[Federal Register Volume 60, Number 245 (Thursday, December 21, 1995)]
[Proposed Rules]
[Pages 66179-66181]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-30994]



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FEDERAL RESERVE SYSTEM

12 CFR Part 226

[Reg. Z; Docket No. R-0908]


Truth in Lending

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Request for comments.

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SUMMARY: The Board is soliciting comment on how the finance charge 
could more accurately reflect the cost of consumer credit. In 
particular, the Board is asking for the public's views on the 
feasibility of treating as finance charges all costs imposed by the 
creditor or payable by the consumer as an incident to the extension of 
credit. The Truth in Lending Act Amendments of 1995 direct the Board to 
submit a report to the Congress regarding these issues. Under present 
law, costs such as interest are part of the finance charge; other 
costs, including many associated with real estate-secured lending, are 
excluded from the finance charge. The Board is also required to address 
in its report abusive refinancing practices engaged in by creditors for 
the purpose of avoiding a consumer's rescission rights.

DATES: Comments must be received on or before February 9, 1996.

ADDRESSES: Comments should refer to Docket No. R-0908, and may be 
mailed to William W. Wiles, Secretary of the Board of Governors of the 
Federal Reserve System, 20th Street and Constitution Avenue, NW., 
Washington, DC 20551. Comments also may be delivered to Room B-2222 of 
the Eccles Building between 8:45 a.m. and 5:15 p.m. weekdays, or to the 
guard station in the Eccles Building courtyard on 20th Street, NW., 
(between Constitution Avenue and C Street) at any time. Comments may be 
inspected in Room MP-500 of the Martin Building between 9 a.m. and 5 
p.m. weekdays, except as provided in 12 CFR 261.8 of the Board's rules 
regarding the availability of information.

FOR FURTHER INFORMATION CONTACT: Jane E. Ahrens, Senior Attorney, or 
Sheilah Goodman, or Kurt Schumacher, Staff Attorneys, Division of 
Consumer and Community Affairs, Board of Governors of the Federal 
Reserve System, at (202) 452-3667 or 452-2412. For users of 
Telecommunications Devices for the Deaf, contact Dorothea Thompson, at 
(202) 452-3544.

SUPPLEMENTARY INFORMATION:

I. Background

    The Truth in Lending Act Amendments of 1995 (1995 Amendments Act), 
Pub. L. 104-29, 109 Stat. 271, enacted into law on September 30, 1995, 
direct the Board to submit a report to the Congress concerning the use 
of finance charges to accurately reflect the cost of consumer credit. 
The Board must consider the feasibility of including in the finance 
charge all charges payable directly or indirectly by the consumer and 
imposed directly or indirectly by the creditor as an incident to the 
credit transaction--especially costs associated with real estate- or 
home-secured lending that are currently excluded from the finance 
charge under section 106 of the Truth in Lending Act. As contemplated 
by the Congress, perhaps only charges payable in a comparable cash 
transaction would continue to be excluded from the finance charge. The 
report must also address abusive refinancing practices engaged in by a 
creditor for the purpose of avoiding a consumer's rescission rights. 
The Board will submit its report to the Congress in early spring 1996, 
based on the comments of interested parties and on its own analysis.

[[Page 66180]]


II. Finance Charges

Definition

    The Truth in Lending Act (15 U.S.C. 1601 et seq.) contains rules 
governing the disclosure of finance charges (Section 106). The act is 
implemented by the Board's Regulation Z (12 CFR part 226). Rules on 
finance charges are contained in Regulation Z Sec. 226.4 and 
accompanying official staff interpretations. The finance charge is 
defined as the cost of consumer credit expressed as a dollar amount. It 
includes any charge payable directly or indirectly by the consumer and 
imposed directly or indirectly by the creditor as an incident to or a 
condition of the extension of credit. The term ``imposed'' is 
interpreted broadly, to include any cost charged by the creditor 
(unless otherwise excluded), including charges for optional services 
paid by the consumer. Examples of a finance charge include interest, 
points, and service or transaction fees.
    The act excludes certain costs from the finance charge, such as 
charges payable in a comparable cash transaction and fees paid to 
third-party closing agents (unless the creditor requires the services 
provided or retains the fee). Many costs associated with loans secured 
by real estate or a principal dwelling are specifically excluded; 
examples are fees for appraisals, document preparation, title 
insurance, and pest inspections prior to loan closing. The regulation 
also excludes charges such as application fees (charged to all 
applicants), late payment fees, and most taxes.
    Still other costs that are generally included in the finance charge 
may nevertheless be excluded. For example, the act provides that credit 
report fees are finance charges, but provides an exception for credit 
report fees associated with real estate- or home-secured loans. The act 
also excludes optional credit life insurance premiums and fees to 
record a security interest if the cost is disclosed to the consumer and 
meets other conditions.

Annual percentage rate

    In addition to requiring disclosure of finance charges as a dollar 
amount, the act and regulation require creditors to disclose the cost 
of consumer credit as an annual percentage rate (APR). Creditors must 
disclose an APR for all types of consumer credit--installment loans 
(closed-end credit) and credit card accounts or home equity lines of 
credit (open-end plans). The APR for closed-end credit and open-end 
plans reflect finance charges, but the distinct nature of these 
products calls for differences in how the APR is calculated.
    The APR for closed-end credit is based on the amounts borrowed by 
the consumer in relation to the amount and timing of payments to the 
creditor. It factors in interest and all other finance charges. Costs 
such as recording fees or title insurance fees may be disclosed, but 
are not a part of the finance charge and thus, are excluded from the 
APR calculation.
    Under open-end plans such as a home equity line of credit, the 
creditor typically sets the maximum amount that can be borrowed at any 
time. The amount that will actually be borrowed by the consumer, 
however, is typically unknown when the credit plan is established. The 
APR stated in advertisements and account-opening disclosures reflects 
only the rate of interest that will be applied to any outstanding 
balance the consumer may have in the future. Additional costs--whether 
finance or other charges--are separately identified.
    Consumers with outstanding balances receive an APR on periodic 
statements. That APR is based on the outstanding balance and certain 
finance charges imposed during the cycle. Some finance charges, such as 
points charged in connection with establishing a home equity plan or 
other fees to open or renew plans, would skew the APR for the billing 
cycle in which they are imposed. These types of finance charges are 
disclosed on periodic statements but are not figured in the APR.

Request for Comment

    The Board requests comments on how the definition of the finance 
charge could be modified, if at all, to reflect the cost of consumer 
credit more accurately. The Congress directs the Board to make 
recommendations on any necessary statutory and regulatory changes. 
(1995 Amendments, Section 2(f).) The Board believes the scope of the 
study is limited to possible modifications to the definition of the 
finance charge.
    The 1995 Amendments contain, for the most part, provisions 
affecting closed-end credit that is real estate- or home-secured. The 
Board believes that the scope of the report is intended to cover the 
treatment of costs as finance charges for all types of consumer credit, 
although a focus of the study will be on those fees associated with 
real estate lending that are currently excluded from the finance 
charge. For example, many costs associated with entering into home-
secured loans are the same whether the credit is an installment loan or 
a line of credit. Similarly, certain application fees are excluded from 
the finance charge for all types of credit transactions, not just those 
affecting installment loans.
    Comment is requested on the feasibility of including in the finance 
charge all charges payable directly or indirectly by the consumer and 
imposed directly or indirectly by the creditor as an incident to the 
credit transaction (other than costs imposed in comparable cash 
transactions), particularly costs associated with real estate- or home-
secured credit that are currently excluded from the finance charge. For 
example, mortgage brokers fees are sometimes, but not always, a finance 
charge under present law: A new statutory provision categorizes all 
brokers fees paid by the consumer to the broker (or to the creditor for 
delivery to the broker) as finance charges, and will go into effect 
when the Board issues a final rule in 1996.
    In assessing the feasibility of this approach, the Board must 
consider the implications of including charges imposed by third 
parties--settlement agents and others--that may not be within the 
creditor's knowledge or control. Comment is requested on compliance 
issues that would arise if the definition of the finance charge were 
expanded to include charges by third parties.
    Treating all costs as a finance charge would, of course, simplify 
creditor compliance with the TILA and Regulation Z; it would reduce the 
potential for disclosure errors. The Board believes the study is, in 
part, a reaction to the spate of class action lawsuits that followed 
the court decision of Rodash v. AIB Mortgage Company. (16 F.3d 1142 
(11th Cir. 1994)). In Rodash, the court found, among other TILA 
violations, that the creditor improperly excluded several fees from the 
finance charge calculation--totalling about $225. The court awarded 
civil money damages and allowed the consumer to rescind a $100,000 
loan.
    Including all costs in the finance charge, however, would also 
increase the APR disclosed for closed-end credit transactions--
dramatically, in some cases. For example, the APR for home-secured 
loans would reflect closing costs such as appraisal fees, title 
insurance and the like. Including premiums for optional credit life 
insurance or for property insurance in the finance charge could also 
have a significant impact on the APR. The resulting APR for installment 
loans may seem distorted, particularly in relation to the APR disclosed 
for a comparable open-end product. For example, disclosures for a home-
secured open-

[[Page 66181]]
end plan would include closing costs and insurance premiums as finance 
charges, but those fees would not be included in the APR stated in 
advertisements or account-opening disclosures, unless the current rules 
on calculating the APR are changed.

III. Abusive Refinancing Practices

    The act and regulation allow consumers to cancel (or rescind) 
certain credit transactions secured by the consumer's principal 
dwelling. For example, the right of rescission applies if a consumer's 
principal dwelling is used to secure a loan financing home improvements 
or a child's education. Other loans secured by a consumer's principal 
dwelling are not rescindable, such as a loan for a business purpose.
    A consumer's right to rescind a refinanced loan depends on both the 
creditor and amount of money involved. If the creditor refinancing the 
loan is the same creditor that initially extended the credit, consumers 
may rescind the refinancing only to the extent new monies are advanced. 
For example, if a consumer's principal dwelling secures a loan with a 
creditor and the consumer seeks to refinance an outstanding balance of 
$100,000 with the same creditor, the transaction is not rescindable. If 
the consumer obtains $25,000 in an additional advance, the refinancing 
could be rescinded up to the new advance of $25,000. If the consumer 
refinances the loan with a new creditor instead, the entire transaction 
is rescindable, whether or not new monies are advanced.
    The Board's report must include recommendations, if any, for 
statutory or regulatory changes necessary to address abusive 
refinancing practices engaged in by a creditor for the purpose of 
avoiding a consumer's rescission rights. Comment is requested on the 
issue.

IV. Form of Comment Letters

    Comment letters should refer to Docket No. R-0908, and, when 
possible, should use a standard courier typeface with a type size of 10 
or 12 characters per inch. This will enable the Board to convert the 
text to machine-readable form through electronic scanning, and will 
facilitate automated retrieval of comments for review. Also, if 
accompanied by an original document in paper form, comments may be 
submitted on 3\1/2\ inch or 5\1/4\ inch computer diskettes in any IBM-
compatible DOS-based format.

    By order of the Board of Governors of the Federal Reserve 
System, December 15, 1995.
William W. Wiles,
Secretary of the Board.
[FR Doc. 95-30994 Filed 12-20-95; 8:45 am]
BILLING CODE 6210-01-P