Regulation Z Truth In Lending - Federal Reserve

Truth in Lendingceeds will be used to buy a car that will beused for both personal and business pur poses), the lender must look to the primarypurpose of the loan to decide whether disclo sures are necessary. A statement of purposeby the consumer will help the lender make thatdecision.– A checked box indicating that the loan is for abusiness purpose could, absent any documen tation showing the intended use of the pro ceeds, be insufficient evidence that the loandoes not have a consumer purpose. The consumer’s primary occupation and how itrelates to the use of the loan proceeds– The higher the correlation between the con sumer’s occupation and the property pur chased from the loan proceeds, the greaterthe likelihood that the loan has a businesspurpose. For example, proceeds used topurchase dental supplies for a dentist wouldindicate a business purpose. Personal management of the assets purchasedfrom the loan proceeds– The less the borrower is personally involved inthe management of the investment or enter prise purchased by the proceeds, the lesslikely the loan has a business purpose. Forexample, borrowing money to purchase stockin an automobile company by an individualwho does not work for that company wouldindicate a personal investment and a con sumer purpose. The size of the transaction– The larger the transaction, the more likely theloan has a business purpose. For example, aloan amount of 5,000,000 for a real estatetransaction might indicate a business pur pose. The amount of income derived from the propertyacquired by the loan proceeds relative to theborrower’s total income– The less the income derived from the acquiredproperty, the more likely the loan has aconsumer purpose. For example, if the bor rower has an annual salary of 100,000,receiving about 500 in annual dividends fromthe acquired property would indicate a con sumer purpose.The lender must evaluate all five factors beforeconcluding that disclosures are not necessary.Normally, evidence suggested by a single factor is,by itself, insufficient to draw a conclusion aboutwhether the transaction is covered by Regulation Z.The diagram ‘‘Coverage Considerations underRegulation Z’’ may be helpful in making thedetermination. In any case, the financial institutionConsumer Compliance Handbookmay choose to furnish disclosures to consumers.Disclosure under such circumstances does notcontrol whether the transaction is covered but canensure protection to the financial institution andcompliance with the law.Determination of theFinance Charge and the APRFinance Charge (Open-End andClosed-End Credit) (§ 226.4)The finance charge is a measure of the cost ofconsumer credit represented in dollars and cents.Along with APR disclosures, the disclosure of thefinance charge is central to the uniform credit costdisclosure envisioned by the TILA.Generally, the finance charge includes anycharges or fees payable directly or indirectly by theconsumer and imposed directly or indirectly by thefinancial institution either incident to or as acondition of an extension of consumer credit. Forexample, the finance charge on a loan alwaysincludes any interest charges and, often, othercharges, such as points, transaction fees, orservice fees.Regulation Z provides examples, applicable toboth open-end and closed-end credit transactions,of what must, must not, or need not be included inthe disclosed finance charge (section 226.4(b)).The finance charge does not include any chargeof a type payable in a comparable cash transac tion, such as taxes, title fees, license fees, orregistration fees paid in connection with an auto mobile purchase.Calculation of the Finance Charge(Closed-End Credit)One of the more complex tasks under Regulation Zis determining whether a charge associated with anextension of credit must be included in, or excludedfrom, the disclosed finance charge. The financecharge initially includes any charge that is, or willbe, connected with a specific loan. Chargesimposed by third parties are finance charges if theinstitution requires use of the third party. Chargesimposed by settlement or closing agents arefinance charges if the institution requires thespecific service that gave rise to the charge andthe charge is not otherwise excluded.The ‘‘Finance Charges’’ diagram summarizesincluded and excluded charges and may behelpful in determining whether a loan-relatedcharge is a finance charge.Reg. Z 3 (1/06)

Truth in LendingCoverage Considerations under Regulation ZIs the creditfor personal,family, orhouseholduse?Regulation Z does not apply, except the rules concerning issu ance of and unauthorized-use liability for credit cards. (Exemptcredit includes loans with a business or agricultural purposeand certain student loans. Credit extended to acquire or im prove rental property that is not owner-occupied is consideredbusiness-purpose credit.)NoYesIs the creditextended to aconsumer?NoRegulation Z does not apply. (Credit that is extended to a landtrust is deemed to be credit extended to a consumer.)The institution is not a “creditor” and Regulation Z does not ap ply unless at least one of the following tests is met:(1) The institution extends consumer credit regularly and(a) The obligation is initially payable to the institution and(b) The obligation either is payable by written agreementin more than four installments or is subject to a financecharge(2) The institution is a card issuer that extends closed-endcredit that is subject to a finance charge or is payable bywritten agreement in more than four installments(3) The institution is a card issuer that extends open-endcredit or credit that is not subject to a finance charge andis not payable by written agreement in more than fourinstallmentsYesIs the creditextended by acreditor?NoFor limited purposes, a person that honors a credit card mayalso be a creditor.Yes(Note: All persons, including noncreditors, must comply withthe advertising provisions of Regulation Z.)Isthe loanor credit plansecured by real property or by the consumer’s principaldwelling?NoIs theamountfinanced orcredit limit 25,000 orless?NoRegulation Z does not apply, but it may applylater if the loan is refinanced for 25,000 orless. If the principal dwelling is taken as collateral after consummation, rescission rightsapply and, in the case of open-end credit,billing disclosures and other provisions ofRegulation Z apply.YesYesRegulation Z applies4 (1/06) Reg. ZConsumer Compliance Handbook

Truth in LendingFinance ChargesFINANCE CHARGE DOLLAR COST OF CONSUMER CREDIT: Includes any charge payable directly or indirectly by the consumerand imposed directly or indirectly by the creditor as a condition of or incident to the extension of creditCHARGES ALWAYSINCLUDEDCHARGESINCLUDED UNLESSCONDITIONS AREMETCONDITIONSFOR EXCLUSION(Any getransactions andloans secured by realestate)(D)InterestPremiums for creditlife, accident andhealth, or loss-of income insuranceInsurance notrequired, disclosuresare made, andconsumer authorizesFees for titleinsurance, titleexamination, propertysurvey, etc.Coverage notrequired, disclosuresare made, andconsumer authorizesFees for preparingloan documents,mortgages, andother settlementdocumentsCHARGES NEVERINCLUDED(E)Charges payable ina comparable cashtransactionTransaction feesLoan origination feesConsumer pointsCredit-guaranteeinsurance premiumsCharges imposedon the creditor forpurchasing the loanthat are passed on tothe consumerDiscounts forinducing paymentby means other thancreditMortgage broker feesOther examples: Feefor preparing TILAdisclosures; realestate constructionloan inspectionfees; fees for postconsummation taxor flood insurancerequirements;required credit lifeinsurance chargesDebt-cancellationfeesPremiums forproperty or liabilityinsuranceConsumer selectsinsurance companyand disclosures aremadePremiums forvendor’s singleinterest (VSI)insuranceInsurer waives rightof subrogation,consumer selectsinsurance company,and disclosures aremadeSecurity interestcharges (filing fees),insurance in lieuof filing fees, andcertain notary feesThe fee is forlien purposes, isprescribed by law,is payable to apublic official, andis itemized anddisclosedCharges imposed bythird partiesUse of the thirdparty is not requiredto obtain loan, andcreditor does notretain the chargeCharges imposed bythird-party closingagentsCreditor does notrequire and does notretain the fee for theparticular serviceAppraisal andcredit-report feesApplication fees,if charged to allapplicants, are notfinance charges.Application fees mayinclude appraisal orcredit-report feesConsumer Compliance HandbookAmounts required tobe paid into escrow,if not otherwiseincluded in thefinance chargeFees forunanticipated latepaymentsOverdraft fees notagreed to in writingSeller’s pointsParticipation ormembership feesNotary feesPre-consummationflood and pestinspection feesDiscount offered bythe seller to inducepayment by cashor other means notinvolving the use of acredit cardAppraisal and creditreport feesInterest forfeited asa result of interestreduction requiredby lawCharges absorbed bythe creditor as a costof doing business*To be excludable, fees mustbe bona fide and reasonable.Reg. Z 5 (1/06)

Truth in Lending Charges always included (col. A)—Lists chargesgiven in the regulation or commentary asexamples of finance charges Charges included unless conditions are met(col. B)—Lists charges that must be included inthe finance charge unless the creditor meetsspecific disclosure or other conditions to excludethe charges from the finance charge Conditions for exclusion (col. C)—Notes theconditions that must be met if the charges listedin column B may be excluded from the financecharge. Although most charges in column B maybe considered part of the finance charge at thecreditor’s option, third-party charges and appli cation fees must be excluded from the financecharge if the relevant conditions are met; how ever, inclusion of appraisal and credit-reportcharges as part of the application fee isoptional. Excludable charges (col. D)—Identifies fees orcharges that may be excluded from the financecharge if they are bona fide and reasonable inamount and the credit transaction is secured byreal property or is a residential mortgage trans action. For example, if a consumer loan issecured by a vacant lot or by commercialreal estate, any appraisal fees connected withthe loan may be excluded from the financecharge. Charges never included (col. E)—Lists chargesgiven in the regulation as examples of chargesthat automatically are not finance charges(for example, fees for unanticipated latepayments).Precomputed Finance ChargesA precomputed finance charge includes, for exam ple, interest added to the note amount that iscomputed by the add-on, discount, or simpleinterest method. If reflected in the face amount ofthe debt instrument as part of the consumer’sobligation, finance charges that are not viewed asprepaid finance charges are treated as precom puted finance charges that are earned over the lifeof the loan.Accuracy Tolerances (Closed-End Credit)(§§ 226.18(d) and 226.23(h))The finance charge tolerances for closed-endcredit provided by Regulation Z are for legalaccuracy and should not be confused with thosetolerances provided in the TILA for reimbursementunder regulatory agency orders. As with disclosedAPRs, if a disclosed finance charge is legallyaccurate, it is not subject to reimbursement.Generally, tolerances for finance charge errors ina closed-end transaction are 5 if the amountfinanced is 1,000 or less and 10 if the amountfinanced exceeds 1,000 (see diagrams on follow ing pages). For certain transactions consummatedon or after September 30, 1995, the tolerances aredifferent, as noted below: Credit secured by real property or a dwelling(closed-end credit only):– The disclosed finance charge is consideredaccurate if it does not vary from the actualfinance charge by more than 100.– Overstatements are not violations.Prepaid Finance Charges (§ 226.18(b))A prepaid finance charge is any finance chargethat (1) is paid separately to the financial institutionor to a third party, in cash or by check, before or atclosing, settlement, or consummation of a transac tion or (2) is withheld from the proceeds of thecredit at any time. Prepaid finance charges effec tively reduce the amount of funds available for theconsumer’s use, usually before or at the time thetransaction is consummated.Examples of finance charges frequently prepaidby consumers are borrower’s points, loan origina tion fees, real estate construction inspection fees,odd days’ interest (interest attributable to part of thefirst payment period when that period is longer thana regular payment period), mortgage guaranteeinsurance fees paid to the Federal Housing Admin istration, private mortgage insurance paid to suchcompanies as the Mortgage Guaranty InsuranceCompany, and, in non-real-estate transactions,credit-report fees.6 (1/06) Reg. Z Rescission rights after the three-business-dayrescission period (closed-end credit only):– The disclosed finance charge is consideredaccurate if it does not vary from the actualfinance charge by more than one-half of1 percent of the credit extended.– The disclosed finance charge is consideredaccurate if it does not vary from the actualfinance charge by more than 1 percent of thecredit extended for the initial and subsequentrefinancings of residential mortgage transac tions when the new loan is made at a differentfinancial institution. (This category excludeshigh-cost mortgage loans subject to section226.32, transactions in which there are newadvances, and new consolidations.) Rescission rights in foreclosure:– The disclosed finance charge is consideredaccurate if it does not vary from the actualfinance charge by more than 35.Consumer Compliance Handbook

Truth in Lending– Overstatements are not considered violations.– The consumer is entitled to rescind if amortgage broker fee is not included as afinance charge.Note: Normally, the finance charge tolerance fora rescindable transaction is either 0.5 percent ofthe credit transaction or, for certain refinancings,1 percent of the credit transaction. However,in the event of a foreclosure, the consumer mayexercise the right of rescission if the disclosedfinance charge is understated by more than 35.Neither the TILA nor Regulation Z provides anytolerances for finance charge errors in open-endcredit disclosures. Open-end credit disclosuresmust be accurate.Annual Percentage Rate(Closed-End Credit) (§ 226.22)Credit costs may vary depending on the interestrate, the amount of the loan and other charges, thetiming and amounts of advances, and the repay ment schedule. The APR, which must be disclosedin nearly all consumer credit transactions, isdesigned to take into account all relevant factorsand to provide a uniform measure for comparingthe costs of various credit transactions.The APR is a measure of the total cost of credit,expressed as a nominal yearly rate. It relates theamount and timing of value received by theconsumer to the amount and timing of paymentsmade by the consumer. The disclosure of the APRis central to the uniform credit cost disclosureenvisioned by the TILA.The APR for closed-end credit must be disclosedas a single rate only, whether the loan has a singleinterest rate, a variable interest rate, a discountedvariable interest rate, or graduated paymentsbased on separate interest rates (step rates). Also,the APR must appear with the ‘‘segregated’’disclosures—disclosures grouped together andnot containing any information not directly relatedto the disclosures required under section 226.18.As the APR is a measure of the total cost of credit,including such costs as transaction charges andpremiums for credit-guarantee insurance, it is notan interest rate as that term is generally used. APRcalculations do not rely on definitions of interest instate law and often include charges, such as acommitment fee paid by the consumer, that are notviewed by some state usury statutes as interest.Conversely, APR calculations might not includecharges, such as a credit-report fee in a realproperty transaction, that some state laws view asinterest for usury purposes. Furthermore, measur ing the timing of value received and of paymentsConsumer Compliance Handbookmade, which is essential if APR calculations are tobe accurate, must be consistent with parametersunder Regulation Z.The APR is often considered to be the financecharge expressed as a percentage. However, twoloans could have the same finance charge and stillhave different APRs because of differing values ofthe amount financed or differing payment sched ules. For example, the APR on a loan with anamount financed of 5,000 and 36 equal monthlypayments of 166.07 each is 12 percent, while theAPR on a loan with an amount financed of 4,500and 35 equal monthly payments of 152.18 each,plus a final payment of 152.22, is 13.26 percent. Inboth cases the finance charge is 978.52. TheAPRs on these loans are not the same because anAPR reflects more than the finance charge. Itrelates the amount and timing of value received bythe consumer to the amount and timing of pay ments made by the consumer.The APR is a function of The amount financed, which is not necessarilyequivalent to the loan amount– If the consumer must pay a separate 1 percentloan origination fee (a prepaid finance charge)on a 100,000 residential mortgage loan atclosing, the loan amount is 100,000 but theamount financed is 100,000 less the 1,000loan fee, or 99,000. The finance charge, which is not necessarilyequivalent to the total interest amount– If the consumer must pay a 25 credit-reportfee for an auto loan, the fee must be includedin the finance charge. The finance charge inthis case is the sum of the interest on the loan(that is, the interest generated by the applica tion of a percentage rate against the loanamount) plus the 25 credit-report fee.– If the consumer must pay a 25 credit-reportfee for a home improvement loan secured byreal property, the credit-report fee must beexcluded from the finance charge. The financecharge in this case would be only the intereston the loan. Interest, which is defined by state or otherfederal law but not by Regulation Z The payment schedule, which does not neces sarily include only principal and interest (P I)payments– If the consumer borrows 2,500 for a vacationtrip at 14 percent simple interest per annumand repays that amount with 25 equal monthlypayments beginning one month from consum mation of the transaction, the monthly P Ipayment would be 115.87, if all months areconsidered equal, and the amount financedReg. Z 7 (1/06)

Truth in LendingClosed-End Credit: Accuracy Tolerances for Finance ChargesYesFinance chargetolerance is 35.An overstatedfinance charge isnot considered aviolation.YesIsthis aclosed-endcredit TILAclaim assertingrescissionrights?Is therescissionclaim a defenseto foreclosureaction?NoNoNoIs thetransactionsecured byreal estate or adwelling?NoYesDid thetransactionoriginate before9/30/95?NoYesFinance chargetolerance is 200 forunderstatements.An overstatedfinance charge isnot considered aviolation.Is thetransaction arefinancing?YesFinance chargetolerance is onehalf of 1% of theloan amount or 100, whicheveris greater.An overstatedfinance charge isnot considered aviolation.YesFinance chargetolerance is 100 forunderstatements.An overstatedfinance charge isnot considered aviolation.Is thetransactiona high-costmortgage loan? *NoYesDoes therefinancinginvolve aconsolidation ornew advance?NoFinance chargetolerance is 1% ofthe loan amount or 100, whichever isgreater.An overstatedfinance charge isnot considered aviolation.The finance chargeis consideredaccurate if it is notmore than 5 aboveor below the exactfinance charge in atransaction involvingan amount financedof 1,000 or less, ornot more than 10above or below theexact finance chargein a transactioninvolving an amountfinanced of morethan 1,000.* See 15 USC 160(aa) and 12 CFR 226.32.8 (1/06) Reg. ZConsumer Compliance Handbook

Truth in LendingClosed-End Credit: Accuracy Tolerances forOverstated Finance ChargesIs the loan secured by realestate or a dwelling?NoYesIs the amount financed morethan 1,000?NoIs the disclosed financecharge, less 5, more thanthe correct finance charge?NoNo violationYesIs the disclosed financecharge, less 10, more thanthe correct finance charge?NoYesFinance chargeviolationConsumer Compliance HandbookNo violationNo violationYesFinance chargeviolationReg. Z 9 (1/06)

Truth in LendingClosed-End Credit: Accuracy and Reimbursement Tolerances forUnderstated Finance ChargesIs the loan secured by realestate or a dwelling?NoYesIs the disclosed financecharge understated by morethan 100 (or 200 if the loanoriginated before 9/30/95)?Is the amount financedgreater than 1,000?NoYesIs the disclosed financecharge understated by morethan 5?YesFinance chargeviolationNoIs the disclosed financecharge understated by morethan 10?NoNoYesFinance chargeviolationNo violationYesFinance chargeviolationNo violationIs the loan term morethan 10 years?NoYesIs t

Regulation Z Truth in Lending Background Regulation Z (12 CFR 226) implements the Truth in Lending Act (TILA) (15 USC 1601 et seq.), which was enacted in 1968 as title I of the Consumer Credit Protection Act (Pub. L. 90-321). Since its implementation, the regulation has been