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Regulated Aspects of Installment Lending. Installment Lending Panel Payday Loan Bar Association Summit _______________________________________________________ Presented by Michael A. Raskasky Harlowe & Falk LLP November 14, 2006. Why are we talking about installment lending?.

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regulated aspects of installment lending

Regulated Aspects of Installment Lending

Installment Lending Panel

Payday Loan Bar Association Summit

_______________________________________________________

Presented byMichael A. RaskaskyHarlowe & Falk LLP

November 14, 2006

why are we talking about installment lending
Why are we talking about installment lending?
  • Changing laws, negative climate for PDLs
  • Stay in business if the legislative axe falls
  • Diversify product offerings
why are we talking about installment lending3
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
why are we talking about installment lending4
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
why are we talking about installment lending5
Why are we talking about installment lending?
  • What legal and operational issues arise with this new product?
why are we talking about installment lending6
Why are we talking about installment lending?
  • Contract terms
  • Servicing and Payments
  • Default
caveats
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)
the contract
The Contract
  • Loan amount
    • Large amounts (e.g., >$25,000) or real estate loans frequently outside scope of consumer loan statutes
the contract cont d
The Contract (cont’d)
  • Finance charges
    • Origination fees
      • Typical limit - 2% of principal
      • Prepaid finance charge - special treatment under TILA
    • Contract interest rate (not just the APR)
the contract cont d10
The Contract (cont’d)
  • --Finance charges
    • Interest calculation methodology
      • Simple interest/365 day year
      • Precomputed interest
      • Compounding of interest
      • Describe in the contract
the contract cont d11
The Contract (cont’d)
  • 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
the contract cont d12
The Contract (cont’d)
  • Payment schedule
    • Small loan amounts (e.g., <$1,000) – substantially equal amounts, intervals
    • Big TILA issues, particularly with payments tied to pay periods (irregular, semi-monthly, etc.)
the contract cont d13
The Contract (cont’d)
  • Method of payment
    • ACH
      • Preauthorized ACH – Reg. E limitations, NACHA rules
    • Check
      • NSF fee limits
      • Broader bad-check remedies may be available
the contract cont d14
The Contract (cont’d)
  • Secured lending – collateral considerations
    • Grant language
    • Collateral description (UCC 9-108 and TILA 226.18(m))
the contract cont d15
The Contract (cont’d)
  • --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))
servicing and payments
Servicing and Payments
  • Caveat—
    • Servicing methodology should be described in the loan agreement
servicing and payments17
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
servicing and payments cont d
Servicing and Payments (cont’d)
  • --Late payments
    • Deferral
      • By agreement after-the-fact, or
      • Unilateral – in loan agreement
      • Deferral charges authorized
        • Generally cannot charge deferral AND late charges
servicing and payments cont d19
Servicing and Payments (cont’d)
  • Partial payments
    • Application of payments
      • Specify in contract, but check state law
    • Event of default
    • Triggers a late charge to extent of unpaid installment
servicing and payments cont d20
Servicing and Payments (cont’d)
  • Prepayments
    • Nearly always allowed
    • Rebate for precomputed loans
      • “Earned” may be complicated
servicing and payments cont d21
Servicing and Payments (cont’d)
  • --Prepayments
    • Prepayment penalty
      • Frequently prohibited or limited
        • Certain real estate loans, refinancings by same lender, etc.
      • Disclosures required (TILA, contract)
servicing and payments cont d22
Servicing and Payments (cont’d)
  • Extra payments
    • Application of payments – generally applied to principal, but check statute
servicing and payments cont d23
Servicing and Payments (cont’d)
  • Last payment
    • Balloon payments (ex: 2x average of other payments)
      • May have a statutory right to refinance at same terms
servicing and payments cont d24
Servicing and Payments (cont’d)
  • Receipts and statements
    • Amount paid to date, amount applied to principal and interest, pay-off amount
    • Requires additional programming
default
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
default cont d
Default (cont’d)
  • 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
regulatory challenges for converting payday lenders
Regulatory challenges for “converting” payday lenders
  • Regulatory climate
    • (not exactly “global warming”)
regulatory challenges for converting payday lenders28
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
regulatory challenges for converting payday lenders29
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
regulatory challenges for converting payday lenders30
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
regulatory challenges for converting payday lenders31
Regulatory challenges for “converting” payday lenders
  • --Sampling of proposed rules
    • “Are you experienced?”
      • Store level
      • “District” level
regulatory challenges for converting payday lenders32
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%
regulatory challenges for converting payday lenders33
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?
regulatory challenges for converting payday lenders34
Regulatory challenges for “converting” payday lenders
  • Last, but not least….
    • Washington payment plans
contact information
Contact Information

Michael A. Raskasky

Harlowe & Falk LLP

One Tacoma Avenue North, Suite 300

Tacoma, WA 98403

253-284-4417

mraskasky@harlowefalk.com

payday lending legal summit

Payday Lending Legal Summit

Installment Lending Panel

APR Misconceptions and Problems

tila misconceptions
TILA Misconceptions
  • Loan Origination Systems—OK To Buy An Off-The-Shelf Product
    • “Buy Ours—We’ve 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
off the shelf software
Off-The-Shelf Software
  • PDL Example
    • Lender’s Target Yield: Approximately 260%
      • Loan Amount: $500
      • Simple Interest Rate: 200%
      • Loan Fee: $50 (10 % of Loan Amount)
      • Repayment Schedule: 3 “Monthly” Pmts @ $245.03

Problem:

  • Disclosed APR: 264.66%
  • Actual APR: 388.12%
    • Restitution Violation: Understated by 123.46%
tila misconceptions39
TILA Misconceptions
  • If You Only Charge Interest—Then 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…
fact or fiction
Fact or Fiction?
  • Answer…That Depends
    • Depends On Your Tolerance To Risk
    • Depends On How Gutsy You Are
fact or fiction41
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 Rate—Even If No Other “Finance Charges” Are Imposed
gutsy
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
which would you rather defend
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
which would you rather defend44
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”
what s the difference
What’s 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
monthly payment example
Monthly Payment Example

Interest Rate: 300.00%

Amount Financed: $750.00

Finance Charge: $1657.76

Pmt Schedule: 12 Monthly Pmts

11 @ $200.66

1 @ $200.50

Actuarial APR: 298.77% (APRWIN)

US Rule APR: 300.00%

Which One Is Correct?

which one is correct
Which One Is Correct?

They Both Are!

Actuarial APR: 298.77% (APRWIN)

US Rule APR: 300.00%

tila misconceptions48
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”
so what s the problem
So What’s 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
what s the unit period
What’s 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
twice monthly examples
Twice-Monthly Examples
  • What’s the Unit Period When Pmts. Are Scheduled:
    • 1st and the 16th ?
      • Answer—15 days (“Semi-monthly”)
        • That’s Easy—Supported by Appendix J & APRWIN
    • 1st and the 15th?
      • Answer—14 days (“Bi-Weekly”—Not “Semi-monthly”)
        • Look At All The Periods
        • Common Period
twice monthly examples52
Twice-Monthly Examples
  • What’s the Unit Period When Pmts. Are Scheduled:
    • 5th and the 25th?
      • Answer—20 Days (Not “Semi-monthly”)
        • Look At All The Periods
        • Common Period is 20
    • 15th & 30th (or Last Day of the Month)?
      • Answer—15 days (Not “Semi-Monthly”)
        • Look At All The Periods
        • Then The Common Period Is 15
twice monthly examples53
Twice-Monthly Examples
  • Four Loans With Pmts. Due Twice-Per-Month—Three Different APRs
    • 2 APRs Matched By Coincidence Caused By Dates And Number Of Payments
  • Assumptions:
    • No “Odd Days”
    • 8 Payments Due Twice-Per-Month
best guess when to use semi monthly
Best Guess—When 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

best guess semi monthly
Best Guess—“Semi-Monthly”
  • All Other “Twice-Monthly” Payments, then:
    • Look For Common Period
    • If no Common Period—Then Use “Standard Interval of Time” As Defined By Appendix J
      • Another Topic For Another Conference
slide56

RONALD D. GORSLINECHAMBLISS, BAHNER & STOPHEL, P.C.1000 TALLAN BUILDINGCHATTNOOGA, TN 37402423-756-3000www.cbslawfirm.com

slide57

C

S

I

CLIFF E. COOK

COMPLIANCE SERVICES, INC.TACOMA, WASHINGTON(253) 756-5767

ccook@aol.com