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FED ER AL RESERVE BANK O F NEW YORK Circular No. 8494 January 12,1979 T R U T H IN LENDING Questions on Disclosure of Annual Percentage Rate T o A l l M e m b e r B a n k s, a n d O th e r s C o n cern ed , in th e S e c o n d F e d e r a l R e s e r v e D is tr ic t: Following is the text of a statement issued by the Board of Governors of the Federal Reserve System: The Federal Reserve Board today [January 2] invited public comment on a wide range o f questions bearing on disclosure to borrowers o f the annual percentage rate (APR) required by the Truth in Lending law and its implementing Regulation Z. The APR expresses the cost to the consumer o f borrowing money and paying for purchases on credit. The Board requested comment by March 5, 1979. After this comment has been analyzed the Board will decide whether to publish for comment specific proposals for revision o f the A PR disclosure requirements o f Regulation Z. The Board’s objectives are greater uniformity in methods used to calculate the APR and increased simplicity in its determination, to enhance the ability o f consumers to shop for credit. The Board noted that present rules permit numerous variations in methods for computing the APR and said that these variations result in a lack o f uniformity that deprives consumers o f a standard measure for comparing the cost o f credit from different lenders. The lack o f uniformity arises, the Board said, primarily from the ways in which Regulation Z deals with two issues: (1) the degree o f precision required in calculating and disclosing the annual percentage rate, and (2) the treatment o f irregularities in payment amounts and periods. The Board’s statement said: “ Resolution o f these issues may require a wide range o f regulatory actions, including amendment or revocation o f various provisions o f the regulation, revocation and substitution o f Board interpretations, and revisions o f . . . the Board’s Annual Percentage Rate Tables . . . . “ This notice describes specific problems which the Board has identified in the present annual percentage rate provisions and sets forth possible methods o f resolving those problems. The options presented for each issue may not be mutually exclusive nor do they constitute the only remedies which the Board might consider. After analysis o f the comments received on this matter, the Board will consider what courses o f action, if any, merit further consideration and will propose for comment specific regulatory language to implement those changes.” Printed below is the text of the Board of Governors’ notice. Comments thereon should be submitted by March 5, 1979, and may be sent to our Consumer Affairs Division. PAUL A. VOLCKER, President. [6210-01-M] FEDERAL RESERVE SYSTEM [12 CFR Part 226] [Reg. Z; Docket No. R-01951 TRUTH IN LENDING Calculation and Disclosure o f Annual Percentage Rates AGENCY: Board of Governors of the Federal Reserve System. ACTION: Proposed revisions to Regu lation Z regarding methods of calcu lating and disclosing annual percent age rates. SUMMARY: This notice solicits com ment on the requirements of Regula tion Z with regard to the degree of precision and treatment of payment schedule variations in the calculation and disclosure of the annual percent age rate. The Board is reviewing the existing provisions in order to ascer tain what changes, if any, may be nec essary to provide greater uniformity and simplicity in the determination of this credit term. This publication de scribes certain problems, together with possible alternative and invites comment on other aspects of the annual rate provisions. Specific changes resulting from this be proposed for comment time. solutions, these and percentage regulatory review will at a later DATE: Comments must be received on or before March 5, 1979. ADDRESS: Secretary, Board of G ov ernors of the Federal Reserve System, Washington, D.C. 20551. FOR FURTHER INFORMATION CONTACT: Dolores S. Smith, Section Chief, Di vision of Consumer Affairs, Board of Governors of the Federal Reserve System, Washington, D.C. 20551 (202-452-2412). SUPPLEMENTARY INFORMATION: The Truth in Lending Act requires the Board to prescribe rules for determin ing and disclosing the annual percent age rate, as a measure of the cost of credit for consumer credit transac tions. The present rules permit numer ous variations in the computation methods. These variations result in a lack of uniformity which deprives con sumers of a standard measure for com paring credit sources. Additionally, these variations cause uncertainty for creditors and difficulties in enforce ment. The Board believes that the present lack of uniformity arises primarily from the ways in which Regulation Z deals with two issues: (1) the degree of precision required in calculating and disclosing the annual percentage rate and (2) the treatment of irregularities in payment amounts and periods. The first issue relates both to the number of decimal places employed in compu tation and disclosure and to the limita tion of disclosure options to either an exact or a rounded rate. The second issue involves the manner in which the creditor either takes specific account of variations in the payment schedule or, to the extent permitted, ignores those variations in computing the annual percentage rate. Resolution of these issues may re quire a wide range of regulatory ac tions, including amendment or revoca tion of various provisions of the regu lation, revocation and substitution of Board interpretations, and revisions of Supplement I and Volume I of the Board's Annual. Percentage Rate Tables. In considering such extensive changes, the Board wishes to encour age a thorough public discussion which will address the likely impact of those changes and the extent to which commenters perceive the need for any changes at all. This notice describes specific problems which the Board has identified in the present annual per centage rate provisions and sets forth possible methods of resolving those problems. The options presented for each issue may not be mutually exclu sive, nor do they constitute the only remedies which the Board might con sider. After analysis of the comments received on this matter, the Board will determine which courses of action, if any. merit further consideration, and will propose for comment specific reg ulatory language to implement those changes. The Board believes that all of the options discussed below could be im plemented on the basis of its rulemak ing authority under §§ 105 and 107 of the Truth in Lending Act, but wel comes comment on this matter as well. I. T o leran ce The annual percentage rate for any credit transaction may be disclosed, under the existing rules, as an exact figure or rounded to the nearest onequarter per cent. A number of meth ods for determining annual percentage rates are authorized by the current provisions of Regulation Z and various Board and staff interpretations. How ever, creditors disclosing a rate be tween these ‘ Correct” rates could find themselves in violation of the regula tion. For example, using one author ized computation procedure, a creditor might obtain an annual percentage rate of 9.13 per cent. Using another permitted calculation technique for the same transaction, the creditor might determine the annual percent age rate to be 9.20 per cent. Disclosure of either of these rates or a rounded rate of 9.25 per cent would be permis sible but a creditor disclosing 9.23 per cent wrould be in violation of the regu lation if 9.23 per cent was not deter mined by a specifically sanctioned computation method. Another shortcoming of the round ing option is that the degree of protec tion afforded creditors is not uniform, since the margin of error diminishes as the true annual percentage rate ap proaches the quarter per cent. For ex ample, an annual percentage rate of 9.12 per cent may be rounded down .12 percentage points to 9.00 per cent, while a 9.01 annual percentage rate may be rounded down only .01 per centage points. Finally. w7here the exact annual per centage rate lies extremely close to the midpoint of the one-quarter per cent range, determining whether to round up or down to the nearest quar ter of one per cent becomes an almost impossible task. For example, where the true annual percentage rate is near 9 125 per cent, an error of less than one thousandth of one per cent could result in an understatement at 9.00 per cent or an overstatement at 9.25 per cent. In order to facilitate compliance and eliminate the inequities associated with the current rounding option, the Board is considering replacing this provision with a rule providing a toler ance for minor variations in rate com putation methods and insignificant errors in disclosed annual percentage rates. In view of the complexities in volved in establishing a workable rule, the Board requests comment on the following questions: 1. Should the tolerance be the same for overstatements and understate ments, or should a greater tolerance be permitted for overstatements? One argument for allowing a greater tolerance for overstatements is evi dence indicating the existence of cer tain technical difficulties involving the production and use of rate charts and tables. These difficulties tend to pro duce substantial overstatements. 2 2. How much tolerance should be al lowed? Should the tolerance pre scribed be stated as a fixed amount (e.g., within one eighth of a percent age point from the true rate) or as a variable amount (e.g., as a percentage of the true rate)? 3. Should the same tolerance be pre scribed for both closed end and open end credit transactions? 4. Should distinctions be made on the basis of length of maturity, credit amount, or other such factors? For ex ample, should the same tolerance pre scribed for a credit transaction of $1,000 maturing in one year also be ap plicable to a $50,000 credit extension with a maturity of thirty years? 5. Should distinctions be made be tween rates produced by charts and tables and those generated by poten tially more accurate devices, such as computers and calculators? 6. Howr should the occasional slight differences between rates produced by the United States Rule and those pro duced by the actuarial method be ac counted for in prescribing a tolerance? Since application of the United States Rule sometimes produces a higher rate that the actuarial method for a given amount of finance charge, one alternative might be to measure the degree of overstatement allowed from the rate produced by the former method and determine the degree of permissible understatement based on the latter method. 7. Should the tolerance prescribed apply uniformly to all computation methods or should different treatment continue to be provided, as in the fol lowing cases: (a) Charts and tables applicable to specific ranges or brackets of balances under § 226.5(c)(2)(iv) and (b) The single add-on rate transac tion method under Board Interpreta tion §226.502. 8. Is the constant ratio method of rate computation authorized under § 226.5(e) still needed, or could this provision be deleted? 9. Should use of Volume I of the Board's Annual Percentage Rate Tables be restricted to transactions for which the annual percentage rate pro duced falls within the tolerance to be prescribed? 10. Are there other factors that the Board should consider in establishing a rule allowing a tolerance in annual percentage rate computations? II. N um ber of D e c im a l P l \ces Presently, neither the Act nor the regulation provides definitive rules re garding the degree of precision re quired at various stages in the annual percentage rate computations or for disclosure purposes. Although such guidelines are contained implicitly in Supplement I to Regulation Z and in various Public Information Letters, the absence of specific requirements is a source of confusion in both open end and closed end credit. The number of decimal places to which calculations are carried throughout the rate computation process drastically affects the accura cy of the disclosed annual percentage rate. Certain practices, including trun cation or rounding of “ significant” digits at interim steps in the calcula tion process, frequently result in sig nificant distortions in the disclosed annual percentage rate. To eliminate this problem, the Board is considering adoption of a rule requiring disclosed annual percentage rates for all credit transactions to be rounded to two deci mal places. In arriving at such rates, calculator and computer programs would be expected to carry all availa ble digits throughout the calculations, rounding only the final result to two decimal places. Similarly, charts and tables would be required to provide listed factors that permit a determina tion of the annual percentage rate rounded to two decimals. In open end credit, periodic rates used to compute the finance charge are also required to be disclosed. In this regard, the Board is considering adopting a rule requiring disclosure of the exact periodic rate applied. III. I g n o r in g I r r e g u l a r it ie s Regulation Z currently contains three “ minor irregularities” provi sions: § 226.5(d) and Board Interpreta tions §§ 226.503 and 226.505. These sec tions permit creditors to disregard cer tain variations in payment amounts and payment periods for purposes of determining the annual percentage rate, the amount of the finance charge, or both. That is, where the first payment period differs from the subsequent periods by no more than a specified number of days or where any one payment differs from the other payments by no more than a specified per cent, creditors have been permit ted to ignore such variations, treating the odd period or amount as though it were regular. Use of the minor irregularities provi sions necessarily creates distortion in the annual percentage rate and the fi nance charge disclosed insofar as they allow that which is irregular to be treated as regular. Although the provi sions were designed to minimize the distortion by limiting their applicabil ity to differences within certain speci fied ranges, the variations produced can be considerable. This distortion is proportionately greater in short term transactions. For example, using the minor irregularities option, a variation of 10 days in the length of the first period in a transaction payable month ly will cause the annual percentage rate for a six month transaction to vary by approximately 10 per cent of the true rate; a one year transaction, approximately 5 per cent of the true rate; a two year transaction, approxi mately 2'/2 per cent of the true rate; a five year transaction, approximately 1 per cent of the true rate; and a thirty year transaction, approximately V3 per cent of the true rate. The variability is increased by the fact that creditors are free to take ad vantage of the provisions when it is to their benefit to do so (e.g., treating short periods as regular) and to disre gard them when it is advantageous to take specific account of irregularities (e.g., a long period). The variability is further increased by the fact that, for a given transaction, a lender has the option of using the minor irregulari ties provisions for both the annual percentage rate and the finance charge, for one and not the other, or for neither one. The variation in rates and charges thus obtained under the current minor irregularities rules creates several problems. First, it impairs comparabil ity of what are intended to be the two most important items of credit infor mation to consumers, thus hampering credit shopping. It also considerably complicates administrative enforce ment, in that examiners attempting to verify disclosed information must per form numerous calculations to see whether any one of several permissible approaches might yield the disclosed annual percentage rate or finance charge. Finally, due to their fairly technical nature, these provisions are often misunderstood. In light of these considerations, the Board would like to receive public comment on the following options: Option 1. Eliminate the current minor irregularities provisions alto gether. One argument in favor of this option, aside from those noted above with regard to the variety, of results permitted, is that the need for these provisions has been greatly reduced as the sophistication and availability of tools capable of producing exact rates and charges have increased. The need for the protection offered by these provisions would be further reduced if certain other options suggested in this proposal are adopted. For example, if a uniform method of dealing with ir regular periods is specified (see Sec tion IV below), the task of accounting for the most common irregularity w’ould be simplified. Allowance of a specified tolerance in the annual per centage rate accuracy requirement (see Section I above) could also mini mize the need for the current minor ir regularities provisions. If, for instance, there are irregularities which are truly so minor that ignoring them results in an annual percentage rate close enough to the true rate to fall within the specified tolerance, a creditor could continue to ignore those irregu larities without violating the regula tion. An argument against Option 1 is that the minor irregularities provi sions appear to be widely relied upon by creditors. Their elimination would put a greater burden on creditors to take specific account of payment 3 schedule irregularities, even in those cases w’here the irregularities are caused by a desire to accommodate customer preferences (e.g., scheduling the first payment to coincide with a payday). Option 2 Revise the minor irregular ities provisions to permit only over statements of the annual percentage rate and finance charge. Within this option, several further choices could be made, for example: (a) Should the provisions apply to both periods and payment amounts or just to periods? Under the latter, for example, the extra days in the period from the transaction date to the first payment could be ignored, but any variation in payment amount would have to be reflected. (b) Should the provisions apply to both the annual percentage rate and the finance charge or to just one, for example, the annual percentage rate (so that irregularities could be disre garded for rate computation purposes, but the exact dollar amount of finance charge would have to be disclosed)? If applicable to both the annual percent age rate and the finance charge, should the creditor be required, for a given transaction, to use the minor ir regularities provisions for both annual percentage rate and finance charge if it chooses to use it for either one? (c) Should the “ degree” of irregular ity be limited in some way as in the current provisions (e.g., for a transac tion payable monthly, allow a period of not more than 50 days to be treated as if it were regular)? Since one of the problems with the current provisions is the variety of rates and charges they permit to be disclosed, this option would have the advantage of decreasing the number of permissible disclosures. In addition, customers would never be told that the rate or charge was lower than it actually was. Moreover, since creditors would be making disclosures that might put them at a competitive disad vantage (because they would be dis closing an annual percentage rate or finance charge higher than that actu ally imposed), use of the provision would be discouraged in competitive markets. A major argument against this option is that such a provision would continue to allow inaccurate state ments of the annual percentage rate and finance charge, thus impeding comparison shopping. Option 3 Leave the substance of the current minor irregularities provisions unchanged, making only editorial revi sions. The provisions presently appear in three separate places in the regulation and Board interpretations. At a mini mum, the rules could be restated more clearly in a single location. Option 4 Adopt a new provision to allow slight payment schedule vari ations arising from particular prac tices to be disregarded in determining and disclosing the annual percentage rate, finance charge and schedule of payments. There are a number of very slight payment schedule irregularities which arise from valid (even necessary) busi ness practices, and which affect, how ever negligibly, the amount of certain required disclosures. One such irregu larity is the difference between the final payment and all other payments in a simple interest loan, which differ ence results from the rounding of pay ment amounts to whole cents. This slight irregularity in the payment schedule is unavoidable, since credi tors cannot collect fractions of pen nies. Under the current regulation, however, a technical violation could result unless the precise amount of that final payment were computed and disclosed, and the finance charge adjusted accordingly. Another example arises in certain transactions in which interest is paid on the outstanding balance and pay ments are made by payroll deduction. Although paydays may be scheduled, for example, on the 15th and the last day of the month, the employer may have a policy of advancing the payday if one of those dates falls on a Satur day, Sunday or holiday. The payment schedule would have occasional slight variations due to this practice as well as to the fact that the last day of the month varies. Under the current regu lation. the creditor could not assume a uniform semi-monthly payment sched ule, but would have to take account of the advanced payment dates. The impact of such slight variations on tlip annual percentage rate may be small enough to allow such variations to be disregarded without causing the rate to fall outside the annual percent age rate tolerances discussed in Sec tion I above. However, there are other non-rate disclosures, e.g., finance charge and total of payments, that are also affected by these variations. Option 4 would permit such variations to be ignored for disclosure purposes. The Board would like public com ment on Whether such a provision would be appropriate and, if so, whether there are other similar prac tices resulting in slight payment schedule variations which should properly be included in the provision. IV . A c c o u n t in g for I r r e g u l a r it ie s An irregularity occurs when an in terval between advances or payments in a transaction is shorter or longer than the unit-period for that transac tion. A unit-period is that time inter val between advances or payments which occurs most frequently in the transaction. In the most common case, an odd first period is created when a transaction is consummated on a date which does not fall exactly one unitperiod prior to the first payment or advance date. In cases where the minor irregularities provisions do not apply, or where the creditor chooses to account for these irregularities, the creditor must determine the number of days in the odd period and relate that number to a regular period. Since no single method has ever been specified for making this calcula tion, creditors use a variety of meth ods. Among the methods commonly used by creditors to determine the length of an odd period are counting the actual number of days, counting on the basis of an assumed 30-day month and counting months and days in the period. The possible variations thus produced are further compound ed by the creditor’s choice of options in determining the fractional value of the odd days, which may be related either to 30 (assuming a standard month of 30 days) or to 365/12 (divid ing the number of days per year by the number of months). These seem ingly minor differences in accounting for odd days may produce significant variations in the resulting annual per centage rates. The Board is considering the revi sion of Supplement I to specify a uni form method for determining the number of odd days and relating that number to a regular unit-period. In transactions involving a unit-period of a month, one suggested method is first to determine the number of whole months in the odd period by working back from the calendar date of an ad vance or payment to the correspond ing calendar date in the previous month, and then to count forward the exact number of days from the begin ning of the odd period to the first cal endar date corresponding to the date of the payment or advance, as applica ble. For example, in a transaction con summated on January 5 with the first monthly payment due on February 23, the creditor wTould count back from February 23 to January 23 as one full unit-period, and then count forward from January 5 through January 23, thus determining that there are 18 odd days in the first period. If this ap proach were adopted, Supplement I would also specify uniform rules for transactions involving other unit-peri ods. Although this issue might assume greater importance if the minor irreg ularities provisions discussed above were revoked, it should be emphasized that retention of those provisions would not eliminate this issue. Odd pe riods must continue to be accounted for in those transactions in which the minor irregularities option is not chosen, or in which the number of odd days is beyond the ranges now permit ted to be ignored. 4 V. R e l ia n c e on C harts and T ables Under § 226.5(c)(3), an annual per centage rate or finance charge error that results from an error in the chart or table used by the creditor does not constitute a violation of Regulation Z, subject to certain conditions. Two issues have arisen regarding this provi sion. First, calculators and computer software are now used extensively for computation purposes, in substitution for charts and tables. However, as written, § 226.5(c)(3) appears to be available solely to users of charts and tables. Second, the Board’s statutory authority for implementing this sec tion, which protects creditors against civil liability under § 130 of the Truth in Lending Act, has been questioned. The Board is considering the follow ing alternative courses of action to re solve these issues: Option 1 Rescind § 226.5(c)(3), making creditors using any computa tion tool equally liable for finance charge and annual percentage rate errors, without regard to the source of those errors. Advances over the past ten years in calculator technology and chart pro duction may warrant elimination of §226.5(0(3). This option would also accomodate, in the simplest and most direct fashion, the concerns expressed regarding both the unequal availabil ity of the protection afforded by the present rule and the Board's authority to promulgate it. Option 2 Amend § 226.5(c)(3) to extend its protection to any creditor using fauity software or a faulty calcu lator acquired or produced in good faith. If this option is pursued, the Board may consider conditioning the avail ability of this protection on certain re quirements. such as the maintenance of procedures reasonably adapted to detect or avoid errors and the adjust ment of customers' accounts to correct such errors. To aid in the consideration of these matters by the Board, interested per sons are invited to submit relevant data, views, comments or arguments. Any such material should be submit ted in writing to the Secretary, Board of Governors of the Federal Reserve System, Washington, D.C. 20551, to be received no later than March 5, 1979, and should include the docket number R-0195. The material submitted will be made available for public inspection and copying, except as provided in § 261.6(a) of the Board's Rules Regard ing Availability of Information (12 C.F.R. 261.6(a)). By order of the Board of Governors, December 22, 1978. T h eo d o re E. A l l i s o n , Secretary o f the Board. [FR Doc. 79 345 Filed 1-2-79; 8:45 am]
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