Understanding the Terms and Total Cost of Credit
The principal law relating to the disclosure of credit terms is the federal Truth in Lending Act (TILA) (15 U.S.C. §1601 et seq.). TILA requires disclosures of credit terms in consumer credit transactions. TILA was originally enacted by Congress in 1967 to effectively adopt a new “national loan vocabulary” that means the same in every contract in every state (Mason v. General Finance Corporation of Virginia, 542 F.2d 1226, 1233 (4th Cir. 1976)).
TILA was amended by the Home Ownership and Equity Protection Act of 1994 (HOEPA) (Pub. L. No. 103-325, Title I, Subtitle B, 108 Stat. 2190, adding 15 U.S.C. §§1602(aa) and 1639). HOEPA imposed certain substantive regulations on home mortgage transactions with high interest rates or fees.
Multiple amendments were made to TILA in 2008–2011, including the Mortgage Disclosure Improvement Act of 2008, the Helping Families Save Their Homes Act of 2009, the Credit Card Accountability Responsibility and Disclosure Act of 2009, and the Dodd–Frank Wall Street Reform and Consumer Protection Act (Dodd–Frank Act) (Mortgage Disclosure Improvement Act of 2008, Pub. L. No. 110-289, Div. B, Title V, 122 Stat. 2654, as amended by the Emergency Economic Stabilization Act of 2008, Pub. L. No. 110-343, Div. A, 122 Stat. 3765; Helping Families Save Their Homes Act of 2009, Pub. L. No. 111-22, 123 Stat. 1632; Credit Card Accountability Responsibility and Disclosure Act of 2009 (CARD Act), Pub. L. No. 111-24, 123 Stat. 1734; Dodd–Frank Wall Street Reform and Consumer Protection Act (Dodd–Frank Act), Pub. L. No. 111-203, 124 Stat. 1376 (2010)). These amendments imposed numerous additional substantive regulations and disclosure requirements, mainly on mortgage transactions and credit cards. Some of these regulations and requirements apply to the subsequent administration or “servicing” of the loan as well as to its origination.
Applicability of the Truth in Lending Act
TILA applies only to transactions entered into primarily for personal, family, or household use, as opposed to business use. Generally, this means that over 50 percent of the proceeds of the transaction must be for personal, family, or household use. Transactions for personal use in which the amount financed exceeds $50,000 are not covered unless a security interest is taken in real property or “personal property used or expected to be used as the principal dwelling of the consumer” (mobile homes, cooperative apartments, beneficial interest in an Illinois land trust, ground leases, houseboats) (15 U.S.C. §1603).
Basically, TILA and Regulation Z require disclosure of several key credit terms, computed in a precise manner and using precise terminology. TILA divides credit into open-end credit (exemplified by a credit card or home equity line of credit) and “credit other than open end,” or closed-end credit, such as a conventional mortgage or auto loan.
The key disclosures for closed-end credit transactions are as follows:
•The “amount financed,” which is “the amount of credit provided to [the consumer] or on [the consumer’s] behalf” (12 C.F.R. §1026.18(b)).
•The “finance charge,” which is “the dollar amount the credit will cost [the consumer]” (12 C.F.R. §1026.18(d)). It includes “any charge payable directly or indirectly by the consumer and imposed directly or indirectly by the creditor as an incident to or a condition of the extension of credit” (12 C.F.R. §1026.4(a)).
•The “annual percentage rate” (APR), which is the finance charge expressed as an annual rate (12 C.F.R. §1026.18(e)).
Consumers should always shop for credit, comparing the APR. Consumers should not agree to credit terms based solely on a monthly payment.
CAUTION
Do not obtain credit based solely on the monthly payment.
Car dealers, in particular, try to “sell” consumers deals based solely on the monthly payment. This results in consumers agreeing to increasingly lengthy credit terms, during which the consumer is “under water”—the amount owed exceeds the value of the car. This makes it difficult to sell or trade in the car.
For example, making $300 payments on a $10,000 debt at 10% APR will result in paying it off in 39 to 40 months, during which you will have paid $1,764 in finance charges. Making $300 payments on a $10,000 debt at 20% APR will result in paying it off in 49 to 50 months, with a total of $4,718 in finance charges. Increasing the rate to 30% will increase the duration to 72 to 73 months and the total finance charges to $11,770. Just looking at the $300 monthly payment hides the difference between $1,764 and $11,770.
Under HOEPA and the Dodd–Frank Act, there are additional disclosure requirements and substantive regulations for mortgage loans that exceed certain interest rates. For example, the consumer is allowed an additional “cooling-off” period, and prepayment penalties are forbidden.
The 2008–2011 amendments also added a number of substantive protections for mortgage borrowers. One is a requirement that payments must be credited as of the date of receipt (15 U.S.C. §1639f, as added by Pub. L. No. 111-203, §1464(a)). Another is that payoff balances must be furnished by a creditor or servicer within seven business days of a written request by or on behalf of a borrower (15 U.S.C. §1639g, as added by Pub. L. No. 111-203, §1464(b)). There are also prohibitions against influencing appraisers to inflate property value, and there are restrictions on late fees and delinquency charges.
The key disclosures for open-end credit are the APR and fees. Fees are disclosed separately and do not affect the APR. Other disclosures include a “Minimum Payment Warning” and examples of the length of time required to repay the balance if only the minimum payment is made (15 U.S.C. §1637(b)(11)).
There are disclosure requirements (a) for applications and solicitations (15 U.S.C. §1637(c)), (b) that must be made prior to opening an account (15 U.S.C. §1637(a)), (c) for periodic billing statements (15 U.S.C. §1637(b)), and (d) prior to renewal of an account (15 U.S.C. §1637(d)). Additional disclosure requirements apply if the open-end plan is secured by the consumer’s principal dwelling, such as in the case of a home equity line of credit (15 U.S.C. §1637(a)).
TIP
Review any credit agreement before you agree to it, making sure that you understand all of its aspects. Consumers need to read contracts before they sign them. The law charges you with knowledge of the agreement whether or not you read it. Assume that oral representations about the contents of a document that are inconsistent with the actual contents are not enforceable; with a few exceptions, that is the general rule.
There are generally no limits on the rate of interest that can be charged on a credit card. Prior to about 1980, most states had “usury” laws that imposed maximum rates of interest that a borrower could be charged and imposed substantial penalties for noncompliance (such as forfeiture of all interest, the entire debt, or double the interest or excess interest). When interest rates skyrocketed as a result of inflation at the end of the 1970s, some states removed these restrictions for some or all types of loans, including credit cards. In addition, in 1978 the U.S. Supreme Court decided that federally chartered banks could charge customers located anywhere in the United States those rates permitted under the law of the state where the bank had its principal office (this is referred to as the “exportation” of interest rates) (Marquette Nat. Bank of Minneapolis v. First of Omaha Service Corp., 439 U.S. 299 (1978)). Many banks that issued credit cards promptly obtained federal charters and relocated their principal offices to states where the legislatures could be persuaded to eliminate restrictions on interest rates, notably Delaware, South Dakota, and Utah. This effectively defeated efforts by other states to regulate interest rates on credit cards, as they could neither impose such restrictions on federally chartered banks nor prohibit federally chartered banks from doing business with their residents.
Summary
The law requires disclosure of key credit terms. It is important that you obtain the disclosures, review them, and understand what you are getting into.