Why IS there a Truth in Lending Act (aka) Regulation Z?

As anyone in compliance can attest to, there are Myriad consumer compliance regulations. For bankers, these regulations are regarded as anything from a nuisance, to the very bane of the existence of banks. However, in point of fact, there are no bank consumer regulations that were not earned by the misbehavior of banks in the past. Like it or not these regulations exit to prevent bad behavior and/or to encourage certain practices. We believe that one of the keys to strengthening a compliance program is to get your staff to understand why regulations exist and what it is the regulations are designed to accomplish. To further this cause, we have determined that we will from time to time through the year; address these questions about various banking regulations. We call this series “Why is there….”

For any lender that has made a consumer purpose loan in the past 30 years, the Truth in Lending Act aka, Regulation Z has been a major factor. The main part of any consumer lending audit or examination is compliance with the Omni present Reg. Z. And just as you might know that the regulation exists, you also know that if mistakes are made, they can be costly. If examiners find that a loan or groups of loans has not been properly documented and the consumers not properly informed, various painful enforcement actions may occur. These can range from reimbursements to the customer, a look back at the entire loan portfolio and even the possibility of civil money penalties. It is clear that Reg. Z is a powerful regulation. But why does it exist? What is it the regulators are trying to get banks to do?

We believe that the more you know, the more you comply!

What was Happening?

Starting in the late 1950’s the United State saw a tremendous growth in the amount of credit. In fact, a study the US House of Representatives estimated that the amount of credit in the United States from the end of World War II to the end of 1968 grew from $5.6 billion to $96 billion. [1]

The growth in credit was fueled by consumer credit and in particular, a growing middle class that created a huge demand for housing, cars and various other products that went all with acquiring the American Dream. As time passed more and more stories of consumers being misled about the cost of borrower by terms “easy payments”, “low monthly charges” or “take three years to pay”. The borrowers found out that every though they thought they were paying an interest rate of 1.25 % with add-ons, fees and interest payments that were calculated using deceptive formulas , the rate was actually as much as three times what they thought.

Congress began to investigate the growing level of consumer debt and eventually in 1968 the Truth in Lending Act was first passed. Congress was pretty clear about what they were trying to do:

The Congress finds that economic stabilization would be enhanced and the competition among the various financial institutions and other firms engaged in the extension of consumer credit would be strengthened by the informed use of credit. The informed use of credit results from an awareness of the cost thereof by consumers. It is the purpose of this subchapter to assure a meaningful disclosure of credit terms so that the consumer will be able to compare more readily the various credit terms available to him and avoid the uninformed use of credit, and to protect the consumer against inaccurate and unfair credit billing and credit card practices. [2]

So from the very start the idea behind the Truth in Lending Act is to force lenders to list the cost of borrower in a common format. Consumer should be able to take their Regulation Z disclosures and be able to shop from one financial institution to the next and compare prices.

For the next several years, the Federal Reserve and the courts began to shape what the Truth in Lending law would eventually come to represent. After a series of court decisions and interpretive rulings by the regulators, the law began to grow in importance. The basic history of the regulation is this:

The Truth in Lending Act (TILA), 15 USC 1601 et seq., was enacted on May 29, 1968, as title I of the Consumer Credit Protection Act (Pub. L. 90-321). The TILA, implemented by Regulation Z (12 CFR 226), became effective July 1, 1969.

The TILA was first amended in 1970 to prohibit unsolicited credit cards. Additional major amendments to the TILA and Regulation Z were made by the Fair Credit Billing Act of 1974, the Consumer Leasing Act of 1976, the Truth in Lending Simplification and Reform Act of 1980, the Fair Credit and Charge Card Disclosure Act of 1988, the Home Equity Loan Consumer Protection Act of 1988.

Regulation Z also was amended to implement section 1204 of the Competitive Equality Banking Act of 1987, and in 1988, to include adjustable rate mortgage loan disclosure requirements. All consumer leasing provisions were deleted from Regulation Z in 1981 and transferred to Regulation M (12 CFR 213).

The Home Ownership and Equity Protection Act of 1994 amended TILA. The law imposed new disclosure requirements and substantive limitations on certain closed-end mortgage loans bearing rates or fees above a certain percentage or amount. The law also included new disclosure requirements to assist consumers in comparing the costs and other material considerations involved in a reverse mortgage transaction and authorized the Federal Reserve Board to prohibit specific acts and practices in connection with mortgage transactions. Regulation Z was amended to implement these legislative changes to TILA.

The TILA amendments of 1995 dealt primarily with tolerances for real estate secured credit. Regulation Z was amended on September 14, 1996 to incorporate changes to the TILA. Specifically, the revisions limit lenders’ liability for disclosure errors in real estate secured loans consummated after September 30, 1995. The Economic Growth and Regulatory Paperwork Reduction Act of 1996 further amended TILA. The amendments were made to simplify and improve disclosures related to credit transactions[3]

Changing Times Makes Changing Law

A quick comparison of these changes to the regulation with economic events in the United States will tell a story of bank and financial institutions practices that avoided the general intent of the regulation in one way of another. The growth and development of the credit card market prompted the changes in Reg. Z that have to do with open end credit and the growth of adjustable rate mortgages because the additional changes to mortgage disclosures.

The goal of Regulation Z has always been a desire to tell the borrower the highest amount she may possibly pay for borrowing money from an institution. Regulation Z does not tell a borrower how much they may charge or even how they may structure consumer deals. However, it does require that you disclose what you are charging to the customer in a clear and understandable manner.

One of the most notable changes to the regulation is the right of rescission. This portion of the regulation was written to stop a particularly nasty practice:

TILA’s legislative history indicates that Congress included rescission to provide a cooling off period to borrowers who obtained credit secured by a lien against their primary residence. Congress heard a parade of horror stories from consumers about unscrupulous home improvement contractors who pressured them into financing expensive renovation projects (like aluminum siding) but failed to disclose that the loan was secured by a lien on the consumer’s dwelling. Consumers who defaulted on the financing lost their homes. Rescission is designed to protect consumers from making an impulsive decision by disclosing the lien and providing a three-day cooling off period after the loan closing. With the salesperson gone, the consumer can reconsider whether he wants to place his home at risk.[4]

The point here that as lending practices change, the disclosure requirement may change, but the goal of the regulation remains the same.

Why are They Doing This to Us?

At the end of the day, the goal of the Truth in Lending Act is to make it possible for a borrower to compare the cost of borrowing between one lender and the other AND the cost of borrowing versus the cost of buying the same item for cash. In other words, the borrower should be able to tell how much the bank is costing her to borrower money to buy the car. Unfortunately, the way in which this cost is defined causes headaches!

According to Reg. Z the finance charge should include all of the costs that the lender is creating vis a vis a cash transaction:

The finance charge is the cost of consumer credit as a dollar amount. 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. It does not include any charge of a type payable in a comparable cash transaction.

For many of our clients this language leaves as many questions as it does answers but the basic thrust of it is that things like taxes and official documents are costs that anyone would have when they buy a card or a house. Anything else is generally going to be a finance charge.

Recent Changes and the Future

In 2011, the rule making authority for Regulation Z was transferred to the Consumer Financial Protection Bureau. Since that time we have seen some updates to the regulation including the ability to repay rules, treatment of higher-priced mortgages and appraisal and escrow rules for these high priced mortgages. Again these changes are a directly reflection of lending practices. As loan terms evolve and change, the regulation will also evolve.

The focus of these rules is to ensure that customer of financial institutions know exactly what it is that they are getting into. The best rule to follow is when in doubt, disclosure and make sure you disclose the worst case scenario

[1] Griffith L. Garwood, A Look at the Truth in Lending – Five Years after, 14 Santa Clara Lawyer 491 (1974).
[2] See Preamble to 15 U.S.C. 1601 (1970)
[3] http://www.federalreserve.gov/boarddocs/caletters/2008/0805/08-05_attachment1.pdf
[4] Philadelphia Federal Reserve The Right of Recession: Overview and Recent Developments Compliance Corner 2007