Finance Charge Controversies

QUESTION

In our weekly sales meeting, there was a big debate about how to explain APR and the Finance Charge to borrowers. The problem is that (1) our loan officers do not seem to know how to explain them, (2) those who can explain them can’t do the calculations, and (3) everybody says most borrowers are confused by the explanations and the calculations. 

Then the controversy went to figuring out what charges are finance charges, depending on whether the finance charges are charged to all approved borrowers.

Anyway, we got to the point where the explanations were meshing and even the calculating was under control, but we did not get much of an understanding of how to resolve the controversy about the finance charges. So, we got together as a group and decided to write this question to you, as everyone is willing to rely on your explanation. Here’s our question: if we want to apply a finance charge only to approved applicants, would this be permissible and what are the risks?

ANSWER

Regulation Z, the implementing regulation of the Truth In Lending Act (TILA), includes very detailed instructions on how to calculate a loan’s “finance charge,” critical to determining a loan’s annual percentage rate (APR). Sometimes it must seem like you need to be a math wiz to understand APR.

Loan officers are embarrassed and may even lose deals when they cannot explain APR to applicants. I know some top-notch attorneys who can’t figure it out, let alone explain it to loan officers or borrowers. That said, it is not so inscrutable. However, your question is not about explanation or calculation. It is about the finance charge itself. I will explain how a finance charge applied only to approved applicants may cause considerable mischief for a financial institution – and I’ll give you some caveats, too!

I think I know where you’re going with this question. 

A recent case offers a good place to start with an explanation.

A federal district court in Pennsylvania recently reviewed TILA in connection with a specific loan program. In Payne v. Marriott Employees Federal Credit Union [2019 U.S. Dist. (E.D. Pa. Jan. 9, 2019)], the case turned on the following allegations:

• Marriott Employees Federal Credit Union had obtained loans that provided quick access to $500, repayable in five monthly payments of $90 and a final payment of $79.23. We’ll call these type of loans the “teeny-tiny loans.”
• Members had to pay a $35 “application fee” when they applied for teeny-tiny loans.
• Members who had obtained teeny-tiny loans sued the credit union, alleging that its loan disclosures understated the finance charge and APR in violation of TILA because the credit union had not included the application fee in determining the finance charge. 

The court ultimately dismissed the claim because the members failed to sufficiently allege actual damages, but the court denied a motion to dismiss the finance charge claim. And that is where I want to go with my response to your question!

The allegations in the complaint gave rise to a reasonable inference that the credit union had not charged the $35 application fee to all applicants and that the fee was not related to costs associated with processing applications. The members asserted that the credit union only charged the application fee when their teeny-tiny loans were approved.

Also, they alleged that the fee was not being used “to recover the costs associated with processing applications for credit” because the credit union had never performed any credit checks or investigations into their applications or conducted any review of their property.

Why are those allegations important? Because Regulation Z states that application fees are not finance charges if they are application fees charged to all applicants for credit whether or not credit is actually extended. Thus, if charged only to approved applicants, Regulation Z’s exclusion of application fees would not apply and the $35 fee imposed on borrowers would be considered a finance charge.

So, you can see how a financial institution may get in trouble when it does not decide in advance how it will treat finance charges. Regulation Z offers a list of certain charges that are not finance charges – in effect, exclusions – even if they are listed as examples of finance charges provided in Regulation Z. Certain terms used in the exclusions – for instance, terms such as “bona fide and reasonable” – are critical to the decision-making process.

Here are some caveats that I suggest you consider when, as, and if you want to decide on fees subject to the finance charge. Pass it along in your next sales meeting. It may quell a few controversies. Then again, it may stir them up even more!

In advance, the lender should take heed and beware of:

• Application fees charged to all applicants for credit, whether or not credit is actually extended;
• Charges for actual unanticipated late payment, for exceeding a credit limit, or for delinquency, default, or a similar occurrence;
• Charges imposed by a financial institution for paying items that overdraw an account, unless the payment of those items and the imposition of the charge were previously agreed upon in writing – by the way, this exclusion does not apply to credit accessed by a prepaid card;
• Fees charged for participation in a credit plan, whether assessed on an annual or other periodic basis (although this exclusion does not apply to a fee to participate in a covered, separate credit feature accessible by a hybrid prepaid-credit card, regardless of whether the fee is imposed on the credit feature or asset feature of the prepaid account);
• Seller’s points;
• Interest forfeited as a result of an interest reduction required by law on a time deposit used as security for an extension of credit;
• Discounts offered to induce payment for a purchase by cash, check, or other means; and,
• The following fees in a transaction secured by real property or in a residential mortgage transaction, if the fees are bona fide and reasonable in amount:

(a) fees for title examination, abstract of title, title insurance, property survey, and similar purposes,
(b) fees for preparing deeds, mortgages, and reconveyance, settlement, and similar documents,
(c) notary and credit report fees,
(d) property appraisal fees or fees for inspections to assess the value or condition of the property if the service is performed before closing, including fees relating to pest infestation or flood hazard determinations, and,
(e) amounts required to be paid into escrow or trustee accounts if the amounts would not otherwise be included in the finance charge.

Jonathan Foxx, Ph.D., MBA

Managing Director
Lenders Compliance Group