Final Commentary For Regulation Z
It's out. The FRB has published the 1998 revisions to the Official Staff Commentary to Regulation Z. The new guidance can be followed immediately however compliance is not mandatory until October 1, 1998.
The commentary to ?226.2(a)(2), advertisements, is modified to clarify the type of communications that do and do not constitute advertisements. The new language states that any communication that promotes new credit transactions or new open-end credit plans are advertisements for purposes of the regulation. However, communications designed to promote use of features that are already part of the plan are not advertisements.
This standard may seem clear in theory, however, it should be closely watched in implementation. All staff planning, designing, and actually conducting marketing for open-end should become fluent in this distinction before going forward with a marketing campaign.
When a downpayment isn't a downpayment
In today's car market, it is not uncommon for the outstanding principal on a car loan to exceed the car's book value when the car is turned in as a "downpayment" on the next purchase. This problem leads to some interesting problems and theories about how to disclose a downpayment that is actually a debt. The FRB has risen to the occasion and given guidance on ways to disclose these sums.
When the borrower makes a downpayment with an automobile (or other goods) that is subject to a debt larger than the trade-in value, the new credit should show the downpayment as $0. The downpayment is not a negative amount. What this means is that the customer brought nothing to the table as a trade-in. The previous debt is not a part of the new transaction as a previous debt. However, it may figure into the overall transaction by affecting the new loan amount and it may be reflected in the itemization of amount financed. Under this interpretation, the downpayment is $0, not a negative number. If any part of the old loan is to be paid off with the new loan, that will be reflected in the amount financed. ?226.2(a)(18)-2 and ?226.18(c)-2.
When Is Open-end Credit Open-end?
Three decades ago, the distinction between open-end credit and closed-end was fairly clear. Now, however, the line is getting greyer and greyer. One of the key factors of an open-end credit plan is that the parties, creditor and borrower, reasonably contemplate repeated transactions. The Board's proposal was intended to deal with situations that are actually expected to be closed-end transactions but are set up as open-end. The result is a significant difference in disclosures.
The Board has withdrawn the proposal because of concerns that the proposed language still did not provide a bright line that would not inhibit the industry. However, the Board cautions the industry to review credit programs carefully. Creditors should determine whether the plan is open-end or closed-end based on a careful review of whether the plan reasonably contemplates repeated transactions.
Residential Mortgage Transactions
When making a loan in a situation defined as a residential mortgage transaction, the lender must provide early disclosures within three days of the application. Generally a residential mortgage transaction is defined as a purchase of the dwelling - the acquisition of property that the consumer does not yet own. The commentary update clarifies that when the construction loan is to construct a dwelling on land the consumer already owns, the transaction is still a purchase within the meaning of the definition of residential mortgage transaction. ?226.2((a)(24)-5 and -7
Closing Agents & Finance Charges
No commentary update is complete without something on finance charges. This is the most complex and most difficult area of Truth in Lending, and the most commonly violated. Third party charges have complicated the formula. Third party charges required by the creditor are finance charges. However, charges imposed by third parties that are not for services required by the creditor are not generally finance charges. One area of confusion has been whether the fees of settlement agents themselves are finance charges. The update to the commentary says yes. Charges attributed to conducting or attending the closing are finance charges. They may only be excluded from the finance charge if the charge is incidental to the lump-sum closing fee. ?226.4(a)(2)-2
What Counts as Insurance
Creditors continue to be confused about what forms of risk coverage are subject to the credit life insurance rules in ?226.4(d). Last year, the FRB revised regulation and commentary to apply the finance charge definition to a variety of alternatives to credit insurance, including debt cancellation coverage. This means that, if disclosed as required in ?226.4(d) and affirmatively requested by the borrower, the insurance fee is not a finance charge. Any failure to take one or more of the required steps puts the fee or premium instantly on the finance charge side of the equation.
This provision continues to be one of the most commonly violated provisions of Regulation Z. To address some of the compliance problems, the FRB revised the commentary to include references to debt cancellation coverage. The commentary also explains that the initial term should be based on the period that the creditor or insurer is obligated to provide coverage. Disclosures for open-end plans should be disclosed on a unit-cost basis using the initial term of coverage. ?226.4(d)-1, -4, and -11.
As open-end plans increase in complexity, the rules relating to APR calculations and disclosures grow with them. The new commentary language deals with multifeatured plans that charge rates related to the service and may have a different pricing structure for different features. For example, the plan could have one interest rate for charges and another for cash advances. Each fee structure is a "feature" for purposes of the regulation. The commentary update clarifies that the creditor may consider each feature separately in calculating the denominator. There is no definition of feature. The commentary and regulation leave it to the creditor who should have a "reasonable basis" for determining that something is a feature. ?226.14(c)-5.
The commentary revisions also address how to disclose circumstances that will result in an increase of the APR. The revision makes clear that the increased rate must be included in the initial disclosures. The same disclosures must clearly state the event or circumstance that will trigger the increase. Vague references are not adequate. The purpose of the disclosure is to make sure that the consumer understands the consequences of certain actions. For example, if late payments or exceeding the credit limit will trigger an increase, those events should be specifically mentioned. ?226.6(a)(2)-11.
After all these years, you'd think we'd have the payment schedule down. However, there continue to be essential omissions from, or mistakes in, the payment schedule disclosures. The payment schedule must disclose the timing of payments. The model forms show exactly how to do this, but creditors have come up with creative alternatives that, unfortunately, fail to communicate all of the required information. There are several ways to show the timing of payments. First, creditors may list all of the payments - one by one. This could result in a fairly impressive document for a 30-year mortgage loan with 360 payments!
As a more practical alternative, the creditor may disclose the period of payments scheduled for repayment. When using this option, creditors must describe the intervals (monthly, bi-weekly) as well as the starting point. Saying monthly means nothing unless there is a date for the first payment. When in doubt, use the model language in Appendix H. ?226.18(g)-4.
This paragraph also now explains how to disclose an uncertain starting date for payments. The disclosure can refer to the date or event that will serve as the trigger date for beginning payments. In this case, this particular disclosure should be labeled as an estimate.
- Discuss this distinction between advertisements and promotion of existing plans with marketing staff and anyone in the bank responsible for planning or designing promotions.
- Ensure that the compliance department reviews any open-end credit promotions before they are implemented. Remember to work with (not against) the marketing team. That way they'll come to you next time.
- Review any dealer loan contracts and look for how downpayments are treated. While you're at it, make sure that any security interest charges have been itemized and disclosed.
- Look at your open-end products. Particular products to look for include tax purpose loans, and credit programs designed for large item purchases. Determine whether they really should be open-end or closed-end programs.
- Review open end disclosures to be sure that APRs are correctly described and explained. Look particularly for explanations of circumstances for increasing the APR.
- Notify construction loan officers that a construction loan to finance a dwelling on land the consumer already owns is a residential mortgage transaction calling for early three-day disclosures.
- Review closing practices. If the bank requires the use of an outside settlement service, review the fees and how they are disclosed. Make sure there are no undisclosed finance charges.
- Schedule an audit to review insurance disclosures. Be sure to include all types of credit your bank offers - and all types of credit-related insurance. Also look at payment schedules to be sure all required information is included.
Copyright © 1998 Compliance Action. Originally appeared in Compliance Action, Vol. 3, No. 7, 5/98
First published on 05/01/1998