Consumer Compliance Outlook
The New Compliance Requirements Under Regulation Z for Private Education Loans
February 14, 2010 was the mandatory compliance deadline for the Board of Governors of the Federal Reserve System’s (Board) recent amendments to Regulation Z for private education loans (PELs).1 The amendments introduce new consumer protections and disclosures for PELs. Some lenders believe the new PEL rules do not apply to them because they do not have a formal student lending program, do not routinely arrange such loans, or do not promote loans to cover education expenses. However, any creditor who makes a PEL, as defined in §226.46(b)(5) of Regulation Z, is subject to the disclosure rules. This article provides an overview of those requirements to facilitate compliance.
Scope of Rule
The Board adopted these amendments to implement the requirements of the Higher Education Opportunity Act of 2008 (HEOA),2 which amended the Truth in Lending Act (TILA) to require new disclosures for PELs. Section 226.46(b)(5) of Regulation Z defines a PEL as a loan made to a consumer expressly, in whole or in part, for post-secondary educational expenses. The definition excludes open-end credit, real-estate-secured loans, loans extended by a covered institution of higher education for a term of 90 days or less, or loans for which the covered institution will not charge interest and whose term is for a year or less. The HEOA also amended TILA to cover PELs even if the amount financed exceeds $25,000.
The HEOA defines post-secondary educational expenses as any expenses listed as part of a student’s cost of attendance, as that term is defined in §472 of the Higher Education Act of 1965 (HEA), 20 U.S.C. §1087ll,3 at a covered educational institution. A covered educational institution is an educational institution that meets the definition of an institution of higher education, as defined in §§101-102 of the HEOA, 20 U.S.C. §§1001-1002, and the U.S. Department of Education implementing regulations, without regard to the institution’s accreditation status. Such an institution may include, for example, a university or community college. It may also include an institution, whether accredited or unaccredited, offering instruction to prepare students for gainful employment in a recognized occupation. A covered educational institution does not include elementary or secondary schools.
Thus, unless otherwise exempted, a loan for which any portion of the proceeds will be used for the stated purpose of post-secondary educational expenses is a PEL and subject to the rules in §§226.46-48 of Regulation Z. The types of post-secondary educational expenses that if financed would trigger compliance with these rules are quite broad, including tuition and fees, books, supplies, miscellaneous personal expenses, room and board, and an allowance for any loan fee, origination fee, or insurance premium charged to a student or parent for a loan incurred to cover the cost of the student’s attendance.
Timing and Content of Disclosures
Section 226.46 establishes the timing requirements of the PEL disclosures, and §226.47 prescribes the content. Up to three separate sets of disclosures may be required under §226.47 for a single loan: disclosures at application or solicitation, disclosures after approval, and disclosures after acceptance. To facilitate compliance, the Board included model disclosure forms H-18, H-19, and H-20 in Appendix H of Regulation Z. For regulatory requirements linked to the receipt of disclosures, such as the right to cancel, the consumer is deemed to have received disclosures three business days after mailing.
The formatting requirements for disclosures, including required grouping, permissible additional items that may be included, conspicuousness of certain terminology, and requirements for electronic disclosure, are set forth in §226.46(c). As with Regulation Z’s requirements for other credit products, the disclosures must reflect the terms of the legal obligation. Further, if any information necessary for an accurate disclosure is unknown to the creditor, the creditor must make the disclosure based on the best information reasonably available when the disclosure is provided and must clearly state that the disclosure is an estimate.
Disclosures with Application or Solicitation: §226.47(a)
The disclosures required by §226.47(a) are for an application or solicitation for a PEL. These disclosures may be provided orally for a telephone application or solicitation.
If a loan has an age or school enrollment eligibility requirement for the consumer or a co-signer, it must be disclosed. Additionally, the disclosures must include a statement that the consumer must complete the self-certification form before the loan can be consummated, and that the form may be obtained from the institution of higher education the student attends.4
The application disclosure must provide information about the cost of the loan — including information about interest rates, fees for obtaining the loan, and costs associated with default or late payment — as well as the terms of repayment.
If precise cost information for the specific loan cannot be determined at application, the lender is generally required to disclose a range of costs and explain how the costs will be determined. The term of the loan, which is the period during which regularly scheduled payments of principal and interest will be due, must be disclosed. If the consumer does not have the option to defer payments, the disclosures must state this fact. If the consumer can defer payments, the deferral features must be described, and for each deferral option applicable while the student is enrolled at a covered educational institution, disclosures must indicate:
- whether interest will accrue during the deferral period; and
- if interest accrues, whether payment of interest may be deferred and added to the principal balance.
Section 226.47(a)(4) requires an example (using $5,000 or $10,000, depending on the maximum loan amount the creditor offers for such a loan) of the total cost of the loan. This disclosure is calculated as the total of payments over the term of the loan, for each payment option, using the highest rate of interest disclosed and including all finance charges applicable to loans at that rate. Concerning repayment, the application disclosure must contain a statement that if the consumer files for bankruptcy, the consumer may still be required to pay back the loan.
The lender must include on the application disclosure a statement that if the loan is approved, the terms of the loan will be available and will not change for 30 days except as a result of adjustments to the interest rate and other changes permitted by law. This reflects a consumer’s substantive right under §226.48(c) to accept the terms of a PEL.
One key aspect of the legislation captured by the rule in §226.47(a)(6) is that the lender must disclose to the consumer information about alternatives to PELs, including:
- a statement that the consumer may qualify for federal student financial assistance through a program under Title IV of the HEA (20 U.S.C. 1070 et seq.);
- the interest rates available under each program under Title IV of the HEA (20 U.S.C. 1070 et seq.) and whether the rates are fixed or variable;
- a statement that the consumer may obtain additional information concerning federal student financial assistance from the institution of higher education the student attends or at the website of the U.S. Department of Education, including an appropriate website address; and
- a statement that a covered educational institution may have school-specific education loan benefits and terms not detailed on the disclosure form.
For multiple-purpose loans, a creditor generally will not know in advance whether the consumer intends to use the loan for post-secondary educational expenses. For this reason, the creditor is not required to provide the §226.47(a) disclosures on or with the application or solicitation for a multiple-purpose loan. However, if the consumer expressly indicates that the proceeds of the loan (not otherwise exempt) will be used to pay for post-secondary educational expenses, the creditor must adhere to the limitations detailed in §226.48 and comply with the approval and acceptance disclosure rules in §226.47(b) and (c), respectively. These requirements are discussed below.
Approval Disclosures: §226.47(b)
Before consummation of a PEL, on or with any notice of approval provided to the consumer, the lender must provide to the consumer in writing all of the disclosures required by §226.47(b). The approval disclosures capture information about the interest rate, fees and costs, repayment terms, alternatives to PEL loans, and the rights of the consumer.
Under the repayment terms disclosure, the lender must disclose, in addition to the specific costs and repayment terms, the loan amount for which the consumer has been approved. Using this amount, §226.47(b)(3)(vii) requires the lender to provide an estimate of the total amount of payments calculated based on:
- the interest rate applicable to the loan. Compliance with §226.18(h) (the total of payments) constitutes compliance with this requirement.
- the maximum possible rate of interest for the loan or, if a maximum rate cannot be determined, a rate of 25 percent.
If a maximum interest rate cannot be determined, the estimate of the total amount for repayment must include a statement that there is no maximum rate and that the total amount for repayment disclosed is an estimate and will be higher if the applicable interest rate increases.
Additionally, §226.47(b)(3)(viii) requires the lender to disclose the maximum monthly payment based on the maximum rate of interest for the loan or, if a maximum rate cannot be determined, a rate of 25 percent. If a maximum interest rate cannot be determined, the creditor must disclose that the loan is not subject to a maximum rate and that the monthly payment amount disclosed is an estimate and will be higher if the applicable interest rate increases.
For the disclosure concerning the consumer’s rights, §226.47(b)(5)(ii) requires the lender to disclose that the rates and terms of the loan may not be changed by the creditor during the acceptance period, except for changes to the interest rate and other changes permitted by law. The approval disclosure must also include a statement that the consumer may accept the terms of the loan until the acceptance period — which must be at least 30 days under §226.48(c)(1) — has expired. The statement must include the specific date on which the acceptance period expires, based on the date the consumer received the disclosures. The disclosure must also specify the method or methods by which the consumer may communicate acceptance. Inaccuracies in approval disclosures caused by events subsequent to delivery of the approval disclosures do not violate Regulation Z, and as a general rule, new approval disclosures are not required. However, a few exceptions are discussed below.
Final Disclosures: §226.47(c)
Final disclosures under §226.47(c) must be provided in writing after the consumer accepts the loan. In addition to the specific disclosures required under §226.47 for a PEL, lenders must provide the general closed-end TILA disclosures required by §226.18. Additionally, many of the disclosures required for the approval disclosure must be reiterated in the final disclosures, including:
- interest rate information required to be disclosed under §226.47(b)(1);
- information about fees and default or late payment costs required to be disclosed under §226.47(b)(2); and
- repayment terms information required to be disclosed under §226.47(b)(3).
Inaccuracies in the final disclosures are not violations if attributable to events occurring after disclosures are made and do not require new disclosures, unless one of the exceptions discussed later applies.
Right to Cancel
Under §226.48(d), the consumer has the right to cancel a PEL without penalty for up to three business days after the consumer receives the final disclosures required under §226.47(c). Because of the right to cancel, loan proceeds cannot be disbursed until after the cancellation period expires. Lenders must include a statement of the right to cancel in the final disclosures. The statement must include the specific date on which the cancellation period expires and state that the consumer may cancel by that date. The disclosure must also specify the method or methods by which the consumer may cancel. If the creditor permits cancellation by mail, the statement must specify that the consumer’s mailed request will be deemed timely if placed in the mail no later than the cancellation date specified on the disclosure. The statement of the right to cancel must be more conspicuous than any other disclosure required, except for the finance charge, the interest rate, and the creditor’s identity, which must meet the conspicuousness requirements of section 226.46(c)(2)(iii). Model Form H-23 provides an example of the final disclosures, including the statement of the right to cancel.
Rights and Limitations
Section 226.48 establishes a number of substantive rights for consumers obtaining PELs. Among these is the right to accept the terms of a PEL at any time within 30 calendar days following the date on which the consumer receives the approval disclosures. With limited exceptions, the creditor cannot change the rate and terms of the loan during this 30-day period. Notwithstanding this general prohibition on change, certain changes are permissible under §226.48(c)(3) as follows:
- A creditor may withdraw an offer before consummation of the transaction if the extension of credit would be prohibited by law or if the creditor has reason to believe that the consumer has committed fraud in connection with the loan application;
- Based on adjustments to the index used for a loan, the interest rate may be changed;
- The interest rate and terms may be changed if the change will unequivocally benefit the consumer; or
- The loan amount may be reduced based upon a certification or other information received from the covered educational institution, or from the consumer, indicating that the student’s cost of attendance has decreased or the consumer’s other financial aid has increased. A creditor may make corresponding changes to the rate and other terms only to the extent that the consumer would have received the terms if the consumer had applied for the reduced loan amount.
None of the changes outlined above require the creditor to provide new approval disclosures or an additional 30-day period for the consumer to accept the new terms of the loan; however, final disclosures must be provided to reflect the changed terms.
In some circumstances, new approval disclosures are required. A creditor may change the rate or terms of the loan to accommodate a specific request by the consumer. For example, if the consumer requests a different repayment option, the creditor may, but need not, offer to provide the requested repayment option and make any other changes to the rate and terms. If the creditor does change the rate or terms at the consumer’s request, it must provide the approval disclosures required under §228.47(b) and provide the consumer the 30-day period to accept the loan. The creditor cannot make further changes to the rates and terms of the loan, except as permitted under §226.48(c)(3). Further, unless the consumer accepts the loan offered by the creditor in response to the consumer’s request, the creditor may not withdraw or change the rates or terms (except as permitted by the regulation) of the loan for which the consumer was approved prior to the consumer’s request for a change in loan terms.
A number of other limitations on PELs are contained in §226.48 that generally cover the marketing of such loans and certain relationships between lenders and educational institutions. Section 226.48(a) generally prohibits co-branding. This prohibition means that a creditor, other than the covered educational institution itself, cannot use the name, emblem, mascot, or logo of a covered educational institution, or other words, pictures, or symbols identified with a covered educational institution, in the marketing of PELs in a way that implies that the covered educational institution endorses the creditor’s loans.
The rule permits co-branding when a creditor and a covered educational institution have entered into an endorsed lender arrangement and certain disclosures are made to a consumer. An endorsed lender arrangement exists when a creditor and a covered educational institution have entered into an agreement in which the covered educational institution agrees to endorse the creditor’s PELs, and such arrangement is not prohibited by other applicable law or regulation. To take advantage of the exception to the co-branding prohibition, PEL marketing must include a clear and conspicuous disclosure that is equally prominent and closely proximate to the reference to the covered educational institution that the creditor’s loans are not offered or made by the covered educational institution but are made by the creditor.
Finally, §226.48(f) establishes a requirement that a creditor that has a preferred lender arrangement with a covered educational institution must provide information to the covered educational institution about the PELs it will be offering to students at the institution. Under the regulation, a preferred lender arrangement has the same meaning as in §151(8) of the Higher Education Act of 1965, 20 U.S.C. §1019(8). Generally, such an arrangement exists between a lender and a covered educational institution or an institution-affiliated organization of such covered institution when a lender makes education loans to students, or families of students, attending the covered institution and involves the covered institution, or such institution-affiliated organization, recommending, promoting, or endorsing the education loan products of the lender.
When aware of a preferred lender arrangement with a covered educational institution, a creditor must provide the institution with the information required under §226.47(a)(1)-(5) (certain cost, repayment, and loan eligibility information that must be included in application disclosures), for each type of PEL the lender plans to offer to consumers for students attending the covered educational institution for the period beginning July 1 of the current year and ending June 30 of the following year. The creditor must provide the information annually by the later of the 1st day of April, or within 30 days after entering into, or learning the creditor is a party to, a preferred lender arrangement.
It is possible for a preferred lender arrangement to exist without the knowledge of a lender. For this reason, comment 226.48(f)-1 of the Official Staff Commentary provides that a creditor is subject to the requirements of this section only if the creditor is aware that it is a party to a preferred lender arrangement. For example, if a creditor is placed on a covered educational institution’s preferred lender list without the creditor’s knowledge, the creditor is not required to comply with §226.48(f).
A lender may find that it has historically made, even if only occasionally, loans that now meet the definition of a PEL. Before extending any PELs, lenders should ensure that they have the capacity to comply with these new rules. If disclosure software is purchased from a vendor, the lender will likely want to inquire about the availability and cost of updates for supporting compliance with the new rules. Even if few such transactions are originated, the inability to generate correct disclosures when required would result in violations of Regulation Z. Specific issues and questions should be raised with the consumer compliance contact at your Reserve Bank or with your primary regulator.