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Consumer Credit Regulation: 5.5.6.4 Contract Argument Against Spreading

Consumer law practitioners should observe that spreading usually appears as a defense in a usury action. It is rarely mentioned in the contract itself and may not be closely considered when the contract is drafted. Therefore, creditors may unwittingly insert clauses in the credit contract that are inconsistent with a spreading defense.

Consumer Credit Regulation: 5.5.7 Minimum Finance Charges or Service Charges

Some credit statutes, like the Indiana version of the UCCC, authorize a minimum finance charge. The interrelationship between this charge and a statutory interest rate cap can be confusing. In Indiana, payday lenders argued that the $30 minimum finance charge provision meant that they could charge $30 for any transaction, no matter how short, even if it pushed the APR far above the statutory cap of 36%.

Consumer Credit Regulation: 3.7.5 State Parity Statutes’ Surprising Ricochets

Parity statutes can be interpreted to set off surprising ricochet effects that allow for rate exportation or federal agency preemption in ways not foreseen by either Congress or the state legislature enacting the parity laws. For example, Tennessee allowed state-chartered savings associations, but not state-chartered banks, to charge interest rates as high as 24%. Nevertheless, a Tennessee appellate court allowed a state-chartered bank to charge 24% interest because Tennessee national banks, under the most favored lender doctrine, can charge the state savings association rate of 24%.

Consumer Credit Regulation: 7.4.1 Introduction

Mandatory arbitration provisions are nearly universal in consumer credit contracts. Creditors insist on this requirement because it significantly limits their exposure to class-wide damages, punitive damages awards, discovery, publicity, and even individual damage claims.48 As a general rule, consumer litigants will want to avoid arbitration requirements for these very reasons.

Consumer Credit Regulation: 5.6.1 Calculation of Points

Often, the charges that a borrower must pay to obtain credit are not limited to monthly interest payments. Points are a prime example. In real estate transactions, borrowers are commonly assessed one-time fees at the consummation of a transaction, in addition to their regular monthly installments. Some of these fees directly compensate the creditor for specific third-party expenses, such as filing fees or appraisal fees, and generally do not present problems in calculation.

Consumer Credit Regulation: 5.7.2 Deferral Charges

In addition to allowing late charges, many consumer credit statutes permit creditors to collect a deferment charge (sometimes called an extension or forbearance charge) when monthly payments are deferred for a period of time, extending the maturity date of the loan. Where deferral charges are not specifically addressed by statute, a court may treat such charges as separate forbearance agreements, subject to the relevant usury ceiling.323

Consumer Credit Regulation: 5.8.1 Overview

A distinct form of overcharge often appears when credit is retired early by prepayment of the debt (including by refinancing) or when a debt matures early because of default and acceleration. Since the amount of interest due is in part a function of the time the credit is outstanding,345 shortening the time should, as a matter of logic and fairness, reduce the amount of interest the borrower pays. But that may not always happen.

Consumer Credit Regulation: 5.8.3.1 Introduction

There are two basic ways of structuring consumer credit transactions: “interest bearing” and “precomputed.” The distinction between these is critical to understanding rebates, as a rebate of unearned interest is required only if the transaction is precomputed.

Consumer Credit Regulation: 5.8.3.2 Interest Bearing

The traditional way to compute interest is on an “interest-bearing” basis. In an interest-bearing transaction, the consumer agrees to pay the principal (or amount financed, etc.) plus interest as it accrues at a certain periodic rate. Usually, the consumer signs a note agreeing to pay the principal “together with interest thereon at an annual rate of _________%.”

Consumer Credit Regulation: 5.8.3.3 Precomputed

The other principal way of structuring consumer credit transactions is on a “precomputed” basis. Until fairly recently, almost all consumer credit installment transactions, with the notable exception of mortgages, were structured on a “precomputed” basis.

Consumer Credit Regulation: 5.8.4.1 Early Voluntary and Involuntary Termination

A rebate is required only if the borrower repays the loan early. The key word is “early.” If a borrower defaulted on the last two payments of a loan that was scheduled to mature on April 1, 2009, but the creditor did not seek payment until June 1, 2009, there will be no rebate issues. Since the loan went to (and past) maturity, all the precomputed interest would have been fully earned, as would any credit insurance premiums.388

Consumer Credit Regulation: 5.8.4.2 Partial Prepayments

Federal law and most state laws typically do not require rebates for “partial prepayments.”392 These are early payments that are too small to retire the consumer’s total debt. If, for example, a borrower took out a loan repayable in twenty-four equal monthly installments and then paid both the fifth and sixth installments when only the fifth had come due, the borrower would have made a partial prepayment on the loan.

Consumer Credit Regulation: 5.8.5.2.1 Are points and other prepaid finance charges “earned at consummation”?

One potential area of dispute is whether the federal law or a relevant state law governing the transaction requires the rebate of points, service charges, origination charges, or other one-time fees charged at the time the loan is consummated.413 Some state statutes, particularly ones regulating real-estate-secured loans, explicitly permit the exclusion of points and other prepaid finance charges from the rebate by denominating them as “nonrefundable” or stating that they are to be considered earned at consummation.

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