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Consumer Credit Regulation: 5.8.6.1 Fixing the Date for the Rebate Calculation

That the size of a rebate depends on the time when the debt is prepaid or otherwise matured makes intuitive sense. If a borrower pays off a two-year loan after only one month, the creditor has earned less interest and should have to refund more money than if the consumer paid off the same loan after twenty-two months. The reason is that the borrower who prepays early in the term of the loan has had the use of the borrowed principal for less time than the borrower who prepays near the end of the term of the loan.

Consumer Credit Regulation: 5.8.6.2 Intervals: Rounding the Time Calculation

The next complication in calculating the time that a precomputed loan has been outstanding occurs when contractually interest is “earned” and payments are due at specific intervals, usually monthly, during the term of the loan, but prepayments and accelerations generally do not occur exactly on a payment date. Rather than giving the borrower a partial rebate for the days remaining in the payment interval,449 lenders have traditionally rounded up to the next payment date (rarely back to the previous payment date).

Consumer Credit Regulation: 5.8.7.1.1 Introduction

Once the particular charges that are subject to rebate are identified and the duration of the credit has been determined, the final step in computing the amount of the rebate is to apply to these figures one of the three rebate formulae that are generally used: the pro rata formula, the actuarial formula, or the Rule of 78s. Which formula to apply is partly a question of state law, with a significant overlay of federal law.

Consumer Credit Regulation: 5.8.7.1.2 Federal rebate statute

For consumer credit transactions with terms longer than sixty-one months consummated after September 30, 1993, federal law prohibits the use of the Rule of 78s. It requires instead the use of a formula at least as favorable to the borrower as the actuarial method.461 This federal law preempts any contrary state law.462

Truth in Lending: 9.5.4.4 Prepayment Penalty Restrictions

The FRB restrictions on prepayment penalties that were effective from October 9, 2009 to January 9, 2014 are discussed in the archived version of Chapter 9 available online as companion material to this treatise. Effective for applications received by midnight January 9, 2014 or thereafter, the direct limits on prepayment penalties on higher-priced mortgage loans (HPMLs) were abolished.500

Consumer Credit Regulation: 5.8.7.1.3 The Truth in Lending Act’s rebate requirements for mortgage loans

For high-cost mortgage loans consummated after October 1, 1995, a rule adopted under the Home Ownership and Equity Protection Act of 1994 (HOEPA) prohibits the use of the Rule of 78s when a creditor calculates a rebate of unearned precomputed interest due to loan acceleration as a result of default.467 The rule requires a refund of interest but not other charges, such as points, that are considered finance charges.468

Consumer Credit Regulation: 3.11.1 Introduction

Once it is determined which state’s law applies to a transaction, the next step is to determine under that state law, which statute in that state is applicable, because most states have a number of different statutes regulating credit. In making that determination, the substance of a transaction controls, not its form.942 A creditor cannot evade usury or other credit regulation by creating a fiction as to the nature of a transaction—the transaction’s true nature controls:

Consumer Credit Regulation: 3.11.2 Opting In

Even though a creditor cannot evade credit laws by characterizing a transaction as something other than an extension of credit, it may be stuck with a characterization of the transaction that benefits the consumer. A creditor may “opt in,” or provide by contract that a specific regulatory statute will apply to the transaction, even though it would, in absence of that contractual provision, fall outside the scope of that statute.

Consumer Credit Regulation: 3.11.3.1 General

Usury laws frequently distinguish business from consumer credit, allowing higher interest rates or completely eliminating usury ceilings for business transactions. The distinction may be accomplished by limiting the scope of a usury law to “consumer” credit. For example, the Uniform Consumer Credit Code (UCCC) applies only to credit extended “primarily for a personal, family, household, or agricultural purpose.”952

Consumer Credit Regulation: 3.11.3.2 Criteria for Business vs. Personal Purpose

Typically, loans used for direct investment or to finance a profit-making enterprise are business loans.963 The absence of any profit-making enterprise suggests personal purposes,964 but even if a borrower is engaged in a business, a loan has a non-business purpose if it is used primarily for medical expenses, household expenses, and other personal expenses.965

Consumer Credit Regulation: 3.11.3.4 Intermediaries

It is unclear whether borrowers who act as intermediaries for the true borrowers (typically for relatives who could not obtain loans) have business purposes just because the true borrowers do.981 However, a debtor who signs a genuine business purpose loan as a surety is bound by the business characterization of the transaction just as the principal is.982

Consumer Credit Regulation: 3.11.3.5 Refinancing

Whether loans refinancing preexisting business debts continue to be treated as business debts may depend upon a combination of the borrower’s motivation in seeking the refinancing and what the lender knows of the borrower’s purpose.

Consumer Credit Regulation: 3.11.4 Open-End vs. Closed-End Credit

Open-end credit is extended under a plan in which repeated transactions are contemplated. Credit cards and lines of credit are common examples of open-end credit. Closed-end credit examples include car loans and other installment sales. Where regulation of open-end credit is more favorable for a lender than closed-end, lenders may label as open-end what is really closed-end credit. This is called “spurious open-end credit.”

Consumer Credit Regulation: 3.11.5 Loans vs. Credit Sales; Body-Dragging

A seller of goods or services offering financing with a sale is governed in most states by a retail installment sales act (RISA), even if the credit seller immediately assigns the obligation to a lender.1003 Where a consumer independently arranges a loan from a bank or other lender, even with the express purpose of purchasing goods or services, the transaction is typically governed by a separate statute applicable to direct consumer loans.1004

Consumer Credit Regulation: 3.11.7.1 General

Credit statutes often apply to specific types of creditors, such as finance companies operating under small loan acts, pawnbrokers, insurance premium finance companies, home improvement sellers, and finance or motor vehicle sales finance companies.

Consumer Credit Regulation: 3.11.7.3 Creditor’s Efforts to Evade Licensing Requirements

Creditors may seek to evade state credit requirements by arguing that they need not be licensed because they are making the type of loans prohibited for licensed lenders. That is, the creditor fails to obtain a license, makes loans of a type prohibited for licensed lenders, and argues that the license requirement does not apply because the creditor is making loans of a type prohibited for licensed lenders.

Consumer Credit Regulation: 3.11.8.1 Loan Splitting

A state’s usury law may have a higher ceiling for small loans than for loans above a specified dollar value. To take advantage of the higher ceiling, lenders may split a large loan into several small ones. This practice of “loan-splitting” may be specifically prohibited by the small loan law.1046

Consumer Credit Regulation: 3.11.8.2 Loan Packing; Lending More Than Requested

In some states, usury restrictions apply only if a loan’s principal is under a certain amount.1049 Under such circumstances, creditors want to increase the size of the loan instead of splitting it into smaller loans. For example, in California until January 1, 2020, a loan under $2,500 was restricted to interest rates under 28%,1050 but there were no restrictions on the interest rate for loans over $2,500.1051

Consumer Credit Regulation: 3.11.10 Criminal Usury Statutes

Some states, even when deregulating their civil usury statutes, retain their criminal usury ceilings.1069 Similarly, even if a civil usury statute exempts business loans1070 or does not apply to defaulted debt,1071 a criminal usury ceiling still may apply. Criminal usury statutes are typically found in the state criminal code.