A New Usury Law Coming to You - Prepare and Respond
Andy Zavoina, BOL Guru
Executive Review
Overview
The John Warner National Defense Authorization Act for Fiscal Year 2007 was recently passed. Seemingly not bank related, this will have an impact on your financial institution unless you eliminate small consumer loans and some credit card products from your offerings.
Officially known as Public Law 109-364; Title VI, Sec. 670 contains a predatory lending provision targeted at payday lenders. You may not make these loans but read on. To accomplish its purpose of reducing payday loan problems with servicemembers, the new law places restrictions on you.
- You will have to ask all applicants if they meet this new definition of a servicemember or their dependent to know if they are protected.
- In addition to the APR you already disclose, you will have to calculate another one which includes all fees and charges, even credit insurance. Software systems do not currently do this.
- The second APR you disclose cannot exceed 36 percent. This will be a federal usury limit.
- New disclosure rules require that these be delivered orally and in writing. This includes all loans, whether in a branch, by mail or over the internet.
- Renewals will not be allowed which can affect loan workouts and a qualified borrower's desire to renew and increase their loan.
- The effective date is October 1, 2007 but could be much sooner if the Department of Defense publishes the regulation earlier. They have rule-writing authority.
- Penalties include fines, imprisonment and that the contract be voided.
- These points and more are better explained below. But recognize that the new Congress may review this law and revise it. Your actions may change this law, and these requirements.
Who is Protected
There are already two primary laws that affect your loan programs with the military. The Servicemembers Civil Relief Act (SCRA) has been with us in one form or another since 1918. It defines who is protected and its rules are fairly clear as to protections afforded servicemembers and their spouses. The focal point of the SCRA is that applicable loans are restricted to a six percent rate while the servicemember is on federal active duty. You also comply with the Truth in Lending Act (TILA) which protects consumers and requires loan disclosures, especially the annual percentage rate.
Enter PL 109-364. One section of the new law is meant to require new disclosures and limit interest rates on many consumer loans to active duty military and their dependents. Even if your institution is not near a military base, you will have to implement a procedure to better know your customers and whether they are covered. You will need to inquire if any borrowers are active duty military or if they are dependents of someone who is. After you ask, you will need a method of verification, which will add a new task for your lenders.
Highlighted Requirements Impacting You
- Interest rates may not exceed 36 percent.
This sounds easy because you may have never considered making a loan with an interest rate "that high." But consider this example:
| Principal |
Rate |
Fees |
Fin. Chg. |
Term |
APR |
| $300 |
14% |
0 |
$12.36 |
6 |
13.99% |
| $300 |
14% |
$20 |
$32.36 |
6 |
38.61% |
- Consumer Loans
This new law applies to all consumer loans, except home mortgages and loans for the purchase of "a car or other personal property," if secured by the property purchased. It applies to loans done in a branch, through the mail or over the internet.
- Disclosures, Orally and in Writing
The following will be required to be disclosed both orally and in writing:
- the loan's APR, as calculated inclusive of all fees
- the disclosures required under the Truth in Lending Act (Note: This could mean that two different APRs will have to be disclosed)
- a clear description of the payment requirements for the loan
- No Renewals or Refis
Other than the exceptions noted above for mortgages and personal property purchase loans, renewals and refinances will not be allowed. This may reduce your option to workout problem loans, even if you were trying to reduce the interest rate or payments.
- No Required Allotments
You will not be able to require an allotment for repayment. Many lenders offer discounted interest rates because the loan is repaid by allotment. This practice may be in jeopardy and may be interpreted to include funds transfers from a deposit account.
- Additional Restrictions
Additional restrictions exist prohibiting a waiver of rights, required arbitration, "unreasonable notice," pre-payment penalties and more. These restriction supersede other state and federal laws.
- Penalties
- Knowingly violating the law is a misdemeanor. It is punishable by a fine, incarceration, or both.
- The contract is voided.
- Other rights and remedies afforded by other laws remain in place.
- Effective Date
This law takes effect October 1, 2007, unless the DoD prescribes an earlier date. The law would then be effective after a 90 day notice.
The DoD has rule-making authority here. They will work with the banking regulators, but the primary responsibility does not lay with an entity familiar with the finance industry. Many feel that the law of unintended consequences will prevail and instead of addressing the law's requirements with borrower's questions and procedures, lenders will eliminate these loan products altogether. This could have an adverse impact on innovative products receiving credit under the Community Reinvestment Act (CRA) to allow inexperienced borrowers to develop/reestablish credit. And many small loans are made simply as a means of recovering classified debt/overdrawn deposits and attempting to at least cover the new costs of booking a loan.
What Can be Done?
With the leadership changes in the House and Senate, a leading Democrat indicated that the Senate Banking Committee may revisit this section of the law. South Dakota's Sen. Tim Johnson is concerned that the law of unintended consequences will actually restrict credit to servicemembers and their dependents. The key sponsor of the law, Sen. Talent of Missouri, lost his bid for reelection.
Bankers should consider the implications of this law and how it may impact both your customers and your small loans, credit cards and cash advance fees, overdraft programs and loan production in general. Then contact your elected representatives in Washington and urge that they do in fact give this provision a second look. Bankers may have a chance to right what may well be a wrong for our industry. Banks are generally not lenders with predatory and payday lending practices that need to be controlled. If Washington will not change the law, it will be time to reevaluate all loans that might fall under the coverage of PL 109-364.
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First published on BankersOnline.com 12/07/06
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