I. INTRODUCTION
The Federal Reserve Board amended Regulation AA (12 C.F.R. Part 227; Unfair or Deceptive Acts or Practices) to implement a consumer credit rule for banks similar to the Federal Trade Commission’s Credit Practices Rule. The FTC rule took effect on March 1, 1985, while the amendments to Regulation AA became effective on January 1, 1986. Regulation AA addresses three primary areas: (1) Creditor’s use of remedies to enforce consumer credit obligations; (2) disclosure requirements to inform cosigners of the nature and extent of their obligation under the contract; and (3) assessment and collection of late charges.
II. SCOPE OF REGULATION AA
The regulation applies to all banks and their subsidiaries. Only “consumer” transactions are covered with consumer defined under the rule as a natural person who seeks or acquires goods, services, or money for personal, family or household use other than for the purchase of real property.
Although typical purchase money mortgage loans are not covered by the rules, not all loans secured by real property are excluded. Federal Reserve Staff Guidelines provide the following clarifications of the real property purchase exemption from the rule’s coverage:
A. Secured home improvement loans are subject to the rule since the purchase of real property is not the purpose of the loan.
B. Loans originally made for the purchase of real property which are assumed by a new purchaser, construction loans and loans made to provide permanent financing are considered loans for the purchase of real property and, therefore, are not subject to the rule.
C. The rule does not apply where a consumer obtains a loan to purchase real property, but secures the loan with some other collateral such as a savings account or other real property.
D. A new loan made to refinance a loan that had been made to purchase real property is exempt from the rule as long as the primary purpose of the new loan is, in fact, to refinance the original debt. The amount outstanding on the original loan must represent substantially the entire amount of the new loan with any additional credit extended as a part of the new loan only incidental to the primary purpose of refinancing.
III. UNFAIR CREDIT CONTRACT PROVISIONS
It is an unfair act or practice for a bank to enter into a consumer credit obligation that contains any of the following provisions:
1. A “cognovit” or confession of judgment clause;
2. An executory waiver or limitation of exemption from attachment execution or other legal process on real or personal property held, owned by or due to the consumer, unless the waiver applies solely to the property subject to a security interest executed in conjunction with the consumer credit obligation;
3. An assignment of wages or other earnings, unless: (a) the assignment is revocable at the will of the debtor; (b) the assignment is a payroll deduction plan or preauthorized payment plan commencing at the time of the transaction in which the consumer authorizes a series of wage deductions as a method of making each payment; or (c) the assignment applies only to wages or other earnings already earned at the time of the assignment; and
4. A non-purchase money security interest in household goods.
Although the FTC rule prohibits creditors from purchasing obligations that contain any of these prohibited provisions, the Federal Reserve Board’s rule states that banks may purchase obligations with the prohibited provisions but may not enforce such provisions.
IV. UNFAIR OR DECEPTIVE PRACTICES INVOLVING COSIGNERS
In consumer credit transactions requiring the signature of a cosigner, a bank must accurately represent the cosigner’s liability and give the cosigner a written disclosure statement. The disclosure must be given prior to the cosigner becoming obligated, either on a separate document or included in the documents evidencing the consumer credit obligation. The statement must be clear and conspicuous, whether incorporated in the loan documents or set forth in a separate statement. Notices incorporated into the loan contract must be distinctive, including setting the notice in slightly larger type or otherwise setting it off from the other contract language. In an open-end credit obligation, the disclosure notice must be given prior to the time the cosigner becomes obligated for fees or transactions on the account.
The disclosure must be “substantially similar” to the following statement contained in the rule:
You are being asked to guarantee this debt. Think carefully before you do. If the borrower does not pay the debt, you will have to. Be sure you can afford to pay if you have to, and that you want to accept this responsibility.
You may have to pay up to the full amount of the debt if the borrower does not pay. You may also have to pay late fees or collection costs, which increase this amount.
The bank can collect this debt from you without first trying to collect from the borrower. The bank can use the same collection methods against you that can be used against the borrower, such as suing you, garnishing your wages, etc. If this debt is ever in default, that fact may become a part of your credit record.
This notice is not the contract that makes you liable for the debt.
In the event of a continuing guaranty, the cosigner notice should be provided before the guarantor becomes obligated on the guaranty, that is, at the time the guaranty is executed. The cosigner notice need not be given to the guarantor with each subsequent loan made to the primary debtor as long as the cosigner notice specifies that the guarantor is being asked to guaranty not only the original debt, but also the future debt to the primary debtor. For example, the first sentence of the forgoing cosigner notice could be modified to read “You are being asked to guarantee this debt, as well as all future debts of the borrower entered into with this bank through December 31, 1990.”
“Cosigner” is defined in the rule as a natural person who assumes liability for an obligation of a consumer without receiving compensation in return. The term also includes any person whose signature is requested as a condition: (1) to granting credit to a consumer; or (2) for forbearance on collection of a consumer’s obligation that is in default. The term does not include a spouse whose signature is required by state law in order to perfect a security interest.
V. UNFAIR LATE CHARGES
“Pyramiding” of late charges is prohibited. The rule prohibits the collection of any delinquency charge on a payment, when the only delinquency is attributable to late fees or delinquency charges assessed on earlier installments, and the payment is otherwise a full payment for the applicable period. In the event a consumer misses a monthly payment and fails to make up that payment month after month, the rule does not prohibit the bank from assessing a delinquency charge for each month that the skipped payment remains outstanding and does not prohibit the imposition of interest on an unpaid late fee. An example of permissible and impermissible assessment of late charges is found in the article “Regulation AA – Unfair Credit Contract Provisions” in this section.
VI. CONCLUSION
Bankers are advised to review with legal counsel those consumer contract forms used in the bank itself or distributed by the bank to retailers. Compliance with the rule is enforced by the Comptroller of Currency, the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation.