Consumer Compliance Outlook
The New Dollar Threshold for Regulation Z Coverage
Congress enacted the Truth in Lending Act (TILA) in 1968 “to assure a meaningful disclosure of credit terms so that the consumer will be able to compare more readily the various credit terms available to him and avoid the uninformed use of credit, and to protect the consumer against inaccurate and unfair credit billing and credit card practices.”1 In 1969, a non-dwelling-secured consumer credit transaction2 was subject to TILA and Regulation Z, TILA's implementing regulation, if the transaction: a) had an amount financed in the amount of $25,000 or less, in the case of closed-end credit; or b) had a written credit limit of $25,000 or less, in the case of open-end credit. When the $25,000 threshold was set, a new Corvette sold for under $5,000. But today, 43 years later, the average selling price of a new car exceeds the threshold by nearly $5,000.3
Although consumer credit transactions in any amount that are secured by the consumer's dwelling have been subject to Regulation Z since 1969 and, more recently, private education loans (PELs) have been covered regardless of loan amount,4 Congress recognized that it was time to update TILA's threshold for the remaining categories of consumer credit. Under §1100E of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act),5 the dollar threshold value for TILA coverage was increased from $25,000 to $50,000, effective July 21, 2011. On April 4, 2011, the Board of Governors of the Federal Reserve System (Board) issued a final rule amending Regulation Z to implement §1100E.6 This article reviews the requirements of the final rule.
THE NEW THRESHOLD RULE
A key distinction between the old threshold rule and the new one is that the old threshold for closed-end credit was based on the value of the amount financed, while the new rule is based on the amount of credit extended. To illustrate this difference, assume under the original threshold of $25,000 that the consumer obtains a car loan in the amount of $25,050. Assume further that the consumer must separately pay a $75 credit report fee. The amount financed under those conditions would be $24,975, and the loan would be subject to Regulation Z because the amount financed does not exceed $25,000. Now, assume under the new $50,000 threshold that a consumer obtains a car loan in the amount of $50,050 and pays the same $75 credit report fee. Although the amount financed is $49,975, the loan would not be subject to Regulation Z because the amount of credit extended exceeds $50,000.
Second, the rule requires the threshold to be adjusted for inflation on January 1 of each year. The threshold amount will increase (rounded to the nearest $100 increment) by any annual percentage increase in the consumer price index for urban wage earners and clerical workers (CPI-W), as published by the Bureau of Labor Statistics for June 1 of the prior year. The threshold will not decrease if the index value decreases. The applicable threshold will be $50,000 until December 31, 2011. The Board recently announced the first CPI-W adjustment to $51,800 effective January 1 through December 31, 2012.7
The remainder of this article discusses the threshold changes in more detail.
For open-end credit extensions, the final rule offers two methods for determining if an account is exempt under the revised threshold. The first method determines exemption based on the credit limit at the time the account is opened. The second method determines exemption based on the amount of the initial advance. If the account qualifies under either method, it is exempt, although an account can lose its exempt status in certain circumstances based on subsequent events.
The Official Staff Commentary (Commentary) for Regulation Z states that an open-end account is exempt from Regulation Z if “the creditor makes a firm written commitment at account opening to extend a total amount of credit in excess of the threshold amount in effect at the time the account is opened with no requirement of additional credit information for any advances on the account (except as permitted from time to time with respect to open-end accounts pursuant to §226.2(a)(20)).”8
The account balance under such a credit limit does not have to exceed the applicable threshold amount to remain exempt from Regulation Z. As long as the credit limit at account opening exceeds the threshold and is not secured by real or personal property used or expected to be used as the consumer's principal dwelling, the account is exempt from Regulation Z, even if the threshold is later increased because of changes in the CPI-W. For example, if a credit card was issued on January 2, 2012 with a $55,000 credit limit, and the consumer's balance on the first periodic statement was $10,000, the account is exempt. If the threshold was later increased to $60,000, the account would remain exempt because the credit limit at account opening exceeded the threshold then in effect. However, if the creditor later reduces the credit limit below the threshold then in effect (for example, in response to negative information obtained from a consumer reporting agency during an account review), the exemption no longer applies unless the account is exempt based on the amount of the initial credit extension, as discussed below.
Conversely, if the credit limit at account opening does not exceed the applicable threshold amount, the account is subject to Regulation Z, even if the account balance exceeds the applicable threshold at a later date unless the initial extension of credit exceeds the applicable threshold. For example, on January 1, the applicable threshold is $50,000, and an account is opened on March 1 with a credit limit of $45,000. The initial extension of credit on April 1 is $10,000, and the balance on July 1 is $52,000 because the creditor permitted the debtor to make additional transactions in excess of the credit limit. The account is not exempt.
Initial Credit Extension
The second method for qualifying for the exemption is based on the initial extension of credit. Even if the credit limit at account opening does not exceed the applicable threshold, an account can still be exempt from Regulation Z if the initial credit extension exceeds the applicable threshold. Comment 226.3(b)-2.i.A.1 of the Commentary provides this example: “Assume that the threshold amount in effect on January 1 is $50,000. On February 1, an account is opened but the creditor does not make an initial extension of credit at that time. On July 1, the creditor makes an initial extension of credit of $60,000. In this circumstance, no requirements of this Part apply to the account.”
But if the creditor makes an initial extension of credit that does not exceed the threshold amount in effect, the account is not exempt, and the creditor must have satisfied the requirements of Regulation Z from the date the account was opened. Comment 226.3(b)- 2.i.A.2 provides this example: “Assume that the threshold amount in effect on January 1 is $50,000. On February 1, an account is opened but the creditor does not make an initial extension of credit at that time. On July 1, the creditor makes an initial extension of credit of $50,000 or less. In this circumstance, the account is not exempt and the creditor must have satisfied all of the applicable requirements of this Part from the date the account was opened (or earlier, if applicable).”
If an account exemption was based on an initial extension of credit that exceeded the applicable threshold at account opening, comment 226.3(b)-2.iii clarifies that the account will remain exempt from Regulation Z even under the following circumstances:
- The applicable threshold increases at a later date, even if the value of the subsequent threshold is greater than the amount of the initial extension of credit. For example, if the initial extension of credit at account opening was $52,000 and the applicable threshold at account opening was $50,000, the account is exempt from Regulation Z. If the applicable threshold increases the following year to $55,000, the account would still not be subject to Regulation Z.9
- There are no further extensions of credit.
- Subsequent extensions of credit are made but do not exceed the original threshold amount.
- The account balance is subsequently reduced below the original threshold amount.
- The account credit limit is subsequently reduced below the original applicable threshold limit.
Special Transition Rule for Accounts Exempt Before July 21, 2011
To facilitate the transition to the new threshold, the Board adopted a special transition rule for certain accounts that are currently exempt. If, on July 20, 2011, an open-end account is exempt from Regulation Z because of a firm commitment to extend more than $25,000 in credit,10 the account will remain exempt until December 31, 2011. If that firm commitment is increased to at least $50,000 by December 31, the account will continue to be exempt. Otherwise, the exemption ends on January 1, 2012, and Regulation Z applies.
Subsequent Event: Addition of a Security Interest for Open-End Credit
An open-end account that is exempt from Regulation Z (for example, an account with a credit limit in excess of the threshold) would lose its exempt status if the creditor subsequently takes a security interest in real or personal property used or expected to be used as the consumer's principal dwelling. Furthermore, if the security interest is in the consumer's principal dwelling, the creditor must give the consumer the right to rescind the security interest consistent with §226.15.
If an exempt account becomes a covered account, the creditor must begin complying with all applicable provisions of Regulation Z within a reasonable period of time, including providing initial disclosures under §226.6 and periodic statements under §226.7.11
When Exempt Accounts Become Nonexempt
If an open-end account that initially qualified for the exemption no longer qualifies, the creditor must begin to comply with the applicable Regulation Z requirements “within a reasonable period of time.”12 The regulation's requirements apply to the existing balance on the account. However, the creditor need not comply with the regulation for the period of time when the account was exempt. For example, the Commentary specifies that the creditor must disclose new fees or charges but need not retroactively disclose fees or charges incurred while the account was exempt.
The final rule states that a closed-end loan that is not 1) secured by real property, or 2) secured by personal property that serves as the consumer's principal dwelling, or 3) a private education loan under §226.46(b)(5) is exempt from Regulation Z if either of the following conditions is met:
- The loan amount at consummation exceeds the applicable threshold at consummation.
- The creditor commits at consummation to extend a total amount of credit that will exceed the threshold in effect at consummation (e.g., in connection with a multiple advance construction loan).
VIEW LARGER IMAGE
The closed-end loan will remain exempt even if the loan balance drops below the applicable threshold or the total amount of credit extended under the commitment does not exceed the applicable threshold amount. The loan also remains exempt if the threshold amount increases at a later date.
A new loan that replaces an existing loan (e.g., a refinancing under §226.20(a)) must be evaluated on its own terms. Although the existing loan may be exempt, if the new loan does not itself meet exemption requirements, it is subject to Regulation Z.
For example, if the threshold at consummation of the existing loan was $50,000 and the existing loan amount was $52,000 at consummation, the existing loan is exempt from Regulation Z. Assume that in five years the loan balance is $40,000. The loan is still exempt from Regulation Z, even though the balance is below the original or any subsequent threshold. But if there is a refinancing with the existing loan balance of $40,000 paid in full and replaced by a new loan below the threshold (e.g., in the amount of $40,000), the new loan is subject to Regulation Z. Note that since applicable thresholds may increase but not decrease under the rule, the applicable threshold will never be less than $50,000.
Subsequent Event: Addition of a Security Interest for Closed-End Credit
In contrast to the requirements for open-end credit, an exempt closed-end loan does not lose its exempt status if the creditor subsequently takes a security interest in real or personal property used or expected to be used as the consumer's principal dwelling. However, since the addition of a security interest in the consumer's principal dwelling is considered a transaction for rescission purposes under §226.23, the creditor must provide the consumer with a notice of the right to rescind the security interest consistent with that section, just as it must with open-end credit under §226.15. But the right of rescission applies only to the added security interest, not the original obligation. Consequently, the creditor only has to provide the rescission notice under §226.23(b) and not new material disclosures. The rescission period starts to run from the delivery of the notice.13 Also, if the addition of the security interest in the consumer's principal dwelling involved a refinancing, the closed-end loan itself would also be subject to Regulation Z, regardless of the value of the applicable threshold at the time of refinancing.
The Dodd-Frank Act updated the exemption threshold for TILA coverage from its 1960s level of $25,000 to $50,000 effective July 21, 2011 and included an annual inflation adjustment. As of January 1, 2012, the adjusted threshold will be $51,800. Creditors should ensure that their systems and their vendors' systems are in compliance, paying particular attention to the circumstances in which an account can lose its exempt status. Specific issues and questions about consumer compliance matters should be raised with your primary regulator.