged the Bureau not to adopt the $500 cap because it is too low to meet consumer demand, especially for potential emergencies. The Bureau also does not agree with consumer groups that the Bureau should set the cap closer to the median loan amount for current borrowers of $350 to $375.

For the reasons discussed in the proposed rule and noted above, the Bureau has determined that the $500 limit for the first loan is appropriate in light of current State regulatory limits and ordinances, and will reduce the risks that unaffordable payments will cause consumers to default, re-borrow, or seek to avoid default by failing to meet basic living expenses or other major financial obligations over the course of a loan sequence. The Bureau's empirical research, confirmed by commenters, has also found that average loan sizes are well under this threshold. In addition, without applying the underwriting criteria set out in § 1041.5, the Bureau concludes that short-term loans with a principal amount larger than $500 would carry a significant risk of having unaffordable payments with the ensuing harms to consumers that are discussed more fully above in Market Concerns—Underwriting. Of course, lenders could always choose to proceed by underwriting loans according to the criteria set out in § 1041.5, or they could instead make other types of loans that are not covered by the rule, in amounts higher than $500 to the extent permitted by State law.

Similarly, the Bureau is not persuaded by the concern that the $500 cap is inconsistent with the definition of small-dollar loans in some States, and could lead to compliance problems and costs that would cause lenders to leave the market and reduce the availability of credit. The Bureau determined that many State statutes authorizing payday loans already impose caps on the loan amount, with $500 as a common limit. In States with lower limits on loan amounts, those lower limits would prevail. In States with higher limits, lenders could still make underwritten loans under § 1041.5 at those higher amounts.

The Bureau also concludes that the 3-loan step-down will provide borrowers with sufficient time to repay the loan and mitigate harm to borrowers. It adopted this framework for § 1041.6(b)(1) of the final rule in an attempt to balance the interests of limiting re-borrowing while also providing for a gradual step-down. For each additional loan, the step-down would be less steep (i.e., the amount that would not be refinanced and thus would need to be “repaid” would decrease), but the borrower would incur that much more re-borrowing. For example, if the Bureau adopted a 5-loan limit, the second loan would be 80 percent of the original, the third loan 60 percent, the fourth loan 40 percent, and the fifth loan 20 percent. That would allow for more affordable payments, but would also add two additional loans, with the attendant costs. Ultimately, the Bureau had to determine where to draw the line, which is often an unavoidable exercise in the rulemaking process, and it concluded that the combination of the $500 cap and the 3-loan step-down, resulting in fees from three loans and a maximum “repayment amount” of $166.66 (the amount not refinanced on each step) in principal for each loan, strikes a reasonable balance between these competing concerns.

The Bureau recognizes that some borrowers may not be able to use loans under § 1041.6 to meet new credit needs because of the step-down in loan amounts for the second and third conditionally exempt loan. For example, a borrower who takes out a first loan of $300 under § 1041.6, and then has a new need arise before 30 days has passed, would only be able to take out a further loan of $200 (which is the remaining amount under the principal cap), which may not be sufficient to cover the need. But, as stated above, and in the discussion for § 1041.6(c) and (d), borrowers who return for loans within a 30-day period are often re-borrowing because of difficulty in repaying their previous loan and meeting their obligations rather than taking out a new loan in response to a new need that is separate and independent from the original need. Further, those borrowers may be able to get other types of credit from other lenders to supplement the amount obtainable under § 1041.6, including a loan that would be underwritten in accordance with the provisions of § 1041.5.

One further benefit from the limitations on re-borrowing imposed in the principal cap and the principal reduction feature in § 1041.6(b)(1), as mentioned earlier, is that they are likely to improve the care and consideration with which lenders make these conditionally exempt loans, even though they are not required to be underwritten in accordance with the criteria specified in § 1041.5. As noted above in Market Concerns—Underwriting, a major reason why lenders in this market are willing to lend to borrowers who are unable to repay their loans is that the costs of default are substantially offset by the revenues generated by high levels of re-borrowing; and indeed, many defaults may be deferred rather than immediate because the borrower can opt to re-borrow some number of times—and often in extended loan sequences—before finally defaulting. By strictly limiting the amount of re-borrowing that can occur with loans made under § 1041.6, the Bureau's conditional exemption thus is likely to lead to improved underwriting of these loans, even without imposing any mandatory underwriting criteria upon their origination.

6(b)(2)

Proposed Rule

Proposed § 1041.7(b)(2) would have imposed certain safeguards in the event that a lender chose to structure the loan with multiple payments, such as a 45-day loan with three required payments. Under the proposed requirement, the loan would have required payments that are substantially equal in amount, fall due in substantially equal intervals, and amortize completely during the term of the loan. Proposed comment 7(b)(2)-1 provided an example of a loan with an interest-only payment followed by a balloon payment, which would not satisfy the loan structure requirement under proposed § 1041.7(b)(2).

The requirement under proposed § 1041.7(b)(2) was intended to address covered short-term loans made under proposed § 1041.7 that are structured to have multiple payments. Absent the requirements in proposed § 1041.7(b)(2), the Bureau was concerned that lenders could structure loans to pair multiple interest-only payments with a significantly larger payment of the principal amount at the end of the loan term. The Bureau believed that consumers are better able to manage repayment obligations for payments that are due with reasonable frequency, in substantially equal amounts, and within substantially equal intervals.

Comments Received

One commenter urged the Bureau not to adopt the approach in proposed § 1041.7(b)(2) that requires a payment schedule based on applying a fixed rate of interest. It observed that the States generally regulate payday loan finance charges by limiting fees charged per amount lent instead of using an interest rate, and argued that requiring a payment schedule based on an interest rate would force lenders to reprogram their systems on a scale that goes beyond the Bureau's statutory mandate.

On the other hand, several consumer groups supported the Bureau's proposal to allow multi-payment loans under the exemption, assuming it remained a part of the rule. They asserted that the risk of including the multi-payment loans did not increase the inherent risk of the exemption. They also supported the position taken in the proposal that permitting balloon payments for multiple-payment loans under the conditional exemption would be antithetical to the purpose of the exemption.

Final Rule

The Bureau has considered the comments and is adopting proposed § 1041.7(b)(2), renumbered in this final rule as § 1041.6(b)(2), as proposed. The Bureau also adopts proposed comment 7(b)(2)-1 as proposed, renumbered in this final rule as comment 6(b)(2)-1, with only technical modifications.

As discussed in more detail in the proposed rule and above, § 1041.6(b)(2) provides certain safeguards in the event that a lender chooses to structure a covered short-term loan with multiple payments. Absent the requirements in § 1041.6(b)(2), the Bureau is concerned that lenders could structure loans to pair multiple interest-only payments with a significantly larger payment of the principal amount at the end of the loan term. The Bureau has concluded that consumers are better able to manage repayment obligations for payments that are due with reasonable frequency, in substantially equal amounts, and within substantially equal intervals. The Bureau agrees with commenters that the principal reduction feature will help borrowers make incremental progress on loans. The Bureau also judges that the concern regarding supposed inconsistency with State laws is overstated. Section 1041.6(b)(2) only applies in circumstances where one individual loan has multiple payments, and there is nothing in the text of § 1041.6(b)(2) that limits the imposition of fees, so long as the fees are repaid equally during every scheduled payment.

6(b)(3)

Proposed Rule

In proposed § 1041.7(b)(3), the Bureau proposed to prohibit a lender, as a condition of making a covered short-term loan under proposed § 1041.7, from obtaining vehicle security, as defined in proposed § 1041.3(d). A lender seeking to make a covered short-term loan with vehicle security would have had to make an ability-to-repay determination under proposed § 1041.5 instead. Proposed comment 7(b)(3)-1 clarified this prohibition on a lender obtaining vehicle security on a conditionally exempt loan.

The Bureau proposed this requirement because it was concerned that some consumers obtaining a loan under proposed § 1041.7, without meeting the underwriting criteria in proposed § 1041.5, would not be able to afford the payments required to pay down the principal over a sequence of three loans. Allowing lenders to obtain vehicle security in connection with such loans could substantially increase the harm to consumers by putting their vehicle at risk. The Bureau believed the proposed requirement would protect consumers from the harms of default, re-borrowing, and making unaffordable loan payments to avoid defaulting on covered short-term vehicle title loans. First, the Bureau was particularly concerned about default that could result in the loss of the consumer's vehicle, which could jeopardize their livelihood or their ability to carry out essential everyday affairs. The Bureau found that sequences of short-term vehicle title loans are more likely to end in default than sequences of payday loans are, and that fully 20 percent of loan sequences of single-payment vehicle title loans result in repossession of the consumer's vehicle. Second, due to the potentially serious consequences of defaulting on title loans, the Bureau was concerned that consumers may take extraordinary measures to repay such loans and, as a result, would suffer harm from failing to meet basic living expenses or other major financial obligations. Third, even with the other protections against re-borrowing in proposed § 1041.7, the Bureau was concerned that, due to the serious consequences of defaulting on vehicle title loans, consumers may feel pressure to re-borrow up to the maximum allowed on unaffordable vehicle title loans.

Furthermore, the Bureau believed that proposed § 1041.7(b)(3) is necessary or appropriate to restrict lenders' incentives to make these conditionally exempt loans with unaffordable payments. Because loan sequences would be limited to a maximum of three conditionally exempt loans under proposed § 1041.7(c)(3) and subject to principal reduction under § 1041.7(b)(1), the Bureau believed a lender that makes these conditionally exempt loans would have a strong incentive to underwrite effectively, even without having to comply with the specific underwriting criteria in proposed § 1041.5. However, with vehicle title loans, in which the lender obtains a security interest in an asset of significantly greater value than the principal amount on the loan, the Bureau was concerned that a lender would have much less incentive to evaluate the consumer's ability to repay, because the lender could always simply repossess the vehicle if the loan were not repaid in full, even after the first loan in the sequence.

Comments Received

Consumer groups supported the proposed prohibition on auto title lending under the conditional exemption in proposed § 1041.7. They asserted that the repossession of a borrower's vehicle represented significant harm, especially given the high rate of repossessions. They argued that the harm from repossession is so severe that lenders should not be allowed to make vehicle title loans without assessing ability to repay.

In contrast, commenters associated with the vehicle title lending industry wrote in opposition to the proposed prohibition on title lending under the conditional exemption. An industry trade association argued that requiring all short-term vehicle title loans to satisfy the proposed ability-to-repay standards would have a devastating impact on lenders and on the availability of such loans. They argued that the Bureau had not sufficiently demonstrated that vehicle title lending presents greater risks than other forms of short-term lending and had overstated the rate and impact of repossession, asserting that only about 8 percent of title loans result in repossession. The commenter further argued that the Bureau had exaggerated the effects of repossession, contending that many consumers own a second vehicle and that surveys indicate consumers would have alternative transportation options if their vehicle were repossessed. The industry trade association also argued that the prohibition was inconsistent with the Bureau's mandate to regulate the market fairly and consistently, and that by prohibiting vehicle title lenders from using the conditional exemption the proposed rule would provide an unfair advantage for other types of lenders.

Final Rule

The Bureau has considered the comments and, for the reasons noted in the proposal and above and for the additional reasons discussed below, is adopting proposed § 1041.7(b)(3), renumbered in this final rule as § 1041.6(b)(3), as proposed. The Bureau is also adopting comment 7(b)(3)-1 as proposed, renumbered as comment 6(b)(3)-1. The Bureau concludes, as the consumer groups argued, that the risk of severe consumer harm from repossession of the borrower's vehicle makes it inappropriate to allow lenders to make covered short-term vehicle title loans without satisfying the underwriting requirements in § 1041.5. The Bureau does not agree with the argument of the title lending industry commenters that the Bureau had not sufficiently demonstrated that vehicle title lending presents greater risks than other forms of short-term lending.

The structure of § 1041.6 is intended to reduce defaults and re-borrowing, and if lenders were permitted to make vehicle title loans under this structure, the protections in § 1041.6 might reduce defaults and repossessions to some degree. But the Bureau is concerned that the reduction in defaults may be less likely than for unsecured short-term loans, such as payday loans. As noted in the proposal, as a general matter in this market, sequences of short-term vehicle title loans are more likely to end in default than sequences of payday loans are. Although an industry commenter argued that the Bureau had overstated the rate of repossession, that commenter focused on the per-loan default rate. As discussed in Market Concerns—Underwriting, the Bureau has concluded that a per-sequence rather than per-loan default rate provides a better measure for short-term loans. One in five loan sequences of single-payment vehicle title loans result in repossession of the consumer's vehicle. Moreover, as noted above, once the revenues from repeated re-borrowing are constrained, as they are by the conditions imposed in § 1041.6, the incentive for lenders to make unsecured loans on which the borrower is likely to default are sharply diminished. But the change in incentives is far less pronounced for vehicle title loans, where even as re-borrowing revenues decrease, the lender still has the leverage of a fully securitized loan available to cope with any defaults.

Therefore, even with the protections of § 1041.6, there would still be some borrowers who cannot afford to repay loans made under § 1041.6. And for the reasons just stated, there are likely to be more such borrowers of vehicle title loans than of other covered short-term loans. In addition, the harm produced by unaffordable title loans is greater than for other such loans. If lenders could take vehicle security for loans under § 1041.6, then consumers who could not afford to repay their loans would face the threat of having their vehicles repossessed, and, in many cases, would suffer the severe harms of repossession. The harms from repossession (and comments about those harms) are discussed above in Market Concerns—Underwriting and in the section-by-section discussion of § 1041.4, and, contrary to the assertions by industry commenters, the Bureau has concluded that such harms are often severe. First, consumers facing repossession would suffer the potential loss of transportation to work or school and for many other everyday activities, such as securing food and health care, with consequential losses that may greatly exceed the original cost of the loan. Second, due to the potentially serious consequences of defaulting on title loans, the Bureau is concerned that consumers may take extraordinary measures to repay such loans and, as a result, would suffer greater harm more frequently from failing to meet basic living expenses or other major financial obligations. Third, even with the other protections against re-borrowing in § 1041.6, the Bureau is concerned that, due to the serious consequences of defaulting on vehicle title loans, consumers may feel greater pressure to re-borrow up to the maximum allowed on unaffordable vehicle title loans, since a vehicle title loan is less likely to be repaid after one loan than are other types of covered short-term loans.

In addition, there are still other economic collateral harms of repossession, which is usually a self-help process performed by agents of the lender and which often results in significant consumer fees associated with the costs of the repossession and preparing a vehicle for auction. These processes can put the consumer at greater risk of harm, and often more severe harm, than when a consumer defaults on an unsecured loan. The Bureau has observed typical repossession fees charged to borrowers ranging from $100 to $400 or even higher, which could be larger than the small balance of the defaulted loan made under § 1041.6 (with a maximum of $500 on the first loan, $333.33 on the second loan, and $166.66 on the third loan). And there are additional harms often associated with repossessions, including the potential loss of any property in the vehicle. These harms persist even in States that limit vehicle title lending to so-called non-recourse loans.

For all of these reasons, vehicle title loans that are not subject to the specific underwriting criteria of § 1041.5 present significant additional risks as compared to unsecured loans that are not subject to § 1041.5. Moreover, the harms to consumers that flow from these risks are greater for vehicle title loans. Accordingly, the Bureau has concluded that it is appropriate in § 1041.6 to require lenders making such loans not to take a security interest in the consumer's vehicle.

The Bureau recognizes that, because lenders making short-term vehicle title loans are highly dependent on the revenue from re-borrowing, requiring short-term vehicle title loans to comply with the ability-to-repay requirements in § 1041.5 will have a significant impact on such lenders. Title lenders that are unable to adjust their business models or obtain a license to make unsecured small-dollar loans or installment title loans thus may face greater challenges than payday lenders because they would not be able to make loans under § 1041.6 that would be exempt from the ability-to-repay requirements of § 1041.5. (The Bureau notes that, by its own count, 18 of the 24 States that permit title lending allow title installment lending that would not be covered by § 1041.5.) Nonetheless, the Bureau concludes that, under § 1041.6, covered short-term loans with vehicle security would present more risks and more severe harms than unsecured covered short-term loans. The Bureau therefore is requiring that if a lender takes a security interest in the consumer's vehicle, then it must underwrite any covered short-term loans that it makes pursuant to § 1041.5. Finally, since the rule does not differentiate based on whether a lender is a depository or non-depository lender, or based on any other characteristics of the lender, and instead makes differentiations based on the loan products themselves and the risks associated with them, the Bureau is not imposing inconsistent obligations here on lenders based on their status as depository or non-depository lender.

6(b)(4)

Proposed § 1041.7(b)(4) would have required that, as a condition of making a covered short-term loan under proposed § 1041.7, the loan must not be structured as an open-end loan. Proposed comment 7(b)(4)-1 clarified this prohibition on a lender structuring a conditionally exempt loan as an open-end loan. The Bureau was concerned that permitting open-end loans under proposed § 1041.7 would present significant risks to consumers, as consumers could repeatedly draw down credit without the lender ever determining the consumer's ability to repay. In practice, consumers could re-borrow serially on a single conditionally exempt loan that was structured as an open-end loan. The Bureau also believed that attempting to develop restrictions for open-end loans in proposed § 1041.7 would add undue complexity without providing appreciable benefit for consumers. The Bureau received very limited comments on this provision, with consumer groups supporting the Bureau's proposed prohibition on using the conditional exemption to extend open-end credit and agreeing with its rationale.

For the reasons stated, the Bureau is adopting the proposed prohibition against structuring loans as open-end loans under the conditional exemption, now renumbered as § 1041.6(b)(4). The Bureau is also adopting proposed comment 7(b)(4)-1, renumbered as comment 6(b)(4)-1.

6(c) Borrowing History Requirements

The Bureau proposed to require lenders to determine that the borrowing history requirements under proposed § 1041.7(c), renumbered in this final rule as § 1041.6(c), are satisfied before making a conditionally exempt loan. The Bureau is finalizing this paragraph as proposed, with a few adjustments to reduce redundancy and to reflect the fact that the Bureau is not finalizing the rule as to covered longer-term loans at this time, yet is finalizing the underwriting requirements for covered short-term and longer-term balloon-payment loans in one section, § 1041.5 of the final rule.

One adjustment that the Bureau is making, in particular, is not to finalize proposed § 1041.7(c)(1), which would have required a lender to determine, before making a conditionally exempt loan, that the consumer does not have a covered outstanding loan made under proposed § 1041.5, § 1041.7, or § 1041.9, not including a loan made by the same lender or its affiliate under proposed § 1041.7 that the lender is rolling over. As a result of this change, the Bureau also is not adopting proposed comments 7(c)(1)-1 and 7(c)(1)-2. For purposes of simplification and in light of other changes made to the rule, the Bureau has concluded that this proposed provision could be consolidated with § 1041.7(c)(2), which addresses restrictions on taking out conditionally exempt loans in light of prior loans in specified circumstances. As a result of eliminating § 1041.7(c)(1), the other proposed paragraphs of § 1041.7(c) and the proposed comments are all renumbered in the final rule to conform to this change.

6(c)(1)

Proposed Rule

Proposed § 1041.7(c)(2) would have required that, prior to making a covered short-term loan under proposed § 1041.7, the lender must determine that the consumer has not had an outstanding loan in the past 30 days that was either a covered short-term loan made under proposed § 1041.5 or a covered longer-term balloon-payment loan made under proposed § 1041.9. The requirement under proposed § 1041.7(c)(2) would have prevented a consumer from obtaining a covered short-term loan under proposed § 1041.7 soon after repaying a covered short-term made under proposed § 1041.5 or a covered longer-term balloon-payment loan made under proposed § 1041.9. Proposed comment 7(c)(2)-1 explained that this requirement would apply regardless of whether the prior loan was made by the same lender, an affiliate of the lender, or an unaffiliated lender. The proposed comment also provided an illustrative example.

Proposed § 1041.7(c)(2) would have protected consumers who lack the ability to repay a current or recent covered short-term or longer-term balloon-payment loan from the harms of a covered short-term loan made without meeting the specific underwriting criteria in proposed § 1041.5. As explained above, the Bureau observed that such re-borrowing frequently reflects the adverse budgetary effects of the prior loan and the unaffordability of the new loan.

Moreover, the Bureau believed that permitting a consumer to transition from a covered short-term loan made under proposed § 1041.5 or a covered longer-term balloon-payment loan made under proposed § 1041.9 to a covered short-term loan made under proposed § 1041.7 would be inconsistent with the basic purpose of proposed § 1041.7. As previously noted, proposed § 1041.7 creates an alternative to the underwriting criteria specified in proposed § 1041.5 and features carefully structured consumer protections. If lenders were permitted to make a conditionally exempt loan shortly after making a covered short-term loan under proposed § 1041.5 or a covered longer-term balloon-payment loan under proposed § 1041.9, it would be very difficult to apply all of the requirements under proposed § 1041.7 that are designed to protect consumers. If a consumer were permitted to transition from a proposed § 1041.5 loan to a covered short-term loan made under proposed § 1041.7, for example, the principal reduction requirements under proposed § 1041.7(b)(1) would be undermined.

The Bureau also believed that providing separate paths for covered short-term loans that are made under the specific underwriting criteria in proposed § 1041.5 and under the framework in proposed § 1041.7 would make the rule's application more consistent across provisions and also simpler for both consumers and lenders. The Bureau intended these two proposed lending frameworks to work in tandem, but not in harness, to ensure that lenders could not transition consumers back and forth between covered short-term loans made pursuant to the underwriting criteria specified in proposed § 1041.5 and those made without the same criteria but subject to other consumer protections under proposed § 1041.7. Furthermore, with these proposed provisions in place, and with the two lending frameworks largely kept separate from one another, consumers and lenders would have clear expectations of the types of covered short-term loans that they could and could not make if the consumer were to re-borrow.

Comments Received

Several commenters, including a coalition of consumer groups, two non-profit groups, three faith-based groups, and a State Attorney General urged the Bureau to increase the cooling-off periods in proposed § 1041.7(c), including the cooling-off period in proposed § 1041.7(c)(2) so that, after making a covered short-term loan under § 1041.5, a lender would have to wait 60 days, rather than 30 days, before it could make a conditionally exempt loan under § 1041.6. They argued that a 60-day cooling-off period was more appropriate and more protective, and would do more to help ensure that loans were affordable.

On the other hand, industry commenters generally opposed having a cooling-off period of any length, arguing that it would restrict access to credit for consumers with emergency or unexpected needs that may arise during the cooling-off period. Commenters argued that covered loans are often used for unexpected expenses, which can happen at any time, and that a cooling-off period would harm consumers by restricting their flexibility and reducing access to credit when borrowers needed it.

A large number of individual commenters, including payday loan customers, also criticized the cooling-off periods, objecting to the prospect that they would be restricted from getting more credit after paying off a prior loan.

Final Rule

The Bureau is finalizing proposed § 1041.7(c)(2), renumbered as § 1041.6(c)(1), with a few adjustments. For purposes of simplification and in light of other changes made to the rule, the Bureau has concluded that proposed § 1041.7(c)(1) and (2) can be consolidated together, with technical corrections to accommodate changes to other sections of the rule, including the fact that the underwriting requirements for covered longer-term loans (other than those with balloon payments) are not being finalized. Accordingly, § 1041.6(c)(1) provides that a condition of making a loan under § 1041.6 is that the consumer has not had in the past 30 days an outstanding covered short-term loan under § 1041.5 or a covered longer-term balloon-payment loan under § 1041.5. The Bureau is also adopting proposed comment 7(c)(2)-1, renumbered as 6(c)(1)-1, with similar adjustments.

In response to the commenters that had advocated extending the cooling-off period to 60 days, the Bureau continues to rely on the research and analysis that were used initially to set the 30-day re-borrowing period. In the proposal, the Bureau had chosen the cooling-off period to match the re-borrowing period because the primary objective served by cooling-off periods in this rule is to prevent re-borrowing. The main approach to preventing re-borrowing is to separate out any linkage between different types of loans or different permitted loan sequences by having sufficient time pass to diminish the plausibility that the prior loan was paid off only by taking out another loan that provided the money to do so. Under the Bureau's definition, based on its analysis of the market, loans made after 30 days would not be considered re-borrowing. The Bureau's research found that the number of loans in the average loan sequence increases when the re-borrowing window for identifying a sequence increases from 14 days to 30 days, suggesting that borrowers are returning to re-borrow within 30 days.

The Bureau also concluded that a 30-day cooling-off period is a reasonable and sufficient representation of most consumers' debt and payment cycles. Because payments for basic living expenses and most major financial obligations are due at least monthly, if not more frequently, the Bureau concludes that a consumer who goes more than 30 days between two short-term loans is more likely to be experiencing a new need, rather than continuing to service the need that gave rise to the prior loan, and thus extending the same cycle of indebtedness. The Bureau thus has concluded that setting a cooling-off period of 30 days between a § 1041.5 loan and a § 1041.6 loan is a reasonable exercise in line-drawing that is likely to prevent the perpetuation of hard-to-escape cycles of indebtedness, while allowing consumers greater flexibility for borrowing to cover emergency or other unexpected expenses. While the Bureau acknowledges that a 60-day cooling-off period would do even more to prevent re-borrowing, as some consumers might be able to shuffle around certain expenses in order to reach day 31 in order to re-borrow, the Bureau concludes that the number of such loans is likely to be small given the data noted above, and that preventing relatively few additional consumers from remaining in a cycle of debt is not worth restricting credit to other consumers who may need it for genuine emergency expenses and new needs that may arise during that period (and subject to the protections conferred by this rule).

As for the commenters who objected to cooling-off periods of any kind, including many individual commenters, the effect of this provision is that for 30 days after a § 1041.5 loan, a borrower would not be eligible for a § 1041.6 loan. The Bureau notes that where a lender has already made a § 1041.5 loan, the borrower has succeeded in demonstrating the ability to repay the loan in accordance with the underwriting criteria set forth in § 1041.5 and presumably is likely to continue to qualify for further loans by meeting that same standard. Therefore, if borrowers in that situation are now seeking a § 1041.6 loan instead, that may be because their circumstances have changed and they are now struggling to repay their loans and could no longer meet the underwriting criteria required by § 1041.5. To prevent lenders from using a mixture of § 1041.5 loans and § 1041.6 loans to create continuous cycles of debt where the borrower is confronting unaffordable loans, which would defeat a central purpose of § 1041.6, the Bureau has set this specific restriction. For the same reason of avoiding a mix of loans that could defeat the protections that the Bureau has intended to confer upon consumers under § 1041.6 (although the circumstances are somewhat different), the Bureau has also specified that no lender can make a § 1041.5 loan within 30 days of a § 1041.6 loan.

6(c)(2)

Proposed Rule

Proposed § 1041.7(c)(3) would have provided that a lender cannot make a covered short-term loan under proposed § 1041.7 if the loan would result in the consumer having a loan sequence of more than three conditionally exempt loans made by any lender. Proposed comment 7(c)(3)-1 would have clarified that this requirement applies regardless of whether any or all of the loans in the loan sequence are made by the same lender, an affiliate, or unaffiliated lenders, explained that loans that roll over count toward the sequence as well, and included an example.

The Bureau proposed § 1041.7(c)(3) for several reasons. First, the limitation on the length of loan sequences was aimed at preventing further harms from re-borrowing. Second, the Bureau believed that a 3-loan limit would be consistent with evidence presented in the Bureau's Supplemental Findings on Payday Loans, Deposit Advance Products, and Vehicle Title Loans, that approximately 38 percent of new loan sequences end by the third loan without default. Third, a 3-loan limit would work in tandem with the main restrictions in proposed § 1041.7(b)(1) to allow consumers to repay a covered short-term loan in manageable one-third increments over a loan sequence. Fourth, the Bureau concluded that a 3-loan limit would provide lenders with a strong incentive to evaluate the consumer's ability to repay before making conditionally exempt loans, albeit without complying with the specific underwriting criteria in proposed § 1041.5.

Comments Received

As noted above, a number of commenters urged the Bureau to increase the cooling-off periods in proposed § 1041.7(c) from 30 days to 60 days, including also the period after a borrower had received three loans under the conditional exemption in proposed § 1041.7. It should be noted that though proposed § 1041.7(c)(3) simply prohibited a lender from making a loan that would result in a consumer having a loan sequence of more than three loans under proposed § 1041.7, this provision in combination with the definition of loan sequence under proposed § 1041.2(a)(12) in effect created a 30-day cooling-off period after a three-loan sequence. Here too, consumer groups and others argued that a 60-day cooling-off period would be more protective of consumers and would help ensure that loans were more affordable.

Industry commenters again were generally opposed to a cooling-off period after the loan sequence had ended, contending that it would restrict access to credit for consumers generally, including those with unexpected needs that could come up during a time when the borrower is not permitted to obtain another loan. Relatedly, and as discussed above, several industry commenters raised concerns about whether a three-loan sequence was the appropriate length for sequences of loans made under the conditional exemption, and suggested that the conditional exemption should permit longer loan sequences.

As previously mentioned, large number of individual commenters, including payday loan customers, took issue with the cooling-off period and expressed concern that they might be blocked from getting a loan when they need it.

Final Rule

The Bureau is finalizing proposed § 1041.7(c)(3), renumbered as § 1041.6(c)(2) with certain technical edits. The Bureau is also adopting proposed comment 7(c)(3)-1, renumbered as comment 6(c)(2)-1, with technical edits.

Again, for much the same reasons as explained in the preceding discussion, the Bureau has relied on the same basic research and analysis to set the 30-day re-borrowing period and then has chosen this cooling-off period to match the re-borrowing period. Again, at the end of a 3-loan sequence the purpose of the cooling-off period remains essentially the same, which is to prevent re-borrowing by preventing the borrower from linking different types of loans or different permitted sequences in such a manner as to continue taking out new loans or re-borrowing as the means of paying off the prior loans. Again, loans made after 30 days would not be considered re-borrowing under the Bureau's definition.

As discussed above, the Bureau has determined that a 30-day period is a sound representation of most consumers' debt and payment cycles. Because payments for basic living expenses and most major financial obligations are due at least monthly, if not more frequently, the Bureau concludes that a consumer who goes more than 30 days between loans is more likely to be experiencing a new need, rather than continuing to labor under pressure from the need that gave rise to the prior loan, and thus to be extending a cycle of indebtedness. The Bureau therefore determines that 30 days is a reasonable line to draw in setting a cooling-off period after completing a 3-loan sequence. Again, it helps prevents the perpetuation of hard-to-escape cycles of indebtedness, while allowing greater flexibility for further borrowing as needed to cover emergency or other unexpected expenses. While the Bureau acknowledges that a 60-day cooling-off period would be even more protective of consumers, as some might be able to stretch certain expenses in order to exceed the 30-day cycle before having to re-borrow, the Bureau concludes that the number of such loans will be small and is outweighed by the benefits of having more credit available (with the other protections afforded by this rule) to consumers to meet any new needs that may arise during that period.

As for the commenters that opposed a 30-day cooling-off period after three § 1041.6 loans, the Bureau acknowledges that some borrowers may experience a bona fide new need during that 30-day period and would be prevented from obtaining a new loan. As noted above when discussing the re-borrowing period, the Bureau concludes that borrowing within 30 days of a prior covered short-term loan will more typically reflect the continuing pressure that leads to re-borrowing rather than the emergence of a separate and independent need that prompts the borrower to take out a new loan. One of the primary purposes of this rule is to prevent consumers from falling into long-term re-borrowing cycles that result from loans with unaffordable payments. The Bureau concludes that the rule would fall far short of one of its chief purposes of preventing the risks and harms associated with unaffordable loans if § 1041.6 were to allow re-borrowing to create extended loan sequences in the period immediately after a 3-loan sequence has just been completed. Some built-in mechanism to disrupt a re-borrowing cycle is necessary or appropriate, and the Bureau has concluded that a cooling-off period of 30 days is the most effective way to accomplish that.

Finally, the rationale for limiting loan sequences under § 1041.6(c)(3) to three loans is discussed above in the section-by-section analysis of § 1041.6(b)(1) and that discussion is incorporated here.

6(c)(3)

Proposed Rule

Proposed § 1041.7(c)(4) would have required that a covered short-term loan made under proposed § 1041.7 cannot result in the consumer having more than six such loans outstanding during any consecutive 12-month period or having covered short-term loans outstanding for an aggregate period of more than 90 days during any consecutive 12-month period. The lender would have to determine whether any such loans were outstanding during the consecutive 12-month period. If a consumer obtained a covered short-term loan prior to that period and was obligated on the loan during part of the period, this loan and the time it was outstanding during the consecutive 12-month period would count toward these overall limits.

Under proposed § 1041.7(c)(4), the lender would have to count the proposed new loan toward the loan limit and count the anticipated contractual duration of the new loan toward the indebtedness limit. Under the proposal, because the new loan and its proposed contractual duration would count toward these limits, the lookback period would not start at the consummation date of the new loan. Instead, the lookback period would start at the proposed contractual due date of the final payment on the new loan and consider the full 12 months immediately preceding this date.

Proposed comment 7(c)(4)-1 would have clarified that a consecutive 12-month period begins on the date that is 12 months prior to the proposed contractual due date of the new conditionally exempt loan and ends on the proposed contractual due date. Proposed comment 7(c)(4)-1 would have explained further that the lender would have to obtain information about the consumer's borrowing history on covered short-term loans for the 12 months preceding the proposed contractual due date on that loan, and it also provided an example.

As a general matter, the Bureau was concerned about consumers' frequent use of covered short-term loans made under proposed § 1041.7 for which lenders would not have been required to underwrite the loan in accordance with the criteria specified in proposed § 1041.5. The frequent use of covered short-term loans that do not require such an assessment may be a signal that consumers are struggling to repay such loans without re-borrowing. For purposes of determining whether the making of a loan would satisfy the loan and indebtedness limits in proposed § 1041.7(c)(4), the Bureau proposed to require the lender also to count covered short-term loans made under both proposed § 1041.5 and proposed § 1041.7. Although loans made under proposed § 1041.5 would require the lender to make a reasonable determination of a consumer's ability to repay, the Bureau believed that the consumer's decision to seek a conditionally exempt loan, after previously obtaining a covered short-term loan based on the underwriting criteria in proposed § 1041.5, suggested that the consumer may now lack the ability to repay the loan and that the earlier loan approval may not have fully captured this particular consumer's expenses or obligations. Under proposed § 1041.7(c)(4), consumers could receive up to six conditionally exempt loans and accrue up to 90 days of indebtedness on these loans, assuming the consumer did not also have any covered short-term loans made under proposed § 1041.5 during the same period. Because the duration of covered short-term loans is typically tied to how frequently a consumer receives income, the Bureau believed that the two overlapping proposed requirements were necessary to provide more complete protections for consumers.

Proposed § 1041.7(c)(4)(i) included the proposed requirement that a covered short-term loan made under proposed § 1041.7 cannot result in the consumer having more than six covered short-term loans outstanding during any consecutive 12-month period. Proposed comment 7(c)(4)(i)-1 explained certain aspects of proposed § 1041.7(c)(4)(i) relating to the proposed loan limit. Proposed comment 7(c)(4)(i)-1 clarified that, in addition to the new loan, all covered short-term loans made under either proposed § 1041.5 or proposed § 1041.7 that were outstanding during the consecutive 12-month period would count toward the proposed loan limit. Proposed comment 7(c)(4)(i)-1 also clarified that, under proposed § 1041.7(c)(4)(i), a lender may make a loan that when aggregated with prior covered short-term loans would satisfy the loan limit even if proposed § 1041.7(c)(4)(i) would prohibit the consumer from obtaining one or two subsequent loans in the sequence. Proposed comment 7(c)(4)(i)-2 provided examples.

The Bureau believed that a consumer who seeks to take out a new covered short-term loan after having taken out six covered short-term loans during a consecutive 12-month period may very well be exhibiting an inability to repay such loans. The Bureau believed that if a consumer were seeking a seventh covered short-term loan under proposed § 1041.7 in a consecutive 12-month period, this would be an indicator that the consumer may, in fact, be using covered short-term loans to cope with regular expenses and compensate for chronic income shortfalls, rather than to cover an emergency or other non-recurring need. In these circumstances, the Bureau believed that the lender should make an ability-to-repay determination in accordance with proposed § 1041.5 before making additional covered short-term loans and ensure that the payments on any subsequent loan are affordable for the consumer.

Proposed § 1041.7(c)(4)(ii) included the proposed requirement that a covered short-term loan made under proposed § 1041.7 cannot result in the consumer having covered short-term loans outstanding for an aggregate period of more than 90 days during any consecutive 12-month period. Proposed comment 7(c)(4)(ii)-1 clarified certain aspects of the proposed rule as they relate to the proposed indebtedness limit. Proposed comment 7(c)(4)(ii)-1 explained that, in addition to the new loan, the period in which all covered short-term loans made under either proposed § 1041.5 or proposed § 1041.7 were outstanding during the consecutive 12-month period would count toward the indebtedness limit. The same proposed comment also clarified that, under proposed § 1041.7(c)(4)(ii), a lender may make a loan with a proposed contractual duration, which when aggregated with the time outstanding of prior covered short-term loans, would satisfy the indebtedness limit even if proposed § 1041.7(c)(4)(ii) would not prohibit the consumer from obtaining one or two subsequent loans in the sequence. Proposed comment 7(c)(4)(ii)-2 provided examples.

The Bureau believed it was important to complement the proposed 6-loan limit with the proposed 90-day indebtedness limit in light of the fact that loan durations could vary under proposed § 1041.7. For the typical two-week payday loan, the two thresholds would have reached the same result, since a limit of six loans under proposed § 1041.7 means that the consumer could have been in debt on such loans for up to approximately 90 days per year or one quarter of the year. For 30- or 45-day loans, however, a 6-loan limit would have meant that the consumer could have been in debt for 180 or even 270 days out of a 12-month period. The Bureau believed these kinds of results would be inconsistent with protecting consumers from the harms associated with long cycles of indebtedness.

Given the income profile and borrowing patterns of consumers who borrow monthly, the Bureau believed that the proposed indebtedness limit is an important protection for these consumers. Consumers who receive 30-day payday loans are more likely to live on fixed incomes, and typically are recipients of Social Security. Fully 58 percent of monthly borrowers were identified as recipients of government benefits in the Bureau's 2014 Data Point. These borrowers are particularly vulnerable to default and collateral harms from making unaffordable loan payments. The Bureau found that borrowers receiving public benefits are more highly concentrated toward the lower end of the income range. Nearly 90 percent of borrowers receiving public benefits reported annual incomes of less than $20,000, whereas less than 30 percent of employed borrowers reported annual incomes of less than $20,000. Furthermore, because public benefits are typically fixed and do not vary from month to month, in contrast to wage income that is often tied to the number of hours worked in a pay period, the Bureau believed that monthly borrowers are more likely than bi-weekly borrowers to use covered short-term loans to compensate for a chronic income shortfall rather than to cover an emergency or other non-recurring need.