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1.5.2 Open-End vs. Closed-End Credit

The consumer credit laws of most states distinguish closed-end or installment credit from open-end or revolving credit.183 Generally, closed-end credit statutes address a single extension of credit between a creditor and a debtor that the debtor agrees to pay off in a fixed number of periodic installments of a specified amount. The credit sale of an automobile is a good example of such a transaction because any one sale will almost invariably represent the entire debt outstanding between the two parties. Although the consumer might go back to the same dealer over many years to purchase more automobiles, each credit sale would be viewed as an isolated transaction, to be paid for individually.

Open-end credit statutes, on the other hand, contemplate frequent transactions between the parties in which the debt from each individual transaction is merged into the larger outstanding debt. A typical example of this arrangement is a bank credit card. The debt from each purchase or cash advance is added to an outstanding balance, and the consumer receives a monthly statement giving the total outstanding balance, the accrued finance charge from the preceding month, and the minimum payment due. There is no set number of payments that the consumer will make on the account, and there is no expectation that the size of each payment will be equal. The consumer is required to pay only a stated minimum amount which will vary with the outstanding balance and which will, in most cases, at least equal the accrued finance charge for the previous month.184 The consumer is free to pay off the entire balance whenever he or she wishes. Under the terms of most card agreements, finance charges may be avoided altogether if the full account balance is paid on time every month,185 although annual fees are sometimes imposed regardless of the consumer’s payment record.

The separate regulation of installment credit and open-end credit makes some sense because the two arrangements raise different concerns. For example, calculation of the monthly finance charge or the minimum amount due does not cause much problem in installment credit where the principal is paid down on a regular basis, but does not otherwise fluctuate. Conversely, rebates of unearned interest are not an issue in open-end accounts because the interest on such accounts is not precomputed.186

The interest rate on both fixed-term or open-end credit may be either a fixed rate or a variable rate. Yet it is much more common for closed-end transactions to be at a fixed rate and open-end transactions to be at a variable rate. The charges on closed-end non-mortgage credit are often precomputed while charges on open-end credit are computed monthly. Open-end accounts thus lend themselves to a frequently changing interest rate.

While the distinction between closed-end and open-end credit is generally clear-cut, this is not always the case. If open-end credit allows creditors a higher interest ceiling, fewer restrictions, or fewer disclosures, some creditors will try to structure single transactions as lines of credit that fall under the open-end statutes.187

A related gray area between closed-end and open-end credit is a finance company practice of repeatedly refinancing its customers’ outstanding loans.188 The process works approximately as follows. A finance company either loans a consumer money or, more often, acquires preexisting debt through assignment or debt consolidation. This initial transaction looks like regular installment debt: a fixed number of usually equal payments is required to retire the debt and there is no obligation or even expectation that the creditor will give the borrower any more loans. Yet, before the initial obligation is paid off, the debt is refinanced. The new loan also appears to be a closed-end transaction, but its principal includes not only the outstanding principal from the previous loan, but also unpaid interest, various non-interest fees such as credit insurance premiums, and often a small new cash advance to the borrower. In effect, new charges have been added to the consumer’s account. With each subsequent refinancing, the process is repeated and the consumer’s debt is extended. Repeated refinancing creates a highly remunerative form of an open-end account composed of a series of closed-end transactions.

Footnotes

  • 183 {175} See Seibert v. Sears, Roebuck & Co., 120 Cal. Rptr. 233 (Cal. Ct. App. 1975) (comparing open-end and closed credit); Appx. D, infra (state installment loan laws); Appx. E, infra (state open-end credit laws).

  • 184 {176} If the minimum payment is less than the monthly finance charge, the result of making the minimum payment every month is negative amortization, and the debtor owes progressively more and more money, even if no additional charges (i.e., credit purchases) or cash advances are made on the account. See Ch. 8, infra.

  • 185 {177} Many cards have a “grace period” during which the amount billed in the previous month can be paid without finance charge provided that the customer had entered the month with an account balance of zero. Some cards, however, provide no grace period, and interest is assessed from the day a purchase is recorded (i.e., “posted”) by the creditor. See § 8.6, infra (discussing grace periods and credit cards).

  • 186 {178} In a precomputed contract, all interest charges are determined at the time the contract is entered into, and a fixed monthly payment size is set at a level sufficient to pay off both the interest charges and the principal debt over the term stated in the contract. This is the traditional format for a small loan or credit sale. See § 5.8.3, infra.

  • 187 {179} See § 3.9.4, infra; National Consumer Law Center, Truth in Lending § 6.2 (9th ed. 2015), updated at www.nclc.org/library (spurious open-end credit).

  • 188 {180} See, e.g., Porter v. Ace Cash Express, Inc., 2000 U.S. Dist. LEXIS 15996 (E.D. La. Oct. 25, 2000) (payday lender did not fall within revolving credit statute; insufficient evidence that parties contemplated repeat transactions), aff’d, 277 F.3d 1372 (5th Cir. 2001). See generally §§ 3.9.4 (discussing the distinction between open-end and closed-end credit), 5.9 (discussing refinancing), infra.