Regulation Z: Closed-End Credit Disclosures

Regulation Z disclosure errors are most often due to misunderstanding how to treat charges associated with processing a loan, which leads to incorrectly calculating key items.

Disclosure Statements

A disclosure statement must be completed for every installment loan covered by Regulation Z.

Reg Z requires all material closed-end credit disclosures to apper in a segrated conspicuous spot. These essential disclosures are often called the “Fed Box”.

Disclosing an Amount

When an amount is required to be disclosed in closed-end transactions, it must be shown as a dollar amount.

Key Disclosure Items

Annual Percentage Rate (APR) and Finance Charge

The APR is the cost of credit stated as an annual rate. The finance charage is the total cost of credit as a dollar amount. These two key disclosures must be more conspicious than any of the other required disclosures, because they are considered the most important information for a consumer to use.

Using bold fonts, bolder lines around boxes for these amounts is a good practice.

Amount Financed

The amount financed is the total amount of money that is available to the consumer. It is not neccesarily the principal amount of the loan, so be careful.

The amount financed normally appears at the top of the disclosure statement.

Total of Payments

The total of payments is the amount that the borrower will pay to the lender after all payments are made as scheduled. It’s basically the sum of all payments to be made by the borrower by the time the loan is paid off.

Appears at the top of the disclosure statement.

The Significance of APR

Calculating the APR accuretly is critical to Regulation Z compliance.

• Consumers rely heavily on the APR in choosing a loan. Because it is calculated in a consistent way accross different lenders and loans, it allows consumers to compare different products efficiently.
• Regulators The APR disclosure is the main measure of Regulation Z complience. If an APR amount is under-disclosed, regulators can require lenders to reimburse to the borrowers some of the finance charges. Under federal regulatory enforcement guidelines, regulators expect that financial institutions that find such errors will voluntarily repay consumers.

APR Tolerances

Regulation Z defines a margin of error, or tolerance, for disclosing APR.

If the disclosed APR is lower than teh actual APR by more than the tolerance, regulators could require reimbursement to the borrower of any payments collected that exceed the disclosed rate and any future payments that exceed the tolerance. So, if the disclosed APR is lower than the correct rate, the disclosed rate will govern as the contract rate.

• Tolerane for Regular Loans: 1/8% For a regular loan, the APR tolerance is 1/8 of a percent, or 0.125.
• Tolerance for Irregular Loans: 1/4% An irregular loan is one that includes one or more of the following features
  • Multiple principal advances
  • Irregular payment amounts
  • Irregular payment periods

Because calculating APR for an irregular loan is more complicated, Regulation Z’s tolerance level is more lenient than for regular loans. It is 1/4 of a percent, or 0.250.

Formulas for Calculating APR

Reg Z provides standard mathematical formulas to use in calculating the APR for different types of installment loans. All of the formulas include the following data:

• The loan amount and timing of principal advances
• All finance charges collected during the life of the loan
• The effect of prepaid finance charges on the APR
• The amount and timing of periodic payments scheduled over the life of the loan

The significance of Finance Charge

Along with APR, the finance charge is one of the two key Regulation Z disclosures. A challange in disclosing finance charge is identifying all of the loan costs that should be included in calculating it.

What’s Included in the Finance Charge

The finance charage must include everything ( with certain exceptions) the borrower is paying to get the loan, including:

• Interest
• Points, assumption fees, or loan fees
• Service or transaction fees ( any credit-related fee that is activity related)
• Appraisal, investigation, and credit report fees in a non-mortgage transaction
• Some insurance premiums
• Certain dept cancellation aggreement feses

These aren’t the only finance charges,but they are the most common.

Components of the Finance charge

• Interest is almost always the largest component of the finance charge. Interest is always charged to the borrower as a condition of the loan, so it is considered a finance charge and seldom causes any confusion.
• Loan Fee Many lenders charge a basic fee to perform the loan transaction. Other terms for loan fee are points, origination fee, and ** acquisition fee**. Since loan fees are a condition of the loan, they are part of the loan’s cost and must be included in the finance charge. Loan fees sometimes are collected at the beginning of the loan term, instead of over its life. In this case they are called prepaid. If a loan fee is charged by a loan broker or someone other than the creditor, then it is considered a finance charge. Many Reg Z violations result from overlooking third-party loan fees that should be included in the finance charge.
• Loan Insurance Premiums and Debt Cancellation Aggreement Charges Some types of loan insurance premiums and debt cancellation agreement charges must be included in the finacnce charge if they are required by the creditor. Common types are:
  • Credit life insurance
  • Health and accident insurance
  • Loss of income insurance
  • Debt cancellation fees If a lender requires one or more of these types of insurance in order to make the loan, the premiums must be included in the finance charge, even if the consumer is allowed to choose the insurer.
• Credit Report Fee Most lender rely on a credit deport in determining whether to offer a loan to an applicant. The report provides a record of a borrower’s history of repaying other debts and indicates how likely an applicant is to repay the loan being considered. The fee charged for a credit report may be called different names:
  • Investigation fee
  • Credit report fee
  • Credit bureau fee Since the fee for a credit report is required to be paid by the borrower as a condition of the credit, the fee must be included as a finance charge.
• ** Disbursement and Other Fees** If you charge any fee that is related to borrowing activity, such as a disbursement fee on a construction loan or a charge for documenting a loan, it must be included in the finance charge. Be sure not to forget it.

When is Loan Insurance a Finance Charge ?

If a lender requires insurance to make the loan, the premiums or fees are part of the cost of the credit and must be included in finance charge. This is true wheteher the insurance is purchased from the lender or from a third party and applies to:

• Credit life insurance
• Health and accident insurance
• Loss of income insurance
• A debt cancellation agreement
• Guaranteed automabile protection (GAP)

But if a lender offers such loan insurance as an option, the premiums may be excluded from the finance charge if the following disclosures are made to the borrower in writing:

• A statement that the insurance or debt cancellation is not required to obtain the loan
• The amount of the premium or fee for the initial term of coverage
• The term of the coverage offered ( if less than the term of the loan )

Lender should not disclose charges for debt cancellation coverage as insurance unless their state considers these programs to be insurance – some states don’t.

Optional Loan insurance coverage

In addition, borrowers must sign or initial the disclosure statement if they want to buy optional coverage.

If the disclosures and evidence that the borrower requests the coverage are in place, then premiums for optional coverage may be excluded from the finance charge.

There is no requirement to sign anything if the borrower does not want the optional coverage.

What is not includede in the Finance Charge?

Here are some charges that are not considered part of the finance charge.

• Late Payments, Overdrafts, and Default Charges: These fees are not a cost of credit, but costs paid by the borrower for violating the terms of the loan aggerement.
• Sales Tax, Licence Registration, and Title Fees: These costs are not included in the finance charge because borrowers would have to pay them even if they paid cash for the product.

Application fees

Some lenders charge a fee to borrowers who apply for a loan. These application fees can be excluded from the finance charge only if the fees are charged to all applicants regardsless of whether their credit is approved or denied.

Upcharges

When a fee charged by a third-party is increased to benefit the lender, the increased amount is called an upcharge. Any portition of an upcharge retained by the lender must be included in the finance charge, even if the fee itself is exempt.

Finance Charge Accuracy

For non-mortgage loan, the disclosed finance charge is consideredd accurate within the following limits.

• $1000 or Less: For financed amounts of $1000 or less, the disclosed finance charge is considered accurate if it is not more than $5 above or below the actual finance charge.
• More than $1000 : For financed amounts above $1000 the disclosed finance charge is considered accurate if it is not mor than $10 above or below the actual finance charge.

Amount Financed

The amount financed shouldn’t be confused with the loan principal amount. The basic formula for determining amount financed is:

Amount Financed = Loan principal amount - Prepaid finance charges 

Calculating Principal Amount

To calculate the principal amount, begin with the amount requested by the borrower, then add any charges financed by the lender over the term of the loan. This applies whether the fes are considered finance charges or not.

Loan principal amount = Loan amount requested + Fees financed over loan term 

Prepaid Finance Charge

A prepaid finance charge is one that is paid to the lender before the beginning of the loan’s repayment period. It is not financed.

Additional Disclosures

In addition to the amount financed disclosure, Regulation Z requires lenders to provide a disclosure telling consumers that they are entitled to an itemization of the amount financed.

Your disclosure form will provide space for consumers to check or initial if they want an itemization of the amount financed. Alternatively, you may provide an itemization of the amount financed on every loan. If you provide an itemization, this disclosure cannot be made inside the “Fed Box”.

Amounts paid to others

Sometimes an institution may add finders’s fees or commissions charged by a third party to the amount financed. You’ll beed to disclose these correctly. When a substantial amount of a fee categorized as amounts paid to others is retained by the creditor, the creditor may add language similar to the following

We have retained a portition of the Amout Paid to Others.

The specific amount retained does not need to be disclosed.

Other Reg Z Disclosures

Finance charge, annual percentage rate, and amount financed probably are the three disclosures that cause the most Regulation Z challanges.

But Reg Z requires many other disclosures on installment loans. These include:

• Payment scheduled
• Total Payments
• Variable rate disclosures
• Late payment charges
• Prepayment disclosures
• Security interests
• Demand features

Payment Schedule

Disclosure of the repayment terms and schedule is important to borrowers. It tells them when each payment must be made and what the payment amount will be.

Components

There are three parts to the payment schedule: 1- The number of payments 2- The amounf of each payment 3- The timing of payments

Format

Many lenders use the table method suggested by the Federal Reserve Board to disclose the payment schedule. For Example

Alternatively, some lenders prefere the narrotive approach:

You will repay 35 payments of $179.53, due on the first day of each month starting 05/01/20XX, and one payment of $179.24 due on 04/01/20XX

Amounts included

Which format your institution usesi the amounts reflected in the payment schedule should include the amount financed and all items in the finacne charge that remain to be paid after the loan is made, not just the interest.

Total of Payments

Another required disclosure in installment loan transactions is the total of payments.

The total of payments is the sum of all the payments disclosed in payment schedule. Example:

Your payment schedule will be:

Variable Rate Disclosures

Many types of closed-end loans can have variable interest rates. For variable-rate transactions, you must disclose the following:

• The circumstance(s) under which the rate would change
• Any limitations that exist on rate increases, such as a yearly overall limit.
• The effect that a rate increase would have the repayment of the loan. That is, would the monthly payment, term of the loan, or final payment amount change?
• An example of the payment terms that would result from an increase in the interest rate.

Generic Example

Variable Rate- Your loan contains a variable-rate feature. Disclosures about the variable-rate feature have been provided earlier, or the annual percentage rate may increase during the term of the transaction if ( the circumstance). The rate may not increase(limitations). Any increase will take the form of (effect). If the interest rate increases (example).

Late Payments, Loan Prepayment, and Collateral Disclosures

Late Payments

Reg Z requires lenders to tell borrowers what will happen if they make their payments late.

Example:

If your payment is more than 15 days late, you will be charged $5.00 or 5% of the late payment amount, whichever is more

Loan Prepayment

Reg Z also requires lenders to disclose what rights the borrower has to prepay the loan, and, if the prepayment is permittedi whether any prepayment penalty fee may or will not be charged, and whether the borrower may or will not be entitled to a refund of part of the finance charge.

Security Interest

Reg Z requires that you tell the borrower what collateral, if any, is being used to secure the loan, along with a brief description of the collateral.

Demand Clauses

A demand clause allows the lender to demand full payment at any time during the loan’s repayment term.

• Demand Disclosure An installment loan disclosure statement must clearly inform the consumer if the loan includes a demand clause.

This loan has a demand feature This loan is payable on demand

• Conditional and Unconditional Demand Clauses Some demand clauses are conditional, meaning the lender may demand full repayment if and when a specific event occurs, kike a default by the borrower or other breach of the loan contract.

Other demand clauses are unconditional, meaning the lender may demand full repayment of the loan at any time for any reason.

• Demand Clauses and Maturity Date Some damend loans do not have a stated maturity date in this case, the APR and finance charge are calculated and disclosed assuming the loan will mature in a year.

If a demand loan contains a stated maturity date, or if the loan has a principal reduction schedule that translates into a maturity date, the disclosures of APR and finance charge should not be made using that date, disregarding the demand feature.

Education Loan Requirements

Loans that are made expressly for post-secondary education purposes (collage expenses) have special restrictions and disclosure requirements. These rules apply when the purpose is specifically education expenses, but the loan must be a closed-end loan.

Unlike other non-real estate-secured loans under Reg. Z the threshold exemption does not apply here. If an unsecured loan is made expressly for post-secondary education expenses, the rules apply.

The additional disclosure requirements for education loans do not apply for the following:

• Federal education loans
• Lines of credit and any loan secured by real estate

Educational Loan Disclosures

For covered education loans, additional disclosures must be provided to the applicant/borrower.

Application Disclosure

The application disclosure must include:

• Interest rates
• Fees and default or late payment costs
• Repayment terms
• Cost estimates
• Eligibilty
• Alternatives to private education loans
• Rights after the consumer
• Self-certification information

Regarding alternatives, the disclosure must advise borrowers of the potential availability of fedaral loans and that they shpuld contact their school or the Department of Education to obtain more information.

Approval Disclosure

The approval disclosure must include

• Interest rates
• Fees and default or late payment costs
• Repayment terms
• Alternatives to private education loans
• Rights of the consumer

Estimates of the total repayment amount based on both the current interest rate and the maximum interest rate that can be charged must also be included. The monthly payment at the maximum rate must be disclosed.

Self-Certification

The borrower must complete a self-certification form developed by the Department of Education prior to closing of the loan.

Final Disclosure

The final disclosure must be provided at loan closing and must include:

• Interest rates
• Fees and default or late payment costs
• Repayment terms
• Cancellation rights

The final disclosure must include “Right to Cancel” language.

Consideration Period

Borrowers must be given 30 calendar days after an education loan is approved to decide whether or not to accept the loan temrs offered. During these 30 days, the creditor cannot change the rate or terms of the loan offered, except if the loan is a variable-rate loan based on an index and the index value changes.