Demystifying Regulation Z, Part 2: Applying the Truth to Lending

Demystifying Regulation Z, Part 2: Applying the Truth to Lending

Regulation Z, the rules implementing the Truth in Lending Act, aims to protect consumers by requiring transparency from lenders and standardizing credit transactions. The last blog discussed some of the types of disclosures lenders must provide when offering credit and performing these transactions. Now, this entry will examine Regulation Z’s application to various credit products.

Types of Credit and their Requirements

Regulation Z is broken into subparts containing requirements for different types of credit, with some transactions requiring additional special treatment.

Open-end credit has 3 features: (1) the credit operates as an available pool expected to be used for multiple transactions, like credit cards or overdraft protection; (2) the lender has the ability to levy a finance charge against the unpaid amount; and (3) credit that is used becomes available again once it is paid. By nature, open-end credit is a bit of a wild card: balances will fluctuate wildly and consumers may go long stretches of time without using this credit. Lenders and borrowers do not have the luxury of a predictable amortization table, and the CFPB has enumerated disclosure requirements in extreme detail to protect consumers as the less sophisticated party in the transaction. Fortunately, Appendix G to Regulation Z offers helpful model clauses and forms for open-end credit lenders.

For open-end credit, creditors are able to implement “reasonable” requirements for payments as long as those payments allow “most consumers” to comply. These reasonable requirements may include attaching a payment stub or account number to the payment method, cutoff timeframes for when the payment must be received on the due date, payments made in U.S. dollars, and payments sent to a specified address. Regulation Z also governs how annual percentage rates (APR) are determined and expressed.

Closed-end credit is defined by exclusion: any consumer credit that does not fall within the parameters of “open-end” credit is considered “closed-end.” Regulation Z strictly governs the calculation, application, and disclosure of the APR for closed-end credit. The APR must be disclosed as a single percentage rate that reflects the total cost of credit annually, including interest and other charges as defined. Lenders must closely oversee the accurate computation of the APR to ensure that it is not understated, which could be deemed deceptive.

Some closed-end transactions have special rules, such as mortgages with variable interest rates. These transactions require extensive disclosures about how the interest rates can change, as well as the provision of an example either of (1) how the payment of a $10,000 loan would have been impacted by interest rate changes based on the last 15 years of index values or (2) the maximum interest rate and payment of a $10,000 loan subjected to the highest allowable rate and payment increases.

In addition to closed-end credit rules, special mortgage rules apply to certain types of mortgages. Reverse mortgages are loans against a home that are payable when the owner no longer resides there. These mortgages require certain disclosures such as the projected total cost of credit for a loan based on assumed annual appreciation rates of 0, 4, and 8 percent, and of assumed loan periods of 2 years, the actuarial life expectancy of the consumer, and the actuarial life expectancy multiplied by 1.4, rounded to the nearest year. High cost mortgages either have interest rates that exceed the prime interest rate by at least 6.5 or 8.5 percentage points depending on various factors, very high total points and fees, or are subject to a prepayment penalty. These mortgages are prohibited from containing certain terms that are disadvantageous to consumers, such as negative amortization, and there are limits on acceleration of debt collections.

Private education loans are also covered by Regulation Z. Creditors must exercise caution when marketing these loans, ensuring that any co-branding implying endorsement by an educational institution is covered by an arrangement between the parties that is not prohibited by law and is accompanied by the required conspicuous disclosures.

Credit cards as well as open-end credit offered to college students also have a special subpart. Lenders must consider a consumer’s ability to pay before opening an account or increasing credit limits. Before extending credit to a consumer younger than 21, a lender must verify that the consumer has the ability to pay the required minimum payments or have a signed agreement with a second consumer over the age of 21 who has the ability to pay and who will be jointly liable for the debt. Regulation Z also strictly governs the amount and types of credit card fees, allocation of excess payments, increases in annual percentage rates and fees, and how lenders are to handle transactions that exceed a consumer’s credit limit.

Understanding and implementing statutory and regulatory requirements is essential for any lender operating in today’s financial environment. Lenders must not only ensure current compliance but also stay informed about regulatory updates and court interpretations that can affect their lending practices. Regulation Z’s depth and scope makes it a central piece of a compliance program. 

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