Regulated Aspects of Installment Lending

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Regulated Aspects of Installment Lending

• Installment Lending Panel
• Payday Loan Bar Association Summit
• __________________________________________________
  _____
• Presented byMichael A. RaskaskyHarlowe Falk
  LLP
• November 14, 2006

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Why are we talking about installment lending?

• Changing laws, negative climate for PDLs
• Stay in business if the legislative axe falls
• Diversify product offerings

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Why are we talking about installment lending?

• Offer installment product that combines features
  of payday loans
• Small dollar amounts not offered by banks
• Limited underwriting/credit check
• Fast cash for borrower
• Above prime interest rates
• Secured by check or ACH authorization
• Payments tied to paydays

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Why are we talking about installment lending?

• and additional features of traditional
  installment loans
• Multiple payments over time v. single repayment
• Simple interest (generally) on unpaid balance v.
  fee-based finance charge
• Secured lending option

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Why are we talking about installment lending?

• What legal and operational issues arise with this
  new product?

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Why are we talking about installment lending?

• Contract terms
• Servicing and Payments
• Default

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Caveats

• Focus -- issue spotting
• Rules can vary dramatically by state
• Consumer loan laws
• Uniform Consumer Credit Code (7 states)
• Usury laws
• UCC Rev. Article 9 (secured lending)
• Motor vehicle codes (vehicle secured lending)

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The Contract

• Loan amount
• Large amounts (e.g., gt25,000) or real estate
  loans frequently outside scope of consumer loan
  statutes

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The Contract (contd)

• Finance charges
• Origination fees
• Typical limit - 2 of principal
• Prepaid finance charge - special treatment under
  TILA
• Contract interest rate (not just the APR)

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The Contract (contd)

• --Finance charges
• Interest calculation methodology
• Simple interest/365 day year
• Precomputed interest
• Compounding of interest
• Describe in the contract

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The Contract (contd)

• Loan term
• May be tied to loan amount
• Ex loans up to 300 - up to 25 months
• Loans 301 to 1,000 - up to 37 months

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The Contract (contd)

• Payment schedule
• Small loan amounts (e.g., lt1,000)
  substantially equal amounts, intervals
• Big TILA issues, particularly with payments tied
  to pay periods (irregular, semi-monthly, etc.)

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The Contract (contd)

• Method of payment
• ACH
• Preauthorized ACH Reg. E limitations, NACHA
  rules
• Check
• NSF fee limits
• Broader bad-check remedies may be available

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The Contract (contd)

• Secured lending collateral considerations
• Grant language
• Collateral description (UCC 9-108 and TILA
  226.18(m))

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The Contract (contd)

• --Secured lending - collateral considerations
• Motor vehicles
• Certificate of title
• May implicate title loan statutes
• Household goods
• FTC Unfair or Deceptive Credit Practices Rule
• Limits non-possessory security interests in
  household goods
• Exceptions for PMSI, art works, antiques, jewelry
  (not wedding rings), one television and one radio
• Insurance on collateral Special disclosure
  required to exclude from finance charge (Reg. Z
  226.18(n), 4(d))

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Servicing and Payments

• Caveat
• Servicing methodology should be described in the
  loan agreement

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Servicing and Payments

• Late payments
• Late payment charges
• Ex 10 days late, charge lesser of 5 of
  installment amount or 20
• No pyramiding of interest on late fees

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Servicing and Payments (contd)

• --Late payments
• Deferral
• By agreement after-the-fact, or
• Unilateral in loan agreement
• Deferral charges authorized
• Generally cannot charge deferral AND late charges
  

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Servicing and Payments (contd)

• Partial payments
• Application of payments
• Specify in contract, but check state law
• Event of default
• Triggers a late charge to extent of unpaid
  installment

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Servicing and Payments (contd)

• Prepayments
• Nearly always allowed
• Rebate for precomputed loans
• Earned may be complicated

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Servicing and Payments (contd)

• --Prepayments
• Prepayment penalty
• Frequently prohibited or limited
• Certain real estate loans, refinancings by same
  lender, etc.
• Disclosures required (TILA, contract)

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Servicing and Payments (contd)

• Extra payments
• Application of payments generally applied to
  principal, but check statute

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Servicing and Payments (contd)

• Last payment
• Balloon payments (ex 2x average of other
  payments)
• May have a statutory right to refinance at same
  terms

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Servicing and Payments (contd)

• Receipts and statements
• Amount paid to date, amount applied to principal
  and interest, pay-off amount
• Requires additional programming

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Default

• Statutory definition?
• May be limited to actual nonpayment
• Acceleration generally permitted
• Precomputed loans if a judgment is obtained,
  some statutes require rebate as if full payment
  was made on judgment date

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Default (contd)

• Secured lending issues
• Repossession how?
• Post-repossession interest
• What if customer brings collateral to store?
• UCC 9A-620 (acceptance in satisfaction of debt)
• Limits on taking motor vehicles, other collateral
  in satisfaction of debt (TRUE predatory lending!)
• Pawn statutes?
• Disposition of collateral - Art. 9

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Regulatory challenges for converting payday
lenders

• Regulatory climate
• (not exactly global warming)

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Regulatory challenges for converting payday
lenders

• Nightmare on Winter Street the Oregon example
• Politics and competition the two fronts meet
• Gubernatorial election
• Resistance by existing consumer finance lenders
• New proposed consumer finance rules
• In consultation with (read written by)
  existing consumer finance licensees
• Press release

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Regulatory challenges for converting payday
lenders

• Initially
• 36 rate cap
• Now regulate aspects of PDL business model
• Make it very difficult to operate on PDL platform

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Regulatory challenges for converting payday
lenders

• Sampling of proposed rules
• Regulation of portfolio mix (90 consumer
  loans)
• 6 month minimum term
• Documented underwriting (but no substantive
  ability to pay requirements)
• Equal periodic payments

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Regulatory challenges for converting payday
lenders

• --Sampling of proposed rules
• Are you experienced?
• Store level
• District level

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Regulatory challenges for converting payday
lenders

• --Sampling of proposed rules
• Indirect attempts to regulate interest rate
• Include interest rate in business plan
• Notice if rate changes more than 25

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Regulatory challenges for converting payday
lenders

• --Sampling of proposed rules
• Limits on holding checks/ACH authorizations for
  payments
• DISCLOSURE!!! required
• Challenges are in the works, but who knows?

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Regulatory challenges for converting payday
lenders

• Last, but not least.
• Washington payment plans

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Contact Information

• Michael A. Raskasky
• Harlowe Falk LLP
• One Tacoma Avenue North, Suite 300
• Tacoma, WA 98403
• 253-284-4417
• mraskasky_at_harlowefalk.com

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Payday Lending Legal Summit

• Installment Lending Panel
• APR Misconceptions and Problems

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TILA Misconceptions

• Loan Origination SystemsOK To Buy An
  Off-The-Shelf Product
• Buy OursWeve done installment loans for
  years! Like New!
• Problems
• Not Designed For Payments Tied To Paydays
• Built for Long-Term Loans
• Lower Rates
• More Tolerance For Error

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Off-The-Shelf Software

• PDL Example
• Lenders Target Yield Approximately 260
• Loan Amount 500
• Simple Interest Rate 200
• Loan Fee 50 (10 of Loan Amount)
• Repayment Schedule 3 Monthly Pmts _at_ 245.03
• Problem
• Disclosed APR 264.66
• Actual APR 388.12
• Restitution Violation Understated by 123.46

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TILA Misconceptions

• If You Only Charge InterestThen The APR Is
  Always The Interest Rate!
• It has to be
• There are no other Finance Charges
• e.g., 250 Interest Rate Equals 250 APR
• Fact Or Fiction?
• Answer

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Fact or Fiction?

• AnswerThat Depends
• Depends On Your Tolerance To Risk
• Depends On How Gutsy You Are

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Fact or Fiction?

• Issue US Rule versus Actuarial Methods
• US Rule
• APR Will Always Be The Interest Rate If There
  Are No Other TILA Finance Charges
• Actuarial Method
• APR Is Almost Never The Same As The Interest
  RateEven If No Other Finance Charges Are
  Imposed

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Gutsy?

• Which Would You Rather Defend?
• US Rule Method
• One Paragraph Authorization In Appendix J
• (3)  In contrast, under the United States Rule
  method, at the end of each payment period, the
  unpaid balance of the amount financed is
  increased by the finance charge earned during
  that payment period and is decreased by the
  payment made at the end of that payment period.
  If the payment is less than the finance charge
  earned, the adjustment of the unpaid balance of
  the amount financed is postponed until the end of
  the next payment period. If at that time the sum
  of the two payments is still less than the total
  earned finance charge for the two payment
  periods, the adjustment of the unpaid balance of
  the amount financed is postponed still another
  payment period, and so forth.
• No Formulas or Other Support in Reg. Z

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Which Would You Rather Defend?

• US Rule Method
• Not Used In APRWIN Software (Actuarial)
• US Rule Produces Different Results
• APRWIN Is Accepted Standard For Verification
• Regulators Litigators
• No Supporting Case Law

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Which Would You Rather Defend?

• Actuarial Method
• Clearly Spelled-Out In Appendix J
• 15 Pages of Formulas and Examples
• Too Many To Show Here
• Support in Official Staff Commentary
• Exact Match With APRWIN
• Provided There Is No Garbage In

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Whats The Difference?

• Both Take Into Account Time Value of Money
• Based On Timing And Amounts Of Payments
  Advances
• US Rule
• No Compounding Of Interest
• No Negative Amortization
• Actuarial Method
• Allows For Compounding of Interest
• May Have Negative Amortization
• Both Are After The Fact To Test APRs, And Both
  Ignore Interest Accrual Method

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Monthly Payment Example

• Interest Rate 300.00
• Amount Financed 750.00
• Finance Charge 1657.76
• Pmt Schedule 12 Monthly Pmts
• 11 _at_ 200.66
• 1 _at_ 200.50
• Actuarial APR 298.77 (APRWIN)
• US Rule APR 300.00
• Which One Is Correct?

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Which One Is Correct?

• They Both Are!
• Actuarial APR 298.77 (APRWIN)
• US Rule APR 300.00

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TILA Misconceptions

• Payments Due Semi-monthly Means
  Twice-Per-Month
• Or Does It?
• Problems
• Only Example In Appendix J is 1st 16th
• Only Example In APRWIN is 1st 16th
• Webster Definition Occurring Twice A Month

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So Whats the Problem?

• Are The Following Payment Frequencies
  Semi-monthly?
• Due On the 1st And the 15th?
• Due On the 5th and the 25th?
• Due on the 15th and the 30th?
• Problem
• APR For Each Loan Must Be Based On The Unit
  Period (i.e., the Time-Base) For That Loan

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Whats The Unit Period?

• Unique To Each Loan
• The Interval Of Time (Time-Base) That Best Fits
  The Contracted Payment Schedule
• Identified By
• (1) Measure All Periods In The Loan,
• (2) Determine The Common Period
• Need To Know Before Proceeding With The APR
  Calculation Process

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Twice-Monthly Examples

• Whats the Unit Period When Pmts. Are Scheduled
• 1st and the 16th ?
• Answer15 days (Semi-monthly)
• Thats EasySupported by Appendix J APRWIN
• 1st and the 15th?
• Answer14 days (Bi-WeeklyNot Semi-monthly)
• Look At All The Periods
• Common Period

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Twice-Monthly Examples

• Whats the Unit Period When Pmts. Are Scheduled
• 5th and the 25th?
• Answer20 Days (Not Semi-monthly)
• Look At All The Periods
• Common Period is 20
• 15th 30th (or Last Day of the Month)?
• Answer15 days (Not Semi-Monthly)
• Look At All The Periods
• Then The Common Period Is 15

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Twice-Monthly Examples

• Four Loans With Pmts. Due Twice-Per-MonthThree
  Different APRs
• 2 APRs Matched By Coincidence Caused By Dates
  And Number Of Payments
• Assumptions
• No Odd Days
• 8 Payments Due Twice-Per-Month

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Best GuessWhen to Use Semi-Monthly

• If All Of The Following 3 Conditions Are Met,
  Then
• Always Use 15 Days For the Unit Period
• 1. Must Be 2 Scheduled Due Dates Within Each Full
  Month,
• 2. Due Dates Must Have The Same Two Anniversary
  Dates In Each Full Month (e.g., 5th And 20th Of
  Each Month), AND
• 3. There Are Exactly 15 Days Between The Two
  Payment Dates In Each Month

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Best GuessSemi-Monthly

• All Other Twice-Monthly Payments, then
• Look For Common Period
• If no Common PeriodThen Use Standard Interval
  of Time As Defined By Appendix J
• Another Topic For Another Conference

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RONALD D. GORSLINECHAMBLISS, BAHNER STOPHEL,
P.C.1000 TALLAN BUILDINGCHATTNOOGA, TN
37402423-756-3000www.cbslawfirm.com
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CLIFF E. COOK COMPLIANCE SERVICES, INC.TACOMA,
WASHINGTON(253) 756-5767 ccook_at_aol.com