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^ S A ' k o ' /£ > ,0 /< f March 28, 1986 To the Addressees Enclosed — regulations — Subpart B — for those who maintain sets of the Board of Governors’ is a copy of the Board’s "Staff Guidelines on Regulation A A S The Credit Practices Rule/' effective January 1, 1986„ Questions regarding the Credit Practices Rule or Regulation AA may be directed to our Compliance Examinations Department (Tel, N o 0 212=791-5919). Circulars Division FEDERAL RESERVE BANK OF NEW YORK 0726C Board of Governors of the Federal Reserve System Staff Guidelines on Regulation AA? Subpart IB The Credit Practices Rule Effective January 1, 1986 Any inquiry relating to Regulation AA should be addressed to the Federal Reserve Bank of the Federal Reserve District in which the inquiry arises. January 1986 Contents Page Introduction ................................................. Section 227.11— Authority, purpose, and scope............................................................ Section 227.12— Definitions...................... Section 227.13— Unfair credit contract provisions................................................... Section 227.14— Unfair or deceptive practices involving cosigners................ Section 227.15— Unfair late charges . . . . Section 227.16— State exemptions........... 1 2 2 5 8 11 12 Staff Guidelines on the Credit Practices Rule Effective January 1, 1986 INTRODUCTION 1. Background. On March 1, 1984, the Feder al Trade Commission (F T C ) adopted its Credit Practices Rule, effective March 1, 1985, pursuant to the authority granted the FTC under section 1 8 (a ) (1 )(B ) and section 5 (a ) (1 ) of the Federal Trade Commission Act (FTC A ct), 15 USC 5 7 a ( a ) ( l ) ( B ) and 15 USC 4 5 (a ) (1 ). Under this statute the FTC is authorized to promulgate rules that define and prevent “unfair or deceptive acts or prac tices” in or affecting commerce with respect to extensions of credit to consumers. Section 1 8 (0 of the FTC Act, 15 USC 57a( 0 , pro vides that, whenever the FTC promulgates a rule prohibiting practices which it has deemed to be unfair or deceptive, the Board of Gover nors of the Federal Reserve System (Board) must adopt a substantially similar rule prohib iting such practices by banks. The Board must adopt a rule within 60 days of the effective date of the FT C ’s rule unless the Board finds that such acts or practices by banks are not unfair or deceptive, or that the adoption of similar regulations for banks would seriously conflict with essential monetary and paymentsystems policies of the Board. In April 1985, the Board adopted a rule substantially similar to the FT C ’s Credit Practices Rule, thereby amending the Board’s Regulation A A, Unfair or Deceptive Acts or Practices (12 C FR 227). The Board modified certain provisions of the FT C ’s rule in order to take into account the needs and character istics of the banking industry. The effective date of the Board’s rule is January 1, 1986.2 2. Sum m ary o f rule. The Board’s rule applies to all consumer credit contracts other than those for the purchase of real estate. It prohib its banks from using certain remedies to en force consumer credit obligations. Under the rule, banks may not include these remedies in their consumer credit contracts, and, if banks purchase contracts that contain a prohibited provision(s), banks are prohibited from en forcing the provision(s). The prohibited provisions are: (1 ) a confession-of-judgment clause (also known as a cog novit or warrant of attorney), which permits a creditor to obtain a judgment based on the borrower’s agreement in advance that, in the event of a suit on the obligation, the borrower waives the right to notice and the opportunity to be heard; (2 ) a waiver of exemption in which the consumer relinquishes a statutory right protecting his or her home and other necessities from seizure to satisfy a judgment, unless the waiver applies solely to property that serves as security for the obligation; (3 ) an irrevocable assignment of future wages which gives the bank the right to receive the consumer’s wages or earnings directly from the consumer’s employer, unless the assign ment constitutes a payroll deduction plan or other preauthorized-payment plan; and (4) the taking of nonpossessory security interests in household goods, unless such goods are purchased with the credit extended by the bank. The rule also prohibits a practice known as “pyramiding late charges.” Under the pyra miding provision, a bank is prevented from assessing multiple late charges based on a sin gle late payment that is subsequently paid. The rule also prohibits a bank from misrep resenting a cosigner’s liability and requires the bank to give a cosigner, prior to becoming ob ligated in a consumer credit transaction, a dis closure notice which explains the nature of the cosigner’s obligations and liabilities under the contract. 3. Scope; enforcement. The Board’s rule ap plies to all banks and their subsidiaries. Insti tutions that are members of the Federal Home Loan Bank System and nonbank subsidiaries of bank holding companies are covered by the rules of the Federal Home Loan Bank Board and the FTC, respectively. The Board has enforcement responsibility for state-chartered banks that are members of the Federal Reserve System. The Office of the Comptroller of the Currency has enforcement responsibility for national banks. The Federal 1 § 227.11 Deposit Insurance Corporation has enforce ment responsibility for state-chartered banks that are not members of the Federal Reserve System. 4. State exemptions. The rule provides that states may seek exemptions from the require ments of the rule when the state law provides a level of protection substantially equivalent to, or greater than, the protection afforded by the rule. 5. Format o f sta ff guidelines. The staff guide lines on the Credit Practices Rule— subpart B of Regulation AA— are in question-and-answer format. The questions are identified by hyphenated numbers. The first part of the number indicates the regulatory section; the second part, the sequential order of a particu lar question within that section. For example, 13 (d )—1 indicates the first question in section 227.13(d ). Headings are included to make it easier for users to locate questions. SECTION 227.11—Authority, Purpose, and Scope Q11 ( c ) - l : Penalties fo r noncompliance. What are the penalties for noncompliance with the rule? A: Administrative enforcement of the rule for banks may involve actions under section 8 of the Federal Deposit Insurance Act (12 USC 1818), including cease-and-desist orders re quiring that actions be taken to remedy viola tions. If the terms of the order are violated, the federal supervisory agency may impose penalties of up to $1,000 per day for every day that the bank is in violation of the order. Credit Practices Guidelines use. The rule does not apply, however, to loans made for the purchase of real property. Q 1 2 (a )-2: Business vs. consumer purpose. How can a bank determine whether credit ex tensions are for business purposes and, there fore, not covered by the rule? A: While there is no precise test for what con stitutes business-purpose credit— as opposed to credit primarily for personal, family, or household purposes— banks may consider the factors described in the official staff commen tary to Regulation Z (Truth in Lending, 12 C FR 226) on this issue. The factors include: ° The relationship of the borrower’s primary occupation to the acquisition. The more closely related, the more likely it is to be business purpose. « The degree to which the borrower will per sonally manage the acquisition. The more personal involvement there is, the more likely it is to be business purpose. ® The ratio of income from the acquisition to the total income of the borrower. The higher the ratio, the more likely it is to be business purpose. ° ° The size of the transaction. The larger the transaction, the more likely it is to be busi ness purpose. The borrower’s statement of purpose for the loan. Examples of business-purpose credit include: • A loan to expand a business, even if it is secured by the borrower’s residence or personal property. ° A loan to improve a principal residence by putting in a business office. ° A business account used occasionally for consumer purposes. Examples of consumer-purpose credit include: SECTION 227.12—Definitions ° 12(a) “Consumer ” Q 12(a)-1: Type o f transaction covered. What type of transaction is covered by the rule? ° ° A: The rule covers credit obligations of con sumers to acquire goods, services, or money primarily for personal, family, or household 2 Credit extensions by a company to its em ployees or agents if the loans are used for personal purposes. A loan secured by a mechanic’s tools to pay a child’s tuition. A personal account used occasionally for business purposes. Q 1 2 (a )-3 : Agricultural-purpose loans. What § 227.12 Credit Practices Guidelines about loans made for agricultural purposes? Are they covered by the rule? A: A loan made for an “agricultural pur pose”— as that term is defined in the official staff commentary to Regulation Z— would not be a loan made primarily for personal, family, or household use and, therefore, would not be subject to the rule. An agricultural-purpose loan would include loans for the planting, propagating, nurturing, harvesting, catching, storing, exhibiting, marketing, transporting, processing, or manufacturing of food, bever ages (including alcholic beverages), flowers, trees, livestock, poultry, bees, wildlife, fish, or shellfish by a natural person engaged in farm ing, fishing, or growing crops, flowers, trees, livestock, poultry, bees, or wildlife. Q 1 2 (a )-4 : R eal property loan— not secured by property purchased. Does the rule apply where a consumer obtains a loan to purchase real property but secures the loan with some other collateral, such as a savings account or other real property? A: No, the rule would not apply since the purpose of the loan is to purchase real property. Q 1 2 (a )-5 : Home-improvement loans. What happens when a bank makes a home-improve ment loan to a consumer and secures it with the consumer’s home? Is the transaction sub ject to the rule? A: Yes, the transaction is subject to the rule since the purchase of real property is not the purpose of the loan. Q 1 2 (a )-6 : Mobile home and houseboat pur chases. Is a purchase of a mobile home or houseboat exempt from the rule as a purchase of real property? A: The issue of whether purchases of mobile homes or houseboats are covered by the rule depends on how these dwellings are treated under state law. If the applicable state law considers them real property, as opposed to personal property, then transactions for their purchase would be exempt from the rule. Q 1 2 (a )-7 : Construction loans. Are construc tion loans and loans made to provide perma nent financing exempt from the rule as pur chases of real property? A: Yes, construction loans and loans made to provide permanent financing are considered loans for the purchase of real property and, therefore, not subject to the rule. Q 1 2 (a )-8 : Assumptions. A bank makes a loan for the purchase of real property. The loan is assumed by a new purchaser. Would the assumption be considered a transaction “for the purchase of real property,” and, therefore, not covered by the rule? A: Yes, an assumption of a loan made for the purchase of real property is considered a transaction “for the purchase of real property,” and not covered by the rule. Q 1 2 (a )-9 : Refinancings o f real property loans. What happens if a bank refinances a loan that had been made to purchase real property and, therefore, was exempt from the rule? Is the new loan still exempt from the rule? A: The new loan will be exempt from the rule as long as the primary purpose of the new loan is in fact the refinancing of the original debt (for example, in order to take advantage of lower interest rates). The amount outstand ing on the original loan— which is now being refinanced— must represent substantially the entire amount of the new loan; any additional credit extended as part of the new loan must be incidental to the primary purpose of refinancing. 12(b) “Cosigner” Q 12(b )-1: Cosigner— basic definition. Who is a cosigner under the rule? A: Any natural person who assumes liability for the obligation of a consumer (including, for example, a surety, guarantor, or other accommodation party), and who does so without receiving goods, services, or money in return for the obligation, or, in the case of open-end credit, without receiving the con tractual right to obtain extensions of credit on 3 § 227.12 Credit Practices Guidelines the account, would be considered a cosigner for purposes of the rule. of the applicants eventually chooses not to use the account. Q 12(b )-2: Person's signature requested as a condition to credit or as a condition fo r fo r bearance. If a bank requests a person’s signa The cosigner provision would apply, for example: ture as a condition to granting credit to anoth er individual, or as a condition for forbearance on collection of a consumer’s obligation that is in default, is that person a cosigner? A: Yes, if such a person is asked to sign as a condition to granting credit to another indi vidual, or as a condition for forbearance on collection of an obligation that is in default, such a person would be a cosigner, provided that the person assumes liability for a con sumer’s obligation without receiving goods, services, or money in return. If the person who is asked to sign the credit obligation (for example, for the purchase of an automobile, or for an open-end credit card account) de cides that he or she wishes to be reflected on the title to the automobile being purchased, or to have access to the credit card line, that per son is not a cosigner for purposes of the rule. Q 12(b )-3: Joint applicants. What happens when two people visit a bank to apply for a loan and appear to be applying jointly? Can the bank assume that they are applying as joint applicants, or does the rule require the bank to determine if both of the applicants will actually be “receiving goods, services, or money in return for the obligation”? A: Where two people visit a bank to apply for a loan and appear to be applying jointly, the rule does not require a bank to conduct a de tailed inquiry into the extent to which both persons are “receiving goods, services, or money in return for the obligation.” In the great majority of situations, individuals apply ing together will be coborrowers and will not be covered by the rule. The cosigner provision would not apply, for example: ° ° 4 If two people apply together for a loan to purchase items for their shared use or to be owned jointly. If two people apply jointly for a credit card account and both have the contractu al right to draw on the account, even if one ° If a consumer applies for a loan with a friend or relative and during the applica tion process it becomes apparent to the loan officer that the purpose of the loan is such that the friend or relative will not re ceive any benefit from the loan and that the friend or relative is applying with the consumer solely to aid the consumer in ob taining credit (for example, where the pro ceeds of the loan are to be used to pay the consumer’s dental expenses, or to buy fur niture for the consumer’s home or apartment). Q 12(b )-4: Signature to perfect security inter est— relationship to Regulation B. The rule does not consider a spouse whose signature is required on a credit obligation to perfect a se curity interest pursuant to state law, to be a cosigner. Does this affect a creditor’s obliga tion under the signature rules of Regulation B (Equal Credit Opportunity, 12 C FR 202), which limit the circumstances in which a creditor may require a cosigner? A: No, the rule in no way permits a creditor to obtain the signature of a nonapplicant spouse, or any person, in violation of Regula tion B. The rule merely addresses whether a bank must give a cosigner notice when a per son’s signature is required on the credit obli gation in order to perfect a security interest; whether a bank is in fact permitted to obtain such a signature, however, is controlled by Regulation B. Q 12(b )-5: Hypothecating security. Is a per son who hypothecates security for another’s obligation a cosigner? A: No. A person who merely offers security for a loan, and in so doing signs a security agreement— but not the note, contract, or oth er document that would render the cosigner liable on the underlying obligation— is not a cosigner under the rule. §227.13 Credit Practices Guidelines 12(d) “Household Goods ” Q 12(d )-1: Basic definition o f household goods. What is included in the term “house hold goods”? A: “Household goods” includes clothing, fur niture, appliances, linens, china, crockery, kitchenware, and personal effects of the con sumer and the consumer’s dependents. The term does not include works of art, electronic entertainment equipment (other than one tel evision and one radio), items acquired as an tiques, and jewelry (except wedding rings). Q 12(d )-2: Duplicates o f household goods. Can duplicate items of household goods be used to secure a consumer credit obligation? A: The definition of “household goods” in cludes one television and one radio, but it does not similarly limit furniture or any of the other items included in the definition. Conse quently, duplicates of any items included in the definition— other than duplicates of a tele vision or a radio— are covered by the prohibition. Q 12(d )-3 : Personal effects. What are “per sonal effects” for purposes of the “household goods” definition? A: The term “personal effects” is to be nar rowly construed and is limited to those items that an individual would ordinarily carry about on his or her person and possessions of a uniquely personal nature. This includes items such as personal papers, family photo graphs, or a family Bible. It does not include musical instruments, typewriters, firearms, bi cycles, smowmobiles, cameras and camera equipment, sporting goods, and stamp and coin collections. interest in realty in such cases would not vio late the rule’s prohibition against taking a se curity interest in household goods. 12(e) “Obligation ” Q 1 2(e)-1: Transactions over $25,000. Is a credit transaction exceeding $25,000 excluded from the rule’s requirements? A: Unlike Regulation Z, the credit practices rule does not have any dollar amount cutoff for determining if a transaction is covered by the rule. However, the dollar amount of a transaction is one of the factors that can be considered in determining whether a transac tion is for a business or a consumer purpose. (See Q 1 2 (a )-2 .) SECTION 227.13—Unfair Credit Contract Provisions Q 13-1: Retroactive effect— bank's own con tract. If a bank entered into a contract with a consumer prior to the effective date of the rule, and that contract contained a provision ultimately prohibited by the rule, may the bank enforce the provision? A: Yes, the rule is not intended to have retro active effect. (See, however, Q 15-8.) Q 13-2: Retroactive effect—purchased paper written before effective date o f rule. What hap pens if, after January 1, 1986, a bank buys paper from a third party that was written pri or to the rule’s effective date that contains a provision ultimately prohibited by the rule? May the bank enforce the provision? A: Yes, the bank could enforce the provision since, at the time the paper was written, the provision was not prohibited. Q 13-3: Refinancings— original credit obliga Q 12(d )-4: Appliances as fixtures. What hap pens when appliances are considered “fix tures” under state law? Do they still come within the “household goods” definition? A: No. Under some state laws, appliances are considered fixtures, and, as such, they become part of the realty. A bank that takes a security tion entered into prior to effective date o f rule. Assume that a bank entered into a credit obli gation prior to the effective date of the rule and that the credit obligation contained a pro vision ultimately prohibited by the rule. As sume further that the credit obligation is refi nanced after the effective date of the rule. May the refinanced obligation contain the prohibit- 5 Credit Practices Guidelines §227.13 ed provision, or is the refinancing subject to the rule? A: A refinancing entered into after the effec tive date of the rule is subject to the rule and, therefore, may not contain a contract provi sion prohibited by the rule. 13(a) Confession o f Judgment Q 13(a)-1: Basic definition; coverage. What is a confession of judgment provision? A: A confession of judgment is a contract clause in which the debtor consents in ad vance to allow the creditor to obtain a judg ment against the debtor without giving the debtor prior notice or an opportunity to be heard in court. Such provisions are sometimes referred to as “cognovit” provisions. The Board’s rule prohibits confessions of judgment that involve anticipatory waivers of procedur al due process in the context of consumer credit obligations. It does not prohibit a debt or from acknowledging liability, or from oth erwise entering into a negotiated settlement, after a legal action has been instituted. T h e confession-of-judgm ent provision also does not affect a power of attorney in a mort gage loan obligation or deed of trust for pur poses of foreclosure; nor does the provision affect a power of attorney given to expedite the transfer of pledged securities or the dis posal of repossessed collateral, or to allow the prompt cancellation of insurance in an insur ance-premium finance contract. Q 13(b )-2: Nonpurchase money transactions. Does a waiver of a state homestead exemption for a nonpurchase money security interest (such as a second trust or a home equity line of credit) violate the rule if the waiver applies only to the property that is subject to the se curity interest? A: No, the waiver of homestead exemption provision in the rule is not violated in the non purchase money security interest situation, as long as the waiver only applies to the property that is in fact securing the transaction. 13(c) Assignment o f Wages Q 1 3 (c )-1 : Basic definition. What is an assignment-of-wages clause? A: Under an assignment-of-wages clause the debtor assigns future wages to the creditor in the event of default. Unlike a garnishment, a court judgment is not required. Typically, once a debtor defaults, the creditor presents the assignment of wages to the debtor’s em ployer, who then pays the agreed portion of the employee’s wages directly to the creditor. Q 1 3 (c )-2 : Exceptions. Are there any excep tions to the assignment-of-wages prohibition? A: Yes, the following types of wage assign ments are permitted under the rule: ° ° ° 13(b) Waiver o f Exemption Q13 (b )—1: Basic definition. What is a waiverof-exemption clause? A: A waiver-of-exemption clause is a contract provision under which the debtor agrees to waive a property exemption provided by state law. Generally, state-property exemptions protect the debtor’s home and other necessary items, such as furniture and clothing, from at tachment or execution in order to satisfy the judgment debt. Under the rule, a waiver is permitted if it applies solely to property which was given as security in connection with the consumer credit obligation. 6 ° assignments that are revocable at the will of the debtor; payroll deduction plans regardless of revocability; revocable preauthorized-payment plans (governed by the Electronic Fund Trans fer Act, 15 USC 1693 et seq.) for electron ic fund transfers to accounts from wages; and assignments of wages already earned at the time of the assignment. Q 1 3 (c )-3 : Retroactivity. Does the rule’s pro hibition against wage assignments apply to a loan agreement entered into by the bank prior to the effective date of the rule? A: No. The rule does not invalidate or pre vent enforcement of any wage assignments that were executed prior to January 1, 1986, the effective date of the rule, even through Credit Practices Guidelines such wage assignments may cover wages pay able or earned after the effective date. Q 1 3 (c)-4 : Payment plans entered into after transaction begins. What happens if, sometime after entering into a credit transaction, a con sumer decides that he or she would like to make payments by payroll deduction or by having the payments deducted from wages and electronically transferred to the bank as payment on an account. Would this be consid ered a prohibited wage assignment under the rule? A: While most consumers authorize payroll deduction plans and preauthorized-payment plans at the commencement of the credit obli gation (as is contemplated by the rule), a con sumer’s enrolling in a payroll deduction plan or preauthorized-payment plan after the obli gation has begun is permissible under the rule as long as it is done voluntarily by the con sumer and at the consumer’s request. 13(d) Security Interest in Household Goods Q 13(d )-1: Definition o f type o f security inter est prohibited. What type of security interest is prohibited by the Board’s rule? A: The Board’s rule specifically prohibits banks from taking nonpossessory security in terests— other than purchase money security interests— in items defined as household goods. The purpose of the rule is to prevent consumers from losing basic necessities, which usually have little resale value to the creditor. The Board’s rule does not prohibit a security interest in real property, a security interest in items not defined as household goods, or a possessory security interest (for example, a pawn or pledge) in a consumer’s household goods. Q 13(d )-2: Voluntary offerings o f household goods. What happens if a consumer voluntari ly offers household goods as collateral on a nonpurchase money loan? Is the bank allowed to accept them? A: No. The bank is prohibited from accepting household goods as collateral even if offered voluntarily. §227.13 Q 13(d )-3: Refinancings— original loan pur chase money. Assume that a bank entered into a loan transaction with the consumer— either before or after the effective date of the rule— that involved the taking of a purchase money security interest in household goods. Assume further that the loan is refinanced. May the bank retain its security interest in the house hold goods? Does it make a difference if the new loan is for a larger amount? What if the loan is refinanced more than once? A: The bank may retain its security interest in household goods even if the new transac tion is for a larger amount, and without re gard to how many times the loan is refinanced. Q 1 3 (d )-4 : Cross-collateral and future-ad vances clauses. Does the rule prohibit a cross collateral or future-advances clause in a secu rity agreement for household goods which provides that the household goods would serve as security for other loans— both current and future— that the bank makes to the debtor? A: A cross-collateral or future-advances clause would violate the rule’s prohibition on taking a security interest in household goods where the clause is so broad in its applicability that it goes beyond loans that are refinancings or consolidations of the original loan (which contained the purchase money security inter est in household goods) and extends to other loans— whether current or future— that the bank makes to the debtor. Q 1 3 (d )-5 : Refinancings— releasing a portion o f security interest. When a bank has entered into a purchase money loan transaction se cured by household goods and then advances additional funds to the consumer in subse quent refinancings of that transaction, is the bank required to release a proportionate amount of the security interest in the house hold goods, as the percentage of the original loan amount decreases by virtue of the subse quent advances? A: No, the rule does not require a proportion ate reduction of the security interest as the original loan amount decreases. 7 § 227.13 Q 13(d )-6: Bill-consolidation loans. May Bank A, in making a bill-consolidation loan, secure its loan with the security interest in household goods taken in the original credit transaction with Bank B (which was a pur chase money credit transaction) and which will be paid in full by the bill-consolidation loan? A: Yes, no distinction is made under the rule between a consolidation loan made by a credi tor who already holds the purchase money se curity interest and a consolidation loan made by a different creditor. Q 13(d )-7: Refinancing by sales contract vs. direct loan. May a purchase money security interest in household goods that is acquired by a sales contract be retained if that sales con tract is consolidated or refinanced by a direct loan instead of another sales contract? A: Yes, a bank may retain the security inter est in the household goods even though the sales contract is consolidated or refinanced by a direct loan. Q 13(d )-8: Documentation o f purchase money loan. How is the purchase money nature of a loan to be documented? A: The rule contains no specific documenta tion requirements. For purposes of evidencing compliance, however, the creditor may, for example, place a note or statement in the loan file attesting to the purchase money nature of a loan; include a check-box in the contract which would indicate whether the transaction was a purchase money loan; or reserve a place in the contract for indicating the purpose for which the proceeds will be used. Q13 (d )—9: Appliances as fixtures. When a bank takes a security interest in realty and, under state law, fixtures are part of the realty, does the bank violate the prohibition against taking a security interest in household goods? A: No. See Q 12(d )-4. 8 Credit Practices Guidelines SECTION 227.14— Unfair or Deceptive Practices Involving Cosigners Q 14-1: State-required cosigner notice. If a state law also requires that a notice be given to a cosigner, how should a bank handle the dual requirement? Can the state-required notice substitute for the federal notice? A: No, a state notice cannot be substituted for the federal notice, unless a state has ob tained an exemption from the federal cosigner provision as provided for in section 226.16 of the rule. In those instances in which state law requires that a notice be given to cosigners, the bank may give both notices. The bank could, for example, include both notices in the documents evidencing the credit obligation or on a separate document, unless such would be prohibited by state law. (See Q 14(b )-7 on how to handle language in the federal notice that is inconsistent with state law provisions.) Q14—2: Record retention. Must a bank retain a copy of the cosigner notice it gives its customers? A: As a general matter, the rule does not con tain any record-retention requirements. A bank should be able, however, to demonstrate that it has procedures in place that ensure that the cosigner notice is provided as required by the rule. (See Q 14(b )-9, which discusses the inclusion of acknowledgment statements and signature lines on the cosigner notice.) 14(a) Prohibited Practices Q 1 4 (a )-1 : Retroactivity o f cosigner provision. If a bank has entered into a loan transaction prior to January 1, 1986, in which a cosigner was involved, but at which time the cosigner notice was not required, can the bank attempt to collect against the cosigner after January 1, 1986, should the debtor default? A: Yes, the bank can attempt to collect from the cosigner, since the rule does not apply ret roactively to obligations entered into before the rule’s effective date. Q 1 4 (a )-2 : Purchase o f third-party paper. What happens if a bank, after January 1, 1986, purchases an obligation in which a co- Credit Practices Guidelines §227.14 signer notice should have been given under the rule, but was not? Would a bank’s pur chase of the obligation violate the rule? Would the bank’s attempt to collect from the cosign er in such a situation violate the rule? A: No, the rule does not specify a particular type size, style, or format. The rule does re quire, however, that the notice be clear and conspicuous. A: A bank that purchases an obligation in which the cosigner notice was not given would not be considered to have obligated the cosigner in violation of the rule. The purchas ing bank would violate the rule in such a case, however, if it attempts to collect the debt from the cosigner. Q 14(b )-6: Clear and conspicuous. What is meant by the rule’s requirement that the co signer notice be “clear and conspicuous”? 14(b) Disclosure Requirement Q 14(b )-1: Timing o f cosigner notice. At what point in the transaction must the cosigner no tice be given? A: The cosigner notice must be given to the cosigner before the cosigner becomes obligat ed on the transaction. This means that the co signer should receive the notice prior to the event that makes the cosigner liable. In the case of open-end credit, the cosigner should receive the notice before becoming obligated for any fees or transactions on the account. Q 14(b )-2: Oral vs. written notice. May the cosigner notice be given orally to a cosigner? A: No, the cosigner notice must be in writing. Q 14(b )-3: Form o f cosigner notice. Does the cosigner notice have to be given in a form that the cosigner can keep? A: No, the rule does not require that the co signer notice be in a form that the cosigner can keep. Q 14(b )-4: Acknowledgment o f receipt. Must the cosigner notice be signed by the cosigner? A: The rule does not require that the cosigner sign the cosigner notice, or otherwise ac knowledge its receipt. (See, however, Q 14(b )-9 on permissible additions to the co signer notice.) Q 14(b )-5: Type-size, form at requirements. Does the cosigner notice have to be in a par ticular type size or format? A: A cosigner notice is clear and conspicuous if it is noticeable, readable and understand able. In those instances in which the notice is included in the body of the documents evi dencing the obligation, special attention should be given to ensure that the cosigner notice is prominent or distinctive— that is, to ensure that it is noticeable and readable. Any modifications or additions to the notice should not jeopardize its clarity. Q 14(b )-7: Modifying the cosigner notice; in consistency with state law provisions. Must a bank give a cosigner notice that is identical to that set forth in the rule, or can the bank modify the notice? What if language in the federal notice is inconsistent with state law provisions? A: Under the rule, a bank must give a cosign er notice that is substantially similar to the one set forth in the rule; the notice does not have to be identical. Language in the notice may be deleted or modified to take into ac count the rights and responsibilities of cosign ers under applicable state law. Language may be deleted or modified if it is inapplicable or if it inaccurately reflects the agreement with the cosigner. For example, the federal cosigner notice states that a bank can collect from a cosigner without first collecting from the bor rower. It also states that a bank can garnish a cosigner’s wages. If either of these statements is inaccurate under state law, then the inaccu rate language may be deleted or modified. In addition, minor editorial changes can be made to the notice, such as changing the word “bor rower” to “accountholder,” or changing the word “debt” to “account,” as appropriate. Q 14(b )-8: Guarantee language in cosigner notice. The cosigner notice in the rule states “You are being asked to guarantee this debt.” 9 §227.14 If a bank does not consider the cosigner a guarantor, may the bank modify the notice? A: The word “guarantee” is used in the co signer notice in its generic or colloquial sense merely as a way to describe the fact that the cosigner has an obligation to repay the debt. The underlying contract— not the notice— is what defines or determines a cosigner’s liabili ty. However, if use of the term conflicts with or causes confusion under state law, language such as, “You are being asked to become lia ble on this debt” can be substituted. Q 14(b )-9: Additional information included on notice. If the cosigner notice is given on a separate document, may a bank place addi tional information on the document? May the bank print the notice on its letterhead? A: Yes, a bank may print the notice on its letterhead. The bank may also include addi tional information on the document such as: ° » ° ° » ° the date of the transaction the loan amount name(s) and addresses the account number and other information describing or identifying the debt in question acknowledgment of receipt language a signature line As a general rule, any additional information should be concisely written so as not to de tract from the notice’s message. Moreover, care should be taken not to add unnecessary information to the notice. Q 14(b )-10: Cosigner notice on credit applica tion. May the cosigner notice be placed on a credit application form? A: Yes, the cosigner notice may be placed on a credit application form. Q 1 4 (b )-1 1: Documents o f principal debtor vs. those o f cosigner. What happens if the docu ment obligating the cosigner is separate from that obligating the principal debtor? May the cosigner notice be included in the document obligating the cosigner? A: Yes. Where the cosigner is required to sign a separate document that obligates the 10 Credit Practices Guidelines cosigner, the cosigner notice may be included in that document. Q 14(b )-12: Multiple cosigners. What hap pens if there are two or more cosigners in volved in a transaction? Must each one receive the cosigner notice? A: Yes, each cosigner must be given the co signer notice. However, since there is no re quirement in the regulation that the cosigner notice be given in a form that the cosigner can retain (see Q 1 4 (b )-3 ), each cosigner does not have to receive his or her own notice. One notice that serves to notify all cosigners is sufficient. Q 14(b )-13: Continuing guaranties. When must a bank give the cosigner notice to a con sumer who has executed a guaranty for not only the original loan, but also for future loans of the primary debtor? Must a cosigner notice be given to the guarantor with each subsequent loan to the primary debtor? A: The cosigner notice should be provided before the guarantor becomes obligated on the guaranty— that is, at the time the guaranty is executed. The cosigner notice need not be giv en to the guarantor with each subsequent loan made to the primary debtor, as long as the cosigner notice specifies that the guarantor is being asked to guaranty not only the original debt, but also the future debts of the primary obligor. For example, the first sentence of the cosigner notice could read “You are being asked to guaranty this debt, as well as all fu ture debts of the borrower entered into with this bank through December 31, 1987.” Q 14(b )-14: Renewal o f credit obligation. What happens when a credit obligation in volving a cosigner is renewed? Must a bank give the cosigner another notice at the time of renewal? A: If under the terms of the original credit agreement the cosigner is obligated for renew als or refinancings of the credit obligation, and, therefore, the bank would not require the cosigner to sign another credit obligation at the time of the renewal or refinancing, then §227.15 Credit Practices Guidelines another cosigner required. notice would not be Q 14(b)—15: Placement o f cosigner notice above signature line. When the cosigner notice is included in the documents evidencing the consumer credit obligation, does the notice have to be located above the place reserved for the cosigner’s signature? A: The regulation does not specify the loca tion of the cosigner notice when it is con tained in the documents evidencing the con sumer credit obligation. Since a bank must, however, provide the notice to the cosigner prior to the cosigner’s becoming obligated on the consumer credit transaction, placement of the notice above the cosigner’s signature line would seem wise. Q 14(b)-16: Foreign language translation. May a foreign language translation of the co signer notice be provided? A: Yes, a foreign language translation of the cosigner notice may be provided. Q 14(b )-17: Contract in foreign language. What if the underlying contract is in a foreign language? Must the cosigner notice be in the same language? A: Yes, the cosigner notice should be provid ed in the same language as that used in the underlying contract. SECTION 227.15—Unfair Late Charges Q 15—1: Basic definition o f unfair-late-charges prohibition. What does the rule prohibit with regard to the imposition of late charges? A: Under the rule banks are prohibited from levying or collecting any delinquency charge on a payment, when the only delinquency is attributable to late fees or delinquency charges assessed on earlier installments, and the payment is otherwise a full payment for the applicable period and is paid on its due date or within an applicable grace period. Q 15-2: Skipped payments. What happens if a consumer misses a monthly payment and fails to make up that payment month after month? May the bank assess a delinquency charge for each month that passes in which the consum er fails to make the missed or “skipped” payment? A: Yes, the rule does not prohibit the bank from assessing a delinquency charge for each month that the skipped payment remains outstanding. Q15-3: Multiple late charges assessed on pay m ent subsequently paid. Assume the follow ing: A consumer’s payments are $40 a month. The consumer makes his or her February pay ment in full, but makes it late. The bank as sesses a $5 late charge. The consumer makes the March payment of $40 on time, but fails to pay the $5 late charge. The bank uses part of the March payment to pay off the outstand ing late charge, and then considers the March payment deficient. May the bank then assess another late charge? A: No, the bank cannot assess another late charge since the March payment was made in full and on time. Q15-4: Subsequent paym ent made late. As sume the same facts as those detailed in Q15-3, but that the consumer makes the March payment of $40 late. May the bank as sess another late charge? A: Yes, the bank may assess another late charge since the consumer failed to make the March payment on time. Q15-5: Partial paym ent short more than amount o f outstanding late fee. Assume the same facts as those detailed in Q15-3, but that the consumer only pays $20 of the $40 March payment. May the bank assess another late charge? A: Yes, the bank may assess another late charge since the consumer failed to make the March payment in full. Q15-6: Open-end credit plans. Does the rule’s late-charges provision come into play in an open-end credit plan that involves a periodic statement that reflects a late charge upon its imposition, as well as a minimum payment 11 §227.15 amount that serves to inform the consumer of the full amount due to remain current on the account? A: No, in an open-end credit plan where the bank discloses late charges to the consumer as they are imposed and informs the consumer of the full amount that the consumer must pay for the applicable period in order to remain current on the account, the rule’s provision on late charges does not come into play. Q 15-7: Interest limitations. Does the rule prohibit a bank from imposing interest on an unpaid late fee? A: The rule does not address the issue of whether interest may be imposed on unpaid late fees. Q15-8: Retroactivity o f unfair-late-charges prohibition. Does the unfair-late-charges pro hibition reach obligations entered into prior to the rule’s effective date? A: Yes. Unlike the other provisions in the rule which do not affect obligations entered into prior to the rule’s effective date, the un fair-late-charges prohibition applies to all out standing consumer credit obligations regard less of when they were entered into. SECTION 227.16— State Exemptions Q16—1: Applicability o f exemption granted by another agency. If the FTC grants an exemp tion from a provision(s) of its rule, are banks, which are subject to the Board’s rule, able to take advantage of that exemption or must the state apply to the Board for an exemption? A: Exemptions that are granted by the FTC apply only to those creditors that are covered by that agency’s rule. The state agency would have to apply to the Board for an exemption for banks under the Board’s rule. 16(a) General Rule Q 1 6 (a )-1 : Who may request an exemption. May a private individual or a bank apply for an exemption? 12 Credit Practices Guidelines A: No, neither private individuals nor banks may apply for an exemption from the rule’s provisions. The rule provides that “an appro priate state agency” may apply for an exemption. Q 1 6 (a )-2 : Criteria fo r exemption. When may a state agency apply for an exemption? A: A state agency may apply for an exemp tion from the rule’s provisions: ° when there is a state requirement or prohi bition in effect that applies to any transac tion (s) to which a provision of the rule applies; and o when the state requirement or prohibition affords a level of protection to consumers that is substantially equivalent to, or great er than, the protection afforded by the rule’s provision. 16(b) Applications Q 1 6 (b )-1 : Board guidelines on exemption ap plications. Does the Board have guidelines for applying for an exem ption from the rule? A: Yes, a state agency applying for an exemp tion should use the procedures set forth in ap pendix B to Regulation Z. These procedures indicate: where an application should be filed; what should be contained in the application; what types of supporting documents should accompany the application; factors on which the Board bases its determination; the conse quences of favorable and adverse Board deter minations; and the procedures involved in re voking an exemption. Q 16(b )-2: Deadline fo r exemption applica tion. Is there a time by which a state agency must submit its exemption application in or der to receive consideration? Must it be sub mitted by the effective date of the rule? A: There is no deadline for submitting an ex emption application. Applications can be sub mitted anytime before or after the effective date of the rule.
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