Truth In Lending Commentary Update Proposed

The Federal Reserve Board staff has held constant and issued a proposed update to Regulation Z's Official Staff Commentary in time for the holiday mail. This year's proposed changes are not major but would clear up several knotty problems.

Fees for Expedited Services
First on the list is a clarification of the finance charge status of certain fees charged for specific services related to credit cards. Creditors have asked for clarification on the finance charge status of certain fees that creditors impose for special services requested by customers. Because the services and fees for them arise in the context of a credit relationship, there has been concern that the fees could be treated under Regulation Z as finance charges even though the services and charges are not part of the credit plan agreement.

One of the fees is charged to consumers who request an expedited payment service for their payment. Usually this occurs when the consumer needs an expedited service in order to avoid a late payment charge. The Federal Reserve staff considers an expedited payment method to be any payment or delivery method using other than standard U.S. Postal Service. It would include payments made by an electronic transfer or by authorizing a draft on the customer's checking account.

Staff has concluded that a fee for expedited delivery is not a fee "incidental to the extension of credit" unless it is the established method for making payments under the account agreement. It is therefore not a finance charge. The charge should be disclosed instead with "other charges." 12 CFR 226.6(b)-1.

Slightly different treatment would be given to a charge for expedited delivery of the card. A fee imposed for expediting delivery of the card, at the request of the consumer, would not be considered an "other charge." It is not a finance charge because it is not incidental to the extension of credit nor is it a significant part of the credit plan. In fact, credit is available on the same terms without payment of the expedited service fee. 12 CFR 226.6(b)-2.

Another way of distinguishing these fees from finance charges is that both are fees requested by the consumer as a convenience or service but not as part of the credit program. The analysis would produce a different result if the creditor required these services as a condition of the credit.

Federal Reserve staff has also proposed a clarification to 226.9(c)(2)-1 explaining that a change in a fee for expedited service requested by customers is not a change in terms and would not need to be disclosed as such.

Those Funny-Looking New Cards
You've seen the ads. A customer hands the check-out clerk a funny-looking card, says it's a credit card, and everyone in line crowds around to have a look at it. It's the latest gimmick in the credit card business. The problem is that a card shaped like a letter opener doesn't work in every store's credit card machines. They swipe, but they don't imprint.

Because they don't work everywhere, creditors issuing these novelty cards want to issue two cards - one in the novelty shape and one in a traditional shape. But Regulation Z prohibits issuing credit cards except in response to a consumer's request. The existing commentary imposes a "one-for-one" rule, allowing a creditor to issue one renewal card for one existing (expiring) card. The limitation for issuance of credit cards is imposed to protect consumers from liability. The same rule protects creditors from liability exposure. Before this rule was imposed, creditors mailed out credit cards to consumers without consumers knowing that the card was coming. When thieves intercepted such cards in the mail, no one knew of the theft until the bills came in.

In proposing this commentary change, Federal Reserve staff takes note of significant changes in the credit card industry. Staff concludes that current security measures provide strong protection for consumers and creditors. Staff also notes the differences in Regulations Z and E.

Currently, the Commentary permits separating a combined card product into separate credit and debit cards. The issuance of the debit card would not violate Regulation Z's limitations because the debit card would not be subject to Regulation Z and Regulation E does not limit the issuance of cards.

Staff notes that consumers have no liability for a credit card unless they have accepted the card. A renewal card is not "accepted" until the consumer receives it. Industry practices that require activation of the card effectively protect the industry. Staff therefore is proposing to allow the issuance of a novelty card together with a standard card as a part of the renewal process. Staff solicits comments on whether this interpretation should exist without being restricted to renewals.

Payment Schedule Clarifications
The rules limiting the term of private mortgage insurance ("PMI") have produced nasty complications for escrow accounts and payment schedules. Truth in Lending requires disclosures to show the underlying legal obligation. Now that obligation includes termination of PMI at an anticipated point in the life of the loan. Because PMI is a finance charge, this means that the calculation of the finance charge and the payment schedule must reflect the correct number of PMI payments, given what is known and expected at settlement.

Staff is proposing ways to treat any PMI payments that are escrowed. The proposal relies on the underlying legal obligation. The payment schedule should include PMI up to the date when the law requires termination, even though the consumer might be able to request termination earlier. If there is an escrow account, and there usually is when PMI is involved, the question becomes how the escrowed payments should be treated.

The proposal uses an example of 130 expected PMI payments with a two-month escrow cushion. If the creditor will apply the two month-cushion to the final PMI payments, the payment schedule should show 128 PMI payments. However, if the lender will hold the escrow cushion and refund it when PMI is released, then the payment schedule should show 130 payments to PMI. 12 CFR 226.18(g)-5.

Finding the Right Treasury Index
No sooner did the regulators get out rules on predatory lending, including revisions to high-cost mortgage rules and HMDA reporting, than treasury dropped the most important index for mortgage lenders. This commentary proposal would provide answers the question everyone is asking: what index do I use if there isn't an exact match?

The proposed rule is fairly simple. First, use the closed index. Second, if there are two choices, use the lower one. The lower one ensures maximum capture of loans that could be considered predatory.

Lenders should use statistical release H-15 to find the correct index. Select the index that corresponds to the constant maturity that is closest to the loan's maturity. Do not use an index for average maturities.

"Bounce Protection" Plans Could Be Credit
The Commentary proposal doesn't stop with the usual updating issues. The FRB staff is using the commentary proposal to request comment on a new issue: whether bounce protection services should be treated as credit. This involves two questions. First, does the bounce protection plan meet the definition of credit? If so is it open-end or closed-end credit? Second, are the fees imposed finance charges? Both questions have to be answered in the affirmative if the plans are to be subject to Regulation Z.

Meeting the definition of credit - open-end credit at that - is fairly easily accomplished. The plan allows the customer to incur debt and defer its payment. It also creates a renewable credit line. The trick lies in whether the fees are finance charges. The FRB is seeking comment on how such programs are structured and how the programs should be treated under Truth in Lending.

Driving this attention from the FRB is the concern that bounce protection programs actually function as payday lending or other short-term, high-cost credit. This brings the practice under the umbrella of possible unfair or deceptive practices. Presenting what is functionally a credit program as a "deposit service" without telling the customer the credit-comparable cost could be considered a deceptive practice.

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