regulated aspects of installment lending installment lending panel payday loan bar association...

Regulated Aspects of Installment Lending

Installment Lending PanelPayday Loan Bar Association Summit

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Presented byMichael A. Raskasky

Harlowe & Falk LLPNovember 14, 2006

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Why are we talking about installment lending?

Changing laws, negative climate for PDLs

Stay in business if the legislative axe falls

Diversify product offerings

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Offer installment product that combines features of payday loans…:

Small dollar amounts not offered by banks Limited underwriting/credit check Fast cash for borrower “Above prime” interest rates “Secured” by check or ACH authorization Payments tied to paydays

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…and additional features of traditional installment loans:

Multiple payments over time v. single repayment

Simple interest (generally) on unpaid balance v. fee-based finance charge

Secured lending option

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What legal and operational issues arise with this new product?

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Contract terms Servicing and Payments Default

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Caveats

Focus -- issue spotting Rules can vary dramatically by state

Consumer loan laws Uniform Consumer Credit Code (7

states) Usury laws UCC Rev. Article 9 (secured lending) Motor vehicle codes (vehicle secured

lending)

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The Contract

Loan amount Large amounts (e.g., >$25,000) or

real estate loans frequently outside scope of consumer loan statutes

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The Contract (cont’d)

Finance charges Origination fees

Typical limit - 2% of principal Prepaid finance charge - special

treatment under TILA Contract interest rate (not just the

APR)

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--Finance charges Interest calculation methodology

Simple interest/365 day year Precomputed interest Compounding of interest Describe in the contract

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Loan term May be tied to loan amount

Ex: loans up to $300 - up to 25 months Loans $301 to $1,000 - up to 37 months

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Payment schedule Small loan amounts (e.g., <$1,000)

– substantially equal amounts, intervals

Big TILA issues, particularly with payments tied to pay periods (irregular, semi-monthly, etc.)

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Method of payment ACH

Preauthorized ACH – Reg. E limitations, NACHA rules

Check NSF fee limits Broader bad-check remedies may be

available

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Secured lending – collateral considerations

Grant language Collateral description (UCC 9-108

and TILA 226.18(m))

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The Contract (cont’d) --Secured lending - collateral considerations

Motor vehicles Certificate of title May implicate title loan statutes

Household goods FTC Unfair or Deceptive Credit Practices Rule Limits non-possessory security interests in household

goods Exceptions for PMSI, art works, antiques, jewelry (not

wedding rings), one television and one radio Insurance on collateral – Special disclosure

required to exclude from finance charge (Reg. Z 226.18(n), 4(d))

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Servicing and Payments

Caveat— Servicing methodology should be

described in the loan agreement

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Servicing and Payments

Late payments Late payment charges

Ex: 10 days late, charge lesser of 5% of installment amount or $20

No “pyramiding” of interest on late fees

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Servicing and Payments (cont’d)

--Late payments Deferral

By agreement after-the-fact, or Unilateral – in loan agreement Deferral charges authorized

Generally cannot charge deferral AND late charges

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Partial payments Application of payments

Specify in contract, but check state law

Event of default Triggers a late charge to extent of

unpaid installment

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Prepayments Nearly always allowed Rebate for precomputed loans

“Earned” may be complicated

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--Prepayments Prepayment penalty

Frequently prohibited or limited Certain real estate loans, refinancings by

same lender, etc. Disclosures required (TILA, contract)

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Extra payments Application of payments – generally

applied to principal, but check statute

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Last payment Balloon payments (ex: 2x average

of other payments) May have a statutory right to refinance

at same terms

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Receipts and statements Amount paid to date, amount

applied to principal and interest, pay-off amount

Requires additional programming

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Default

Statutory definition? May be limited to actual

nonpayment Acceleration generally permitted

Precomputed loans – if a judgment is obtained, some statutes require rebate as if full payment was made on judgment date

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Default (cont’d)

Secured lending issues Repossession – how?

Post-repossession interest What if customer brings collateral to store?

UCC 9A-620 (acceptance in satisfaction of debt) Limits on taking motor vehicles, other collateral in

satisfaction of debt (TRUE predatory lending!) Pawn statutes?

Disposition of collateral - Art. 9

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Regulatory challenges for “converting” payday lenders

Regulatory climate (not exactly “global warming”)

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“Nightmare on Winter Street” – the Oregon example

Politics and competition – the two fronts meet

Gubernatorial election Resistance by existing consumer finance lenders

New proposed consumer finance rules “In consultation with” (read: written by) existing

consumer finance licensees Press release

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Initially – 36% rate cap

Now – regulate aspects of PDL business model

Make it very difficult to operate on PDL platform

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Sampling of proposed rules Regulation of portfolio mix (90%

“consumer loans”) 6 month minimum term “Documented” underwriting (but no

substantive “ability to pay” requirements)

Equal periodic payments

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--Sampling of proposed rules “Are you experienced?”

Store level “District” level

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--Sampling of proposed rules Indirect attempts to regulate

interest rate Include interest rate in business plan Notice if rate changes more than 25%

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--Sampling of proposed rules Limits on holding checks/ACH

authorizations for payments

“DISCLOSURE!!!” required

Challenges are in the works, but who knows?

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Last, but not least….

Washington payment plans

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Contact InformationMichael A. RaskaskyHarlowe & Falk LLPOne Tacoma Avenue North, Suite 300Tacoma, WA [email protected]

Payday Lending Legal Payday Lending Legal SummitSummit

Installment Lending PanelInstallment Lending Panel

APR Misconceptions and APR Misconceptions and ProblemsProblems

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TILA Misconceptions TILA Misconceptions Loan Origination Systems—OK To Loan Origination Systems—OK To

Buy An Off-The-Shelf ProductBuy An Off-The-Shelf Product ““Buy Ours—We’ve done installment Buy Ours—We’ve done installment

loans for years!” loans for years!” Like New!Like New!

ProblemsProblems:: Not Designed For Payments Tied To Not Designed For Payments Tied To

PaydaysPaydays Built for Long-Term LoansBuilt for Long-Term Loans

Lower RatesLower Rates More Tolerance For ErrorMore Tolerance For Error

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Off-The-Shelf Software Off-The-Shelf Software PDL ExamplePDL Example

Lender’s Target Yield: Approximately 260%Lender’s Target Yield: Approximately 260% Loan Amount: $500Loan Amount: $500 Simple Interest Rate: 200% Simple Interest Rate: 200% Loan Fee: $50 (10 % of Loan Amount)Loan Fee: $50 (10 % of Loan Amount) Repayment Schedule: 3 “Monthly” Pmts @ Repayment Schedule: 3 “Monthly” Pmts @

$245.03$245.03

Problem:Problem: Disclosed APR: 264.66%Disclosed APR: 264.66% Actual APR: 388.12%Actual APR: 388.12%

Restitution Violation: Understated by Restitution Violation: Understated by 123.46%123.46%

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TILA MisconceptionsTILA Misconceptions

If You Only Charge Interest—Then The If You Only Charge Interest—Then The APR Is APR Is AlwaysAlways The “Interest Rate!” The “Interest Rate!” It has to beIt has to be::

There are no There are no otherother “Finance Charges” “Finance Charges”e.g., 250% Interest Rate e.g., 250% Interest Rate EqualsEquals 250% 250% APRAPR

Fact Or Fiction?Fact Or Fiction? Answer…Answer…

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Fact or Fiction?Fact or Fiction?

Answer…That DependsAnswer…That Depends Depends On Your Tolerance To RiskDepends On Your Tolerance To Risk Depends On How Gutsy You AreDepends On How Gutsy You Are

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Fact or Fiction?Fact or Fiction?

Issue: Issue: US RuleUS Rule versus versus ActuarialActuarial Methods:Methods: US RuleUS Rule::

APR Will APR Will Always Always Be The Interest Rate Be The Interest Rate IfIf There Are No Other TILA “Finance There Are No Other TILA “Finance Charges” Charges”

Actuarial MethodActuarial Method:: APR Is Almost APR Is Almost NeverNever The Same As The The Same As The

Interest Rate—Even If No Other “Finance Interest Rate—Even If No Other “Finance Charges” Are ImposedCharges” Are Imposed

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Gutsy? Gutsy? Which Would You Rather Defend?Which Would You Rather Defend?

US Rule MethodUS Rule Method One Paragraph Authorization In One Paragraph Authorization In

Appendix JAppendix J(3) In contrast, under the United States Rule method, at the end of (3) In contrast, under the United States Rule method, at the end of

each payment period, the unpaid balance of the amount financed each payment period, the unpaid balance of the amount financed is increased by the finance charge earned during that payment is increased by the finance charge earned during that payment period and is decreased by the payment made at the end of that period and is decreased by the payment made at the end of that payment period. If the payment is less than the finance charge payment period. If the payment is less than the finance charge earned, the adjustment of the unpaid balance of the amount earned, the adjustment of the unpaid balance of the amount financed is postponed until the end of the next payment period. If financed is postponed until the end of the next payment period. If at that time the sum of the two payments is still less than the at that time the sum of the two payments is still less than the total earned finance charge for the two payment periods, the total earned finance charge for the two payment periods, the adjustment of the unpaid balance of the amount financed is adjustment of the unpaid balance of the amount financed is postponed still another payment period, and so forth.postponed still another payment period, and so forth.

No Formulas or Other Support in Reg. ZNo Formulas or Other Support in Reg. Z

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Which Would You Rather Defend?Which Would You Rather Defend?

US Rule MethodUS Rule Method Not Used InNot Used In APRWIN APRWIN Software Software

(Actuarial)(Actuarial)US Rule Produces Different US Rule Produces Different

ResultsResultsAPRWINAPRWIN Is Accepted Standard For Is Accepted Standard For

VerificationVerificationRegulators & LitigatorsRegulators & Litigators

No Supporting Case LawNo Supporting Case Law

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Which Would You Rather Defend?Which Would You Rather Defend?

Actuarial MethodActuarial Method Clearly Spelled-Out In Appendix JClearly Spelled-Out In Appendix J 15 Pages of Formulas and Examples15 Pages of Formulas and Examples

Too Many To Show HereToo Many To Show HereSupport in Official Staff Support in Official Staff

CommentaryCommentary Exact Match With Exact Match With APRWINAPRWIN

Provided There Is No “Garbage In”Provided There Is No “Garbage In”

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What’s The Difference?What’s The Difference? Both Take Into Account “Time Value of Money”Both Take Into Account “Time Value of Money”

Based On Timing And Amounts Of Payments & Based On Timing And Amounts Of Payments & Advances Advances

US Rule:US Rule: No Compounding Of InterestNo Compounding Of Interest No Negative AmortizationNo Negative Amortization

Actuarial Method:Actuarial Method: Allows For Compounding of InterestAllows For Compounding of Interest May Have Negative AmortizationMay Have Negative Amortization

Both Are “After The Fact” To Test APRs, And Both Both Are “After The Fact” To Test APRs, And Both Ignore Interest Accrual MethodIgnore Interest Accrual Method

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Monthly Payment ExampleMonthly Payment ExampleInterest Rate: 300.00%Interest Rate: 300.00%Amount Financed: $750.00Amount Financed: $750.00Finance Charge: $1657.76Finance Charge: $1657.76Pmt Schedule: 12 Monthly PmtsPmt Schedule: 12 Monthly Pmts

11 @ $200.6611 @ $200.66 1 @ $200.501 @ $200.50

Actuarial APR: 298.77% (Actuarial APR: 298.77% (APRWINAPRWIN))US Rule APR: 300.00%US Rule APR: 300.00%

Which One Is Correct?Which One Is Correct?

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Which One Is Correct?Which One Is Correct?

They Both Are!They Both Are!

Actuarial APR: 298.77% (Actuarial APR: 298.77% (APRWINAPRWIN))

US Rule APR: 300.00%US Rule APR: 300.00%

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TILA MisconceptionsTILA Misconceptions Payments Due “Semi-monthly” Payments Due “Semi-monthly”

Means “Twice-Per-Month”Means “Twice-Per-Month” Or Does It?Or Does It?

Problems:Problems: Only Example In Appendix J is 1Only Example In Appendix J is 1stst & &

1616thth

Only Example In Only Example In APRWIN APRWIN is 1is 1stst & 16 & 16thth

Webster Webster DefinitionDefinition: “: “Occurring Twice Occurring Twice A Month”A Month”

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So What’s the Problem?So What’s the Problem? Are The Following Payment Are The Following Payment

Frequencies Semi-monthly?Frequencies Semi-monthly? Due On the 1Due On the 1stst And the 15 And the 15thth?? Due On the 5Due On the 5thth and the 25 and the 25thth?? Due on the 15Due on the 15thth and the 30 and the 30thth??

Problem:Problem: APR For Each Loan Must Be APR For Each Loan Must Be

Based On The “Unit Period” (i.e., Based On The “Unit Period” (i.e., the Time-Base) For That Loanthe Time-Base) For That Loan

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What’s The Unit Period?What’s The Unit Period?

Unique To Each Loan Unique To Each Loan The Interval Of Time (Time-Base) That The Interval Of Time (Time-Base) That

Best Fits The Contracted Payment Best Fits The Contracted Payment ScheduleSchedule

Identified By:Identified By: (1) Measure All “Periods” In The Loan, (1) Measure All “Periods” In The Loan, && (2) Determine The “Common Period”(2) Determine The “Common Period”

Need To Know Before Proceeding Need To Know Before Proceeding With The APR Calculation ProcessWith The APR Calculation Process

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Twice-Monthly ExamplesTwice-Monthly Examples What’s the Unit Period When Pmts. Are What’s the Unit Period When Pmts. Are

Scheduled:Scheduled: 11stst and the 16 and the 16thth ? ?

Answer—15 days (“Semi-monthly”)Answer—15 days (“Semi-monthly”)That’s Easy—Supported by Appendix That’s Easy—Supported by Appendix

J & J & APRWINAPRWIN 11stst and the 15 and the 15thth??

Answer—14 days (“Bi-Weekly”—Not Answer—14 days (“Bi-Weekly”—Not “Semi-monthly”)“Semi-monthly”)

Look At All The PeriodsLook At All The PeriodsCommon PeriodCommon Period

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Twice-Monthly ExamplesTwice-Monthly Examples What’s the Unit Period When Pmts. Are What’s the Unit Period When Pmts. Are

Scheduled:Scheduled: 55thth and the 25 and the 25thth??

Answer—20 Days (Not “Semi-monthly”)Answer—20 Days (Not “Semi-monthly”)Look At All The PeriodsLook At All The PeriodsCommon Period is 20Common Period is 20

1515thth & 30 & 30thth (or Last Day of the Month)? (or Last Day of the Month)?Answer—15 days (Not “Semi-Monthly”)Answer—15 days (Not “Semi-Monthly”)

Look At All The PeriodsLook At All The PeriodsThen The Common Period Is 15Then The Common Period Is 15

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Twice-Monthly ExamplesTwice-Monthly Examples Four Loans With Pmts. Due Four Loans With Pmts. Due

Twice-Per-Month—Twice-Per-Month—Three Three Different APRsDifferent APRs 2 APRs Matched By Coincidence 2 APRs Matched By Coincidence

Caused By Dates And Number Of Caused By Dates And Number Of PaymentsPayments

Assumptions:Assumptions: No “Odd Days”No “Odd Days” 8 Payments Due Twice-Per-Month8 Payments Due Twice-Per-Month

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Best Guess—When to Use Best Guess—When to Use “Semi-Monthly”“Semi-Monthly”

If If AllAll Of The Following 3 Conditions Are Of The Following 3 Conditions Are Met, ThenMet, Then

AlwaysAlways Use 15 Days For the “Unit Period”: Use 15 Days For the “Unit Period”:1. Must Be 2 Scheduled Due Dates Within 1. Must Be 2 Scheduled Due Dates Within

Each Full Month,Each Full Month,

2. Due Dates Must Have The Same Two 2. Due Dates Must Have The Same Two Anniversary Dates In Each Full Month Anniversary Dates In Each Full Month (e.g., 5(e.g., 5thth And 20 And 20thth Of Each Month), Of Each Month), ANDAND

3. There Are Exactly 15 Days Between The 3. There Are Exactly 15 Days Between The Two Payment Dates In Each Month Two Payment Dates In Each Month

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Best Guess—“Semi-Best Guess—“Semi-Monthly”Monthly”

All Other “Twice-Monthly” All Other “Twice-Monthly” Payments, then:Payments, then:

Look For Common PeriodLook For Common Period If no Common Period—Then Use If no Common Period—Then Use

“Standard Interval of Time” As “Standard Interval of Time” As Defined By Appendix JDefined By Appendix J

Another Topic For Another Another Topic For Another ConferenceConference

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RONALD D. GORSLINECHAMBLISS, BAHNER & STOPHEL, P.C.

1000 TALLAN BUILDINGCHATTNOOGA, TN 37402

423-756-3000www.cbslawfirm.com

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CLIFF E. COOKCOMPLIANCE SERVICES, INC.

TACOMA, WASHINGTON(253) [email protected]

regulated aspects of installment lending installment lending panel payday loan bar association...

Documents

installment product

contract termsservicing

loan agreementservicing

loan amountex

loan agreementdeferral

contract contdloan term

late charges

late fees