Why IS there a Truth in Lending Act (aka) Regulation
Z?
As anyone in compliance can attest to, there are Myriad
consumer compliance regulations. For
bankers, these regulations are regarded as anything from a nuisance, to the
very bane of the existence of banks.
However, in point of fact, there are no bank consumer regulations that
were not earned by the misbehavior of banks in the past. Like it or not these regulations exit to prevent
bad behavior and/or to encourage certain practices. We believe that one of the keys to strengthening
a compliance program is to get your staff to understand why regulations exist
and what it is the regulations are designed to accomplish. To further this cause, we have determined
that we will from time to time through the year; address these questions about
various banking regulations. We call
this series “Why is there….”
For any lender that has made a consumer purpose loan in the
past 30 years, the Truth in Lending Act aka, Regulation Z has been a major
factor. The main part of any consumer
lending audit or examination is compliance with the Omni present Reg. Z. And just
as you might know that the regulation exists, you also know that if mistakes
are made, they can be costly. If
examiners find that a loan or groups of loans has not been properly documented
and the consumers not properly informed, various painful enforcement actions
may occur. These can range from
reimbursements to the customer, a look back at the entire loan portfolio and
even the possibility of civil money penalties.
It is clear that Reg. Z is a powerful regulation. But why does it exist? What is it the regulators are trying to get
banks to do?
We believe that the more you know, the more you comply!
What was Happening?
Starting in the late 1950’s the United State saw a
tremendous growth in the amount of credit.
In fact, a study the US House of Representatives estimated that the
amount of credit in the United States from the end of World War II to the end
of 1968 grew from $5.6 billion to $96 billion.
[1]
The growth in credit was fueled by consumer credit and in
particular, a growing middle class that created a huge demand for housing, cars
and various other products that went all with acquiring the American
Dream. As time passed more and more
stories of consumers being misled about the cost of borrower by terms “easy payments”,
“low monthly charges” or “take three years to pay”. The
borrowers found out that every though they thought they were paying an interest
rate of 1.25 % with add-ons, fees and interest
payments that were calculated using deceptive formulas , the rate was actually
as much as three times what they thought.
Congress began to investigate the growing level of consumer
debt and eventually in 1968 the Truth in Lending Act was first passed. Congress was pretty clear about what they
were trying to do:
The Congress finds that economic stabilization would be
enhanced and the competition among the various financial institutions and other
firms engaged in the extension of consumer credit would be strengthened by the
informed use of credit. The informed use of credit results from an awareness of
the cost thereof by consumers. It is the purpose of this subchapter to assure a
meaningful disclosure of credit terms so that the consumer will be able to
compare more readily the various credit terms available to him and avoid the
uninformed use of credit, and to protect the consumer against inaccurate and
unfair credit billing and credit card practices. [2]
So from the very start the idea
behind the Truth in Lending Act is to force lenders to list the cost of borrower
in a common format. Consumer should be
able to take their Regulation Z disclosures and be able to shop from one
financial institution to the next and compare prices.
For the next several years, the
Federal Reserve and the courts began to shape what the Truth in Lending law
would eventually come to represent. After
a series of court decisions and interpretive rulings by the regulators, the law
began to grow in importance. The basic history of the regulation is
this:
The Truth in Lending Act (TILA), 15 USC
1601 et seq., was enacted on May 29, 1968, as title I of the Consumer Credit
Protection Act (Pub. L. 90-321). The TILA, implemented by Regulation Z (12 CFR 226), became
effective July 1, 1969.
The TILA was first amended in 1970 to
prohibit unsolicited credit cards. Additional major amendments to the TILA and Regulation Z
were made by the Fair Credit Billing Act of 1974, the Consumer Leasing Act of 1976,
the Truth in Lending Simplification and Reform Act of 1980, the Fair Credit and Charge
Card Disclosure Act of 1988, the Home Equity Loan Consumer Protection Act of 1988.
Regulation Z also was amended to
implement section 1204 of the Competitive Equality Banking Act of 1987, and in 1988, to
include adjustable rate mortgage loan disclosure requirements. All consumer leasing
provisions were deleted from Regulation Z in 1981 and transferred to Regulation
M (12 CFR 213).
The Home Ownership and Equity
Protection Act of 1994 amended TILA. The law imposed new disclosure
requirements and substantive limitations on certain closed-end mortgage loans
bearing rates or fees above a certain percentage or amount. The law also
included new disclosure requirements to assist consumers in comparing the costs
and other material considerations involved in a reverse mortgage transaction
and authorized the Federal Reserve Board to prohibit specific acts and
practices in connection with mortgage transactions. Regulation Z was amended to
implement these legislative changes to TILA.
The TILA amendments of 1995 dealt
primarily with tolerances for real estate secured
credit. Regulation Z was amended on
September 14, 1996 to incorporate changes to the TILA. Specifically, the revisions limit
lenders' liability for disclosure errors in real estate secured loans consummated after
September 30, 1995. The Economic Growth and Regulatory Paperwork Reduction Act of
1996 further amended TILA. The amendments were made to simplify and improve
disclosures related to credit transactions[3]
Changing
Times Makes Changing Law
A quick comparison of these changes to the
regulation with economic events in the United States will tell a story of bank
and financial institutions practices that avoided the general intent of the regulation
in one way of another. The growth and development
of the credit card market prompted the changes in Reg. Z that have to do with
open end credit and the growth of adjustable rate mortgages because the
additional changes to mortgage disclosures.
The goal of Regulation Z has always been
a desire to tell the borrower the highest amount she may possibly pay for
borrowing money from an institution.
Regulation Z does not tell a borrower how much they may charge or even
how they may structure consumer deals.
However, it does require that you disclose what you are charging to the
customer in a clear and understandable manner.
TILA's legislative history indicates
that Congress included rescission to provide a cooling off period to borrowers who
obtained credit secured by a lien against their primary residence. Congress
heard a parade of horror stories from consumers about unscrupulous home
improvement contractors who pressured them into financing expensive renovation
projects (like aluminum siding) but failed to disclose that the loan was
secured by a lien on the consumer's dwelling. Consumers who defaulted on the
financing lost their homes. Rescission is designed to protect consumers from
making an impulsive decision by disclosing the lien and providing a three-day
cooling off period after the loan closing. With the salesperson gone, the
consumer can reconsider whether he wants to place his home at risk.[4]
The point here that as lending practices
change, the disclosure requirement may change, but the goal of the regulation
remains the same.
Why
are They Doing This to Us?
At the end of the day, the goal of the Truth
in Lending Act is to make it possible for a borrower to compare the cost of
borrowing between one lender and the other AND the cost of borrowing versus the
cost of buying the same item for cash.
In other words, the borrower should be able to tell how much the bank is
costing her to borrower money to buy the car.
Unfortunately, the way in which this cost is defined causes headaches!
According to Reg. Z the finance charge
should include all of the costs that the lender is creating vis a vis a cash
transaction:
The finance charge is the cost of
consumer credit as a dollar amount. It includes any charge payable directly or
indirectly by the consumer and imposed directly or indirectly by the creditor
as an incident to or a condition of the extension of credit. It
does not include any charge of a type payable in a comparable cash transaction.
For many of our clients this language
leaves as many questions as it does answers but the basic thrust of it is that
things like taxes and official documents are costs that anyone would have when
they buy a card or a house. Anything
else is generally going to be a finance charge.
Recent
Changes and the Future
[1] Griffith
L. Garwood, A Look at the Truth in Lending - Five Years after, 14 Santa Clara
Lawyer 491 (1974).
[2]
See Preamble to 15 U.S.C. 1601 (1970)
[3] http://www.federalreserve.gov/boarddocs/caletters/2008/0805/08-05_attachment1.pdf
[4]
Philadelphia Federal Reserve The Right of Recession: Overview and Recent Developments
Compliance Corner 2007
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