Consumer Compliance Outlook
Compliance Requirements for Young Consumers
Young consumers — defined as persons under 21 years of age or college students — have been an attractive demographic for financial institutions. According to a recent report on college credit card agreements prepared by the Board of Governors of the Federal Reserve System (Board) for Congress, card issuers made payments totaling approximately $83.5 million to institutions of higher education in 2009 for the right to market credit cards to college students and affiliated organizations, resulting in 53,164 new credit card accounts.1 Additionally, students at institutions of higher education borrowed approximately $10 billion in private education loans in the 2008-2009 school year.2
In the past, consumer protection laws relied primarily on disclosures, assuming that if financial institutions clearly and conspicuously disclosed the terms and conditions of the account, consumers would have the necessary tools to make informed decisions. But more recently, Congress has also used substantive provisions that ban or restrict certain practices. Thus, in 2009 Congress passed the Credit Card Accountability Responsibility and Disclosure Act of 2009 (Credit CARD Act), which amended the Truth in Lending Act (TILA) and the Fair Credit Reporting Act (FCRA) to provide greater substantive protections, including special provisions for borrowers under age 21 and college students. Similarly, in 2008, Congress passed the Higher Education Opportunity Act (HEOA), which amended TILA to provide new disclosures and substantive protections for students at institutions of higher education applying for private education loans. This article reviews these compliance requirements.
CREDIT CARD ACT
Marketing to Underage Consumers
The Credit CARD Act amended §604(c)(1)(B)(iv) of the FCRA, 15 U.S.C. §1681b(c)(1)(B)(iv), to prohibit creditors and insurance companies from obtaining the credit report of consumers whose age is not specified in their report or those under 21 for purposes of making an unsolicited pre-screened offer of credit or insurance (known as a firm offer of credit or insurance). Creditors cannot obtain the consumer report of a young consumer unless the consumer has authorized it. Thus, this provision imposes a significant restriction on creditors wishing to make unsolicited credit offers to underage consumers, such as the ubiquitous credit card offers mailed to many consumers.
Credit Card Applications from Underage Consumers
In addition to amending the FCRA, the Credit CARD Act extensively revised TILA. To implement these revisions, the Board amended Regulation Z in January 2010.3 Under the new §226.51(b)(1), credit card issuers cannot open a credit card account for consumers under age 21 unless the applicant submits a written application. More important, card issuers must also obtain financial information indicating underage consumers have independent means to make the minimum periodic payment on the debt based on the terms and conditions of the loan. For purposes of estimating the minimum payments on the account, Regulation Z contains a safe harbor if issuers determine the minimum payment by assuming that the credit line will be fully utilized on the borrower's first use (including applicable mandatory fees if used to calculate the minimum payment), and the minimum payment includes any finance charges likely to be incurred and any mandatory fees for the card.4
In determining whether the applicant has sufficient income or assets to pay the debt, comment 226.51(a)(1)-4 of the Regulation Z Official Staff Commentary (Commentary) states that an issuer may consider any reasonably expected assets or income, including current or expected salary, wages, bonus pay, tips, commissions, dividends, retirement benefits, public assistance, alimony, child support, or separate maintenance payments. This comment also states that an issuer may rely on information provided by the consumer and may consider any other information obtained through an empirically derived, demonstrably and statistically sound model that reasonably estimates a consumer's income or assets.
The requirement that an issuer evaluate a young consumer's repayment ability applies not only during the initial credit card application but also when an issuer is evaluating whether to increase a credit limit on an existing account, regardless of whether the consumer requested the increase or the issuer initiated it.
If the applicant cannot pay the debt independently, the applicant can still qualify with a co-signer who is over age 21 and has the ability to pay the debt. In addition, for an account issued with a co-signer, §226.51(b)(2) prohibits issuers from increasing the credit line unless the co-signer agrees to assume liability on the increase.
Special Rules for Credit Cards on College Campuses
In addition to the rules in §226.51(b) that apply to all young consumers, §226.57 includes requirements that apply only to part- and full-time students at institutions of higher education. Specifically, credit card issuers cannot offer inducements to students to apply for a card if the offer is made on a college campus, within 1,000 feet of the campus, or at a college-sponsored event. In clarifying the requirements of the rule, comment 226.57(c)-2 explains that inducements do not include gifts that are not contingent on accepting the credit card. In addition, promotional rates, discounts, or reward points are not inducements because they apply only after the credit line is approved.
For transparency, the Credit CARD Act requires issuers to submit an annual report to the Board summarizing and detailing any affinity agreements the issuer has with an institution of higher learning, alumni association, or foundation (covered institution). The issuer must identify any agreements it has with a covered institution for the issuance of cards; the amount of any payments the issuer paid to the covered institution during the period; the terms of the agreement; the number of card accounts opened during the period; and the total number of accounts covered by the agreement outstanding at the end of the period. The Board maintains a searchable database of these agreements, which can be accessed at: http://www.federalreserve.gov/creditcardagreements/Search.aspx .
HIGHER EDUCATION OPPORTUNITY ACT
The HEOA creates new substantive protections for private education loans and also requires new TILA disclosures at the three stages of the loan process: application/solicitation, approval, and consummation. To ensure consumer comprehension of the disclosures, the HEOA directed the Board to develop model disclosure forms based on consumer testing. The Board retained a consultant for this purpose, who determined after extensive research and testing that:
Families turn to private loans due to time constraints, incomplete funding to cover all costs of education, and ineligibility for Federal aid. In most cases, the decision maker relied heavily on the school to provide information about the loan options available. Many took loans from education financing organizations or banks they recognized by name. The incidence of comparison shopping varies, with many going with the first loan offered to them. Given that the process is confusing and complicated for consumers, it is critical that the private loan disclosures provided to families are clear and concise, as well as educational in helping them understand the loan they are considering and other educational funding options available.5
After it finished researching and testing disclosures, the Board announced a final rule under Regulation Z, effective February 14, 2010, to implement the HEOA's requirements.6 The Board codified its implementing regulations in sub-part F of Regulation Z, §§226.46-48. These requirements apply to a private education loan.
Private Education Loan Defined
Section 226.46(b)(5) defines a private education loan as an extension of credit that:
- is not made, insured, or guaranteed under Title IV of the Higher Education Act of 1965 (HEA), 20 U.S.C. 1070 et seq.;
- is extended to a consumer expressly, in whole or in part, for post-secondary educational expenses, regardless of whether the loan is provided by the educational institution that the student attends;
- does not include open-end credit or any loan secured by real property or a dwelling; and
- does not include an extension of credit in which the educational institution is the creditor if the loan term is 90 days or less or an interest rate will not be applied to the credit balance and the loan term is one year or less, even if the credit is payable in more than four installments.
Under this definition, if a personal loan will be used in whole or in part to pay post-secondary educational expenses7 at a covered financial institution,8 the loan is considered a private education loan and is subject to heightened disclosure requirements. The Commentary indicates that even banks that offer personal loans not specifically marketed as student loans may be covered by the new disclosure requirement. Under comment 226.46(b)(5)-2, multi-purpose loans that are used in part to cover educational expenses are deemed private student loans if the customer expressly states that part of the proceeds of the loan will be used for paying post-secondary educational expenses. However, the regulation does not place a high burden on financial institutions to determine the purpose of the loan. They can rely solely on a purpose line or a check box to determine how the loan proceeds will be used.
Disclosure Requirements for Private Education Loans
If your institution is a creditor offering private education loans, several disclosures must be provided to borrowers at each of the three stages of the loan process.
Section 226.47(a) requires creditors to disclose on or with a solicitation or an application for a private education loan the following information:
- loan rates;
- itemization of any applicable fees, including late fees and adjustments to the rate and principal if the borrower defaults;
- repayment terms;
- cost estimates;
- age or school eligibility requirements; and
- federal loan alternatives, including a listing of the rates for the alternative loans
For telephone applications, the information may be provided orally or may be mailed no later than three business days after the consumer applies.
The approval disclosure must be provided before consummation on or with any notice of approval. The disclosure requirements appear in §226.47(b) and repeat the types of information in the application/solicitation disclosures but are transaction specific. The approval disclosures also emphasize the consumer's substantive right to accept the loan on the terms disclosed within 30 business days of receipt of the disclosures.
The final disclosures are governed by §226.47(c), which requires creditors to disclose, after the consumer accepts the loan, the identical transaction-specific information in the approval disclosures, except that creditors must also disclose the right-to-cancel clause and exclude the federal loan alternatives information provided in the two previous disclosures. The right-to-cancel clause informs borrowers that they have three business days after receiving the final disclosures to cancel the loan without penalty. Because of this right, which appears in §226.48(d), the loan proceeds cannot be disbursed until the cancellation period expires.
To facilitate compliance, the Board has provided model forms H-18 (application and solicitation disclosure), H-19 (approval disclosure), and H-20 (final disclosure). The forms are available in Appendix H to Regulation Z and reflect extensive consumer testing. Use of the model forms provides a safe harbor for the disclosure requirements.
In 2007, an investigation by New York's attorney general revealed conflicts of interest between some student lenders and institutions of higher education, with some lenders making payments to the institutions in exchange for receiving preferred treatment when the institutions recommend loan providers.9 Congress included provisions in the HEOA to address this issue, which the Board implemented in §226.48. This section prohibits the use of co-branding arrangements between creditors and institutions of higher education unless certain disclosures are made. In particular, §226.48 requires creditors to disclose if the institution of higher education agrees to endorse a creditor's private education loan products. The marketing for the loans must clearly and conspicuously state, in equal prominence and close proximity to the reference to the educational institution, that the creditor's loans are not offered or made by the educational institution but by the creditor.
While young consumers can be a profitable consumer segment, financial institutions must be mindful of the additional protections Congress has provided to this group. Understanding these protections will help institutions avoid the financial and legal harm that can result from noncompliance. Specific issues and questions about consumer compliance matters should be raised with the appropriate contact at your Reserve Bank or with your primary regulator.