Truth in Lending

FEDERAL RESERVE SYSTEM

12 CFR Part 226

[Regulation Z; Docket No. R-1029]

Truth in Lending

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Proposed rule; official staff interpretation.

-----------------------------------------------------------------------

SUMMARY: The Board is publishing for comment proposed revisions to the

official staff commentary to Regulation Z (Truth in Lending). The

commentary applies and interprets the requirements of Regulation Z. The

proposed update addresses the prohibition against the issuance of

unsolicited credit cards. It provides guidance on calculating payment

schedules involving private mortgage insurance. In addition, the

proposed update discusses credit sale transactions where downpayments

include cash and property used as a trade-in.

DATES: Comments must be received on or before January 22, 1999.

ADDRESSES: Comments, which should refer to Docket No. R-1029, may be

mailed to Ms. Jennifer J. Johnson, Secretary, Board of Governors of the

Federal Reserve System, 20th Street and Constitution Avenue, N.W.,

Washington, D.C. 20551. Comments addressed to Ms. Johnson may also be

delivered to the Board's mail room between 8:45 a.m. and 5:15 p.m., and

to the security control room at all other times. Both the mail room and

the security control room are accessible from the courtyard entrance on

20th Street between Constitution Avenue and C Street, N.W. Comments may

be inspected in room MP-500 between 9:00 a.m. and 5:00 p.m. in

accordance with Secs. 261.12 and 261.14 of the Board's Rules Regarding

the Availability of Information, 12 CFR 261.12 and 261.14.

FOR FURTHER INFORMATION CONTACT: Jane E. Ahrens, Senior Counsel, or

Pamela Morris Blumenthal or James H. Mann, Staff Attorneys; Division of

Consumer and Community Affairs, Board of Governors of the Federal

Reserve System, at (202) 452-3667 or 452-2412; for users of

Telecommunications Device for the Deaf (TDD) only, Diane Jenkins at

the Availability of Information, 12 CFR 261.12 and 261.14.

FOR FURTHER INFORMATION CONTACT: Jane E. Ahrens, Senior Counsel, or

Pamela Morris Blumenthal or James H. Mann, Staff Attorneys; Division of

Consumer and Community Affairs, Board of Governors of the Federal

Reserve System, at (202) 452-3667 or 452-2412; for users of

Telecommunications Device for the Deaf (TDD) only, Diane Jenkins at

(202) 452-3544.

SUPPLEMENTARY INFORMATION:

I. Background

The purpose of the Truth in Lending Act (TILA; 15 U.S.C. 1601 et

seq.) is to promote the informed use of consumer credit by providing

for disclosures about its terms and cost. The act requires creditors to

disclose the cost of credit as a dollar amount (the finance charge) and

as an annual percentage rate. Uniformity in creditors' disclosures is

intended to assist consumers in comparison shopping. TILA requires

additional disclosures for loans secured by a consumer's home and

permits consumers to rescind certain transactions that involve their

principal dwelling. In addition, the act regulates certain practices of

creditors. The act is implemented by the Board's Regulation Z (12 CFR

Part 226).

The Board's official staff commentary (12 CFR Part 226 (Supp. I))

interprets the regulation, and provides guidance to creditors in

applying the regulation to specific transactions. The commentary is a

substitute for individual staff interpretations; it is updated

periodically to address significant questions that arise. The Board

expects to adopt revisions to the commentary in final form in March

1999; to the extent the revisions impose new requirements on creditors,

compliance would be

optional until October 1, 1999, the effective date for mandatory

compliance.

II. Proposed Revisions

Subpart A--General

previously accepted credit card. The prohibition

addresses various concerns including the potential for theft and fraud

and the consumer inconvenience of refuting claims of liability.

The law does not prohibit creditors from issuing unsolicited cards

that have a non-credit purpose--such as check-guarantee or purchase

price-discount cards, so long as they cannot be used also to obtain

credit. Consumers may later be able to convert these cards to credit

cards if the issuer makes a credit feature available and the consumer

requests the credit.

Comment 12(a)(1)-7 provides guidance regarding a card that is

issued and accepted by the consumer as a non-credit device and that

subsequently is converted for use as a credit device at the consumer's

request. The comment would be revised to reflect more clearly its

intended purpose. For example, a purchase-price discount card may be

issued on an unsolicited basis if the card issuer does not propose to

connect the card with any credit plan. If the issuer later establishes

a credit plan to which the card could be connected and the consumer

requests access to the plan, the previously issued card can be re-

encoded (or the issuer may reprogram its computers to allow the card to

be used to access credit) without violating TILA.

Questions about the comment's meaning have been raised regarding

its application to recent programs where unsolicited cards are marketed

from the outset as both stored-value cards and credit cards. The

revised comment would clarify that, because these multifunction cards

are connected with credit plans when they are issued, and thus are

credit cards, these cards may not be sent without the consumer's prior

request or application. See comment 2(a)(15)-2. To the extent that the

interpretation of rule previously may have been unclear, the Board

believes that liability should not attach to a card issuer's prior

reliance on comment 12(a)(1)-7 in issuing multifunction cards that

included a credit feature

are issued, and thus are

credit cards, these cards may not be sent without the consumer's prior

request or application. See comment 2(a)(15)-2. To the extent that the

interpretation of rule previously may have been unclear, the Board

believes that liability should not attach to a card issuer's prior

reliance on comment 12(a)(1)-7 in issuing multifunction cards that

included a credit feature.

Section 226.14--Determination of Annual Percentage Rate

14(c) Annual Percentage Rate for Periodic Statements. Comment

14(c)-10 addresses finance charges that are imposed during the current

billing cycle but that relate to account activity that occurred during

a prior billing cycle. The comment refers expressly to current-cycle

and prior-cycle debits but not to current-cycle or prior-cycle credits.

The comment is meant to cover both debits and credits, and would be

revised accordingly.

Subpart C--Closed-end Credit

Section 226.18--Content of Disclosures

18(g) Payment Schedule. The Homeowners Protection Act of 1998

(HPA) limits the amount of private mortgage insurance consumers can be

required to purchase. Borrowers may request cancellation of private

mortgage insurance under some circumstances and lenders must terminate

private mortgage insurance automatically when certain conditions are

met. For example, creditors must stop collecting insurance premiums

when the outstanding loan balance is 78 percent of the original value

of the property provided the account is current (unless the mortgage is

``high-risk'' as defined in the statute).

Comment 18(g)-5 would be added in response to creditors' requests

for guidance on how the requirements of the HPA affect TILA

disclosures. TILA disclosures are based on the legal obligation between

the parties. (See Sec. 226.17(c)(1).) The payment schedule disclosure

required by section 18(g) should reflect all components of the finance

charge, including private mortgage insurance for the time period there

is a legal obligation to maintain the insurance

ts

for guidance on how the requirements of the HPA affect TILA

disclosures. TILA disclosures are based on the legal obligation between

the parties. (See Sec. 226.17(c)(1).) The payment schedule disclosure

required by section 18(g) should reflect all components of the finance

charge, including private mortgage insurance for the time period there

is a legal obligation to maintain the insurance.

18(j) Total Sale Price. Comment 18(j)-2 provides the formula for

calculating the total sale price in a credit sale transaction. In

response to requests for guidance, the comment would be revised to

address how the total sale price may be affected by downpayments

involving cash and property that is being used as a trade-in and that

has a lien exceeding the value of the trade-in.

III. Form of Comment Letters

Comment letters should refer to Docket No. R-1029, and, when

possible, should use a standard typeface with a type size of 10 or 12

characters per inch. This will enable the Board to convert the text to

machine-readable form through electronic scanning, and will facilitate

automated retrieval of comments for review. Also, if accompanied by an

original document in paper form, comments may be submitted on 3\1/2\

inch computer diskettes in any IBM-compatible DOS- or Windows-based

format.

List of Subjects in 12 CFR Part 226

Advertising, Banks, banking, Consumer protection, Credit, Federal

Reserve System, Mortgages, Reporting and recordkeeping requirements,

Truth in lending.

Text of Proposed Revisions

Certain conventions have been used to highlight the proposed

revisions to the text of the staff commentary. New language is shown

inside bold-faced arrows, while language that would be deleted is set

off with bold-faced brackets. Comments are numbered to comply with

Federal Register publication rules.

For the reasons set forth in the preamble, the Board proposes to

amend 12 CFR part 226 as follows:

PART 226--TRUTH IN LENDING (REGULATION Z)

e proposed

revisions to the text of the staff commentary. New language is shown

inside bold-faced arrows, while language that would be deleted is set

off with bold-faced brackets. Comments are numbered to comply with

Federal Register publication rules.

For the reasons set forth in the preamble, the Board proposes to

amend 12 CFR part 226 as follows:

PART 226--TRUTH IN LENDING (REGULATION Z)

1. The authority citation for part 226 continues to read as

follows:

Authority: 12 U.S.C. 3806; 15 U.S.C. 1604 and 1637(c)(5).

2. In Supplement I to Part 226, under Section 226.2--Definitions

and Rules of Construction, the following amendments would be made:

a. Under Paragraph 2(a)(15) Credit card., paragraph 2. would be

revised; and

b. Under Paragraph 2(a)(18) Downpayment., paragraph 3. would be

revised.

The revisions would read as follows:

* * * * *

Supplement I--Official Staff Interpretations

* * * * *

Subpart A--General

* * * * *

Sec. 226.2 Definitions and rules of construction

2(a) Definitions.

* * * * *

2(a)(15) Credit card.

* * * * *

2. Examples. i. Examples of credit cards include:

A. A card that guarantees checks or similar instruments, if the

asset account is also tied to an overdraft line or if the instrument

directly accesses a line of credit.

B. A card that accesses both a credit and an asset account (that

is, a debit card).

C. An identification card that permits the consumer to defer

payment on a purchase.

D. An identification card indicating loan approval that is

presented to a merchant or to a lender, whether or not the consumer

signs a separate promissory note for each credit extension.

E. A card or device that can be activated upon

receipt to access credit, notwithstanding the fact that the

recipient must first contact the card issuer before using the card.

F

defer

payment on a purchase.

D. An identification card indicating loan approval that is

presented to a merchant or to a lender, whether or not the consumer

signs a separate promissory note for each credit extension.

E. A card or device that can be activated upon

receipt to access credit, notwithstanding the fact that the

recipient must first contact the card issuer before using the card.

F. A card that has a substantive use other than credit, such as

a purchase-price discount card, if the card also may be used to

obtain credit (even if the recipient must first contact the card

issuer to access or activate the credit feature).

ii. In contrast, a credit card does not include, for example:

A. A check-guarantee or debit card with no credit feature or

agreement, even if the creditor occasionally honors an inadvertent

overdraft.

B. Any card, key, plate, or other device that is used in order

to obtain petroleum products for business purposes from a wholesale

distribution facility or to gain access to that facility, and that

is required to be used without regard to payment terms.

* * * * *

2(a)(18) Downpayment.

* * * * *

3. Effect of existing liens. In a credit sale, the ``downpayment''

may only be used to reduce the cash price. For example, when the

existing lien on an automobile to be traded in exceeds the value of the

automobile, creditors must disclose a zero on the downpayment line

rather than a negative number. To illustrate, assume a consumer owes

$10,000 on an existing automobile loan and that the trade-in value of

the automobile is only $8,000, leaving a $2,000 deficit. The creditor

should disclose a downpayment of $0, not -$2,000. Similarly,

if the consumer pays $1,500 in cash (which does not extinguish the

$2,000 deficit) the creditor should disclose a downpayment of $0, not -

$500. But if the consumer provides $3,000 in cash (which eliminates the

$2,000 deficit and contributes $1,000 to reduce the cash price), the

creditor should disclose a downpayment of $1,000.

* * * * *

3

disclose a downpayment of $0, not -$2,000. Similarly,

if the consumer pays $1,500 in cash (which does not extinguish the

$2,000 deficit) the creditor should disclose a downpayment of $0, not -

$500. But if the consumer provides $3,000 in cash (which eliminates the

$2,000 deficit and contributes $1,000 to reduce the cash price), the

creditor should disclose a downpayment of $1,000.

* * * * *

3. In Supplement I to Part 226, under Section 226.12--Special

credit card provisions, under Paragraph 12(a)(1), paragraph 7. would be

revised to read as follows:

* * * * *

Subpart B--Open-End Credit

* * * * *

Sec. 226.12 Special credit card provisions

* * * * *

12(a) Issuance of credit cards.

Paragraph 12(a)(1)

* * * * *

7. Issuance of non-credit cards. i. General. Under

12(a)(1), a credit card cannot be issued except in response to a

request or an application. (See comment 2(a)(15)-2 for examples of

cards or devices that are and are not credit cards.) A credit feature

may be added to a previously issued non-credit card only upon the

consumer's specific request. Adding a credit feature includes re-

encoding the non-credit device, or reprogramming the issuer's computer

program or automated teller machines.

ii. Examples. Purchase-price discount cards may be sent on an

unsolicited basis by an issuer that does not propose to connect the

card to any credit plan. If the issuer subsequently establishes a

credit plan that could be accessed by the card, it may solicit

customers who have received the discount cards to offer them the credit

feature, and may then reprogram its computers to provide credit access

to consumers who request activativation of the credit

feature

ited basis by an issuer that does not propose to connect the

card to any credit plan. If the issuer subsequently establishes a

credit plan that could be accessed by the card, it may solicit

customers who have received the discount cards to offer them the credit

feature, and may then reprogram its computers to provide credit access

to consumers who request activativation of the credit

feature.

[The issuance of an unsolicited device that is not, but may become,

a credit card, is not prohibited provided:

The device has some substantive purpose other than

obtaining credit, such as access to non-credit services offered by the

issuer;

It cannot be used as a credit card when issued; and

A credit capability will be added only on the recipient's

request.

For example, the card issuer could send a check guarantee card on

an unsolicited basis, but could not add a credit feature to that card

without the consumer's specific request. The re-encoding of a debit

card or other existing card that had no credit privileges when issued

would be appropriate after the consumer has specifically requested a

card with credit privileges. Similarly, the card issuer may add a

credit feature, for example, by reprogramming the issuer's computer

program or automated teller machines, or by a similar program

adjustment.]

* * * * *

4. In Supplement I to Part 226, Section 226.14--Determination of

Annual Percentage Rate, under Paragraph 14(c) Annual percentage rate

for periodic statements., paragraph 10.ii. is republished and paragraph

10.ii.B. would be revised to read as follows:

* * * * *

Sec. 226.14 Determination of annual percentage rate

ram or automated teller machines, or by a similar program

adjustment.]

* * * * *

4. In Supplement I to Part 226, Section 226.14--Determination of

Annual Percentage Rate, under Paragraph 14(c) Annual percentage rate

for periodic statements., paragraph 10.ii. is republished and paragraph

10.ii.B. would be revised to read as follows:

* * * * *

Sec. 226.14 Determination of annual percentage rate

* * * * *

14(c) Annual percentage rate for periodic statements.

* * * * *

10. Prior-cycle adjustments.

* * * * *

ii. Finance charges relating to activity in prior cycles should be

reflected on the periodic statement as follows:

* * * * *

B. If a finance charge that is

posted[debited] to the account relates to activity for which

a finance charge was debited or credited to the

account in a previous billing cycle, for example, if the finance charge

relates to an adjustment such as the resolution of a billing error

dispute, or an unintentional posting error, or a payment by check that

was later returned unpaid for insufficient funds or other reasons, the

creditor shall at its option:

1. Calculate the annual percentage rate in accord with ii.A. of

this paragraph, or

2. Disclose the finance charge adjustment on the periodic statement

and calculate the annual percentage rate for the current billing cycle

without including the finance charge adjustment in the numerator and

balances associated with the finance charge adjustment in the

denominator.

* * * * *

5. In Supplement I to Part 226, under Sec. 226.18--Content of

disclosures, the following amendments would be made:

a. Under 18(g) Payment schedule., a new paragraph 5. would be

added; and

b. Under 18(j) Total sale price., paragraph 2. would be revised.

The addition and revision would read as follows:

* * * * *

Subpart C--Closed-End Credit

* * * * *

Sec. 226.18 Content of disclosures

* *

5. In Supplement I to Part 226, under Sec. 226.18--Content of

disclosures, the following amendments would be made:

a. Under 18(g) Payment schedule., a new paragraph 5. would be

added; and

b. Under 18(j) Total sale price., paragraph 2. would be revised.

The addition and revision would read as follows:

* * * * *

Subpart C--Closed-End Credit

* * * * *

Sec. 226.18 Content of disclosures

* * * * *

18(g) Payment schedule.

* * * * *

5. Mortgage insurance. The payment schedule should

reflect the consumer's mortgage insurance payments until the date on

which the creditor must automatically terminate coverage under

applicable law, even though the consumer may have a right to request

that the insurance be cancelled earlier.

* * * * *

18(j) Total sale price.

* * * * *

2. Calculation of total sale price. The figure to be disclosed is

the sum of the cash price, other charges added under Sec. 226.18(b)(2),

and the finance charge disclosed under Sec. 226.18(d). When

a credit sale transaction involves property that is being used as a

trade-in (an automobile, for example) and that has a lien exceeding the

value of the trade-in, the total sale price is affected by the amount

of any cash provided. To illustrate, assume a consumer finances the

purchase of an automobile with a cash price of $20,000. The consumer

owes $10,000 on an existing loan on an automobile with a trade-in value

of $8,000, leaving a $2,000 deficit that the consumer must finance. If

the consumer pays $3,000 in cash and no other costs are financed, the

total sale price would be the sum of the $20,000 cash price and the

finance charge; because the $3,000 cash payment extinguishes the $2,000

trade-in deficit no charges are added under Sec. 226.18(b)(2). (The

remaining $1,000 is a downpayment, which does not affect the total

sales price.) However, if the cash payment were $1,500, the total sale

price would be the sum of the $20,000 cash price, an additional $500

financed under Sec

e $20,000 cash price and the

finance charge; because the $3,000 cash payment extinguishes the $2,000

trade-in deficit no charges are added under Sec. 226.18(b)(2). (The

remaining $1,000 is a downpayment, which does not affect the total

sales price.) However, if the cash payment were $1,500, the total sale

price would be the sum of the $20,000 cash price, an additional $500

financed under Sec. 226.18(b)(2) (the $2,000 deficit reduced by the

$1,500 cash payment), and the finance charge.

* * * * *

By order of the Board of Governors of the Federal Reserve

System, acting through the Secretary of the Board under delegated

authority, December 1, 1998.

Jennifer J. Johnson,

Secretary of the Board.

[FR Doc. 98-32339 Filed 12-4-98; 8:45 am]

BILLING CODE 6210-01-P