Final Commentary on Truth in Lending

The Federal Reserve has published its annual update to the Official Staff Commentary to Regulation Z. There is some change from the proposal, but most of the concepts in the proposal appear in the final Commentary. In this issue, we discuss the new paragraphs and changes to the Official Staff Commentary to Subparts A, B and C of Regulation Z. In the next issue, we will discuss the Commentary to new Subpart E. One element of the earlier Commentary proposal which would have provided new guidance how to treat fees charged in connection with debt cancellation agreements has been withdrawn. Based on the issues raised in the comments, the Board concluded that the issue should be dealt with in an amendment to the regulation rather than in the Commentary.

Alert:
The fact that the proposal has been withdrawn does not mean that the issue has become unimportant. Paragraph 4(d)-5 clarifies that premiums for insurance may be excluded only if the purchase of the insurance is truly voluntary. Premiums for credit insurance are a finance charge even if the applicant may choose between several types of insurance and the consumer chooses to purchase credit life. However, if in the same transaction the consumer instead chose to pledge an existing life insurance policy, the premium for the pledged policy would not be a finance charge. That policy was purchased voluntarily and was not purchased as a part of the credit transaction.

In the arena of open end credit, there have been numerous questions about whether various types of application fees and membership fees are finance charges. New Paragraph 6(b)-1, "Other Charges," has been revised to clarify when a membership fee to join an organization is an "other charge" that is not a finance charge. The fee must be disclosed if the primary benefit of membership is simply the opportunity to apply for a credit card. A key test is whether other benefits are merely incidental and offer no substantive benefits in addition to the credit program.

Regulation Z contains complex rules dealing with consumer claims and defenses. The FRB has revised Paragraph 12(c)(2)-1 to clarify how the creditor may treat the balance on the account while the complaint is under investigation. The card issuer may not take any action on the disputed balance. However, the card issuer may pursue normal collection activities for the portion of the balance that is delinquent and undisputed. Caveat: don't take collection action based on unpaid finance charge calculated on the amount in dispute.

The FRB has added a new 12(c)(2)-2 to give clear guidance on the nature of investigation a creditor must conduct to resolve a claim or defense. The new language provides guidance on the extent of a "reasonable" investigation. The card issuer must make an effort to obtain information from both the merchant and the cardholder. The investigation is not sufficient if the card issuer merely relies on the statement or explanation of the merchant.

The card issuer may request the card holder's "reasonable cooperation." The card issuer must make some effort to obtain needed information from the card holder. The card holder's refusal to respond is not sufficient grounds for closing the investigation or finding in favor of the merchant. Fundamentally, this paragraph establishes a rule of fairness and good faith. Compliance resolution is not a responsibility that the bank can safely ignore.

The commentary now contains a new paragraph 14(c)-10 which provides guidance for APR calculations when a transaction occurs at the end of one billing cycle but is posted in a subsequent cycle.

Disclosures for discounted variable rate loans are perhaps the most complex and difficult to prepare correctly. Not only must creditors calculate and disclose blended rate APRs, discounted variable rate loans often contain other features making compliance with Truth in Lending difficult. For example, some loan contracts provide that the rate will be based on an index value in effect at a certain point before the change date, such as 30 or 45 days. Paragraph 17(c)(1)-10 has been revised to provide that, for these loans, which contain a delay in implementing index values, the creditor may use any index in effect during that time delay period for purposes of disclosures and calculations.

When preparing the itemization of the amount financed, many creditors have disclosed amounts paid for insurance, extended warranties and similar services as paid to the vendor although the creditor may retain a percentage of the fee as a commission or finders fee. The Commentary now contains a new Paragraph 18(c)(1)(iii)-2 to provide guidance on how to itemize and disclose these charges. This comment establishes the principle that the amount shown as "amount paid to others" may include an amount retained by the creditor. It is not necessary to identify or separately disclose the amount that the creditor retains.

The Commentary also provides help in dealing with the predicament of the substituted or disappearing index. The Commentary has for some time ruled that adding a variable rate feature or exercising a variable rate feature that had not been disclosed triggers a requirement for new disclosures. Revisions to paragraph 20(a)-3 now provide that changing the index on a variable rate loan to a comparable index or replacing an index that has disappeared does not trigger new disclosures.

The final commentary has been modified from the proposal to clarify that the substitution may be to replace an existing index or to substitute an index for one that no longer exists.

Although new disclosures may not be required, consider the customer service element of providing the customer with information about the change and the new index. Also consider whether to explain your choice of index. For example, when choosing an index to replace one that no longer exists, briefly explain that the new index was chosen because it has a similar history and the bank expects that the substitution will have minimal effect on the customer's loan.

ACTION STEPS

If your bank charges such fees for debt cancellation agreements, review the disclosures carefully.
If you have questions about how to disclose the fees, check your state law and consult your regulator.
Review how your bank treats credit life insurance. If credit life is offered or required for any loans, make sure that loan officers and anyone preparing disclosures understands how to treat the insurance.
Review a sample of disclosures for open end accounts. Look particularly for transactions posted in the following billing cycle. Determine whether the APRs are correctly calculated. Also determine whether any membership fees are correctly disclosed.
Check your complaint investigation procedures. Make sure that they correctly reflect the requirements of 226.12(c).
Audit your procedure for handling balances in dispute and for reporting delinquent credit to determine compliance with 226.12(c).
Review the loan products and rate indexes used in your bank to identify loan products that may be affected by paragraphs 20(a)-3 and 17(c)-10.
Review these provisions of the regulation and commentary with operations staff.
Schedule an audit of ARM redisclosures.