Truth In Lending: Debt Cancellation Fees & Gap
The final rule provides clear guidance on the treatment of debt cancellation fees, GAP, and similar items that function as alternatives to credit insurance or credit life insurance. The good news is that the FRB decided not to defer to state law to determine whether debt cancellation or GAP is "insurance." The rule takes the common sense approach of treating these in the same way as the regulation treats credit life insurance and the rule is uniform for all states. ?226.4(b)(10), ?226.4(d)(3).
If the creditor requires the insurance, debt cancellation, or GAP, and requires the consumer to pay for them, the fee is a finance charge. However, when the purchase is optional to the consumer, the fee may be excluded from the finance charge by following several steps in the disclosure process.
First, the creditor must disclose in writing that the service is optional.
Second, the creditor must disclose the amount of the fee or premium. For closed end loans, the fee must be disclosed in full. In addition, the creditor must clearly explain any limitations on the term or coverage of the service if it does not run for the full term of the loan.
The fee may be disclosed on a unit cost basis only if the transaction is open-end, or if the application is taken by mail or telephone and the loan amount is not known when the disclosures are prepared. Third, the creditor must obtain the consumer's signature or initials as an indication that the consumer wants to purchase the service. This signature must occur after the disclosures are made.
Note that this disclosure must be in writing. In addition to these new provisions on debt cancellation fees, the FRB has amended ?226.4(d)(1) to clarify that the disclosure to the customer that the insurance is optional must be in writing.
When examiners review your loan documents for compliance with ?226.4(d), they look for several things. First, they will determine whether the bank's staff followed appropriate procedures. Second, they look for correct and complete disclosure of the required information about the insurance or alternative product and the consumer's signature or initials for every instance when the product was sold.
Third, they review the sales pattern to determine whether it supports the creditor's claim that the insurance is voluntary. When most or all of the customers purchase the insurance, there is an implication that the purchase is not truly optional. If the product is truly voluntary, there should be a lower pattern of sales. If the fact pattern implies that customers may not understand or believe that the purchase is actually optional, the examiners may conclude that the insurance was not voluntary. The next step would be to review finance charge calculations to see whether the fees were included or excluded from the finance charge.
- This is a good time to review procedures for disclosing credit life insurance as well as providing instructions on GAP and debt cancellation coverage.
- If your bank sells or offers credit life or debt cancellation coverage, notify all lending staff involved in those products about the new disclosure provisions.
- Audit a sample of loan files for compliance with ?226.4(d). Analyze files by loan officer to determine whether some loan officers have an unusually, perhaps inappropriately, high sale rate for these insurance products.
Copyright © 1996 Compliance Action. Originally appeared in Compliance Action, Vol. 1, No. 15, 10/96
First published on 10/01/1996