Official Staff Commentary on Regulation Z, Truth in Lending

Page 1

FEDERAL RESERVE BANK OF NEW YORK August 23, 1995 To All Depository Institutions in the Second Federal Reserve District, and Others Maintaining Sets of Board Regulations: Enclosed is a copy of the Official Staff Commentary on Regulation Z, "Truth in Lending," as revised effective April 1, 1995. The revised pamphlet supersedes the previous printing of this regulation and any subsequent amendments thereto. These pamphlets have been punched with an additional hole so that they can be inserted into our new, two-volume, 8-1/2 x 11 size binders. Circulars Division Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 2

Board of Governors of the Federal Reserve System _ Official Staff Commentary on Regulation Z Truth in Lending As revised effective April 1, 1995 o Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 3

Any inquiry relating to Regluation Z should be addressed to the Federal Reserve Bank of Federal Reserve District in which the inquiry arises. July 1995 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 4

Contents Page Introduction ..................................................................... Subpart A — G eneral Section 226.1— A uthority, purpose, coverage, organization, enforcem ent and lia b ility ........................................................................... Section 2 2 6 .2 — D efinitions and rules o f co n stru ctio n .................................................................. Section 226.3— E xem pt tran saction s............. Section 226.4— Finance c h a r g e ....................... Subpart B — O pen-E nd Credit Section 226.5— G eneral disclosure req u ir e m e n ts........................................................... Section 226.5a— Credit and charge card applications and s o lic ita tio n s....................... Section 226.5b — R equirem ents for hom eequity plans ........................................................... Section 22 6 .6 — Initial disclosure statem ent .................................................................. ( Section 2 2 6 .7 — Periodic sta te m e n t................. Section 226.8— Identification o f tra n sa ctio n s.............................................................. Section 2 2 6 .9 — Subsequent disclosure re q u ir e m e n ts........................................................... Section 2 2 6 .1 0 — Prom pt crediting o f paym ents .................................................................. Section 2 2 6 .1 1 — Treatm ent o f credit b a la n c e s ..................................................................... Section 2 2 6 .1 2 — Special credit card p r o v is io n s .................................................................. 7 4 Section 226.13— Billing-error resolution .

Section 226.14— Determ ination o f annual percentage rate ..................................................... Section 2 2 6.15— R ight o f r e sc issio n ............. Section 2 2 6 .1 6 — A d v e r tisin g .............................. Subpart C— C losed-E nd Credit Section 2 2 6 .1 7 — G eneral disclosure r e q u ir e m e n ts........................................................... Section 2 2 6 .1 8 — Content o f disclosures . . 113 Page Section 226.19—Certain residential mortgage transactions..............................124 Section 226.20—Subsequent disclosure requirements...........................................135 Section 226.21—Treatment of credit balances..................................................139 Section 226.22—Determination of annual percentage rate........................... 140 Section 226.23—Right of rescission.........142 Section 226.24—Advertising.......................148 Subpart D—Miscellaneous Section 226.25—Record retention........... 151 Section 226.26—Use of annual percentage rate in oral disclosures . . . . 152 Section 226.27—Spanish-language disclosures............................................... 152 Section 226.28—Effect on state laws . . . . 153 Section 226.29—State exemptions........... 157 Section 226.30—Limitation on rates . . . . 158 Appendix A—Effect on state law s.........161 Appendix B—State exemptions.................. 161 Appendix C—Issuance of staff interpretations .........................................162 Appendix D—Multiple-advance construction loans .................................. 162 Appendix E—Rules for card issuers that bill on a transaction-by­ transaction basis.................................... 163 Appendix F—Annual percentage rate computations for certain open-end credit plans............................................. 163 Appendix G—Open-end model forms and clauses............................................. 163 Appendix H—Closed-end model forms and clauses............................................. 165 Appendix I—Federal enforcement agencies..................................................169 Appendix J—Annual percentage rate computations for closed-end credit transactions............................................. 169 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 5

Official Staff Commentary on Regulation Z As revised effective April 1, 1995* INTRODUCTION 1. Official status. This commentary is the ve­ hicle by which the staff of the Division of Consumer and Community Affairs of the Fed­ eral Reserve Board issues official staff inter­ pretations of Regulation Z. Good faith compli­ ance with this commentary affords protection from liability under section 130(f) of the Truth in Lending Act. Section 130(f) (15 USC 1640) protects creditors from civil liability for any act done or omitted in good faith in con­ formity with any interpretation issued by a duly authorized official or employee of the Federal Reserve System.

2. Procedure for requesting interpretations. Under appendix C of the regulation, anyone may request an official staff interpretation. In­ terpretations that are adopted will be incorpo­ rated in this commentary following publica­ tion in the Federal Register. No official staff interpretations are expected to be issued other than by means of this commentary. 3. Status of previous interpretations. All state­ ments and opinions issued by the Federal Re­ serve Board and its staff interpreting previous Regulation Z remain effective until October 1, 1982 only insofar as they interpret that regula­ tion. When compliance with revised Regula­ tion Z becomes mandatory on October 1, 1982, the Board and staff interpretations of the previous regulation will be entirely super­ seded by the revised regulation and this com­ mentary except with regard to liability under the previous regulation.

4. Rules of construction.

(a) Lists that appear in the commentary may be exhaustive or illustrative; the appro­ priate construction should be clear from the context. In most cases, illustrative lists are introduced by phrases such as “including, but not limited to,” “among other things,” “for example,” or “such as.” (b) Throughout the commentary and regula­ * Reliance on April 1, 1995, revisions optional until Oc­ tober 1, 1995.

tion, reference to the regulation should be construed to refer to revised Regulation Z, unless the context indicates that a reference to previous Regulation Z is also intended, (c) Throughout the commentary, reference to “this section” or “this paragraph” means the section or paragraph in the regulation that is the subject of the comment. 5. Comment designations. Each comment in the commentary is identified by a number and the regulatory section or paragraph which it interprets. The comments are designated with as much specificity as possible according to the particular regulatory provision addressed. For example, some of the comments to sec­ tion 226.18(b) are futher divided by subpara­ graph, such as comment 18(b)( 1)-1 and com­ ment 18(b)(2)-1. In other cases, comments have more general application and are desig­ nated, for example, as comment 18-1 or com­ ment 18(b)-1. This introduction may be cited as comments 1-1 through 1-7. The appendixes may be cited as comments app. A-l through app. J-2.

6. Cross-references. The following cross-refer­ ences to related material appear at the end of each section of the commentary: (a) “Stat­ ute”—those sections of the Truth in Lending Act on which the regulatory provision is based (and any other relevant statutes); (b) “Other sections”—other provisions in the reg­ ulation necessary to understand that section; (c) “Previous regulation”—parallel provisions in previous Regulation Z; and (d) “1981 changes”—a brief description of the major changes made by the 1981 revisions to Regu­ lation Z. Where appropriate, a fifth category (“Other regulations”) provides cross-refer­ ences to other regulations. 7. Transition rules.

(a) Though compliance with the revised regulation is not mandatory until April 1, 1982, creditors may begin complying as of April 1, 1981. During the intervening year, a creditor may convert its entire operation to the new requirements at one time, or it Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 6

§ 226.1 m ay con vert to the n ew req u irem en ts in stages. In gen eral, h o w ev er, a creditor m ay not m ix the regulatory requirem ents w h en m aking d isclo su res for a particular clo sed en d transaction or op en -en d account; all the d isclo su res for a sin g le clo sed -en d transac­ tion (or op en -en d accou n t) m ust b e m ade in accord an ce w ith the p reviou s regu lation, or all the d isclo su res m ust b e m ade in accor­ d an ce w ith the revised regu lation. A s an e x ­ cep tion to the gen eral rule, the rev ised re­ sc issio n rules and the rev ised ad vertisin g ru les m ay b e fo llo w ed ev en if the d isc lo ­ sures are b ased on the p reviou s regu lation. F or p u rp oses o f this regu lation, the creditor is not required to take any particular action b ey o n d the requirem ents o f the rev ised reg­ ulation to in d icate its co n v ersio n to the re­ v ise d regulation.

(b) T h e rev ised regulation m ay b e relied on to d eterm in e if any d isclo su res are required for a particular transaction or to determ ine if a person is a “ creditor” su b ject to Truth in L en d in g req u irem en ts, w h eth er or not other op eration s h ave b een con verted to the rev ised regu lation . For ex a m p le, la y a w a y p lan s are not subject to the revised regu la­ tion , nor are oral agreem en ts to len d m on ey if there is no finan ce charge. T h ese p rovi­ sio n s m ay b e relied on ev en if the creditor is m akin g other d isclosu res under the p revi­ o u s regu lation . T h e n ew ru les g o v ern in g w h eth er or not d isclosu res m ust b e m ade for refin an cings and assu m p tion s are a lso a v ailab le to a creditor that h as not yet co n ­ v e r te d its o p e r a tio n s to th e r e v is e d regu lation.

(c) In addition to the ab ove ru les, ap p lica­ b le to b oth op en -en d and clo sed -en d credit, th e fo llo w in g g u id e lin e s are relev a n t to op en -en d credit:

• T h e creditor n eed not rem ake in itial d is­ clo su res that w ere m ade under the p revi­ o u s r e g u la tio n , e v e n i f th e r e v is e d p eriod ic statem ents con tain term in ology that is in con sisten t w ith th ose in itial d is­ closu res.

• A cred itor m ay add in serts to its old op en -en d form s in order to con vert them to the rev ised rules until su ch tim e as the o ld form s are u sed up. • N o ch an ge-in -term s n otice is required for Regulation Z Commentary ch a n g es resu ltin g from the co n v ersio n to the rev ised regulation.

• T h e p reviou s b illin g rights statem ents are su b stan tially sim ilar to the rev ised b illin g rights statem ents and m ay con tin u e to b e u sed , ex cep t that, if the creditor has an autom atic debit program , it m ust u se the revised autom atic d eb it p rovision . • F or th ose creditors w ish in g to u se the annual b illin g rights statem ent, the cred i­ tor m ay cou n t from the date on w h ich it sent its last statem ent under the p reviou s regu lation in d eterm in in g w h en to g iv e the first statem ent under the n ew regu la­ tion. F or ex a m p le, i f the creditor sent a sem ian n u al statem ent in June 1981 and con verts to the n ew regu lation in O cto ­ ber 1981, the creditor m ust g iv e the b ill­ in g rights statem ent so m etim e in 1982, and it m ust n ot b e few er than 6 nor m ore than 18 m o n th s after th e Ju n e statem ent.

• S ectio n 2 2 6 .1 1 o f the revised regulation affects o n ly cred it b alan ces that are cre­ ated o n or after the d ate the cred itor con verts the accou n t to the rev ised regu ­ lation.

SUBPART A—GENERAL SECTION 226.1—Authority, Purpose, Coverage, Organization, Enforcement and Liability 1(c) Coverage 1. Foreign applicability. R egu lation Z ap p lies to all p ersons (in clu d in g branches o f foreign banks and sellers located in the U n ited S tates) that exten d con su m er credit to resid en ts (in ­ clu d in g resid en t alien s) o f any state as defined in sectio n 2 2 6 .2 . If an accou n t is located in the U n ited S tates and credit is exten d ed to a U .S . resid en t, the transaction is su b ject to the regu lation. T h is w ill b e the ca se w h eth er or not a particular ad van ce or p urchase on the accou n t takes p lace in the U n ited S tates and w h eth er or n o t th e e x te n d e r o f c red it is chartered or b ased in the U n ited S tates or a foreign country. T h u s, a U .S . resid en t’s u se in E urope o f a credit card issu ed by a bank in the co n su m er’s h o m e tow n is co v ered by the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 7

Regulation Z Commentary § 226.2 regulation. The regulation does not apply to a foreign branch of a U.S. bank when the for­ eign branch extends credit to a U.S. citizen residing or visiting abroad or to a foreign na­ tional abroad.

R e f e r e n c e s Statute: § 102 Other sections: None Previous regulation: § 226.1 1981 changes: A discussion of coverage has been added to section 226.1 so that the reader will understand from the start what is subject to the regulation. Language has also been added to explain the reorganization of the reg­ ulation into subparts that group together the provisions relating to general matters, openend credit, closed-end credit, and miscellane­ ous rules. The provisions on consumer leasing have been issued by the Board as a separate regulation, Regulation M (12 CFR 213). S E C T I O N 2 2 6 .2 — D e f in itio n s a n d R u le s o f C o n str u c tio n 2 ( a ) D e f in itio n s 2(a)(2) “Advertisement”

1. Coverage. Only commercial messages that promote consumer credit transactions requir­ ing disclosures are advertisements. Messages inviting, offering, or otherwise announcing generally to prospective customers the availa­ bility of credit transactions, whether in visual, oral, or print media, are covered by the regu­ lation. Examples include:

• Messages in a newspaper, magazine, leaf­ let, promotional flyer, or catalog • Announcements on radio, television, or public address sytem • Direct mail literature or other printed mate­ rial on any exterior or interior sign • Point-of-sale displays • Telephone solicitations • Price tags that contain credit information • Letters sent to customers as part of an or­ ganized solicitation of business • Messages on checking account statements offering auto loans at a stated annual per­ centage rate T h e term d o es not include: • D irect p ersonal con tacts, su ch as fo llo w u p letters, co st estim ates for in d ivid u al c o n ­ sum ers, or oral or w ritten com m u n ication relatin g to the n eg o tia tio n o f a sp ec ific transaction • Inform ational m aterial, for ex a m p le, inter­ est rate and loan term m em o s, distributed o n ly to b u sin ess en tities • N o tices required b y fed eral or state law , if the law m andates that sp ecific inform ation b e d isp la y ed and o n ly the in form ation so m andated is in clu d ed in the n otice • N e w s a rticles the u se o f w h ich is c o n ­ trolled b y the n ew s m ed iu m • M arket research or ed u ca tio n a l m aterials that d o not so licit b u sin ess 2. Persons covered. A ll “ p erso n s” m ust c o m ­ p ly w ith the ad vertisin g p ro v isio n s in sectio n s 2 2 6 .1 6 and 2 2 6 .2 4 , not ju st th o se that m eet the d efinition o f creditor in sectio n 2 2 6 .2 (a )- (1 7 ). T h u s, h o m e b u ild ers, m erch an ts, and others w h o are not th e m selv es creditors m ust co m p ly w ith the ad vertisin g p ro v isio n s o f the regu lation if th ey ad vertise co n su m er credit transactions. H o w ev er, under sectio n 145 o f the act, the ow n er and the p erson n el o f the m ed iu m in w h ich an ad vertisem en t appears, or through w h ich it is d issem in a ted , are n ot su b ­ je c t to c iv il liab ility for v io la tio n s. 2(a)(4) “Billing Cycle” or “Cycle" 1. Intervals. In op en -en d credit p lan s, the b ill­ in g c y c le d eterm in es the in tervals for w h ich p erio d ic d isclo su re sta tem en ts are required; th e se in tervals are a lso u sed as m easu rin g p oin ts for other d u ties o f the creditor. T yp i­ ca lly , b illin g c y c le s are m on th ly, but th ey m ay b e m ore frequent or less frequent (but not less frequent than quarterly).

2. Creditors that do not bill. T h e term “ c y ­ c le ” is in terch an geab le w ith “ b illin g c y c le ” for d efinition al p u rp oses, sin ce so m e cred itors’ c y c le s do not in v o lv e the sen d in g o f b ills in the traditional sen se but o n ly statem ents o f a c­ co u n t a ctiv ity . T h is is c o m m o n ly th e c a se w ith financial in stitu tion s w h en p eriod ic p ay­ m en ts are m ade through p ayroll d ed u ction or through autom atic d eb it o f the co n su m er’s a s­ set account.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 8

§ 226.2 Regulation Z Commentary 3. Equal cycles.

A lth o u g h c y c le s m u st b e eq u al, there is a p erm issib le varian ce to ac­ cou n t for w eek en d s, h olid ays, and d ifferen ces in the num ber o f d ays in m onth s. If the actual date o f each statem ent d oes not vary b y m ore than four d ays from a fixed “ d a y ” (for ex a m ­ p le, the third T hursday o f ea ch m on th ) or “ d a te” (for ex a m p le, the 15th o f each m onth) that the creditor regularly u ses, the intervals b etw een statem ents are con sid ered eq u al. T h e requirem ent that c y c le s be eq u al ap p lies ev en if the creditor ap p lies a daily p eriod ic rate to d eterm in e the finan ce charge. T h e requirem ent that in tervals b e equal d o es not apply to the transitional b illin g c y c le that can occu r w h en the cred itor o cca sio n a lly ch a n g es its b illin g c y c le s so as to estab lish a n ew statem ent day or d a te .

( S e e th e co m m e n ta ry to se c tio n 2 2 6 .9 (c ).) 4. Payment reminder. T he sen d in g o f a regu ­ lar p aym en t rem inder (rather than a late p ay­ m en t n o tice) esta b lish es a c y c le for w h ich the creditor m ust sen d period ic statem ents. 2(a)(6) “Business Day”

1. Business function test. A c tiv ities that in d i­ cate that the creditor is op en for su b stan tially all o f its b u sin ess fu n ction s in clu d e the availa­ b ility o f p erso n n el to m ake lo a n d isb u rse­ m en ts, to o p en n ew accou n ts, and to handle credit transaction inquiries. A c tiv ities that in ­ d icate that the creditor is not op en for su b ­ stan tially all o f its b u sin ess fu n ction s in clu d e a retailer’s m erely accep tin g credit cards for pu rch ases or a b an k ’s h aving its cu stom er-ser­ v ic e w in d o w s op en o n ly for lim ited p u rp oses su ch as d ep o sits and w ithdraw als, b ill p ayin g, and related serv ices.

2. Rescission rule. A m ore p recise rule for w hat is a b u sin ess day (all calendar d ays e x ­ cep t S u n d ays and the federal leg a l h o lid ays listed in 5 U S C 6 1 0 3 (a )) ap p lies w h en the right o f rescissio n is in v o lv ed . 2(a)(7) “Card Issuer”

1. Agent. A n agen t o f a card issu er is c o n sid ­ ered a card issu er. B eca u se a g en cy relation ­ sh ip s are traditionally defined b y contract and by state or other ap p licab le law , the regu lation d o es not d efin e agen t. M erely p rovid in g ser­ v ic e s relating to the p rod u ction o f credit cards or data p ro cessin g for others, h o w ev er, d o es not m ake o n e the agen t o f the card issu er. In contrast, a finan cial in stitu tion m ay b eco m e the agen t o f the card issu er if an agreem en t b etw een the in stitu tion and the card issu er p rovid es that the cardholder m ay u se a lin e o f credit w ith the financial in stitu tion to p ay o b ­ ligation s incurred b y u se o f the cred it card. 2(a)(8) “Cardholder”

1. General rule. A cardholder is a natural per­ son at w h o se request a card is issu ed for c o n ­ su m er credit p u rp oses or w h o is a co -o b lig o r or guarantor for su ch a card issu ed to another. T h e seco n d category d o es not in clu d e an em ­ p lo y ee w h o is a c o -o b lig o r or guarantor on a card issu ed to the em p lo y er for b u sin ess pur­ p o ses, nor d o es it in clu d e a person w h o is m erely the authorized user o f a card issu ed to another.

2. Limited application of regulation. F or the lim ited p u rp oses o f the rules on issu a n ce o f credit cards and liab ility for unauthorized u se, a cardholder in clu d es any p erson, in clu d in g an organ ization, to w h o m a card is issu ed for any purpose— in clu d in g a b u sin ess, agricultural, or com m ercial purpose.

3. Issuance. S ee the com m entary to section 2 2 6 .1 2 (a ).

4. Dual-purpose cards and dual-card systems. S o m e card issu ers o ffer d u al-p u rp ose cards that are for b u sin ess as w e ll as con su m er pur­ p o ses. I f a card is issu ed to an in d ivid u al for con su m er p u rp oses, the fact that an organ iza­ tion has guaranteed to pay the debt d o es not m ake it b u sin ess credit. O n the other hand, if a card is issu ed for b u sin ess p u rp oses, the fact that an in d ivid u al so m etim es u ses it for co n ­ su m er pu rch ases d o es not su b ject the card is ­ suer to the p rovision s on p eriod ic statem ents, b illin g-error resolu tion , and other p rotection s afforded to con su m er credit. S o m e card issu ­ ers o ffer dual-card sy stem s— that is, they issu e tw o cards to the sam e in d ivid u al, o n e in tend ed for b u sin ess u se, the other for con su m er or personal u se. W ith su ch a sy stem , the sam e person m ay b e a cardholder for gen eral pur­ p o se s w h en u sin g the card issu ed for co n ­ su m er u se, and a cardholder o n ly for the lim ­ Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 9

Regulation Z Commentary § 226.2 ited p u rp oses o f the restrictions on issu an ce and liab ility w h en u sin g the card issu ed for b u sin ess p urposes.

2(a)(9) “Cash Price"

1. Components.

T h is a m ou n t is a startin g p oin t in com p u tin g the am ount financed and the total sa le price under sectio n 2 2 6 .1 8 for credit sa les. A n y charges im p osed eq u ally in cash and credit transactions m ay b e in clu d ed in the cash p rice, or th ey m ay be treated as o th e r a m o u n ts fin a n c e d u n d er s e c t io n 2 2 6 .1 8 (b )(2 ).

2. Service contracts. S erv ice contracts in clu d e con tracts for the repair or the serv icin g o f g o o d s, su ch as m ech an ical breakdow n co v er­ age, ev en if su ch a contract is ch aracterized as insurance under state law .

3. Rebates. T h e creditor has co m p lete flex ib il­ ity in the w a y it treats rebates for p u rp oses o f d isclosu re and calcu lation . S ee the co m m e n ­ tary to sectio n 2 2 6 .1 8 (b ). 2(a)(10) “Closed-End Credit ”

1. General. T h e co v era g e o f this term is d e­ fined by e x clu sio n . That is, it in clu d es any credit arrangem ent that d o es not fall w ithin the d efinition o f op en -en d credit. Subpart C co n ta in s the d isclo su re rules for clo sed -en d cred it w h en the ob ligation is su b ject to a fi­ nance charge or is payable by w ritten agree­ m ent in m ore than four in stallm en ts. 2(a)(ll) “Consumer"

1. Scope. G uarantors, endorsers, and sureties are not g en erally con su m ers for p u rp oses o f the regu lation, but they m ay be en titled to re­ scin d u nder certain circu m stan ces and they m ay h ave certain rights if they are ob ligated on credit card plans.

2. Rescission rules. For p u rp oses o f rescissio n under sectio n s 2 2 6 .1 5 and 2 2 6 .2 3 , a con su m er in clu d es any natural person w h o se ow n ersh ip interest in h is or her principal d w ellin g is su b ­ je c t to the risk o f lo ss. T hus, if a secu rity interest is taken in A ’s o w n ersh ip interest in a h o u se and that h ou se is A ’s principal d w e ll­ in g, A is a con su m er for p u rp oses o f rescis­ sio n , ev en if A is not liab le, eith er prim arily or seco n d a rily , on the u n d erlyin g con su m er credit transaction. A n o w n ersh ip interest d o es not in clu d e, for ex a m p le, lea seh o ld s or in ch o ­ ate rights, su ch as d ow er.

3. Land trusts. C redit exten d ed to land trusts, as d escrib ed in the co m m en ta ry to se ctio n 2 2 6 .3 (a ), is con sid ered to b e exten d ed to a natural person for p u rp oses o f the d efin ition o f con su m er.

2(a)(12) “Consumer Credit”

1. Primary purpose. T here is n o p recise test for w hat con stitu tes credit offered or exten d ed for personal, fa m ily , or h o u seh o ld pu rp oses, nor for w hat con stitu tes the prim ary purpose. S ee, h ow ever, the d iscu ssio n o f b u sin ess pur­ p o ses in the com m entary to sectio n 2 2 6 .3 (a ). 2(a)(13) “Consummation ”

1. State law governs. W h en a contractual o b ­ ligation on the co n su m er’s part is created is a m atter to b e d eterm in ed under ap p licab le law ; R egu lation Z d o es not m ake this determ ina­ tio n . A con tractual co m m itm en t a g reem en t, for ex a m p le, that under ap p licab le law binds the con su m er to the cred it term s w o u ld be con su m m ation . C on su m m ation , h o w ev er, d o es not o ccu r m erely b eca u se the con su m er has m ade so m e financial in vestm en t in the trans­ action (for ex a m p le, b y p ayin g a nonrefundab le fe e ) u n less, o f co u rse, a p p lica b le law h old s oth erw ise.

2. Credit v. sale. C on su m m ation d o es not o c ­ cur w h en the con su m er b eco m es contractually co m m itted to a sale transaction, u n less the con su m er a lso b eco m es leg a lly ob lig a ted to a ccep t a particular cred it arrangem ent. For e x ­ am ple, w h en a con su m er p ays a nonrefundab le d ep o sit to p u rch ase an a u to m o b ile, a purchase contract m ay b e created, but c o n ­ su m m ation for p u rp oses o f the regulation d o es not o ccu r u n less the con su m er a lso contracts for finan cin g at that tim e.

2(a)(14) “Credit"

1. Exclusions. T h e fo llo w in g situ a tio n s are n ot co n sid e r e d cred it fo r p u rp o ses o f the regulation:

• L a y a w a y p la n s, u n le ss th e c o n su m er is Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 10

§ 226.2 Regulation Z Commentary con tractually ob ligated to co n tin u e m aking p aym ents. W hether the co n su m er is so o b ­ ligated is a m atter to b e d eterm in ed under ap p licab le law . T h e fact that the con su m er is not en titled to a refund o f any am ounts paid tow ards the cash p rice o f the m er­ ch a n d ise d o es n ot bring la y a w a y s w ith in the d efin ition o f credit.

T ax lie n s, tax a sse ssm e n ts, cou rt ju d g ­ m en ts, and court ap provals o f reaffirm ation o f d eb ts in bankruptcy. H o w ev er, thirdparty finan cin g o f such o b lig a tio n s (for e x ­ am p le, a bank loan ob tain ed to p ay o ff a tax lien ) is credit for p u rp oses o f the regulation.

Insurance prem ium plans that in v o lv e p ay­ m en t in in stallm en ts w ith each in stallm en t rep rese n tin g th e p a y m e n t fo r in su ra n ce c o v e r a g e for a certain futu re p erio d o f tim e, u n less the con su m er is contractually o b lig a ted to con tin u e m aking paym ents H o m e im p ro v em en t tran saction s that in ­ v o lv e progress p aym ents, if the con su m er p a y s, as th e w ork p r o g resses, o n ly for w ork co m p leted and has n o contractual o b ­ lig a tio n to con tin u e m aking paym ents “ B o r r o w in g ”

a g a in st th e a ccru ed ca sh v alu e o f an insurance p o licy or a p en sion accou n t, i f there is no in d ep en dent o b lig a ­ tion to repay L etters o f credit T h e ex ecu tio n o f op tion contracts. H o w e v ­ er, there m ay b e an ex ten sio n o f credit w h en the op tion is ex ercised , if there is an agreem en t at that tim e to d efer p aym ent o f a debt.

In vestm en t p lans in w h ich the party e x ­ ten d in g cap ital to the con su m er risks the lo ss o f the capital advanced. T h is in clu d es, for ex a m p le, an arrangem ent w ith a h om e purchaser in w h ich the in vestor p ays a por­ tion o f the d ow n p aym en t and o f the p eri­ o d ic m ortgage p aym ents in return for an o w n ersh ip in terest in th e p ro p erty , and sh ares in an y g a in or lo s s o f p rop erty valu e.

M ortgage a ssistan ce plans ad m in istered by a g overn m en t a g en cy in w h ich a portion o f the co n su m er’s m onthly p aym ent am ount is paid b y the a g en cy . N o finan ce charge is im p o sed on the su b sid y am ount, and that am ount is d u e in a lu m p -su m p aym en t on a set date or upon the occu rrence o f certain ev en ts. (If p aym ent is not m ade w h en due, a n ew n ote im p o sin g a finan ce ch arge m ay be w ritten, w h ich m ay then b e su b ject to the regu lation.) 2(a)(15) “Credit Card”

1. Usable from time to time. A credit card m ust b e u sab le from tim e to tim e. S in ce this in v o lv es the p o ssib ility o f repeated u se o f a sin g le d ev ice, ch eck s and sim ilar instrum ents that can b e u sed o n ly o n ce to obtain a sin g le credit ex ten sio n are not credit cards. 2 . Examples.

E x a m p le s o f c r e d it c a r d s include:

• A card that guarantees ch eck s or sim ilar instrum ents, if the a sset accou n t is a lso tied to an overdraft lin e or if the instrum ent d i­ rectly a ccesse s a lin e o f credit • A card that a ccesse s b oth a cred it and an a sset accou n t (that is, a d eb it-cred it card) • A n id en tification card that perm its the co n ­ su m er to d efer p aym ent on a p urchase • A n id en tification card in d icatin g loan ap­ proval that is presen ted to a m erchant or to a len d er, w h eth er or n o t th e co n su m er sig n s a separate prom issory n ote for each credit ex ten sio n In contrast, credit card d o es n ot in clu d e, for exam p le:

• A ch eck -gu aran tee or deb it card w ith no cred it featu re or ag reem en t, ev en if the creditor o c ca sio n a lly honors an inadvertent overdraft • A n y card, k ey, p late, or other d ev ice that is u sed in order to obtain p etroleu m products for b u sin ess p u rp oses from a w h o lesa le d is­ tribution fa cility or to gain a ccess to that fa cility , and that is required to b e u sed w ith ou t regard to p aym ent term s. 3. Charge card. G en erally, charge cards are cards u sed in co n n ectio n w ith an accou n t on w h ich ou tstand in g b alan ces can n ot b e carried from o n e b illin g c y c le to another and are p ay­ ab le w h en a p eriod ic statem ent is received . U n d er the reg u la tio n , a referen ce to cred it cards g en era lly in clu d es ch arge card s. T h e term “ charge card ” is, h o w ev er, d istin gu ish ed fr o m “ c r e d it c a r d ”

in s e c t io n s 2 2 6 .5 a , Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 11

Regulation Z Commentary § 226.2 2 2 6 .9 (e ), 2 2 6 .9 (f) and 2 2 6 .2 8 (d ), and appen­ d ix e s G - 1 0 through G -1 3 . W h en the term “ credit card ” is u sed in th ose p ro v isio n s, it refers to credit cards other than charge cards. 2(a)( 16) “Credit Sale"

1. Special disclosure. If the seller is a creditor in the transaction, the transaction is a credit sa le and the sp ecia l cred it sa le d isclo su res (th a t is , th e d is c lo s u r e s u n d e r s e c tio n 2 2 6 .18(j)) m ust b e g iv en . T h is ap p lies ev en if there is m ore than o n e creditor in the transac­ tion and the creditor m aking the d isclo su res is not the seller. S e e the com m entary to sectio n 2 2 6 .1 7 (d ).

2. Sellers who arrange credit. If the seller o f the property or serv ices in v o lv ed arranged for fin an cin g but is not a creditor as to that sale, the transaction is not a cred it sale. T hus, if a seller a ssists the con su m er in ob tain in g a d i­ rect loan from a financial institution and the co n su m er’s n ote is payab le to the financial in ­ stitution, the transaction is a loan and on ly the financial in stitu tion is a creditor. H 3. Refinancings. G en erally, w h en a credit sale is refinanced w ith in the m ean ing o f sectio n 2 2 6 .2 0 (a ), loan d isclo su res sh ou ld b e m ade. o w ev er, if a n ew sa le o f g o o d s or serv ices is a lso in v o lv ed , the transaction is a credit sale. 4 . Incidental sales. S o m e len d ers “ s e ll” a product or serv ice— such as credit, property, or health insurance— as part o f a loan transac­ tio n . S e c tio n 2 2 6 .4 co n ta in s th e ru les on w h eth er the co st o f credit life , d isab ility or p rop erty in su ra n ce is part o f th e fin a n ce charge. If the insu ran ce is finan ced, it m ay b e d isclo sed as a separate cred it sa le transaction or d isclo sed as part o f the prim ary transaction; if the latter approach is taken, eith er loan or credit sa le d isclo su res m ay b e m ade. S ee the com m entary to sectio n 2 2 6 .1 7 (c )(1 ) for further d iscu ssio n o f this point.

5. Credit extensions for educational purposes. A credit ex ten sio n for ed u cational p u rp oses in w h ich an ed u cation al institution is the creditor m ay b e treated as either a cred it sa le or a lo a n , reg a rd less o f w h eth er th e fu n d s are g iv en d irectly to the student, cred ited to the stu d en t’s accou n t, or d isbursed to other per­ so n s o n the stu d en t’s b eh alf. T h e d isclo su re o f the total sa le p rice n eed not b e g iv en i f the transaction is treated as a loan. 2(a)(17) “Creditor”

1. General. T h e d efinition con tain s four in d e­ pendent tests. I f any o n e o f the tests is m et, the person is a creditor for p u rp oses o f that particular test.

Paragraph 2(a)(17)(i) 1. Prerequisites. T h is test is co m p o sed o f tw o requirem ents, both o f w h ich m ust b e m et in order for a particular credit ex ten sio n to be su b ject to the regulation and for the credit e x ­ ten sion to cou n t tow ards satisfaction o f the n u m erical tests m en tio n ed in fo o tn o te 3 to sectio n 2 2 6 .2 (a )(1 7 ). First, there m ust be e i­ ther or both o f the fo llo w in g : • A w ritten (rather than oral) agreem en t to p ay in m ore than four in stallm en ts. A letter that m erely co n firm s an oral a g reem en t d o es not con stitu te a w ritten agreem en t for p u rp oses o f the d efinition . • A finan ce charge im p o sed for the credit. T h e ob ligation to p ay the finan ce charge n eed not b e in w riting.

Second, the ob ligation m ust b e p ayab le to the person in order for that person to b e co n sid ­ ered a creditor. If an ob lig a tio n is m ade p ay­ ab le to “ bearer,” the creditor is the o n e w h o in itially a ccep ts the ob ligation . 2. Assignees. If an ob lig a tio n is in itially p ay­ ab le to o n e person, that p erson is the creditor ev en if the o b ligation b y its term s is sim u lta­ n e o u s ly a s s ig n e d to a n o th e r p e r so n . F or exam p le:

• A n auto d ealer and a bank h ave a b u sin ess relation sh ip in w h ich the bank su p p lies the d ealer w ith credit sa le con tracts that are in ­ itially m ade p ayab le to the d ealer and pro­ v id e for the im m ed iate a ssig n m en t o f the o b ligation to the bank. T h e d ealer and pur­ ch aser ex ecu te the contract o n ly after the bank ap p roves the cred itw orth in ess o f the purchaser. B e ca u se the o b ligation is in itial­ ly p a y a b le o n its fa c e to th e d e a le r , th e d e a le r is th e o n ly cr e d ito r in th e transaction.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 12

§ 226.2 Regulation Z Commentary 3. Numerical tests. T h e ex a m p les b elo w illu s­ trate h o w the num erical tests o f fo o tn o te 3 are applied. T h e ex a m p les assu m e that con su m er credit w ith a finan ce charge or w ritten agree­ m ent for m ore than four in stallm en ts w as e x ­ tended in the years in q u estion and that the p erson d id not exten d such credit in 1982. 4 . Counting transactions.

F or p u rp o ses o f c lo se d -e n d cred it, the cred itor co u n ts ea ch credit transaction. F or op en -en d credit, “ trans­ a ctio n s” m ean s accou n ts, so that ou tstand in g a cco u n ts are co u n ted in stea d o f in d iv id u a l cred it ex te n sio n s. N o rm a lly th e n u m b er o f transactions is m easu red by the p reced in g ca l­ endar year; if the req u isite n um ber is m et, then the p erson is a creditor for all transac­ tion s in the current year. H o w ev er, i f the per­ son d id n ot m eet the test in the p reced in g year, the num ber o f transactions is m easured by the current calendar year. F or ex a m p le, if the person exten d s con su m er cred it 2 6 tim es in 1983, it is a creditor for p u rp oses o f the regu lation for the last ex ten sio n o f credit in 1983 and for all ex ten sio n s o f con su m er credit in 1984. O n the other hand, if a b u sin ess b e ­ g in s in 1983 and exten d s con su m er credit 2 0 tim es, it is n ot a creditor for p u rp oses o f the regu lation in 1 9 8 3 . I f it ex ten d s co n su m er credit 75 tim es in 1984, h o w ev er, it b eco m es a creditor for p u rp oses o f the regu lation (and m ust b eg in m akin g d isclo su res) after the 25th ex ten sio n o f credit in that year and is a cred i­ tor for all ex ten sio n s o f con su m er credit in 1985.

5. Relationship between consumer credit in general and credit secured by a dwelling. E x ­ ten sio n s o f credit secured by a d w ellin g are co u n ted tow ards the 2 5 -ex te n sio n s test. For e x a m p le, if in 198 3 a p erson ex ten d s u n ­ secu red con su m er credit 23 tim es and co n ­ sum er credit secu red by a d w ellin g tw ice, it b eco m es a creditor for the su cceed in g ex ten ­ sio n s o f credit, w h eth er or not they are se ­ cured b y a d w ellin g . O n the other hand, e x ­ ten sio n s o f con su m er credit not secu red b y a d w ellin g are not cou n ted tow ards the num ber o f cred it ex ten sio n s secu red b y a d w ellin g . F or e x a m p le, if in 1983 a p erson ex ten d s credit not secu red by a d w ellin g eig h t tim es and cred it secu red b y a d w ellin g three tim es, it is not a creditor.

6. Effect of satisfying one test. O n ce o n e o f the num erical tests is satisfied , the person is a lso a creditor for the other typ e o f credit. For ex a m p le, in 1983 a person ex ten d s con su m er credit secu red b y a d w ellin g five tim es. That person is a creditor for all su cc eed in g credit ex te n sio n s, w h eth er th ey in v o lv e cred it se ­ cured by a d w ellin g or not.

7. Trusts. In the ca se o f credit exten d ed by trusts, ea ch in d ivid u al trust is co n sid ered a separate en tity for p u rp oses o f ap p lyin g the criteria. For exam p le:

• A bank is the trustee for three trusts. Trust A m akes 15 ex ten sio n s o f con su m er credit annually; Trust B m akes 10 ex ten sio n s o f co n su m e r cred it a n n u a lly ; and T rust C m ak es 3 0 e x ten sio n s o f co n su m er cred it annually. O n ly Trust C is a creditor for p u rp oses o f the regulation.

8. Loans from employee savings plans. S o m e em p lo y ee sa v in g s p lans perm it participants to b orrow m o n ey up to a certain p ercen tage o f their accou n t b a la n ces, and u se a trust to ad­ m in iste r th e r e c e ip t an d d isb u r se m e n t o f funds. U n less each participant’s accou n t is an in d ivid u al plan and trust, the creditor sh ou ld apply the n u m erical tests to the plan as a w h o le rather than to the in d ivid u al accou n t, ev en if the loan am ount is d eterm in ed b y ref­ eren ce to the b alan ce in the in d ivid u al accou n t and the rep aym en ts are cred ited to the in d iv id ­ ual accou n t. T h e person to w h o m the o b lig a ­ tion is origin ally m ade p ayab le (w h eth er the plan, the trust, or the trustee) is the creditor for p u rp oses o f the act and regulation. Paragraph 2(a)( 17)(Hi) 1. Card issuers subject to subpart B. S ectio n 2 2 6 .2 (a )(1 7 )(iii) m ak es certain card issu ers creditors for p u rp oses o f the op en -en d credit p ro v isio n s o f the regu lation. T h is in clu d es, for ex a m p le, the issu ers o f so -ca lled travel and entertainm ent cards that ex p ect rep aym en t at the first b illin g and d o not im p o se a finance charge. S in ce all d isclo su res are to b e m ade o n ly as ap p licab le, su ch card issu ers w o u ld om it finan ce ch arge d isclo su res. O ther p rovi­ sio n s o f the regu lation regarding su ch areas as sc o p e , d e fin itio n s, d eterm in a tio n o f w h ich ch arges are finan ce ch arges, S p an ish lan gu age Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 13

Regulation Z Commentary § 226.2 d isclo su res, record retention, and u se o f m od el form s, a lso ap p ly to such card issu ers. Paragraph 2(a)(17)(iv) 1. Card issuers subject to subparts B and C. S ectio n 2 2 6 .2 (a )(1 7 )(iv ) in clu d es as creditors card issu ers ex ten d in g c lo se d -e n d cred it in w h ich there is a finance charge or an agree­ m ent to pay in m ore than four in stallm en ts. T h ese card issu ers are subject to the appropri­ ate p rovision s o f subparts B and C , as w e ll as to the general p rovision s.

2(a)(18) “Downpayment”

1. Allocation. If a con su m er m akes a lum p­ su m p a y m en t, p artially to red u ce the ca sh p rice and p artially to p ay p rep aid fin a n ce ch arges, o n ly the portion attributable to red u c­ in g the cash p rice is part o f the d ow n p aym en t. (S e e the com m en tary to sectio n 2 2 6 .2 (a )(2 3 ).) 2. Pickup payments. C reditors m ay treat the deferred portion o f the d ow n p aym en t, o ften referred to as “ p ick u p p a y m en ts,” in a num ­ ber o f w a y s. If the pick u p p aym ent is treated as part o f the dow n p aym en t: • It is subtracted in arriving at the am ount finan ced under section 2 2 6 .1 8 (b ) It m ay, but n eed not, b e reflected in the p aym ent sch ed u le under section 2 2 6 .1 8 (g ) I f the p ick u p p aym ent d o es not m eet the d efi­ n ition (fo r ex a m p le, if it is payab le after the seco n d regularly sch ed u led p aym ent) or if the creditor ch o o se s not to treat it as part o f the d ow n p aym en t:

• It m ust b e in clu d ed in the am ount financed • It m ust b e sh o w n in the p aym ent sch ed u le W h ich ev er w a y the pickup p aym ent is treated, the total o f p aym en ts under sectio n 2 2 6 .1 8 (h ) m ust eq u al the su m o f the paym ents d isclo sed under sectio n 2 2 6 .1 8 (g ).

2(a)(19) “Dwelling”

1.

Scope. A d w ellin g n eed not b e the co n ­ su m e r ’s principal resid en ce to fit the d efin i­ tio n , and thus a va ca tio n or se co n d h o m e co u ld b e a d w ellin g . H ow ever, for p u rp oses o f the d efinition o f residential m ortgage transac­ tion and the right to rescind, a d w ellin g m ust b e the p rincipal resid en ce o f the con su m er. S ee the com m entary to sectio n s 2 2 6 .2 (a )(2 4 ), 2 2 6 .1 5 , and 2 2 6 .2 3 .

2. Use as a residence. M o b ile h o m es, boats, and trailers are d w ellin g s if th ey are in fact u sed as resid en ces, ju st as are con d o m in iu m and coop erative units. R ecreation al v eh icles, cam p ers, and the lik e not u sed as resid en ces are not d w ellin g s.

3. Relation to exemptions. A n y transaction in­ v o lv in g a secu rity in terest in a co n su m er’s p rin cip al d w e llin g (a s w e ll as in an y real property) rem ains su b ject to the regu lation d e­ s p it e th e g e n e r a l e x e m p tio n in s e c tio n 2 2 6 .3 (b ) for credit ex ten sio n s o v er $ 2 5 ,0 0 0 . 2(a)(20) “Open-End Credit”

1. General. T h is d efinition d escrib es the char­ acteristics o f op en -en d credit (for w h ich the a p p licab le d isclosu re and other rules are co n ­ tained in subpart B ), as d istin ct from clo sed en d credit. O p en -end cred it is con su m er credit that is exten d ed under a plan and m eets all three criteria set forth in the d efinition . 2. Existence of a plan. T h e d efin ition requires that there b e a plan, w h ich co n n o tes a co n ­ tractual arrangem ent b etw een the creditor and the con su m er. S o m e creditors o ffer program s con tain in g a num ber o f d ifferen t credit fea ­ tures. T h e con su m er has a sin g le accou n t w ith the institution that can b e a ccesse d repeatedly v ia a num ber o f su b accou n ts estab lish ed for the differen t program features and rate struc­ tures. S o m e features o f the program m ight be u sed rep ea ted ly (fo r e x a m p le, an overd raft lin e), w h ile others m igh t b e u sed in freq uently (su ch as the part o f the credit lin e availab le for secu red credit). If the program as a w h o le is su b ject to prescrib ed term s and oth erw ise m eets the d efin ition o f o p en -en d credit, su ch a program w o u ld b e co n sid ered a sin g le, m ultifeatured plan.

3. Repeated transactions. U n d er this criterion, the creditor m ust reason ably con tem p late re­ p eated transactions. T h is m ean s that the credit plan m ust b e u sab le from tim e to tim e and the cred itor m u st leg itim a tely e x p e c t that there w ill b e repeat b u sin ess rather than a o n e-tim e credit ex ten sio n . T h e creditor m ust ex p ect re- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 14

§ 226.2 Regulation Z Commentary peated d ealin gs w ith the co n su m er under the credit plan as a w h o le and n eed not b elie v e the con su m er w ill reu se a particular feature o f the plan. A standard based on reason ab le b e­ lie f b y a creditor n ecessarily in clu d es so m e m argin for ju d gm en tal error. T h e fact that a particular con su m er d o es not return for further credit ex ten sio n s d o es not p reven t a plan from h avin g b een properly ch aracterized as op en end. F or ex a m p le, i f m uch o f the cu stom er b a se o f a c lo t h in g sto r e m a k e s r e p e a t pu rch ases, the fact that so m e con su m ers u se the plan o n ly o n ce w o u ld not affect the char­ acterization o f the store’s plan as op en -en d credit. T h e criterion regarding repeated trans­ action s is a q u estion o f fact to b e d ecid ed in the co n tex t o f the creditor’s typ e o f b u sin ess and the creditor’s relation sh ip w ith the co n ­ sum er. For exam p le:

• It w o u ld b e m ore reason able for a thrift in stitu tion chartered for the b en efit o f its m em b ers to con tem p late repeated transac­ tion s w ith a m em ber than for a seller o f a lu m in u m sid in g to m ak e the sa m e a s­ su m p tion about its cu stom ers. • It would be more reasonable for a bank to make advances from a line of credit for the purchase of an automobile than for an au­ tomobile dealer to sell a car under an open-end plan.

4. Finance charge on an outstanding balance. T h e requirem ent that a finance ch arge m ay be com p u ted and im p o sed from tim e to tim e on the ou tstand in g b alan ce m ean s that there is no sp e c ific a m ou n t fin an ced for th e p lan for w h ich the finan ce charge, total o f p aym ents, and p aym ent sch ed u le can b e calcu lated . A p lan m ay m eet the d efin itio n o f o p en -e n d credit ev en thou gh a finance charge is not nor­ m ally im p o sed , provid ed the creditor has the righ t, un d er the p lan , to im p o se a fin an ce ch arge from tim e to tim e on the ou tstand in g b alan ce. For ex a m p le, in so m e p lan s, su ch as certain “ ch in a clu b ” plans, a finan ce charge is not im p osed if the con su m er p ays all or a sp ecified portion o f the ou tstand in g b alan ce w ithin a g iv en tim e period. S u ch a plan cou ld m eet the finan ce-ch arge criterion, if the cred i­ tor has the right to im p o se a finan ce charge, ev en thou gh the con su m er actu ally p ays no fin an ce ch arges during the ex iste n c e o f the plan b eca u se the con su m er takes ad van tage o f the op tion to pay the b alan ce (eith er in fu ll or in in stallm en ts) w ith in the tim e n ecessary to avoid finan ce charges.

5. Reusable line. T h e total am ount o f credit that m ay b e exten d ed during the e x isten ce o f an op en -en d plan is u n lim ited b eca u se a v a il­ able credit is gen erally rep len ish ed as earlier ad van ces are repaid. A lin e o f cred it is se lf­ rep len ish in g ev en thou gh the plan itse lf h as a fixed exp iration date, as lo n g as during the p la n ’s e x isten ce the co n su m er m ay u se the lin e, repay, and reuse the credit. T h e creditor m ay verify credit in form ation su ch as the co n ­ su m er’s co n tin u ed in co m e and em p lo y m en t status or in form ation for secu rity p u rp oses. T h is criterion o f u n lim ited credit d istin g u ish es o p en -e n d cred it from a se ries o f a d v a n ces m ad e pursuant to a c lo se d -e n d cred it loan com m itm en t. F or exam p le:

• U nder a clo sed -en d co m m itm en t, the cred i­ tor m ight agree to len d a total o f $ 1 0 ,0 0 0 in a series o f a d van ces as n eed ed by the con su m er. W h en a con su m er has borrow ed the fu ll $ 1 0 ,0 0 0 , n o m ore is a d v a n ced under that p articu lar ag reem en t, e v e n if there has b een repaym ent o f a portion o f the debt.

T h is criterion d o es not m ean that the creditor m ust estab lish a sp ecific credit lim it for the lin e o f credit or that the lin e o f credit m ust a lw a y s b e rep len ish ed to its original am ount. T he creditor m ay red u ce a credit lim it or re­ fu se to exten d n ew credit in a particular case due to ch a n g es in the eco n o m y , the creditor’s fin a n c ia l c o n d itio n , o r th e c o n s u m e r ’ s c r e d it w o r t h in e s s .

(T h e r u le s in s e c tio n 2 2 6 .5 b (f), h o w ev er, lim it the ab ility o f a cred ­ itor to su sp en d credit ad van ces for h o m e-eq ­ u ity p lan s.) W h ile con su m ers sh ou ld h ave a reason able exp ectation o f ob tain in g credit as lo n g as th ey rem ain current and w ith in any p reset c red it lim its, fu rth er e x te n s io n s o f credit n eed not b e an ab solu te right in order for the p lan to m eet th e se lf-r e p le n ish in g criterion.

6. Open-end real estate mortgages. S o m e credit p lan s call for n egotiated ad van ces under so -ca lled op en -en d real estate m ortgages. E ach su ch p lan m ust b e in d ep en d en tly m easu red Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 15

Regulation Z Commentary § 226.2 against the definition of “open-end credit,” regardless of the terminology used in the in­ dustry to describe the plan. The fact that a particular plan is called an open-end real es­ tate mortgage, for example, does not, by itself, mean that it is open-end credit under the regulation.

2(a)(21) “Periodic Rate"

1. Basis. The periodic rate may be stated as a percentage (for example, IV2 percent per month) or as a decimal equivalent (for exam­ ple, .015 monthly). It may be based on any portion of a year the creditor chooses. Some creditors use 1/360 of an annual rate as their periodic rate. These creditors: .

o May disclose a 1/360 rate as a “daily” pe­ riodic rate, without further explanation, if it is in fact only applied 360 days per year. But if the creditor applies that rate for 365 days, the creditor must note that fact and, of course, disclose the true annual percent­ age rate.

Would have to apply the rate to the balance to disclose the annual percentage rate with the degree of accuracy required in the reg­ ulation (that is, within 1/8 of 1 percentage point of the rate based on the actual 365 days in the year).

2. Transaction charges. “Periodic rate” does not include initial one-time transaction charges, even if the charge is computed as a percentage of the transaction amount. 2(a)(22) “Person”

1. Joint ventures. A joint venture is an organi­ zation and is therefore a person. 2. Attorneys. An attorney and his or her client are considered to be the same person for pur­ poses of this regulation when the attorney is acting within the scope of the attorney-client relationship with regard to a particular transaction.

3. Trusts. A trust and its trustee are consid­ ered to be the same person for purposes of this regulation.

2(a)(23) “Prepaid Finance Charge” 1. General. Prepaid finan ce ch arges m ust be taken into accou n t under sectio n 2 2 6 .1 8 (b ) in com p u tin g the d isclo sed am oun t finan ced, and m ust b e d isclo sed if the creditor p rovid es an item ization o f the am ount finan ced under se c ­ tion 2 2 6 .1 8 (c ).

2. Examples. C om m on ex a m p les o f prepaid finan ce ch arges include:

• B u y er’s p oints • S erv ice fees • L oan fees • F in d er’s fees • L oan-guarantee insurance • C red it-in vestigation fees H o w ev er, in order for th ese or an y other fi­ n an ce ch arges to b e co n sid ered prepaid, they m u st b e eith er p aid sep a ra tely in ca sh or ch eck or w ith h eld from the p roceed s. Prepaid finan ce ch arges in clu d e any portion o f the fi­ n an ce charge paid prior to or at c lo sin g or settlem en t.

3. Exclusions.

“ A d d -o n ” and “ d isco u n t” fi­ n an ce ch arges are not prepaid finan ce ch arges fo r p u r p o se s o f th is r e g u la tio n . F in a n c e ch a rg es are n ot “ p rep a id ” m erely b eca u se they are precom puted, w h eth er or not a por­ tion o f the charge w ill b e rebated to the co n ­ su m er upon prepaym ent. S e e the com m entary to sectio n 2 2 6 .1 8 (b ). 4 . Allocation of lump-sum payments. In a credit sa le transaction in v o lv in g a lu m p -su m p aym ent by the con su m er and a d iscou n t or other item that is a finan ce ch arge under se c ­ tion 2 2 6 .4 , the d isco u n t or other item is a pre­ paid finan ce charge to the ex ten t the lu m p ­ su m p aym ent is not ap p lied to the cash price. For ex a m p le, a seller se lls property to a co n ­ sum er for $ 1 0 ,0 0 0 , requires the con su m er to pay $ 3 ,0 0 0 at the tim e o f the p u rchase, and finan ces the rem ainder as a clo sed -en d credit transaction. T h e cash p rice o f the property is $ 9 ,0 0 0 . T h e seller is the creditor in the trans­ action and therefore the $ 1 ,0 0 0 d ifferen ce b e­ tw een the credit and cash p rices (the d iscou n t) is a finan ce charge. (S e e the com m en tary to sectio n s 2 2 6 .4 (b )(9 ) and 2 2 6 .4 (c )(5 ).) If the creditor ap p lies the entire $ 3 ,0 0 0 to the cash p rice and adds the $ 1 ,0 0 0 finan ce charge to Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 16

§ 226.2

Regulation Z Commentary

the interest on the $6,000 to arrive at the total finance charge, all of the $3,000 lump-sum

226.17(c)(6), each one is considered to be a

residential mortgage transaction, even if dif- ln

payment is a downpayment and the discount ferent creditors are involved. For example: “~ is not a prepaid finance charge. However, if the creditor only applies $2,000 of the lump- * The creditor makes a construction loan to sum payment to the cash price, then $2,000 of finance the initial construction of the conthe $3,000 is a downpayment and the $1,000 sumer’s principal dwelling, and the loan discount is a prepaid finance charge. will be disbursed in five advances. The creditor gives six sets of disclosures (five for the construction phase and one for the 2(a)(24) “Residential Mortgage Transaction” permanent phase). Each one is a residential 1. Relation to other sections. This term is im- mortgage transaction. portant in six provisions in the regulation: + One creditor finances the initial construc- . . tion of the consumer’s principal dwelling ¢ Section 226.4(c)(7)—exclusions from the and another creditor makes a loan to satisfy finance charge : the construction loan and provide perma- + Section 226.15(f)—exemption from the nent financing. Both transactions are resiright of rescission dential mortgage transactions. « Section 226.18(q)—whether or not the obligation is assumable 5. Acquisition. A transaction is not “to fi- + Section 226.19—special timing rules nance the acquisition” of the consumer’s prin- + Section 226.20(b)—disclosure requirements cipal dwelling (and therefore is not a residenfor assumptions tial mortgage transaction) if the consumer had + Section 226.23(f}—exemption from the previously purchased the dwelling and acright of rescission quired some title to the dwelling, even though 2. Lien status. The definition is not limited to ‘he consumer nas oo ro cen oe first lien transactions. For example, a con- Thus, the Hahowing types Of + enemies ras sumer might assume a paid-down first mort- not residential mortgage transactions: age (or borrow part of the purchase price : ao sa bere the faicace of ea ° bist aa avy pier fons we cg ic ae ae seen ar ants + An extension of credit made to a joint dential mortgage transaction” if the dwelling aes eer ee re purchased is the consumer’s principal residence. As a result, in giving the disclosures for these 3. Principal dwelling. A consumer can have ‘Tansactions several provisions of the regulaonly one principal dwelling at a time. Thus, a 10M are not applicable, for example, the exvacation or other second home would not be a C€Ptions to the right of rescission (sections principal dwelling. However, if a consumer 226.23(f)(1) and 226.15(f)(1)), the early disbuys or builds a new dwelling that will be- closure requirement (section 226.19(a)), and come the consumer’s principal dwelling the disclosure concerning assumability (secwithin a year or upon the completion of con- tion 226.18(q)). In the following situation, by struction, the new dwelling is considered the ©ntrast, since the transaction is not a residenprincipal dwelling for purposes of applying ial mortgage transaction, no disclosures are this definition to a particular transaction. See Tequired by section 226.20(b) and therefore the commentary to sections 226.15(a) and the right of rescission does not apply: PARED): - A written agreement between a creditor eC 4. Construction financing. If a transaction holding a seller’s mortgage and the buyer “

meets the definition of a residential mortgage transaction and the creditor chooses to disclose it as several transactions under section

of the property which allows the buyer to assume the mortgage, where the buyer previously purchased the property and agreed

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 17

Regulation Z Commentary § 226.2 w ith the seller to m ake the m ortgage p ay­ m ents.

6. Multiple-purpose transactions. A transac­ tion m eets the d efinition o f this section if any part o f the loan p roceed s w ill be used to fi­ n an ce the acq u isition or in itial con stru ction o f the co n su m er’s principal d w ellin g . For ex a m ­ p le, a transaction to finan ce the in itial co n ­ struction o f the co n su m er’s principal d w ellin g is a resid en tial m ortgage transaction ev en if a portion o f the fun d s w ill b e d isbursed d irectly to the con su m er or u sed to satisfy a loan for the purchase o f the land on w h ich the d w e ll­ in g w ill b e built.

2(a)(25) “Security Interest”

D 1. Threshold test.

T h e th r e sh o ld te st is w h eth er a particular interest in property is rec­ o g n ized as a secu rity interest under ap p licab le la w .

T h e r e g u la tio n d o e s n o t d e te r m in e w h eth er a particular interest is a secu rity inter­ est under a p p licab le law . If the creditor is un­ sure w h eth er a particular interest is a secu rity interest under ap p licab le law (for ex a m p le, if statutes and ca se law are either silen t or in­ c o n clu siv e on the issu e), the creditor m ay at its op tion co n sid er such interests as secu rity interests for Truth in L end in g p urposes. H o w ­ ever, the regulation and the com m entary do e x c lu d e sp ec ific in terests, su ch as a fter-a c­ q u ired p rop erty an d a c c e s so r ie s, from the sc o p e o f the d efinition regard less o f their ca te­ g o riza tio n un d er a p p lica b le la w , and th ese nam ed ex clu sio n s m ay n ot b e d isclo sed as se ­ curity interests under the regulation. (B u t see the d iscu ssio n o f e x clu sio n s elsew h ere in the com m en tary to sectio n 2 2 6 .2 (a )(2 5 ).) 2. Exclusions. T h e general d efinition o f secu r­ ity interest ex clu d es three groups o f interests: in cid en tal interests, interests in after-acquired property, and interests that arise so le ly by o p ­ eration o f law . T h ese interests m ay not be d is­ c lo se d w ith the d isclo su res required under se c ­ tion 2 2 6 .1 8 , but the creditor is not p recluded from preservin g th ese rights elsew h ere in the contract d ocu m en ts, or in v o k in g and en forcin g su ch rights, if it is oth erw ise law fu l to d o so. If the creditor is unsure w h eth er a particular interest is o n e o f the ex clu d ed interests, the creditor m ay, at its op tion , co n sid er su ch in­ terests as security interests for Truth in L en d ­ ing purposes.

3. Incidental interests. Incidental in terests in property that are not secu rity in terests in clu d e, am on g other things:

• A ssig n m en t o f rents • R igh t to con d em n ation p roceed s • Interests in a ccesso ries and rep lacem en ts • Interests in escro w a ccou n ts, su ch as for taxes and insurance • W aiver o f h om estead or personal property rights T h e n otion o f an “ in cid en tal in terest” d o es not en co m p a ss an ex p licit secu rity interest in an insu ran ce p o licy if that p o licy is the pri­ m ary collateral for the transaction— for ex a m ­ p le , in an in su r a n c e p r e m iu m fin a n c in g transaction.

4 . Operation of law. Interests that arise so le ly by op eration o f law are ex clu d ed from the gen eral d efinition . A lso ex clu d ed are interests arisin g by operation o f law that are m erely repeated or referred to in the contract. H o w ­ ever, if the creditor has an interest that arises b y operation o f la w , su ch as a ven d o r’s lien , and takes an in d ep en dent secu rity interest in the sam e property, su ch as a U C C secu rity interest, the latter interest is a d isclo sa b le se ­ curity interest u n less o th erw ise provided. 5 . Rescission rules.

S ecu r ity in te rests that arise so le ly by op eration o f law are security interests for p u rp oses o f rescissio n . E xam p les o f su ch interests are m ech a n ics’ and m aterialm en ’s lien s.

6. Specificity of disclosure. A cred itor n eed not separately d isc lo se m ultip le secu rity inter­ ests that it m ay h old in the sam e collateral. T h e creditor n eed o n ly d isc lo se that the trans­ action is secu red by the collateral, ev en w h en secu rity in terests from prior transactions re­ m ain o f record and a n ew secu rity interest is taken in co n n ectio n w ith the transaction. In d isclo sin g the fact that the transaction is se ­ cured b y the collateral, the creditor a lso need not d isc lo se h o w the secu rity interest arose. For ex a m p le, in a clo sed -en d credit transac­ tion, a rescissio n n otice n eed not sp ecifica lly state that a n ew secu rity interest is “ acq u ired ” or an ex istin g secu rity interest is “ retain ed ” Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 18

§ 226.2 Regulation Z Commentary in the transaction. The acquisition or retention of a security interest in the consumer’s princi­ pal dwelling instead may be disclosed in a rescission notice with a general statement such as the following: “Your home is the security for the new transaction.” A statement such as this may be used, for example, instead of the second sentence in model form H-9 and could apply both to a refinancing in which a new security interest is taken by the original credi­ tor to replace a preexisting security interest and one in which an existing security interest is maintained. Of course, because model form H-9 adequately discloses the fact that the home is security for the transaction, it may be used without modification in both a refinanc­ ing in which a new security interest is taken by the original creditor to replace a preexist­ ing security interest and one in which an ex­ isting security interest is retained by that creditor.

2(b) Rules of Construction 1. Footnotes. Footnotes are used extensively in the regulation to provide special exceptions and more detailed explanations and examples. Material that appears in a footnote has the same legal weight as material in the body of the regulation.

References Statute: § 103 Other sections: None Other regulations: Regulation E (12 CFR 205.2(d)) Previous regulation: §§ 226.2, 226.8, and 226.9 1981 changes: Section 226.2 implements amended section 103 of the act. Separate defi­ nitions for “comparative index of credit cost,” “discount,” “organization,” “period,” “real property,” “real property transaction,” “regu­ lar price,” and “surcharge” have been de­ leted. The definitions relating specifically to consumer leases are now found in the separate consumer leasing regulation, Regulation M (12 CFR 213).

Several terms are now defined elsewhere in the regulation or commentary rather than in section 226.2. For example, “finance charge” is described and explained in section 226.4, and “agricultural purpose” is discussed in the commentary to section 226.3. Some terms, such as “unauthorized use,” are now defined as part of the substantive sections to which they apply. Other terms previously defined, such as “customer” and “organization,” are merged into new definitions. Section 226.2 contains new definitions for “arranger of credit,” “business day,” “closed-end credit,” “consumer,” “consummation,” “downpay­ ment,” “prepaid finance charge,” and “resi­ dential mortgage transaction.” The major changes in the definitions are as follows:

“Arranger of credit” has a significantly dif­ ferent meaning. It reflects the statutory amendment that limits “arrangers” to those who regularly arrange credit extensions for persons who are not themselves creditors. This definition was deleted effective October 1, 1982.

“Billing cycle” largely restates the prior definition, but requires cycles to be regular, and allows the four-day variance to be mea­ sured from a regular day as well as date. The definition also incorporates an interpretation that cycles may be no longer than quarterly. “Business day” is new in the sense that the term previously appeared only in a footnote to the rescission provision, but it is now of gen­ eral applicability. The general rule that it is a day when the creditor is open for business is new, but the rule for rescission purposes is the same as in the previous regulation. “Cash price” now explicitly permits inclu­ sion of various incidental charges imposed equally in cash and credit transactions. “Consumer” has a narrower meaning in that guarantors, sureties, and endorsers are ex­ cluded from the general definition. “Consumer credit” reflects the new statu­ tory exemption for agricultural credit. “Consummation” is a significant departure from longstanding interpretations of the previ­ ous definition. It now focuses only on the time the consumer becomes contractually obli­ gated, rather than the time the consumer pays a nonrefundable fee or suffers an economic penalty for failing to go forward with the credit transaction.

“Credit” generally parallels the previous Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 19

Regulation Z Commentary § 226.3 definition, but modifies the previous interpre­ tations of the definition by excluding more transactions.

“Creditor” reflects the statutory amend­ ments to the act that were intended to elimi­ nate the problem of multiple creditors in a transaction. The “regularly” standard is still used, but it is now defined in terms of the frequency of the credit extensions. The new definition also requires that there be a written agreement to pay in more than four install­ ments if no finance charge is imposed. Fi­ nally, the obligation must be initially payable to a person for that person to be the creditor. “Dwelling” reflects the statutory amend­ ment that expanded the scope of the definition to include any residential structure, whether or not it is real property under state law. “Open-end credit” reflects the amended statutory definition requiring that the creditor reasonably contemplate repeated transactions. The new definition no longer requires the con­ sumer to have the privilege of paying either in installments or in full.

“Periodic rate” combines the previous defi­ nitions of “period” and “periodic rate” with clarification in the commentary concerning transaction charges and 360-day-year factors. “Security interest” is much narrower than the previous definition. Reflecting the legisla­ tive history of the simplification amendments, incidental interests are expressly excluded from the definition. Except for purposes of re­ scission, interests that arise solely by opera­ tion of law are also excluded. SECTION 226.3—Exempt Transactions 3(a) Business, Commercial, Agricultural, or Organizational Credit 1. Primary purposes. A creditor must deter­ mine in each case if the transaction is prima­ rily for an exempt purpose. If some question exists as to the primary purpose for a credit extension, the creditor is, of course, free to make the disclosures, and the fact that disclo­ sures are made under such circumstances is not controlling on the question of whether the transaction was exempt.

2. Factors. In determining whether credit to finance an acquisition—such as securities, an­ tiques, or art—is primarily for business or commercial purposes (as opposed to a con­ sumer purpose), the following factors should be considered:

• The relationship of the borrower’s primary occupation to the acquisition. The more closely related, the more likely it is to be business purpose.

• The degree to which the borrower will per­ sonally manage the acquisition. The more personal involvement there is, the more likely it is to be business purpose. • The ratio of income from the acquisition to the total income of the borrower. The higher the ratio, the more likely it is to be business purpose.

• The size of the transaction. The larger the transaction, the more likely it is to be busi­ ness purpose.

• The borrower’s statement of purpose for the loan.

Examples of business-purpose credit include: • A loan to expand a business, even if it is secured by the borrower’s residence or per­ sonal property • A loan to improve a principal residence by putting in a business office • A business account used occasionally for consumer purposes Examples of consumer-purpose credit include: • Credit extensions by a company to its em­ ployees or agents if the loans are used for personal purposes • A loan secured by a mechanic’s tools to pay a child’s tuition • A personal account used occasionally for business purposes 3. Non-owner-occupied rental property. Credit extended to acquire, improve, or maintain rental property (regardless of the number of housing units) that is not owner-occupied is deemed to be for business purposes. This in­ cludes, for example, the acquisition of a ware­ house that will be leased or a single-family house that will be rented to another person to live in. If the owner expects to occupy the property for more than 14 days during the coming year, the property cannot be consid­ Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 20

§ 226.3 Regulation Z Commentary ered non-owner-occupied and this special rule will not apply. For example, a beach house that the owner will occupy for a month in the coming summer and rent out the rest of the year is owner-occupied and is not governed by this special rule. See comment 3(a)-4, however, for rules relating to owner-occupied rental property.

4. Owner-occupied rental property. If credit is extended to acquire, improve, or maintain rental property that is or will be owner-occu­ pied within the coming year, different rules apply:

• Credit extended to acquire the rental prop­ erty is deemed to be for business purposes if it contains more than two housing units. • Credit extended to improve or maintain the rental property is deemed to be for busi­ ness purposes if it contains more than four housing units. Since the amended statute defines “dwelling” to include one to four housing units, this rule preserves the right of rescission for credit extended for pur­ poses other than acquisition. Neither of these rules means that an extension of credit for property containing fewer than the requisite number of units is necessarily consumer credit. In such cases, the determina­ tion of whether it is business or consumer credit should be made by considering the fac­ tors listed in comment 3(a)-2. 5. Business credit later refinanced. Business purpose credit that is exempt from the regula­ tion may later be rewritten for consumer pur­ poses. Such a transaction is consumer credit requiring disclosures only if the existing obli­ gation is satisfied and replaced by a new obli­ gation made for consumer purposes under­ taken by the same obligor.

6. Agricultural purpose. An “agricultural pur­ pose” includes the planting, propagating, nur­ turing, harvesting, catching, storing, exhibit­ ing, marketing, transporting, processing, or manufacturing of food, beverages (including alcoholic beverages), flowers, trees, livestock, poultry, bees, wildlife, fish, or shellfish by a natural person engaged in farming, fishing, or growing crops, flowers, trees, livestock, poul­ try, bees, or wildlife. The exemption also ap­ plies to a transaction involving real property that includes a dwelling (for example, the purchase of a farm with a homestead) if the transaction is primarily for agricultural purposes.

7. Organizational credit. The exemption for transactions in which the borrower is not a natural person applies, for example, to loans to corporations, partnerships, associations, churches, unions, and fraternal organizations. The exemption applies regardless of the pur­ pose of the credit extension and regardless of the fact that a natural person may guarantee or provide security for the credit. 8. Land trusts. Credit extended for consumer purposes to a land trust is considered to be credit extended to a natural person rather than credit extended to an organization. In some jurisdictions, a financial institution financing a residential real estate transaction for an indi­ vidual uses a land trust mechanism. Title to the property is conveyed to the land trust for which the financial institution itself is trustee. The underlying installment note is executed by the financial institution in its capacity as trustee and payment is secured by a trust deed, reflecting title in the financial institution as trustee. In some instances, the consumer executes a personal guaranty of the indebted­ ness. The note provides that it is payable only out of the property specifically described in the trust deed and that the trustee has no per­ sonal liability on the note. Assuming the transactions are for personal, family, or house­ hold purposes, these transactions are subject to the regulation since in substance (if not form) consumer credit is being extended. 3(b) Credit Over $25,000 Not Secured by Real Property or a Dwelling 1. Coverage. Since a mobile home can be a dwelling under section 226.2(a)(19), this ex­ emption does not apply to a credit extension secured by a mobile home used or expected to be used as the principal dwelling of the con­ sumer, even if the credit exceeds $25,000. A loan commitment for closed-end credit in ex­ cess of $25,000 is exempt even though the amounts actually drawn never actually reach $25,000.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 21

Regulation Z Commentary § 226.3 2. Open-end credit. An open-end credit plan is exempt under section 226.3(b) (unless se­ cured by real property or personal property used or expected to be used as the consumer’s principal dwelling) if either of the following conditions is met:

• The creditor makes a firm commitment to lend over $25,000 with no requirement of additional credit information for any ad­ vances.

• The initial extension of credit on the line exceeds $25,000.

If a security interest is taken at a later time in any real property, or in personal property used or expected to be used as the consumer’s principal dwelling, the plan would no longer be exempt. The creditor must comply with all of the requirements of the regulation, includ­ ing, for example, providing the consumer with an initial disclosure statement. If the security interest being added is in the consumer’s prin­ cipal dwelling, the creditor must also give the consumer the right to rescind the security in­ terest. (See the commentary to section 226.15 concerning the right of rescission.) 3. Closed-end credit—subsequent changes. A closed-end loan for over $25,000 may later be rewritten for $25,000 or less, or a security in­ terest in real property or in personal property used or expected to be used as the consumer’s principal dwelling may be added to an exten­ sion of credit for over $25,000. Such a trans­ action is consumer credit requiring disclosures only if the existing obligation is satisfied and replaced by a new obligation made for con­ sumer purposes undertaken by the same obli­ gor. (See the commentary to section 226.23(a)(1) regarding the right of rescission when a security interest in a consumer’s prin­ cipal dwelling is added to a previously ex­ empt transaction.) 3(c) Public-Utility Credit 1. Examples. Examples of public utility ser­ vices include:

• Gas, water, or electrical services • Cable television services • Installation of new sewer lines, water lines, conduits, telephone poles, or metering equipment in an area not already serviced by the utility The exemption does not apply to extensions of credit, for example:

• To purchase appliances such as gas or elec­ tric ranges, grills, or telephones • To finance home improvements such as new heating or air conditioning systems. 3(d) Securities or Commodities Accounts 1. Coverage. This exemption does not apply to a transaction with a broker registered solely with the state or to a separate credit extension in which the proceeds are used to purchase securities.

3(e) Home Fuel Budget Plans 1. Definition. Under a typical home fuel budget plan, the fuel dealer estimates the total cost of fuel for the season, bills the customer for an average monthly payment, and makes an adjustment in the final payment for any difference between the estimated and the ac­ tual cost of the fuel. Fuel is delivered as needed, no finance charge is assessed, and the customer may withdraw from the plan at any time. Under these circumstances, the arrange­ ment is exempt from the regulation, even if a charge to cover the billing costs is imposed. 3(f) Student Loan Programs 1. Coverage. This exemption applies to the Guaranteed Student Loan program (adminis­ tered by the federal government, state and pri­ vate nonprofit agencies), the Auxiliary Loans to Assist Students (also known as PLUS) pro­ gram, and the National Direct Student Loan program.

References Statute: §§ 103(s) and (t) and 104 Other sections: § 226.12(a) and (b) Previous regulation: § 226.3 and interpreta­ tions §§ 226.301 and 226.302. 1981 changes: The business-credit exemption has been expanded to include credit for agri­ cultural purposes. The rule of interpretation section 226.302, concerning credit relating to Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 22

§ 226.3 Regulation Z Commentary structures containing more than four housing units, has been modified and somewhat ex­ panded by providing more exclusions for transactions involving rental property. The exemption for transactions above $25,000 secured by real estate has been nar­ rowed; all transactions secured by the con­ sumer’s principal dwelling (even if not con­ sidered real property) are now subject to the regulation.

The public-utility exemption now covers the financing of the extension of a utility into an area not earlier served by the utility, in addi­ tion to the financing of services. The securities-credit exemption has been extended to broker-dealers registered with the CFTC as well as the SEC.

A new exemption has been created for home fuel budget plans.

SECTION 226.4—Finance Charge 4(a) Definition 1. Charges in comparable cash transactions. Charges imposed uniformly in cash and credit transactions are not finance charges. In deter­ mining whether an item is a finance charge, the creditor should compare the credit transac­ tion in question with a similar cash transac­ tion. A creditor financing the sale of property or services may compare charges with those payable in a similar cash transaction by the seller of the property or service. i. For example, the following items are not finance charges:

A. Taxes, license fees, or registration fees paid by both cash and credit customers. B. Discounts that are available to cash and credit customers, such as quantity dis­ counts.

C. Discounts available to a particular group of consumers because they meet certain criteria, such as being members of an or­ ganization or having accounts at a particu­ lar financial institution. This is the case even if an individual must pay cash to ob­ tain the discount, provided that credit cus­ tomers who are members of the group and do not qualify for the discount pay no more than the nonmember cash customers. D. Charges for a service policy, auto club membership, or policy of insurance against latent defects offered to or required of both cash and credit customers for the same price.

ii. In contrast, the following items are fi­ nance charges:

A. Inspection and handling fees for the staged disbursement of construction-loan pro­ ceeds.

B. Fees for preparing a Truth in Lending dis­ closure statement, if permitted by law (for example, the Real Estate Settlement Proce­ dures Act prohibits such charges in certain transactions secured by real property). C. Charges for a required maintenance or ser­ vice contract imposed only in a credit transaction.

iii. If the charge in a credit transaction ex­ ceeds the charge imposed in a comparable cash transaction, only the difference is a fi­ nance charge. For example:

A. If an escrow agent is used in both cash and credit sales of real estate and the agent’s charge is $100 in a cash transac­ tion and $150 in a credit transaction, only $50 is a finance charge.

2. Costs of doing business. Charges absorbed by the creditor as a cost of doing business are not finance charges, even though the creditor may take such costs into consideration in de­ termining the interest rate to be charged or the cash price of the property or service sold. However, if the creditor separately imposes a charge on the consumer to cover certain costs, the charge is a finance charge if it otherwise meets the definition. For example: • A discount imposed on a credit obligation when it is assigned by a seller-creditor to another party is not a finance charge as long as the discount is not separately im­ posed on the consumer. (See section 226.4(b)(6).) • A tax imposed by a state or other govern­ mental body on a creditor is not a finance charge if the creditor absorbs the tax as a cost of doing business and does not sepa­ rately impose the tax on the consumer. (For additional discussion of the treatment Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 23

Regulation Z Commentary § 226.4 of taxes, see other commentary to section 226.4(a).) 3. Charges by third parties. Charges imposed on the consumer by someone other than the creditor are finance charges (unless otherwise excluded) if the creditor requires the use of a third party as a condition of or incident to the extension of credit, even if the consumer can choose the third party, or the creditor retains the charge. For example:

i.

The cost of required mortgage insurance, even if the consumer is allowed to choose the insurer.

ii.

A mortgage broker fee, to the extent that the broker shares the fee with the credi­ tor.

4. Charges by settlement agents. Charges im­ posed on the consumer by a settlement agent (such as an attorney, escrow agent, or title company) are finance charges only if the cred­ itor requires the particular services for which the settlement agent is charging the borrower and the charge for those services is not other­ wise excluded from the finance charge. For example, a fee for courier service charged by a settlement agent to send a document to the title company or some other party is not a finance charge, provided that the creditor has not required the use of a courier or retained the charge.

5. Forfeitures of interest. If the creditor reduces the interest rate it pays or stops pay­ ing interest on the consumer’s deposit account or any portion of it for the term of a credit transaction (including, for example, an over­ draft on a checking account or a loan secured by a certificate of deposit), the interest lost is a finance charge. (See the commentary to sec­ tion 226.4(c)(6).) For example: • A consumer borrows $5,000 for 90 days and secures it with a $10,000 certificate of deposit paying 15 percent interest. The creditor charges the consumer an interest rate of 6 percent on the loan and stops paying interest on $5,000 of the $10,000 certificate for the term of the loan. The in­ terest lost is a finance charge and must be reflected in the annual percentage rate on the loan.

However, the consumer must be entitled to the interest that is not paid in order for the lost interest to be a finance charge. For example:

• A consumer wishes to buy from a financial institution a $10,000 certificate of deposit paying 15 percent interest but has only $4,000. The financial institution offers to lend the consumer $6,000 at an interest rate of 6 percent but will pay the 15 per­ cent interest only on the amount of the consumer’s deposit, $4,000. The creditor’s failure to pay interest on the $6,000 does not result in an additional finance charge on the extension of credit, provided the consumer is entitled by the deposit agree­ ment with the financial institution to inter­ est only on the amount of the consumer’s deposit.

• A consumer enters into a combined time deposit/credit agreement with a financial institution that establishes a time deposit account and an open-end line of credit. The line of credit may be used to borrow against the funds in the time deposit. The agreement provides for an interest rate on any credit extension of, for example, 1 per­ cent. In addition, the agreement states that the creditor will pay 0 percent interest on the amount of the time deposit that corre­ sponds to the amount of the credit exten­ sion^). The interest that is not paid on the time deposit by the financial institution is not a finance charge (and therefore does not affect the annual percentage rate computation).

6. Treatment of fees for use of automated teller machines. Any charge imposed on a cardholder by a card issuer for the use of an automated teller machine (ATM) to obtain a cash advance (whether in a proprietary, shared, interchange, or other system) is not a finance charge to the extent that it does not exceed the charge imposed by the card issuer on its cardholders for using the ATM to with­ draw cash from a consumer asset account, such as a checking or savings account. (See the commentary to section 226.6(b).) 7. Taxes, i. Generally, a tax imposed by a state or other governmental body solely on a Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 24

§ 226.4 Regulation Z Commentary creditor is a finance charge if the creditor sep­ arately imposes the charge on the consumer. ii. In contrast, a tax is not a finance charge (even if it is collected by the creditor) if ap­ plicable law imposes the tax: A.

Solely on the consumer;

B.

On the creditor and the consumer jointly; or C.

On the credit transaction, without indicat­ ing which party is liable for the tax; or D.

On the creditor, if applicable law directs or authorizes the creditor to pass the tax on to the consumer. (For purposes of this section, if applicable law is silent as to passing on the tax, the law is deemed not to authorize passing it on.) iii. For example, a stamp tax, property tax, intangible tax, or any other state or local tax imposed on the consumer, or on the credit transaction, is not a finance charge even if the tax is collected by the creditor. iv. In addition, a tax is not a finance charge if it is excluded from the finance charge by another provision of the regulation or com­ mentary (for example, if the tax is imposed uniformly in cash and credit transactions). 4(b) Examples of Finance Charges 1. Relationship to other provisions. Charges or fees shown as examples of finance charges in section 226.4(b) may be excludable under section 226.4(c), (d), or (e). For example: • Premiums for credit life insurance, shown as an example of a finance charge under section 226.4(b)(7), may be excluded if the requirements of section 226.4(d)(1) are met.

• Appraisal fees mentioned in section 226.4(b)(4) are excluded for real property or residential mortgage transactions under section 226.4(cX7).

Paragraph 4(b)(2) 1. Checking account charges. The checking or transaction account charges discussed in sec­ tion 226.4(b)(2) include, for example, the fol­ lowing situations:

• An account with an overdraft line of credit incurs a $4.50 service charge, while an ac­ count without a credit feature has a $2.50 service charge; the $2.00 difference is a fi­ nance charge. If the difference is not relat­ ed to account activity, however, it may be excludable as a participation fee. (See the commentary to section 226.4(c)(4).) • A service charge of $5.00 for each item that triggers an overdraft credit line is a finance charge. However, a charge imposed uniformly for any item that overdraws a checking account, regardless of whether the items are paid or returned and whether the account has a credit feature or not, is not a finance charge.

Paragraph 4(b)(3) 1. Assumption fees. The assumption fees men­ tioned in section 226.4(b)(3) are finance charges only when the assumption occurs and the fee is imposed on the new buyer. The as­ sumption fee is a finance charge in the new buyer’s transaction.

Paragraph 4(b)(5) 1. Credit loss insurance. Common examples of the insurance against credit loss mentioned in section 226.4(b)(5) are mortgage-guaranty insurance, holder-in-due-course insurance, and repossession insurance. Such premiums must be included in the finance charge only for the period that the creditor requires the insurance to be maintained.

2. Residual-value insurance. Where a creditor requires a consumer to maintain residual-value insurance or where the creditor is a benefici­ ary of a residual-value insurance policy writ­ ten in connection with an extension of credit (as is the case in some forms of automobile balloon-payment financing, for example), the premiums for the insurance must be included in the finance charge for the period that the insurance is to be maintained. If a creditor pays for residual-value insurance and absorbs the payment as a cost of doing business, such costs are not considered finance charges. (See comment 4(a)-2.) Paragraphs 4(b)(7) and (8) 1. Preexisting insurance policy. The insurance discussed in section 226.4(b)(7) and (8) does Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 25

Regulation Z Commentary § 226.4 not include an insurance policy (such as a life or an automobile collision insurance policy) that is already owned by the consumer, even if the policy is assigned to or otherwise made payable to the creditor to satisfy an insurance requirement. Such a policy is not “written in connection with” the transaction, as long as the insurance was not purchased for use in that credit extension, since it was previously owned by the consumer.

2. Insurance written in connection with a transaction. Insurance sold after consumma­ tion in closed-end credit transactions or after the opening of a plan in open-end credit trans­ actions is not “written in connection with” the credit transaction if the insurance is writ­ ten because of the consumer’s default (for ex­ ample, by failing to obtain or maintain re­ quired property insurance) or because the consumer requests insurance after consumma­ tion or the opening of a plan (although creditsale disclosures may be required for the insur­ ance sold after consummation if it is financed).

3. Substitution of life insurance. The premium for a life insurance policy purchased and as­ signed to satisfy a credit life insurance re­ quirement must be included in the finance charge, but only to the extent of the cost of the credit life insurance if purchased from the creditor or the actual cost of the policy (if that is less than the cost of the insurance available from the creditor). If the creditor does not of­ fer the required insurance, the premium to be included in the finance charge is the cost of a policy of insurance of the type, amount, and term required by the creditor. 4. Other insurance. Fees for required insur­ ance not of the types described in section 226.4(b)(7) and (8) are finance charges and are not excludable. For example: • The premium for a hospitalization insur­ ance policy, if it is required to be pur­ chased only in a credit transaction, is a finance charge.

0Paragraph 4(b)(9) 1. Discounts for payment by other than credit. The discounts to induce payment by other than credit mentioned in section 226.4(b)(9) include, for example, the following situation: • The seller of land offers individual tracts for $10,000 each. If the purchaser pays cash, the price is $9,000, but if the pur­ chaser finances the tract with the seller the price is $10,000. The $1,000 difference is a finance charge for those who buy the tracts on credit.

2. Exception for cash discounts. Discounts of­ fered to induce consumers to pay for property or services by cash, check, or other means not involving the use of either an open-end credit plan or a credit card (whether open-end or closed-end credit is extended on the card) may be excluded from the finance charge under section 167(b) of the act (as amended by Pub. L. 97-25, July 27, 1981). The discount may be in whatever amount the seller desires, ei­ ther as a percentage of the regular price (as defined in section 103(z) of the act, as amended) or a dollar amount. This provision applies only to transactions involving an openend credit plan or a credit card. The merchant must offer the discount to prospective buyers whether or not they are cardholders or mem­ bers of the open-end credit plan. The merchant may, however, make other distinc­ tions. For example:

• The merchant may limit the discount to payment by cash and not offer it for pay­ ment by check or by use of a debit card. • The merchant may establish a discount plan that allows a 15 percent discount for payment by cash, a 10 percent discount for payment by check, and a 5 percent dis­ count for payment by a particular credit card. None of these discounts is a finance charge.

Section 171(c) of the act excludes section 167(b) discounts from treatment as a finance charge or other charge for credit under any state usury or disclosure laws. 3. Determination of the regular price. The “regular price” is critical in determining whether the difference between the price charged to cash customers and credit custom­ ers is a “discount” or a “surcharge,” as these terms are defined in amended section 103 of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 26

§ 226.4 Regulation Z Commentary the act. The “regular price” is defined in sec­ tion 103 of the act as “the tag or posted price charged for the property or service if a single price is tagged or posted, or the price charged for the property or service when payment is made by use of an open-end credit account or a credit card if either (1) no price is tagged or posted, or (2) two prices are tagged or posted. . . .” For example, in the sale of mo­ tor vehicle fuel, the tagged or posted price is the price displayed at the pump. As a result, the higher price (the open-end credit or credit card price) must be displayed at the pump, either alone or along with the cash price. Ser­ vice station operators may designate separate pumps or separate islands as being for either cash or credit purchases and display only the appropriate prices at the various pumps. If a pump is capable of displaying on its meter either a cash or a credit price depending upon the consumer’s means of payment, both the cash price and the credit price must be dis­ played at the pump. A service station operator may display the cash price of fuel by itself on a curb sign, as long as the sign clearly indi­ cates that the price is limited to cash purchases.

4(c) Charges Excluded from the Finance Charge Paragraph 4(c)(1) 1. Application fees. An application fee that is excluded from the finance charge is a charge to recover the costs associated with processing applications for credit. The fee may cover the costs of services such as credit reports, credit investigations, and appraisals. The creditor is free to impose the fee in only certain of its loan programs, such as mortgage loans. How­ ever, if the fee is to be excluded from the finance charge under section 226.4(c)(1), it must be charged to all applicants, not just to applicants who are approved or who actually receive credit.

Paragraph 4(c)(2) 1. Late-payment charges.

Late-payment charges can be excluded from the finance charge under section 226.4(c)(2) whether or not the person imposing the charge continues to extend credit on the account or continues to provide property or services to the consumer. In determining whether a charge is for actual unanticipated late payment on a 30-day ac­ count, for example, factors to be considered include:

• The terms of the account. For example, is the consumer required by the account terms to pay the account balance in full each month? If not, the charge may be a finance charge.

• The practices of the creditor in handling the accounts. For example, regardless of the terms of the account, does the creditor allow consumers to pay the accounts over a period of time without demanding payment in full or taking other action to collect? If no effort is made to collect the full amount due, the charge may be a finance charge. Section 226.4(c)(2) applies to late-payment charges imposed for failure to make payments as agreed, as well as failure to pay an account in full when due.

2. Other excluded charges. Charges for “deliquency, default, or a similar occurrence” in­ clude, for example, charges for reinstatement of credit privileges or for submitting as pay­ ment a check that is later returned unpaid. Paragraph 4(c)(3) 1. Assessing interest on an overdraft balance. A charge on an overdraft balance computed by applying a rate of interest to the amount of the overdraft is not a finance charge, even though the consumer agrees to the charge in the account agreement, unless the financial in­ stitution agrees in writing that it will pay such items.

Paragraph 4(c)(4) 1. Participation fees—periodic basis. The par­ ticipation fees mentioned in section 226.4(c)(4) do not necessarily have to be for­ mal membership fees, nor are they limited to credit card plans. The provision applies to any credit plan in which payment of a fee is a condition of access to the plan itself, but it does not apply to fees imposed separately on individual closed-end transactions. The fee Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 27

Regulation Z Commentary § 226.4 may be charged on a monthly, annual, or other periodic basis; a one-time, non-recurring fee imposed at the time an account is opened is not a fee that is charged on a periodic ba­ sis, and may not be treated as a participation fee.

2. Participation fees— exclusions. Minimum monthly charges, charges for non-use of a credit card, and other charges based on either account activity or the amount of credit avail­ able under the plan are not excluded from the finance charge by section 226.4(c)(4). Thus, for example, a fee that is charged and then refunded to the consumer based on the extent to which the consumer uses the credit avail­ able would be a finance charge. (See the com­ mentary to section 226.4(b)(2). Also, see com­ ment 14(c)-7 for treatment of certain types of fees excluded in determining the annual per­ centage rate for the periodic statement.) Paragraph 4(c)(5) 1. Seller’s points. The seller’s points men­ tioned in section 226.4(c)(5) include any charges imposed by the creditor upon the noncreditor seller of property for providing credit "o the buyer or for providing credit on certain terms. These charges are excluded from the finance charge even if they are passed on to the buyer, for example, in the form of a higher sales price. Seller’s points are fre­ quently involved in real estate transactions guaranteed or insured by governmental agen­ cies. A “commitment fee” paid by a non­ creditor seller (such as a real estate developer) to the creditor should be treated as seller’s points. Buyer’s points (that is, points charged to the buyer by the creditor), however, are fi­ nance charges.

2. Other seller-paid amounts. Mortgage insur­ ance premiums and other charges are some­ times paid at or before consummation or set­ tlement on the borrower’s behalf by a noncreditor seller. In such cases, the creditor should treat the payment made by the seller as seller’s points and exclude it from the finance charge. A creditor who gives disclosures before the payment has been made should base them on the best information reasonably available, as called for by the estimate provi­ sions of the regulation.

Paragraph 4(c)(6) 1. Lost interest. Certain federal and state laws mandate a percentage differential between the interest rate paid on a deposit and the rate charged on a loan secured by that deposit. In some situations because of usury limits the creditor must reduce the interest rate paid on the deposit and, as a result, the consumer loses some of the interest that would other­ wise have been earned. Under section 226.4(c)-(6), such “lost interest” need not be included in the finance charge. This rule ap­ plies only to an interest reduction imposed be­ cause a rate differential is required by law and a usury limit precludes compliance by any other means. If the creditor imposes a differ­ ential that exceeds that required, only the lost interest attributable to the excess amount is a finance charge. (See the commentary to sec­ tion 226.4(a).) Paragraph 4(c)(7) 1. Real estate or residential mortgage trans­ action charges. The list of charges in section 226.4(c)(7) applies both to residential mort­ gage transactions (which may include, for ex­ ample, the purchase of a mobile home) and to other transactions secured by real estate. The fees are excluded from the finance charge even if the services for which the fees are imposed are performed by the creditor’s em­ ployees rather than by a third party. In addi­ tion, the cost of verifying or confirming infor­ mation connected to the item is also excluded. For example, credit-report fees cover not only the cost of the report but also the cost of veri­ fying information in the report. In all cases, charges excluded under section 226.4(c)(7) must be bona fide and reasonable. 2. Lump-sum charges. If a lump sum charged for several services includes a charge that is not excludable, a portion of the total should be allocated to that service and included in the finance charge. However, a lump sum charged for conducting or attending a closing (for example, by a lawyer or a title company) is excluded from the finance charge if the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 28

§ 226.4 Regulation Z Commentary charge is primarily for services related to items listed in section 226.4(c)(7) (for exam­ ple, reviewing or completing documents), even if other incidental services such as ex­ plaining various documents or disbursing funds for the parties are performed. The entire charge is excluded even if a fee for the inci­ dental services would be a finance charge if it were imposed separately.

3. Charges assessed during the loan term. Real estate or residential mortgage transaction charges excluded under section 226.4(c)(7) are those charges imposed solely in connection with the initial decision to grant credit. This would include, for example, a fee to search for tax liens on the property or to determine if flood insurance is required. The exclusion does not apply to fees for services to be per­ formed periodically during the loan term, re­ gardless of when the fee is collected. For ex­ ample, a fee for one or more determinations during the loan term of the current tax-lien status or flood-insurance requirements is a fi­ nance charge, regardless of whether the fee is imposed at closing, or when the service is performed. If a creditor is uncertain about what portion of a fee to be paid at consumma­ tion or loan closing is related to the initial decision to grant credit, the entire fee may be treated as a finance charge. 4(d) Insurance 1. General. Section 226.4(d) permits insur­ ance premiums and charges to be excluded from the finance charge. The required disclo­ sures must be made in writing. The rules on location of insurance disclosures for closedend transactions are in section 226.17(a). 2. Timing of disclosures. If disclosures are given early, for example under section 226.17(f) or section 226.19(a), the creditor need not redisclose if the actual premium is different at the time of consummation. If in­ surance disclosures are not given at the time of early disclosure and insurance is in fact written in connection with the transaction, the disclosures under section 226.4(d) must be made in order to exclude the premiums from the finance charge.

3. Premium-rate increases. The creditor should disclose the premium amount based on the rates currently in effect and need not des­ ignate it as an estimate even if the premiums rates may increase. An increase in insurance rates after consummation of a closed-end credit transaction or during the life of an open-end credit plan does not require redis­ closure in order to exclude the additional pre­ mium from treatment as a finance charge. 4. Unit-cost disclosures. One of the transac­ tions for which unit-cost disclosures (such as 50 cents per year for each $100 of the amount financed) may be used in place of the total insurance premium involves a particular kind of insurance plan. For example, a consumer with a current indebtedness of $8,000 is cov­ ered by a plan of credit life insurance cover­ age with a maximum of $10,000. The con­ sumer requests an additional $4,000 loan to be covered by the same insurance plan. Since the $4,000 loan exceeds, in part, the maximum amount of indebtedness that can be covered by the plan, the creditor may properly give the insurance cost disclosures on the $4,000 loan on a unit-cost basis.

5. Required credit life insurance. Credit life, accident, health, or loss-of-income insurance must be voluntary in order for the premiums'* or charges to be excluded from the finance charge. Whether the insurance is in fact re­ quired or optional is a factual question. If the insurance is required, the premiums must be included in the finance charge, whether the in­ surance is purchased from the creditor or from a third party. If the only option the creditor gives the consumer is to purchase credit life insurance from the creditor or to assign an existing life insurance policy, and the con­ sumer purchases the credit life insurance, the premium must be included in the finance charge. (If the consumer assigns a preexisting policy instead, no premium is included in the finance charge. See the commentary to section 226.4(b)(7) and (8).) 6. Other types of voluntary insurance. Insur­ ance is not credit life, accident, health, or loss-of-income insurance if the creditor or the credit account of the consumer is not the ben­ eficiary of the insurance coverage. If such in­ surance is not required by the creditor as an Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 29

Regulation Z Commentary § 226.4 incident to or a condition of credit, it is not covered by section 226.4.

7. Signatures. If the creditor offers a number of insurance options under section 226.4(d), the creditor may provide a means for the con­ sumer to sign or initial for each option, or it may provide for a single authorizing signature or initial with the options selected designated by some other means, such as a check mark. The insurance authorization may be signed or initialed by any consumer, as defined in sec­ tion 226.2(a)(ll), or by an authorized user on a credit card account.

8. Property insurance. To exclude property insurance premiums or charges from the fi­ nance charge, the creditor must allow the con­ sumer to choose the insurer and disclose that fact. This disclosure must be made whether or not the property insurance is available from or through the creditor. The requirement that an option be given does not require that the in­ surance be readily available from other sources. The premium or charge must be dis­ closed only if the consumer elects to purchase 4he insurance from the creditor; in such a case, the creditor must also disclose the term of the property insurance coverage if it is less ‘han the term of the obligation. 9. Single-interest insurance. Blanket and spe­ cific single-interest coverage are treated the same for purposes of the regulation. A charge for either type of single-interest insurance may be excluded from the finance charge if: • The insurer waives any right of subrogation • The other requirements of section 226.4(d)(2) are met. This includes, of course, giving the consumer the option of obtaining the insurance from a person of the consumer’s choice. The creditor need not ascertain whether the consumer is able to purchase the insurance from someone else.

10. Single-interest insurance defined. The term “single-interest insurance” as used in the egulation refers only to the types of coverage traditionally included in the term “vendor’s single-interest insurance” (or “VSI”), that is, protection of tangible property against normal property damage, concealment, confiscation, conversion, embezzlement, and skip. Some comprehensive insurance policies may include a variety of additional coverages, such as re­ possession insurance and holder-in-due-course insurance. These types of coverage do not constitute single-interest insurance for pur­ poses of the regulation, and premiums for them do not qualify for exclusion from the finance charge under section 226.4(d). If a policy that is primarily VSI also provides cov­ erages that are not VSI or other property in­ surance, a portion of the premiums must be allocated to the nonexcludable coverages and included in the finance charge. However, such allocation is not required if the total premium in fact attributable to all of the non-VSI cov­ erages included in the policy is $1.00 or less (or $5.00 or less in the case of a multiyear policy).

11. Initial term. The initial term of insurance coverage determines the period for which a premium amount must be disclosed. In some cases the initial term is clear, for example, a property insurance policy on an automobile written for one year (even though the term of the credit transaction is four years) or a credit life insurance policy for the term of the credit transaction purchased by paying or financing a single premium. In other cases, however, it may not be clear what the initial term of the insurance is, for example, when the consumer agrees to pay a premium that is assessed peri­ odically and the consumer is under no obliga­ tion to continue making the payments. In cases such as this, the cost disclosure may be made on the basis of a premium for one year of insurance coverage. The premium must be clearly labeled as being for one year. 12. Loss-of-income insurance. The loss-ofincome insurance mentioned in section 226.4(d) includes involuntary unemployment insurance, which provides that some or all of the consumer’s payments will be made if the consumer becomes unemployed involuntarily. 4(e) Certain Security-Interest Charges 1. Examples.

i. Excludable charges. Sums must be actu­ ally paid to public officials to be excluded from the finance charge under section Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 30

§ 226.4 Regulation Z Commentary 226.4(e)(1). Examples are charges or other fees required for filing or recording security agreements, mortgages, continuation state­ ments, termination statements, and similar documents, and intangible property or other taxes imposed by the state solely on the credi­ tor and payable by the consumer (if the tax must be paid to record a security agreement). ii. Charges not excludable. If the obligation is between the creditor and a third party (an assignee, for example), charges or other fees for filing or recording security agreements, mortgages, continuation statements, termina­ tion statements, and similar documents relat­ ing to that obligation are not excludable from the finance charge under this section. 2. Itemization. The various charges described in section 226.4(e)(1) may be totaled and dis­ closed as an aggregate sum, or they may be itemized by the specific fees and taxes im­ posed. If an aggregate sum is disclosed, a general term such as security interest fees or “filing fees” may be used.

3. Notary fees. In order for a notary fee to be excluded under section 226.4(e)(1), all of the following conditions must be met: • The document to be notarized is one used to perfect, release, or continue a security interest.

• The document is required by law to be no­ tarized.

• A notary is considered a public official under applicable law.

• The amount of the fee is set or authorized by law.

4. Nonfiling insurance. The exclusion in sec­ tion 226.4(e)(2) is available only if nonfiling insurance is purchased. If the creditor collects and simply retains a fee as a sort of “selfinsurance” against nonfiling, it may not be excluded from the finance charge. If the non­ filing insurance premium exceeds the amount of the fees excludable from the finance charge under section 226.4(e)(1), only the excess is a finance charge. For example: • The fee for perfecting a security interest is $5.00 and the fee for releasing the security interest is $3.00. The creditor charges $10.00 for nonfiling insurance. Only $8.00 of the $10.00 is excludable from the fi­ nance charge.

4(f) Prohibited Offsets 1. Earnings on deposits or investments. The rule that the creditor shall not deduct any earnings by the consumer on deposits or in­ vestments applies whether or not the creditor has a security interest in the property. References Statute: §§ 106, 167, and 171(c) Other sections: §§ 226.9(d) and 226.12 Previous regulation: § 226.4 and interpreta­ tions § 226.401 through 226.407. 1981 changes: While generally continuing the rules under the previous regulation, section 226.4 reflects amendments to section 106 of the act and makes certain other changes in the rules for determining the finance charge. For example, section 226.4(a) expressly excludes from the finance charge amounts payable in comparable cash transactions. Section 226.8(o) of the previous regulation, dealing with dis­ counts for prompt payment of a credit sale, was deleted in the revised regulation since the general test for a finance charge now focuses on a comparison of cash and credit transac­ tions. With respect to various exclusions from the finance charge: application fees imposed on all applicants are no longer finance charges, continuing to extend credit to a con­ sumer is no longer a controlling test for deter­ mining whether a late payment charge is bona fide, seller’s points are not to be included in the finance charge, and the special exclusions for real estate transactions apply to all “resi­ dential mortgage transactions.” The simplified rules for excluding insurance from the finance charge allow unit-cost disclo­ sure in certain closed-end credit transactions, permit initials as well as signatures on the au­ thorization, permit any consumer to authorize insurance for other consumers, and delete the requirement that the authorization be sepa­ rately dated.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 31

Regulation Z Commentary § 226.5 SUBPART B—OPEN-END CREDIT SECTION 226.5—General Disclosure Requirements 5(a) Form of Disclosures clearly labelled to show that they relate to one another A brochure that contains disclosures and explanatory material about a range of ser­ vices the creditor offers, such as credit, checking account, and electronic fund transfer features Paragraph 5(a)(1) 1. Clear and conspicuous. The “clear and conspicuous” standard requires that disclo­ sures be in a reasonably understandable form. It does not require that disclosures be segre­ gated from other material or located in any particular place on the disclosure statement, or that numerical amounts or percentages be in any particular type size. The standard does not prohibit:

• Pluralizing required terminology (“finance charge” and “annual percentage rate”) • Adding to the required disclosures such items as contractual provisions, explana­ tions of contract terms, state disclosures, 4 ^ and translations • Sending promotional material with the re­ quired disclosures • Using commonly accepted or readily un­ derstandable abbreviations (such as “mo.” for “ month” or “ Tx.” for “ Texas” ) in making any required disclosures • Using codes or symbols such as “APR” (for annual percentage rate), “FC” (for fi­ nance charge), or “Cr” (for credit balance), so long as a legend or description of the code or symbol is provided on the disclo­ sure statement 2. Integrated document. The creditor may make both the initial disclosures (§ 226.6) and the periodic-statement disclosures (§ 226.7) on more than one page, and use both the front and the reverse sides, so long as the pages constitute an integrated document. An inte­ grated document would not include disclosure pages provided to the consumer at different times or disclosures interspersed on the same I page with promotional material. An integrated iocument would include, for example: • Multiple pages provided in the same enve­ lope that cover related material and are folded together, numbered consecutively, or Paragraph 5(a)(2) 1. When disclosures must be “more conspicu­ ous.” The terms “finance charge” and “an­ nual percentage rate,” when required to be used with a number, must be disclosed more conspicuously than other required disclosures, except in the two cases provided in footnote 9. At the creditor’s option, “finance charge” and “annual percentage rate” may also be disclosed more conspicuously than the other required disclosures even when the regulation does not so require. The following examples illustrate these rules:

• In disclosing the annual percentage rate as required by section 226.6(a)(2), the term “annual percentage rate” is subject to the “more conspicuous” rule.

• In disclosing the amount of the finance charge, required by section 226.7(f), the term “finance charge” is subject to the “more conspicuous” rule.

• Although neither “finance charge” nor “annual percentage rate” need be empha­ sized when used as part of general infor­ mational material or in textual descriptions of other terms, emphasis is permissible in such cases. For example, when the terms appear as part of the explanations required under section 226.6(a)(3) and (4), they may be equally conspicuous as the disclosures required under sections 226.6(a)(2) and 226.7(g).

2. Making disclosures more conspicuous. In disclosing the terms “finance charge” and “annual percentage rate” more conspicuously, only the words “finance charge” and “annual percentage rate” should be accentuated. For example, if the term “total finance charge” is used, only “finance charge” should be empha­ sized. The disclosures may be made more conspicuous by, for example: Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 32

§ 226.5 Regulation Z Commentary • Capitalizing the words when other disclo­ sures are printed in lower case • Putting them in bold print or a contrasting color • Underlining them • Setting them off with asterisks • Printing them in larger type 3. Disclosure of figures—exception to “more conspicuous” rule. The terms “annual per­ centage rate” and “finance charge” need not be more conspicuous than figures (including, for example, numbers, percentages, and dollar signs).

5(b) Time of Disclosures 5(b)(1) Initial disclosures 1. Disclosure before the first transaction. The rule that the initial disclosure statement must be furnished “before the first transaction” re­ quires delivery of the initial disclosure state­ ment before the consumer becomes obligated on the plan. For example, the initial disclo­ sures must be given before the consumer makes the first purchase (such as when a con­ sumer opens a credit plan and makes purchases contemporaneously at a retail store), receives the first advance, or pays any fees or charges under the plan other than an applica­ tion fee or refundable membership fee (see below). The prohibition on the payment of fees other than application or refundable membership fees before initial disclosures are provided does not apply to home-equity plans subject to section 226.5b. See the commentary to section 226.5b(h) regarding the collection of fees for home-equity plans covered by sec­ tion 226.5b.

• If the consumer pays a membership fee before receiving the Truth in Lending dis­ closures, or the consumer agrees to the im­ position of a membership fee at the time of application and the Truth in Lending dis­ closure statement is not given at that time, disclosures are timely as long as the con­ sumer, after receiving the disclosures, can reject the plan. The creditor must refund the membership fee if it has been paid, or clear the account if it has been debited to the consumer’s account.

• If the consumer receives a cash advance check at the same time the Truth in Lend­ ing disclosures are provided, disclosures are still timely if the consumer can, after receiving the disclosures, return the cash advance check to the creditor without obli­ gation (for example, without paying finance charges).

• Initial disclosures need not be given before the imposition of an application fee under section 226.4(c)(1).

• If, after receiving the disclosures, the con­ sumer uses the account, pays a fee, or ne­ gotiates a cash advance check, the creditor may consider the account not rejected for purposes of this section.

2. Reactivation of suspended account. If an account is temporarily suspended (for exam­ ple, because the consumer has exceeded a credit limit, or because a credit card is re­ ported lost or stolen) and then is reactivated, no new initial disclosures are required. 3. Reopening closed account. If an account has been closed (for example, due to inactiv­ ity, cancellation, or expiration) and then is re­ opened, new initial disclosures are required. No new initial disclosures are required, how­ ever, when the account is closed merely to assign it a new number (for example, when a credit card is reported lost or stolen) and the “new” account then continues on the same terms.

4. Converting closed-end to open-end credit. If a closed-end credit transaction is converted to an open-end credit account under a written agreement with the consumer, the initial dis­ closures under section 226.6 must be given before the consumer becomes obligated on the open-end credit plan. (See the commentary to section 226.17 on converting open-end credit to closed-end credit.) 5. Balance transfers. A creditor that solicits the transfer by a consumer of outstanding bal­ ances from an existing account to a new open-end plan must comply with section 226.6 before the balance transfer occurs. Card issuers that are subject to the requirements of section 226.5a may establish procedures that comply with both sections in a single disclo­ sure statement.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 33

Regulation Z Commentary § 226.5 5(b)(2) Periodic Statements *'aragraph 5(b)(2)(i) 1. Periodic statements not required. Periodic statements need not be sent in the following cases:

• If the creditor adjusts an account balance so that at the end of the cycle the balance is less than $1—so long as no finance charge has been imposed on the account for that cycle • If a statement was returned as undeliver­ able. If a new address is provided, howev­ er, within a reasonable time before the creditor must send a statement, the creditor must resume sending statements. Receiving the address at least 20 days before the end of a cycle would be a reasonable amount of time to prepare the statement for that cycle. For example, if an address is re­ ceived 22 days before the end of the June cycle, the creditor must send the periodic statement for the June cycle. (See section 226.13(a)(7).) 2. Termination of credit privileges. When an open-end account is terminated without being 'onverted to closed-end credit under a written .greement, the creditor must continue to pro­ vide periodic statements to those consumers entitled to receive them under section 226.5(b)(2)(i) (for example, when an open-end credit plan ends and consumers are paying off outstanding balances) and must continue to follow all of the other open-end credit require­ ments and procedures in subpart B. Paragraph 5(b)(2)(ii) 1. 14-day rule. The 14-day rule for mailing or delivering periodic statements does not apply if charges (for example, transaction or activity charges) are imposed regardless of the timing of a periodic statement. The 14-day rule does apply, for example:

If current debits retroactively become sub­ ject to finance charges when the balance is not paid in full by a specified date • If charges other than finance charges will accrue when the consumer does not make timely payments (for example, late pay­ ment charges or charges for exceeding a credit limit) 2. Computer malfunction. Footnote 10 does not extend to the failure to provide a periodic statement because of computer malfunction. 3. Calling for periodic statements. The credi­ tor may permit consumers to call for their pe­ riodic statements but may not require them to do so. If the consumer wishes to pick up the statement and the plan has a free-ride period, the statement must be made available in ac­ cordance with the 14-day rule. 5(c) Basis of Disclosures and Use of Estimates 1. Legal obligation. The disclosures should reflect the credit terms to which the parties are legally bound at the time of giving the disclosures.

• The legal obligation is determined by ap­ plicable state or other law. • The fact that a term or contract may later be deemed unenforceable by a court on the basis of equity or other grounds does not, by itself, mean that disclosures based on that term or contract did not reflect the le­ gal obligation.

• The legal obligation normally is presumed to be contained in the contract that evi­ dences the agreement. But this may be re­ butted if another agreement between the parties legally modifies that contract. 2. Estimates—obtaining information. Disclo­ sures may be estimated when the exact infor­ mation is unknown at the time disclosures are made. Information is unknown if it is not rea­ sonably available to the creditor at the time disclosures are made. The “reasonably avail­ able” standard requires that the creditor, act­ ing in good faith, exercise due diligence in obtaining information. In using estimates, the creditor is not required to disclose the basis for the estimated figures, but may include such explanations as additional information. The creditor normally may rely on the repre­ sentations of other parties in obtaining infor­ mation. For example, the creditor might look Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 34

§ 226.5 Regulation Z Commentary to insurance companies for the cost of insurance.

3. Estimates— redisclosure. If the creditor makes estimated disclosures, redisclosure is not required for that consumer, even though more accurate information becomes available before the first transaction. For example, in an open-end plan to be secured by real estate, the creditor may estimate the appraisal fees to be charged; such an estimate might reasonably be based on the prevailing market rates for simi­ lar appraisals. If the exact appraisal fee is de­ terminable after the estimate is furnished but before the consumer receives the first advance under the plan, no new disclosure is necessary.

5(d) Multiple Creditors; Multiple Consumers 1. Multiple creditors. Under section 226.5(d): • Creditors must choose which of them will make the disclosures • A single, complete set of disclosures must be provided, rather than partial disclosures from several creditors • All disclosures for the open-end credit plan must be given, even if the disclosing credi­ tor would not otherwise have been obligat­ ed to make a particular disclosure 2. Multiple consumers. Disclosures may be made to either obligor on a joint account. Dis­ closure responsibilities are not satisfied by giving disclosures to only a surety or guaran­ tor for a principal obligor or to an authorized user. In rescindable transactions, however, separate disclosures must be given to each consumer who has the right to rescind under section 226.15.

5(e) Effect of Subsequent Events 1. Events causing inaccuracies. Inaccuracies in disclosures are not violations if attributable to events occurring after disclosures are made. For example, when the consumer fails to ful­ fill a prior commitment to keep the collateral insured and the creditor then provides the cov­ erage and charges the consumer for it, such a change does not make the original disclosures inaccurate. The creditor may, however, be required to provide a new disclosure(s) under section 226.9(c).

2. Use of inserts. When changes in a credi­ tor’s plan affect required disclosures, the cred­ itor may use inserts with outdated disclosure forms. Any insert:

• Should clearly refer to the disclosure provi­ sion it replaces • Need not be physically attached or affixed to the basic disclosure statement • May be used only until the supply of out­ dated forms is exhausted References Statute: §§ 121(a) through (c), 122(a) and (b), 124, 127(a) and (b), and 163(a) Other sections: §§ 226.6, 226.7, and 226.9 Previous regulation: §§ 226.6(a) and (c) through (g), and 226.7(a) through (c) 1981 changes: Section 226.5 implements amendments to the act and reflects several simplifying changes to the regulation. The use of required terminology, except for “finance charge” and “annual percentage rate,” is no longer required. Type size requirements have been deleted. Initial and periodic statement disclosures may be multipage, so long as they constitute an integrated statement. New rules are provided for the basis of disclosures and for the use of estimates. The rules for credit plans involving multiple creditors or multiple consumers now provide that only one creditor need make the disclosures and that the disclo­ sures need be made to only one primarily lia­ ble consumer.

SECTION 226.5a—Credit and Charge Card Applications and Solicitations 1. General. Section 226.5a generally requires that credit disclosures be contained in applica­ tion forms and preapproved solicitations initi­ ated by a card issuer to open a credit or charge card account. (See the commentary to section 226.5a(a)(3) and 226.5a(e) for excep­ tions; see also section 226.2(a)(15) and ac­ companying commentary for the definition of charge card.) 2. Combining disclosures. The initial disclo- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 35

Regulation Z Commentary § 226.5a sures required by section 226.6 do not substi­ tute for the disclosures required by section 226.5a; however, a card issuer may establish procedures so that a single disclosure state­ ment meets the requirements of both sections. For example, if a card issuer in complying with section 226.5a(e)(2) provides all the ap­ plicable disclosures required under section 226.6, in a form that the consumer may keep and in accordance with the other format and timing requirements for that section, the issuer satisfies the initial disclosure requirements under section 226.6 as well as the disclosure requirements of section 226.5a(e)(2). Or if, in complying with section 226.5a(c) or 226.5a(d)(2), a card issuer provides an inte­ grated document that the consumer may keep, and provides the section 226.5a disclosures (in a tabular format) along with the additional disclosures required under section 226.6 (pre­ sented outside of the table), the card issuer satisfies the requirements of both sections 226.5a and 226.6.

a(a) General Rules 5a(a)(2) Form of Disclosures Prominent location. Certain of the required sclosures provided on or with an application or solicitation must be prominently lo­ cated—that is, readily noticeable to the con­ sumer. There are, however, no requirements that the disclosures be in any particular loca­ tion or in any particular type size or typeface. 2. Multiple accounts or varying terms. If a tabular format is required to be used, card is­ suers offering several types of accounts may disclose the various terms for the accounts in a single table or may provide a separate table for each account. Similarly, if rates or other terms vary from state to state, card issuers may list the states and the various disclosures in a single table or in separate tables. 3. Additional information. The table contain­ ing the disclosures required by section 226.5a should contain only the information required or permitted by this section. (See the com­ mentary to section 226.5a(b) for guidance on information permitted in the table.) Other credit information may be presented on or with an application or solicitation, provided such information appears outside the required table.

4. Location of certain disclosures. A card is­ suer has the option of disclosing any of the fees in section 226.5a(b)(8) through (10) in the required table or outside the table. 5. Terminology.

In general, section 226.5a(a)(2)(iv) requires that the terminology used for the disclosures specified in section 226.5a(b) be consistent with that used in the disclosures under sections 226.6 and 226.7. This standard requires that the section 226.5a(b) disclosures be close in meaning to those under sections 226.6 and 226.7; how­ ever, the terminology used need not be identi­ cal. In addition, section 226.5a(a)(2)(i) re­ quires that the headings, content, and format of the tabular disclosures be substantially sim­ ilar, but need not be identical, to the tables in appendix G. A special rule applies to the grace-period disclosure, however; the term “grace period” must be used, either in the heading or in the text of the disclosure. 6. Deletion of inapplicable disclosures. Gen­ erally, disclosures need only be given as ap­ plicable. Card issuers may, therefore, delete inapplicable headings and their corresponding boxes in the table. For example, if no transac­ tion fee is imposed for purchases, the disclo­ sure form may contain the heading “Transac­ tion fee for purchases” and a box showing “none,” or the heading and box may be de­ leted from the table. There is an exception for the grace-period disclosure, however; even if no grace period exists, that fact must be stated.

5a(a)(3) Exceptions 1. Coverage. Certain exceptions to the cover­ age of section 226.5a are stated in section 226.5a(a)(3); in addition, the requirements of section 226.5a do not apply to the following: • Lines of credit accessed solely by account numbers • Addition of a credit or charge card to an existing open-end plan 2. Noncoverage of “consumer-initiated” re­ quests. Applications provided to a consumer Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 36

§ 226.5a Regulation Z Commentary upon request are not covered by section 226.5a, even if the request is made in re­ sponse to the card issuer’s invitation to apply for a card account. To illustrate, if a card is­ suer invites consumers to call a toll-free num­ ber or to return a response card to obtain an application, the application sent in response to the consumer’s request need not contain the disclosures required under section 226.5a. Similarly, if the card issuer invites consumers to call and make an oral application on the telephone, section 226.5a does not apply to the application made by the consumer. If, however, the card issuer calls a consumer or initiates a telephone discussion with a con­ sumer about opening a card account and con­ temporaneously takes an oral application, such applications are subject to section 226.5a, spe­ cifically section 226.5a(d). 3. General-purpose applications. The require­ ments of this section do not apply to generalpurpose applications unless the application, or material accompanying it, indicates that it can be used to open a credit or charge card account.

5a(a)(5) Certain Fees that Vary by State 1. Manner of disclosing range. If the card is­ suer discloses a range of fees instead of dis­ closing the amount of the fee imposed in each state, the range may be stated as the lowest authorized fee (zero, if there are one or more states where no fee applies) to the highest au­ thorized fee.

5a(b) Required Disclosures 5a(b)(l) Annual Percentage Rate 1. Periodic rate. The periodic rate, expressed as such, may be disclosed in the table in addi­ tion to the required disclosure of the corre­ sponding annual percentage rate. 2. Variable-rate accounts— definition. For pur­ poses of section 226.5a(b)(l), a variable-rate account exists when rate changes are part of the plan and are tied to an index or formula. (See the commentary to section 226.6(a)(2) for examples of variable-rate plans.) variable-rate disclosures in direct-mail applica­ tions and solicitations subject to sectior 226.5a(c), and in applications and solicitations made available to the general public subject to section 226.5a(e), the rules concerning accu­ racy of the annual percentage rate are stated in section 226.5a(b)(l)(ii). For variable-rate disclosures in telephone applications and so­ licitations subject to section 226.5a(d), the card issuer must provide an annual percentage rate currently applicable when oral disclosures are provided under section 226.5a(d)(l). For the alternate disclosures under section 226.5a(d)(2), the card issuer must provide the annual percentage rate in effect at the time the disclosures are mailed or delivered. A rate in effect also includes the rate as of a specified date (which rate is then updated from time to time, for example, each calendar month) or an estimated rate provided in accordance with section 226.5(c).

4. Variable-rate accounts—other disclosures. In describing how the applicable rate will be determined, the card issuer must identify the index or formula and disclose any margin oi spread added to the index or formula in set­ ting the rate. The card issuer may disclose the margin or spread as a range of the highest and lowest margins that may be applicable to the account. A disclosure of any applicable limita­ tions on rate increases or decreases may also be included in the table.

5. Introductory rates—discounted rates. If the initial rate is temporary and is lower than the rate that will apply after the temporary rate expires, the card issuer must disclose the an­ nual percentage rate that would otherwise ap­ ply to the account. In a fixed-rate account, the card issuer must disclose the rate that will ap­ ply after the introductory rate expires. In a variable-rate account, the card issuer must dis­ close a rate based on the index or formula applicable to the account in accordance with the rules in section 226.5a(b)(l)(ii) and com­ ment 5a(b)(l)-3. An initial discounted rate may be provided in the table along with the rate required to be disclosed if the card issuer also discloses the time period during which the introductory rate will remain in effect. 3. Variable-rate accounts—rates in effect. For -6. Introductory rates—premium rates. If the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 37

Regulation Z Commentary § 226.5a initial rate is temporary and is higher than the permanently applicable rate, the card issuer must disclose the initial rate. The issuer may disclose in the table the rate that would other­ wise apply if the issuer also discloses the time period during which the initial rate will re­ main in effect.

5a(b)(2) Fees for Issuance or Availability 1. Membership fees. Membership fees for opening an account must be disclosed under this paragraph. A membership fee to join an organization that provides a credit or charge card as a privilege of membership must be disclosed only if the card is issued automati­ cally upon membership. Such a fee need not be disclosed if membership results merely in eligibility to apply for an account. 2. Enhancements. Fees for optional services in addition to basic membership privileges in a credit or charge card account (for example, travel insurance or card-registration services) should not be disclosed in the table if the ba­ sic account may be opened without paying such fees.

3. One-time fees. Disclosure of nonperiodic fees is limited to fees related to opening the account, such as one-time membership fees. The following are examples of fees that should not be disclosed in the table: • Fees for reissuing a lost or stolen card • Statement-reproduction fees • Application fees described in section 226.4(c)(1) 4. Waived or reduced fees. If fees required to be disclosed are waived or reduced for a lim­ ited time, the introductory fees or the fact of fee waivers may be provided in the table in addition to the required fees if the card issuer also discloses how long the fees or waivers will remain in effect.

5. Fees stated as annual amount. Fees im­ posed periodically must be stated as an annual total. For example, if a fee is imposed quar­ terly, the disclosures would state the total amount of the fees for one year. (See, how­ ever, the commentary to section 226.9(e) with regard to disclosure of such fees in renewal notices.) 5a(b)(4) Transaction Charges 1. Charges imposed by person other than card issuer. Charges imposed by a third party, such as a seller of goods, would not be dis­ closed under this section; the third party would be responsible for disclosing the charge under section 226.9(d)(1).

5a(b)(5) Grace Period 1. How disclosure is made. The card issuer may, but need not, refer to the beginning or ending point of any grace period and briefly state any conditions on the applicability of the grace period. For example, the grace period disclosure might read “30 days” or “30 days from the date of the periodic statement (pro­ vided you have paid your previous balance in full by the due date).”

5a(b)(6) Balance-Computation Method 1. Form of disclosure. In cases where the card issuer uses a balance-calculation method that is identified by name in the regulation, the card issuer may only disclose the name of the method in the table. In cases where the card issuer uses a balance-computation method that is not identified by name in the regulation, the disclosure in the table should clearly explain the method in as much detail as set forth in the descriptions of balance methods in section 226.5a(g). The explanation need not be as detailed as that required for the disclosures under section 226.6(a)(3). (See the commentary to section 226.5a(g) for guidance on particular methods.) 2. Determining the method. In determining the appropriate balance-computation method for purchases for disclosure purposes, the card issuer must assume that a purchase balance will exist at the end of any grace period. Thus, for example, if the average-daily-bal­ ance method will include new purchases or cover two billing cycles only if purchase bal­ ances are not paid within the grace period, the card issuer would disclose the name of the average-daily-balance method that includes new purchases or covers two billing cycles, respectively. The card issuer should not as­ sume the existence of a purchase balance, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 38

§ 226.5a Regulation Z Commentary however, in making other disclosures under section 226.5a(b).

5a(b)(7) Statement on Charge Card Payments 1. Applicability and content. The disclosure that charges are payable upon receipt of the periodic statement is applicable only to charge card accounts. In making this disclosure, the card issuer may make such modifications as are necessary to more accurately reflect the circumstances of repayment under the account. For example, the disclosure might read, “Charges are due and payable upon receipt of the periodic statement and must be paid no later than 15 days after receipt of such statement.”

5a(b)(8) Cash-Advance Fee 1. Applicability. The card issuer must disclose only those fees it imposes for a cash advance that are finance charges under section 226.4. For example, a charge for a cash advance at an automated teller machine (ATM) would be disclosed under section 226.5a(b)(8) if no similar charge is imposed for ATM transac­ tions not involving an extension of credit. (See comment 4(a)-5 for a description of such a fee.) 5a(b)(9) Late-Payment Fee 1. Applicability. The disclosure of the fee for a late payment includes only those fees that will be imposed for actual, unanticipated late payments. (See the commentary to section 226.4(c)(2) for additional guidance on latepayment fees.) 5a(b)(10) Over-the-Limit Fee 1. Applicability. The disclosure of fees for ex­ ceeding a credit limit does not include fees for other types of default or for services re­ lated to exceeding the limit. For example, no disclosure is required of fees for reinstating credit privileges or fees for the dishonor of checks on an account that, if paid, would cause the credit limit to be exceeded. 5a(c) Direct-Mail Applications and Solicitations 1. Accuracy. In general, disclosures in directmail applications and solicitations must be ac­ curate as of the time of mailing. (An accurate variable annual percentage rate is one in effect within 60 days before mailing.) 2. Mailed publications. Applications or solici­ tations contained in generally available publi­ cations mailed to consumers (such as sub­ scription magazines) are subject to the requirements applicable to “take-ones” in sec­ tion 226.5a(e), rather than the direct-mail re­ quirements of section 226.5a(c). However, if a primary purpose of a card issuer’s mailing is to offer credit or charge card accounts—for example, where a card issuer “prescreens” a list of potential cardholders using credit crite­ ria, and then mails to the targeted group its catalog containing an application or a solicita­ tion for a card account—the direct-mail rules apply. In addition, a card issuer may use a single application form as a “take-one” (in racks in public locations, for example) and for direct mailings, if the card issuer complies with the requirements of section 226.5a(c) even when the form is used as a “takeone”—that is, by presenting the required sec­ tion 226.5a disclosures in a tabular format. When used in a direct mailing, the credit-term disclosures must be accurate as of the mailing date, whether or not the section 226.5a (e)(l)(ii) and (iii) disclosures are included; when used in a take-one, the disclosures must be accurate for as long as the takeone forms remain available to the public if the section 226.5a(e)(l)(ii) and (iii) disclosures are omit­ ted. (If those disclosures are included in the take-one, the credit term disclosures need only be accurate as of the printing date.) 5a(d) Telephone Applications and Solicitations 1. Coverage. This paragraph applies if: • A telephone conversation between a card issuer and consumer may result in the issu­ ance of a card as a consequence of an issu­ er-initiated offer to open an account for which the issuer does not require any ap- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 39

Regulation Z Commentary § 226.5a plication (that is, a “preapproved” tele­ phone solicitation).

The card issuer initiates the contact and at the same time takes application information over the telephone.

This paragraph does not apply to: • Telephone applications initiated by the con­ sumer.

• Situations where no card will be is­ sued—because, for example, the consumer indicates that he or she does not want the card, or the card issuer decides either dur­ ing the telephone conversation or later not to issue the card.

5a(e) Applications and Solicitations Made Available to General Public 1. Coverage. Applications and solicitations made available to the general public include what are commonly referred to as “take-one” applications typically found at counters in banks and retail establishments, as well as ap­ plications contained in catalogs, magazines and other generally available publications. In the case of credit unions, this paragraph ap­ plies to applications and solicitations to open card accounts made available to those in the general field of membership. 2. Cross-selling. If a card issuer invites a con­ sumer to apply for a credit or charge card (for example, where the issuer engages in cross­ selling), an application provided to the con­ sumer at the consumer’s request is not consid­ ered an application made available to the gen­ eral public and therefore is not subject to section 226.5a(e). For example, the following are not covered:

A consumer applies in person for a car loan at a financial institution and the loan officer invites the consumer to apply for a credit or charge card account; the consumer accepts the invitation.

An employee of a retail establishment, in the course of processing a sales transaction using a bank credit card, asks a customer if he or she would like to apply for the retail­ er’s credit or charge card; the customer re­ sponds affirmatively.

3. Toll-free telephone number. If a card issuer, in complying with any of the disclosure op­ tions of section 226.5a(e), provides a tele­ phone number for consumers to call to obtain credit information, the number must be tollfree for nonlocal calls made from an area code other than the one used in the card is­ suer’s dialing area. Alternatively, a card issuer may provide any telephone number that al­ lows a consumer to call for information and reverse the telephone charges. 5a(e)(l) Disclosure of Required Credit Information 1. Date of printing. Disclosure of the month and year fulfills the requirement to disclose the date an application was printed. 2. Form of disclosures. The disclosures speci­ fied in section 226.5a(e)(l)(ii) and (iii) may appear either in or outside the table containing the required credit disclosures. 5a(e)(2) Inclusion of Certain Initial Disclosures 1. Accuracy of disclosures. The disclosures required by section 226.5a(e)(2) generally must be current as of the time they are made available to the public. Disclosures are consid­ ered to be made available at the time they are placed in public locations (in the case of “take-ones”) or mailed to consumers (in the case of publications).

2. Accuracy— exception. If a card issuer dis­ closes all the information required by section 226.5a(e)(l)(ii) on the application or solicita­ tion, the disclosures under section 226.5a(e)(2) need only be current as of the date of print­ ing. (A current variable annual percentage rate would be one in effect within 30 days before printing.) 5a(e)(3) No Disclosure of Credit Information 1. When disclosure option available. A card issuer may use this option only if the issuer does not include on or with the application or solicitation any statement that refers to the credit disclosures required by section 226.5a(b). Statements such as “no annual fee,” “low interest rate,” “favorable rates,” and “low costs” are deemed to refer to the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 40

§ 226.5a Regulation Z Commentary required credit disclosures and, therefore, may not be included on or with the solicitation or application, if the card issuer chooses to use this option.

5a(e)(4) Prompt Response to Requests for Information 1. Prompt disclosure. Information is promptly disclosed if it is given within 30 days of a consumer’s request for information but in no event later than delivery of the credit or charge card.

2. Information disclosed. When a consumer requests credit information, card issuers need not provide all the required credit disclosures in all instances. For example, if disclosures have been provided in accordance with section 226.5a(e)(l) or (2) and a consumer calls or writes a card issuer to obtain information about changes in the disclosures, the issuer need only provide the items of information that have changed from those previously dis­ closed on or with the application or solicita­ tion. If a consumer requests information about particular items, the card issuer need only pro­ vide the requested information. If, however, the card issuer has made disclosures in accor­ dance with the option in section 226.5a(e)(3) and a consumer calls or writes the card issuer requesting information about costs, all the re­ quired disclosure information must be given. 3. Manner of response. A card issuer’s re­ sponse to a consumer’s request for credit in­ formation may be provided orally or in writ­ ing, regardless of the manner in which the consumer’s request is received by the issuer. Furthermore, the card issuer may provide the information listed in either section 226.5a(e)(l) or (2). Information provided in writing need not be in a tabular format. 5a(f) Special Charge Card Rule—Card Issuer and Person Extending Credit Not the Same Person 1. Duties of charge card issuer. Although the charge card issuer is not required to disclose information about the underlying open-end credit plan if the card issuer meets the condi­ tions set forth in section 226.5a(f), the card issuer must disclose the information relating to the charge card plan itself. 2. Duties of creditor maintaining open-end plan. Section 226.5a does not impose disclo­ sure requirements on the creditor that main­ tains the underlying open-end credit plan. This is the case even though the creditor offering the open-end credit plan may be considered an agent of the charge card issuer. (See comment 2(a)(7)-1.) 3. Form of disclosures. The disclosures re­ quired by section 226.5a(f) may appear either in or outside the table containing the required credit disclosures in circumstances where a tabular format is required.

5a(g) Balance-Computation Methods Defined 1. Daily-balance method. Card issuers using the daily-balance method may disclose it us­ ing the name “average daily balance (includ­ ing new purchases)” or “average daily bal­ ance (excluding new purchases),”

as appropriate. Alternatively, such card issuers may explain the method. (See comment 7(e)-5 for a discussion of the daily-balance method.) 2. Two-cycle average-daily-balance methods. The “two-cycle average-daily-balance” meth­ ods described in section 226.5a(g)(2)(i) and (ii) include those methods in which the aver­ age daily balances for two billing cycles may be added together to compute the finance charge. Such methods also include those in which a periodic rate is applied separately to the balance in each cycle, and the resulting finance charges are added together. The method is a “two-cycle average daily bal­ ance” even if the finance charge is based on both the current- and prior-cycle balances only under certain circumstances, such as when purchases during a prior cycle were carried over into the current cycle and no finance charge was assessed during the prior cycle. Furthermore, the method is a “two-cycle aver­ age-daily-balance method” if the balances for both the current and prior cycles are average daily balances, even if those balances are fig­ ured differently. For example, the name “twocycle average-daily-balance (excluding new purchases)” should be used to describe a Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 41

Regulation Z Commentary § 226.5b method in which the finance charge for the current cycle, figured on an average daily bal­ ance excluding new purchases, will be added to the finance charge for the prior cycle, fig­ ured on an average daily balance of only new purchases during that prior cycle. SECTION 226.5b—Requirements for Home-Equity Plans 2. Changes to home-equity plans entered into on or after November 7, 1989. Section 226.9(c) applies if, by written agreement under section 226.5b(f)(3)(iii), a creditor changes the terms of a home-equity plan—entered into on or after November 7, 1989—at or before its scheduled expiration, for example, by renewing a plan on different O terms. A new plan results, however, if the plan is renewed (with or without changes to the terms) after the scheduled expiration. The new plan is subject to all open-end credit rules, including sections 226.5b, 226.6, and 226.15.

3. Transition rules and renewals of preexist­ ing plans. The requirements of this section do not apply to home-equity plans entered into before November 7, 1989. The requirements of this section also do not apply if the original consumer, on or after November 7, 1989, re­ news a plan entered into prior to that date (with or without changes to the terms). If, on or after November 7, 1989, a security interest in the consumer’s dwelling is added to a line of credit entered into before that date, the sub­ stantive restrictions of this section apply for O the remainder of the plan, but no new disclo­ sures are required under this section. 4. Disclosure of repayment phase—applica bility of requirements. Some plans provide in the initial agreement for a period during which no further draws may be taken and re­ payment of the amount borrowed is made. All of the applicable disclosures in this section must be given for the repayment phase. Thus, for example, a creditor must provide payment information about the repayment phase as well as about the draw period, as required by sec­ tion 266.5b(d)(5). If the rate that will apply during the repayment phase is fixed at a known amount, the creditor must provide an annual percentage rate under section 226.5b(d)(6) for that phase. If, however, a creditor uses an index to determine the rate that will apply at the time of conversion to the repayment phase—even if the rate will thereafter be fixed—the creditor must provide the information in section 226.5b(d)(12), as applicable.

5. Payment terms—applicability of closed-end provisions and substantive rules. All payment terms that are provided for in the initial agree­ ment are subject to the requirements of sub­ part B and not subpart C of the regulation. Payment terms that are subsequently added to the agreement may be subject to subpart B or to subpart C, depending on the circumstances. The following examples apply these general rules to different situations: • If the initial agreement provides for a re­ payment phase or for other payment terms such as options permitting conversion of part or all of the balance to a fixed rate during the draw period, these terms must be disclosed pursuant to sections 226.5b and 226.6, and not under subpart C. Fur­ thermore, the creditor must continue to provide periodic statements under section 226.7 and comply with other provisions of subp B (such as the substantive require­ ments oi '*',6.5b(0) throughout the plan, including the repaj.... nt phase. • If the consumer and the creditor enter into an agreement during the draw pt.iod to re­ pay all or part of the principal balance on different terms (for example, with a fixed rate of interest) and the amount of avail­ able credit will be replenished as the prin­ cipal balance is repaid, the creditor must continue to comply with subpart B. For ex­ ample, the creditor must continue to pro­ vide periodic statements and comply with 1. Coverage. This section applies to all openend credit plans secured by the consumer’s “dwelling,” as defined in section 226.2(a)(19), and is not limited to plans secured by the con­ sumer’s principal dwelling. (See the commen­ tary to section 226.3(a), which discusses whether transactions are consumer or busi­ ness-purpose credit, for guidance on whether a home-equity plan is subject to Regulation Z.) Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 42

§ 226.5b Regulation Z Commentary the substantive requirements of section 226.5b(f) throughout the plan. • If the consumer and creditor enter into an agreement during the draw period to repay all or part of the principal balance and the amount of available credit will not be re­ plenished as the principal balance is repaid, the creditor must give closed-end credit disclosures pursuant to subpart C for that new agreement. In such cases, subpart B, including the substantive rules, does not apply to the closed-end credit transaction, although it will continue to apply to any remaining open-end credit available under the plan.

6. Spreader clause. When a creditor holds a mortgage or deed of trust on the consumer’s dwelling and that mortgage or deed of trust contains a “spreader clause” (also known as a “dragnet” or cross-collateralization clause), subsequent occurrences such as the opening of an open-end plan are subject to the rules ap­ plicable to home-equity plans to the same de­ gree as if a security interest were taken di­ rectly to secure the plan, unless the creditor effectively waives its security interest under the spreader clause with respect to the subse­ quent open-end credit extensions. 5b(a) Form of Disclosures 5b(a)(l) General 1. Written disclosures. The disclosures re­ quired under this section must be clear and conspicuous and in writing, but need not be in a form the consumer can keep. (See the com­ mentary to section 226.6(e) for special rules when disclosures required under section 226.5b(d) are given in a retainable form.) 2. Disclosure of annual percentage rate— more-conspicuous requirement. As provided in section 226.5(a)(2), when the term “annual percentage rate” is required to be disclosed with a number, it must be more conspicuous than other required disclosures. 3. Segregation of disclosures. While most of the disclosures must be grouped together and segregated from all unrelated information, the creditor is permitted to include information that explains or expands on the required dis­ closures, including, for example: • Any prepayment penalty • How a substitute index may be chosen • Actions the creditor may take short of ter­ minating and accelerating an outstanding balance • Renewal terms • Rebate of fees An example of information that does not ex­ plain or expand on the required disclosures and thus cannot be included is the creditor’s underwriting criteria, although the creditor could provide such information separately from the required disclosures. 4. Method of providing disclosures. A creditor may provide a single disclosure form for all of its home-equity plans, as long as the dis­ closure describes all aspects of the plans. For example, if the creditor offers several payment options, all such options must be disclosed. (See, however, the commentary to section 226.5b(d)(5)(iii) and 226.5b(d)(12)(x) and (xi) for disclosure requirements relating to these provisions.) If any aspects of a plan are linked together, the creditor must disclose clearly the relationship of the terms to each other. For example, if the consumer can only obtain a particular payment option in conjunction with a certain variable-rate feature, this fact must be disclosed. A creditor has the option of pro­ viding separate disclosure forms for multiple options or variations in features. For example, a creditor that offers different payment options for the draw period may prepare separate dis­ closure forms for the two payment options. A creditor using this alternative, however, must include a statement on each disclosure form that the consumer should ask about the credi­ tor’s other home-equity programs. (This dis­ closure is required only for those programs available generally to the public. Thus, if the only other programs available are employee preferred-rate plans, for example, the creditor would not have to provide this statement.) A creditor that receives a request for information about other available programs must provide the additional disclosures as soon as reasona­ bly possible.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 43

Regulation Z Commentary § 226.5b 5b(a)(2) Precedence of Certain Disclosures . Precedence rule. The list of conditions pro­ vided at the creditor’s option under section 226.5b(d)(4)(iii) need not precede the other disclosures.

5b(b) Time of Disclosures 1. Mail and telephone applications. If the creditor sends applications through the mail, the disclosures and a brochure must accom­ pany the application. If an application is taken over the telephone, the disclosures and bro­ chure may be delivered or mailed within three business days of taking the application. If an application is mailed to the consumer follow­ ing a telephone request, however, the creditor also must send the disclosures and a brochure along with the application.

2.

General-purpose applications. The disclo­ sures and a brochure need not be provided when a general-purpose application is given to ' consumer unless (1) the application or materials accompanying it indicate that it can be used to apply for a home-equity plan or (2) the application is provided in response to a "sonsumer’s specific inquiry about a home-eq- .ity plan. On the other hand, if a generalpurpose application is provided in response to a consumer’s specific inquiry only about credit other than a home-equity plan, the dis­ closures and brochure need not be provided even if the application indicates it can be used for a home-equity plan, unless it is accompa­ nied by promotional information about homeequity plans.

3. Publicly available applications. Some cred­ itors make applications for home-equity plans, such as “take-ones,” available without the need for a consumer to request them. These applications must be accompanied by the dis­ closures and a brochure, such as by attaching the disclosures and brochure to the application form.

V Response cards. A creditor may solicit con­ sumers for its home-equity plan by mailing a “response card” which the consumer returns to the creditor to indicate interest in the plan. If the only action taken by the creditor upon receipt of the response card is to send the consumer an application form or to telephone the consumer to discuss the plan, the creditor need not send the disclosures and brochure with the response card.

5. Denial or withdrawal of application. In sit­ uations where footnote 10a permits the credi­ tor a three-day delay in providing disclosures and the brochure, if the creditor determines within that period that an application will not be approved, the creditor need not provide the consumer with the disclosures or brochure. Similarly, if the consumer withdraws the ap­ plication within this three-day period, the creditor need not provide the disclosures or brochure.

6. Intermediary agent or broker. In determin­ ing whether or not an application involves an “intermediary agent or broker” as discussed in footnote 10a, creditors should consult the provisions in comment 19(b)-3. 5b(c) Duties of Third Parties 1. Disclosure requirements. Although third parties who give applications to consumers for home-equity plans must provide the brochure required under section 226.5b(e) in all cases, such persons need provide the disclosures re­ quired under section 226.5b(d) only in certain instances. A third party has no duty to obtain disclosures about a creditor’s home-equity plan or to create a set of disclosures based on what it knows about a creditor’s plan. If, however, a creditor provides the third party with disclosures along with its application form, the third party must give the disclosures to the consumer with the application form. The duties under this section are those of the third party; the creditor is not responsible for ensuring that a third party complies with those obligations. If an intermediary agent or broker takes an application over the telephone or re­ ceives an application contained in a magazine or other publication, footnote 10a permits that person to mail the disclosures and brochure within three business days of receipt of the application. (See the commentary to section 226.5b(h) about imposition of nonrefundable fees.) Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 44

§ 226.5b Regulation Z Commentary 5b(d) Content of Disclosures 1. Disclosures given as applicable. The dis­ closures required under this section need be made only as applicable. Thus, for example, if negative amortization cannot occur in a homeequity plan, a reference to it need not be made.

2. Duty to respond to requests for informa­ tion. If the consumer, prior to the opening of a plan, requests information as suggested in the disclosures (such as the current index value or margin), the creditor must provide this information as soon as reasonably possi­ ble after the request.

5b(d)(l) Retention of Information 1. When disclosure not required. The creditor need not disclose that the consumer should make or otherwise retain a copy of the disclo­ sures if they are retainable—for example, if the disclosures are not part of an application that must be returned to the creditor to apply for the plan.

5b(d)(2) Conditions for Disclosed Terms Paragraph 5b(d)(2)(i) 1. Guaranteed terms. The requirement that the creditor disclose the time by which an ap­ plication must be submitted to obtain the dis­ closed terms does not require the creditor to guarantee any terms. If a creditor chooses not to guarantee any terms, it must disclose that all of the terms are subject to change prior to opening the plan. The creditor also is permit­ ted to guarantee some terms and not others, but must indicate which terms are subject to change.

2. Date for obtaining disclosed terms. The creditor may disclose either a specific date or a time period for obtaining the disclosed terms. If the creditor discloses a time period, the consumer must be able to determine from the disclosure the specific date by which an application must be submitted to obtain any guaranteed terms. For example, the disclosure might read, “To obtain the following terms, you must submit your application within 60 days after the date appearing on this disclosure,” provided the disclosure form also shows the date.

Paragraph 5b(d)(2)(ii) 1. Relation to other provisions. Creditors should consult the rules in section 226.5b(g) regarding refund of fees.

5b(d)(4) Possible Actions by Creditor Paragraph 5b(d)(4)(i) 1. Fees imposed upon termination. This dis­ closure applies only to fees (such as penalty or prepayment fees) that the creditor imposes if it terminates the plan prior to normal expi­ ration. The disclosure does not apply to fees that are imposed either when the plan expires in accordance with the agreement or if the consumer terminates the plan prior to its scheduled maturity. In addition, the disclosure does not apply to fees associated with collec­ tion of the debt, such as attorneys’ fees and court costs, or to increases in the annual per­ centage rate linked to the consumer’s failure to make payments. The actual amount of thd^, fee need not be disclosed.

2. Changes specified in the initial agreement. If changes may occur pursuant to sectio? 226.5b(f)(3)(i), a creditor must state that cer-^ tain changes will be implemented as specified in the initial agreement.

Paragraph 5b(d)(4)(iii) 1. Disclosure of conditions. In making this disclosure, the creditor may provide a high­ lighted copy of the document that contains such information, such as the contract or se­ curity agreement. The relevant items must be distinguished from the other information con­ tained in the document. For example, the creditor may provide a cover sheet that specif­ ically points out which contract provisions contain the information, or may mark the rele­ vant items on the document itself. As an alter­ native to disclosing the conditions in this manner, the creditor may simply describe the' conditions using the language in section 226.5b(f)(2)(iMiii), 226.5b(f)(3)(i) (regarding freezing the line when the maximum annual percentage rate is reached), and 226.5b Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 45

Regulation Z Commentary § 226.5b (f)(3)(vi) or language that is substantially sim­ ilar. The condition contained in section 226.5b(f)(2)(iv) need not be stated. In describ­ ing specified changes that may be imple­ mented during the plan, the creditor may pro­ vide a disclosure such as: “Our agreement permits us to make certain changes to the terms of the line at specified time or upon the occurrence of specified events.” 2. Form of disclosure. The list of conditions under section 226.5b(d)(4)(iii) may appear with the segregated disclosures or apart from them. If the creditor elects to provide the list of conditions with the segregated disclosures, the list need not comply with the precedence rule in section 226.5b(a)(2). 5b(d)(5) Payment Terms Paragraph 5b(d)(5)(i) 1. Length of the plan. The combined length of the draw period and any repayment period need not be stated. If the length of the repay­ ment phase cannot be determined because, for example, it depends on the balance outstand­ ing at the beginning of the repayment period, the creditor must state that the length is deter­ mined by the size of the balance. If the length of the plan is indefinite (for example, because there is no time limit on the period during which the consumer can take advances), the creditor must state that fact. 2. Renewal provisions. If, under the credit agreement, a creditor retains the right to re­ view a line at the end of the specified draw period and determine whether to renew or ex­ tend the draw period of the plan, the possibil­ ity of renewal or extension—regardless of its likelihood—should be ignored for purposes of the disclosures. For example, if an agreement provides that the draw period is five years and that the creditor may renew the draw period for an additional five years, the possibility of renewal should be ignored and the draw pe­ riod should be considered five years. (See the D commentary accompanying section 226.9(c)(1) dealing with change in terms requirements.) Paragraph 5b(d)(5)(ii) 1. Determination of the minimum periodic payment. This disclosure must reflect how the minimum periodic payment is determined, but need only describe the principal and interest components of the payment. Other charges that may be part of the payment (as well as the balance-computation method) may, but need not, be described under this provision. 2. Fixed-rate and term-payment options dur­ ing draw period. If the home-equity plan per­ mits the consumer to repay all or part of the balance during the draw period at a fixed rate (rather than a variable rate) and over a speci­ fied time period, this feature must be dis­ closed. To illustrate, a variable-rate plan may permit a consumer to elect during a ten-year draw period to repay all or a portion of the balance over a three-year period at a fixed rate. The creditor must disclose the rules relat­ ing to this feature including the period during which the option can be selected, the length of time over which repayment can occur, any fees imposed for such a feature, and the spe­ cific rate or a description of the index and margin that will apply upon exercise of this choice. For example, the index and margin disclosure might state, “If you choose to con­ vert any portion of your balance to a fixed rate, the rate will be the highest prime rate published in the Wall Street Journal that is in effect at the date of conversion plus a mar­ gin.” If the fixed rate is to be determined ac­ cording to an index, it must be one that is outside the creditor’s control and is publicly available in accordance with section 226.5b(f)(l). The effect of exercising the op­ tion should not be reflected elsewhere in the disclosures, such as in the historical example required in section 226.5b(d)(12)(xi). 3. Balloon payments. In programs where the occurrence of a balloon payment is possible, the creditor must disclose the possibility of a balloon payment even if such a payment is uncertain or unlikely. In such cases, the dis­ closure might read, “Your minimum payments may not be sufficient to fully repay the princi­ pal that is outstanding on your line. If they are not, you will be required to pay the entire outstanding balance in a single payment.” In programs where a balloon payment will occur, such as programs with interest-only payments during the draw period and no repayment pe­ Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 46

§ 226.5b Regulation Z Commentary riod, the disclosures must state that fact. For example, the disclosure might read, “Your minimum payments will not repay the princi­ pal that is outstanding on your line. You will be required to pay the entire outstanding bal­ ance in a single payment.” In making this dis­ closure, the creditor is not required to use the term “balloon payment.” The creditor also is not required to disclose the amount of the bal­ loon payment. (See, however, the requirement under section 226.5b(d)(5)(iii).) The balloonpayment disclosure does not apply in cases where repayment of the entire outstanding bal­ ance would occur only as a result of termina­ tion and acceleration. The creditor also need not make a disclosure about balloon payments if the final payment could not be more than twice the amount of other minimum payments under the plan.

Paragraph 5b(d)(5)(iii) 1. Minimum-periodic-payment example. In disclosing the payment example, the creditor may assume that the credit limit as well as the outstanding balance is $10,000 if such an as­ sumption is relevant to calculating payments. (If the creditor only offers lines of credit for less than $10,000, the creditor may assume an outstanding balance of $5,000 instead of $10,000 in making this disclosure.) The exam­ ple should reflect the payment comprised only of principal and interest. Creditors may pro­ vide an additional example reflecting other charges that may be included in the payment, such as credit-insurance premiums. Creditors may assume that all months have an equal number of days, that payments are collected in whole cents, and that payments will fall on a business day even though they may be due on a non-business day. For variable-rate plans, the example must be based on the last rate in the historical example required in section 226.5b(d)(12)(xi), or a more recent rate. In cases where the last rate shown in the histori­ cal example is different from the index value and margin (for example, due to a rate cap), creditors should calculate the rate by using the index value and margin. A discounted rate may not be considered a more recent rate in calculating this payment example for either variable- or fixed-rate plans. 2. Representative examples. In plans with multiple payment options within the draw pe riod or within any repayment period, the cred­ itor may provide representative examples as an alternative to providing examples for each payment option. The creditor may elect to provide representative payment examples based on three categories of payment options. The first category consists of plans that permit minimum payment of only accrued finance charges (“interest-only” plans). The second category includes plans in which a fixed per­ centage or a fixed fraction of the outstanding balance or credit limit (for example, 2 percent of the balance or 1/180th of the balance) is used to determine the minimum payment. The third category includes all other types of mini­ mum-payment options, such as a specified dollar amount plus any accrued finance charges. Creditors may classify their mini­ mum-payment arrangements within one of these three categories even if other features exist, such as varying lengths of a draw or repayment period, required payment of pastdue amounts, late charges, and minimum dol­ lar amounts. The creditor may use a single example within each category to represent the payment options in that category. For exam­ ple, if a creditor permits minimum payments of 1 percent, 2 percent, 3 percent or 4 percent of the outstanding balance, it may pick one of these four options and provide the example required under section 226.5b(d)(5)(iii) for that option alone. The example used to re­ present a category must be an option com­ monly chosen by consumers, or a typical or representative example. (See the commentary to section 226.5b(d)(12)(x) and (xi) for a dis­ cussion of the use of representative examples for making those disclosures. Creditors using a representative example within each category must use the same example for purposes of the disclosures under section 226.5b(d)(5)(iii) and 226.5b(d)(12)(x) and (xi).) Creditors may use representative examples under section 226.5b(d)(5) only with respect to the payment example required under paragraph (d)(5)(iii). Creditors must provide a full narrative description of all payment options under sec­ tion 226.5b(d)(5)(i) and (ii). 3. Examples for draw and repayment periods. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 47

Regulation Z Commentary § 226.5b Separate examples must be given for the draw and repayment periods unless the payments are determined the same way during both pe­ riods. In setting forth payment examples for any repayment period under this section (and the historical example under section 226.5b(d)(12)(xi)), creditors should assume a $10,000 advance is taken at the beginning of the draw period and is reduced according to the terms of the plan. Creditors should not assume an additional advance is taken at any time, including at the beginning of any repay­ ment period.

4. Reverse mortgages. Reverse mortgages, also know as reverse-annuity or home-equityconversion mortgages, in addition to permit­ ting the consumer to obtain advances, may in­ volve the disbursement of monthly advances to the consumer for a fixed period or until the occurrence of an event such as the consumer’s death. Repayment of the reverse mortgage (generally a single payment of principal and accrued interest) may be required to be made at the end of the disbursements or, for exam- I ple, upon the death of the consumer. In dis­ closing these plans, creditors must apply the following rules, as applicable: • If the reverse mortgage has a specified pe­ riod for advances and disbursements but re­ payment is due only upon occurrence of a future event such as the death of the con­ sumer, the creditor must assume that dis­ bursements will be made until they are scheduled to end. The creditor must as­ sume repayment will occur when disburse­ ments end (or within a period following the final disbursement which is not longer than the regular interval between disburse­ ments). This assumption should be used even though repayment may occur before or after the disbursements are scheduled to end. In such cases, the creditor may in­ clude a statement such as “The disclosures assume that you will repay the line at the time the draw period and our payments to you end. As provided in your agreement, your repayment may be required at a dif­ ferent time.” The single payment should be considered the “minimum periodic pay­ ment” and consequently would not be treated as a balloon payment. The example of the minimum payment under section 226.5b(d)(5)(iii) should assume a single $10,000 draw.

• If the reverse mortgage has neither a speci­ fied period for advances or disbursements nor a specified repayment date and these terms will be determined solely by refer­ ence to future events, including the con­ sumer’s death, the creditor may assume that the draws and disbursements will end upon the consumer’s death (estimated by using actuarial tables, for example) and that repayment will be required at the same time (or within a period following the date of the final disbursement which is not longer than the regular interval for dis­ bursements). Alternatively, the creditor may base the disclosures upon another fu­ ture event it estimates will be most likely to occur first. (If terms will be determined by reference to future events which do not include the consumer’s death, the creditor must base the disclosures upon the occur­ rence of the event estimated to be most likely to occur first.) • In making the disclosures, the creditor must assume that all draws and disburse­ ments and accrued interest will be paid by the consumer. For example, if the note has a nonrecourse provision providing that the consumer is not obligated for an amount greater than the value of the house, the creditor must nonetheless assume that the full amount to be drawn or disbursed will be repaid. In this case, however, the credi­ tor may include a statement such as “The disclosures assume full repayment of the amount advanced plus accrued interest, al­ though the amount you may be required to pay is limited by your agreement.” • Some reverse mortgages provide that some or all of the appreciation in the value of the property will be shared between the consumer and the creditor. The creditor must disclose the appreciation feature, in­ cluding describing how the creditor’s share will be determined, any limitations, and when the feature may be exercised. 5b(d)(6) Annual Percentage Rate 1. Preferred-rate plans. If a creditor offers a Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 48

§ 226.5b Regulation Z Commentary preferential fixed-rate plan in which the rate will increase a specified amount upon the oc­ currence of a specified event, the creditor must disclose the specific amount the rate will increase.

5b(d)(7) Fees Imposed by Creditor 1. Applicability. The fees referred to in sec­ tion 226.5b(d)(7) include items such as appli­ cation fees, points, annual fees, transaction fees, fees to obtain checks to access the plan, and fees imposed for converting to a repay­ ment phase that is provided for in the original agreement. This disclosure includes any fees that are imposed by the creditor to use or maintain the plan, whether the fees are kept by the creditor or a third party. For example, if a creditor requires an annual credit report on the consumer and requires the consumer to pay this fee to the creditor or directly to the third party, the fee must be specifically stated. Third-party fees to open the plan that are ini­ tially paid by the consumer to the creditor may be included in this disclosure or in the disclosure under section 226.5b(d)(8). 2. Manner of describing fees. Charges may be stated as an estimated dollar amount for each fee, or as a percentage of a typical or repre­ sentative amount of credit. The creditor may provide a stepped fee schedule in which a fee will increase a specified amount at a specified date. (See the discussion contained in the commentary to section 226.5b(f)(3)(i).) 3. Fees not required to be disclosed. Fees that are not imposed to open, use, or maintain a plan, such as fees for researching an account, photocopying, paying late, stopping payment, having a check returned, exceeding the credit limit, or closing out an account do not have to be disclosed under this section. Credit report and appraisal fees imposed to investigate whether a condition permitting a freeze con­ tinues to exist—as discussed in the commen­ tary to section 226.5b(f)(3)(vi)—are not re­ quired to be disclosed under this section or section 226.5b(d)(8).

4. Rebates of closing costs. If closing costs are imposed they must be disclosed, regard­ less of whether such costs may be rebated later (for example, rebated to the extent of any interest paid during the first year of the plan).

5. Terms used in disclosure. Creditors need not use the terms “finance charge” or “other charge” in describing the fees imposed by the creditor under this section or those imposed by third parties under section 226.5b(d)(8). 5b(d)(8) Fees Imposed by Third Parties to Open a Plan 1. Applicability. Section 226.5b(d)(8) applies only to fees imposed by third parties to open the plan. Thus, for example, this section does not require disclosure of a fee imposed by a government agency at the end of a plan to release a security interest. Fees to be disclosed include appraisal, credit report, government agency, and attorneys’ fees. In cases where property insurance is required by the creditor, the creditor either may disclose the amount of the premium or may state that property insur­ ance is required. For example, the disclosure might state, “You must carry insurance on the property that secures this plan.” 2. Itemization of third-party fees. In all cases creditors must state the total of third-party fees as a single dollar amount or a range ex­ cept that the total need not include costs for property insurance if the creditor discloses that such insurance is required. A creditor has two options with regard to providing the more detailed information about third-party fees. Creditors may provide a statement that the consumer may request more specific cost in­ formation about third-party fees from the creditor. As an alternative to including this statement, creditors may provide an itemiza­ tion of such fees (by type and amount) with the early disclosures. Any itemization pro­ vided upon the consumer’s request need not include a disclosure about property insurance. 3. Manner of describing fees. A good faith estimate of the amount of fees must be pro­ vided. Creditors may provide, based on a typi­ cal or representative amount of credit, a range for such fees or state the dollar amount of such fees. Fees may be expressed on a unitcost basis, for example, $5 per $1,000 of credit.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 49

Regulation Z Commentary § 226.5b 4. Rebates of third-party fees. Even if fees imposed by third parties may be rebated, they must be disclosed. (See the commentary to section 226.5b(d)(7).) discusses the disclosure requirements for op­ tions permitting the consumer to convert from a variable rate to a fixed rate. 5b(d)(9) Negative Amortization 1. Disclosure required. In transactions where the minimum payment will not or may not be sufficient to cover the interest that accrues on the outstanding balance, the creditor must dis­ close that negative amortization will or may occur. This disclosure is required whether or not the unpaid interest is added to the out­ standing balance upon which interest is com­ puted. A disclosure is not required merely be­ cause a loan calls for nonamortizing or partially amortizing payments. 5b(d)(10) Transaction Requirements 1. Applicability. A limitation on automated teller machine usage need not be disclosed under this paragraph unless that is the only means by which the consumer can obtain

funds.

5b(d)(12) Disclosures for Variable-Rate Plans 1. Variable-rate provisions. Sample forms in appendix G-14 provide illustrative guidance on the variable-rate rules.

Paragraph 5b(d)(12)(iv) 1. Determination of annual percentage rate. If the creditor adjusts its index through the addi­ tion of a margin, the disclosure might read, “Your annual percentage rate is based on the index plus a margin.” The creditor is not re­ quired to disclose a specific value for the margin.

Paragraph 5b(d)(12)(viii) 1. Preferred-rate provisions. This paragraph requires disclosure of preferred-rate provi­ sions, where the rate will increase upon the occurrence of some event, such as the bor- 4^ rower-employee leaving the creditor’s employ or the consumer closing an existing deposit account with the creditor.

2. Provisions on conversion to fixed rates. The commentary to section 226.5b(d)(5)(ii) Paragraph 5b(d)(12)(ix) 1. Periodic limitations on increases in rates. The creditor must disclose any annual limita­ tions on increases in the annual percentage rate. If the creditor bases its rate limitation on 12 monthly billing cycles, such a limitation should be treated as an annual cap. Rate limi­ tations imposed on less than an annual basis must be stated in terms of a specific amount of time. For example, if the creditor imposes rate limitations on only a semiannual basis, this must be expressed as a rate limitation for a six-month time period. If the creditor does not impose periodic limitations (annual or shorter) on rate increases, the fact that there are no annual rate limitations must be stated. 2. Maximum limitations on increases in rates. The maximum annual percentage rate that may be imposed under each payment option over the term of the plan (including the draw period and any repayment period provided for in the initial agreement) must be provided. The creditor may disclose this rate as a spe­ cific number (for example, 18 percent) or as a specific amount above the initial rate. For ex­ ample, this disclosure might read, “The maxi­ mum annual percentage rate that can apply to your line will be 5 percentage points above your initial rate.” If the creditor states the maximum rate as a specific amount above the initial rate, the creditor must include a state­ ment that the consumer should inquire about the rate limitations that are currently available. If an initial discount is not taken into account in applying maximum rate limitations, that fact must be disclosed. If separate overall lim­ itations apply to rate increases resulting from events such as the exercise of a fixed-rate conversion option or leaving the creditor’s employ, those limitations also must be stated. Limitations do not include legal limits in the nature of usury or rate ceilings under state or federal statutes or regulations. 3. Form of disclosures. The creditor need not disclose each periodic or maximum rate limi­ tation that is currently available. Instead, the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 50

§ 226.5b Regulation Z Commentary creditor may disclose the range of the lowest and highest periodic and maximum rate limi­ tations that may be applicable to the creditor’s home-equity plans. Creditors using this alter­ native must include a statement that the con­ sumer should inquire about the rate limitations that are currently available. Paragraph 5b(d)(12)(x) 1. Maximum-rate-payment example. In calcu­ lating the payment creditors should assume the maximum rate is in effect. Any discounted or premium initial rates or periodic rate limi­ tations should be ignored for purposes of this disclosure. If a range is used to disclose the maximum cap under section 226.5b(d) (12)(ix), the highest rate in the range must be used for the disclosure under this paragraph. As an alternative to making disclosures based on each payment option, the creditor may choose a representative example within the three categories of payment options upon which to base this disclosure. (See the com­ mentary to section 226.5b(d)(5).) However, separate examples must be provided for the draw period and for any repayment period un­ less the payment is determined the same way in both periods. Creditors should calculate the example for the repayment period based on an assumed $10,000 balance. (See the commen­ tary to section 226.5b(d)(5) for a discussion of the circumstances in which a creditor may use a lower outstanding balance.) 2. Time the maximum rate could be reached. In stating the date or time when the maximum rate could be reached, creditors should assume the rate increases as rapidly as possible under the plan. In calculating the date or time, credi­ tors should factor in any discounted or pre­ mium initial rates and periodic-rate limita­ tions. This disclosure must be provided for the draw phase and any repayment phase. Credi­ tors should assume the index and margin shown in the last year of the historical exam­ ple (or a more recent rate) is in effect at the beginning of each phase.

Paragraph 5b(d)( 12)(xi) 1. Index movement. Index values and annual percentage rates must be shown for the entire 15 years of the historical example and must be based on the most recent 15 years. Th example must be updated annually to reflec the most recent 15 years of index values as soon as reasonably possible after the new in­ dex value becomes available. If the values for an index have not been available for 15 years, a creditor need only go back as far as the values have been available and may start the historical example at the year for which val­ ues are first available.

2. Selection of index values. The historical ex­ ample must reflect the method of choosing in­ dex values for the plan. For example, if an average of index values is used in the plan, averages must be used in the example, but if an index value as of a particular date is used, a single index value must be shown. The creditor is required to assume one date (or one period, if an average is used) within a year on which to base the history of index values. The creditor may choose to use index values as of any date or period as long as the index value as of this date or period is used for each year in the example. Only one index value per year need be shown, even if the plan provides for adjustments to the annual percentage rate or payment more than once in a year. In such cases, the creditor can assume that the index rate remained constant for the full year for the purpose of calculating the an­ nual percentage rate and payment. 3. Selection of margin. A value for the margin must be assumed in order to prepare the ex­ ample. A creditor may select a representative margin that it has used with the index during the six months preceding preparation of the disclosures and state that the margin is one that it has used recently. The margin selected may be used until the creditor annually up­ dates the disclosure form to reflect the most recent 15 years of index values. 4. Amount of discount or premium. In reflect­ ing any discounted or premium initial rate, the creditor may select a discount or premium that it has used during the six months preceding preparation of the disclosures, and should dis­ close that the discount or premium is one that the creditor has used recently. The discount or premium should be reflected in the example Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 51

Regulation Z Commentary § 226.5b for as long as it is in effect. The creditor may assume that a discount or premium that would have been in effect for any part of a year was in effect for the full year for purposes of re­ flecting it in the historical example. 5. Rate limitations. Limitations on both peri­ odic and maximum rates must be reflected in the historical example. If ranges of rate limita­ tions are provided under section 226.5b (d)(12)(ix), the highest rates provided in those ranges must be used in the example. Rate lim­ itations that may apply more often than annu­ ally should be treated as if they were annual limitations. For example, if a creditor imposes a 1 percent cap every six months, this should be reflected in the example as if it were a 2 percent annual cap.

6. Assumed advances. The creditor should as­ sume that the $10,000 balance is an advance taken at the beginning of the first billing cycle and is reduced according to the terms of the plan, and that the consumer takes no subse­ quent draws. As discussed in the commentary to section 226.5b(d)(5), creditors should not assume an additional advance is taken at the beginning of any repayment period. If applica­ ble, the creditor may assume the $10,000 is both the advance and the credit limit. (See the commentary to section 226.5b(d)(5) for a dis­ cussion of the circumstances in which a credi­ tor may use a lower outstanding balance.) 7. Representative payment options. The credi­ tor need not provide an historical example for all of its various payment options, but may select a representative payment option within each of the three categories of payments upon which to base its disclosure. (See the com­ mentary to section 226.5b(d)(5).) 8. Payment information. The payment figures in the historical example must reflect all sig­ nificant program terms. For example, features such as rate and payment caps, a discounted initial rate, negative amortization, and rate carryover must be taken into account in calcu­ lating the payment figures if these would have applied to the plan. The historical example should include payments for as much of the length of the plan as would occur during a 15-year period. For example: • If the draw period is 10 years and the re­ payment period is 15 years, the example should illustrate the entire 10-year draw pe­ riod and the first 5 years of the repayment period.

• If the length of the draw period is 15 years and there is a 15-year repayment phase, the historical example must reflect the pay­ ments for the 15-year draw period and would not show any of the repayment peri­ od. No additional historical example would be required to reflect payments for the re­ payment period.

• If the length of the plan is less than 15 years, payments in the historical example need only be shown for the number of years in the term. In such cases, however, the creditor must show the index values, margin and annual percentage rates and continue to reflect all significant plan terms such as rate limitations for the entire 15 years.

A creditor need show only a single payment per year in the example, even though pay­ ments may vary during a year. The calcula­ tions should be based on the actual paymentcomputation formula, although the creditor may assume that all months have an equal number of days. The creditor may assume that payments are made on the last day of the bill­ ing cycle, the billing date or the payment-due date, but must be consistent in the manner in which the period used to illustrate payment information is selected. Information about bal­ loon payments and remaining balance may, but need not, be reflected in the example. 9. Disclosures for repayment period. The his­ torical example must reflect all features of the repayment period, including the appropriate index values, margin, rate limitations, length of the repayment period, and payments. For example, if different indices are used during the draw and repayment periods, the index values for that portion of the 15 years that reflect the repayment period must be the val­ ues for the appropriate index. 10. Reverse mortgages. The historical exam­ ple for reverse mortgages should reflect 15 years of index values and annual percentage rates, but the payment column should be Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 52

§ 226.5b Regulation Z Commentary blank until the year that the single payment will be made, assuming that payment is esti­ mated to occur within 15 years. (See the com­ mentary to section 226.5b(d)(5) for a discus­ sion of reverse mortgages.) 5b(e) Brochure 1. Substitutes. A brochure is a suitable substi­ tute for the Board’s home-equity brochure if it is, at a minimum, comparable to the Board’s brochure in substance and comprehensiveness. Creditors are permitted to provide more de­ tailed information than is contained in the Board’s brochure.

2. Effect of third-party delivery of brochure. If a creditor determines that a third party has provided a consumer with the required bro­ chure pursuant to section 226.5b(c), the credi­ tor need not give the consumer a second brochure.

5b(f) Limitations on Home-Equity Plans 1. Coverage. Section 226.5b(f) limits both ac­ tions that may be taken and language that may be included in contracts, and applies to any assignee or holder as well as to the origi­ nal creditor. The limitations apply to the draw period and any repayment period, and to any renewal or modification of the original agreement.

Paragraph 5b(f)(l) 1. External index A creditor may change the annual percentage rate for a plan only if the change is based on an index outside the credi­ tor’s control. Thus, a creditor may not make rate changes based on its own prime rate or cost of funds and may not reserve a contrac­ tual right to change rates at its discretion. A creditor is permitted, however, to use a pub­ lished prime rate, such as that in the Wall Street Journal, even if the bank’s own prime rate is one of several rates used to establish the published rate.

2. Publicly available. The index must be available to the public. A publicly available index need not be published in a newspaper, but it must be one the consumer can independently obtain (by telephone, for example) and use to verify rates imposed under the plan. 3. Provisions not prohibited. This paragraph does not prohibit rate changes that are specifi­ cally set forth in the agreement. For example, stepped-rate plans, in which specified rates are imposed for specified periods, are permissible. In addition, preferred-rate provisions, in which the rate increases by a specified amount upon the occurrence of a specified event, also are permissible.

Paragraph 5b(f)(2) 1. Limitations on termination and accelera­ tion. In general, creditors are prohibited from terminating and accelerating payment of the outstanding balance before the scheduled expi­ ration of a plan. However, creditors may take these actions in the four circumstances speci­ fied in section 226.5b(f)(2). Creditors are not permitted to specify in their contracts any other events that allow termination and accel­ eration beyond those permitted by the regula­ tion. Thus, for example, an agreement may not provide that the balance is payable on de­ mand nor may it provide that the account will be terminated and the balance accelerated if the rate cap is reached.

2. Other actions permitted. If an event per­ mitting termination and acceleration occurs, a creditor may instead take actions short of ter­ minating and accelerating. For example, a creditor could temporarily or permanently sus­ pend further advances, reduce the credit limit, change the payment terms, or require the con­ sumer to pay a fee. A creditor also may pro­ vide in its agreement that a higher rate or higher fees will apply in circumstances under which it would otherwise be permitted to ter­ minate the plan and accelerate the balance. A creditor that does not immediately terminate an account and accelerate payment or take an­ other permitted action may take such action at a later time, provided one of the conditions permitting termination and acceleration exists at that time.

Paragraph 5b(f)(2)(i) 1. Fraud or material misrepresentation. A creditor may terminate a plan and accelerate Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 53

Regulation Z Commentary § 226.5b the balance if there has been fraud or material misrepresentation by the consumer in connec­ tion with the plan. This exception includes fraud or misrepresentation at any time, either during the application process or during the draw period and any repayment period. What constitutes fraud or misrepresentation is deter­ mined by applicable state law and may in­ clude acts of omission as well as overt acts, as long as any necessary intent on the part of the consumer exists.

Paragraph 5b(f)(2)(ii) 1. Failure to meet repayment terms. A credi­ tor may terminate a plan and accelerate the balance when the consumer fails to meet the repayment terms provided for in the agree­ ment. However, a creditor may terminate and accelerate under this provision only if the con­ sumer actually fails to make payments. For example, a creditor may not terminate and ac­ celerate if the consumer, in error, sends a pay­ ment to the wrong location, such as a branch rather than the main office of the creditor. If a consumer files for or is placed in bankruptcy, the creditor may terminate and accelerate under this provision if the consumer fails to O meet the repayment terms of the agreement. This section does not override any state or other law that requires a right to cure notice, or otherwise places a duty on the creditor before it can terminate a plan and accelerate the balance.

Paragraph 5b(f)(2)(iii) 2. Examples. A creditor may terminate and accelerate, for example, if: • the consumer transfers title to the property or sells the property without the permission of the creditor • the consumer fails to maintain required in­ surance on the dwelling • the consumer fails to pay taxes on the property • the consumer permits the filing of a lien senior to that held by the creditor • the sole consumer obligated on the plan dies • the property is taken through eminent do­ main • a prior lienholder forecloses By contrast, the filing of a judgment against the consumer would permit termination and acceleration only if the amount of the judg­ ment and collateral subject to the judgment is such that the creditor’s security is adversely affected. If the consumer commits waste or otherwise destructively uses or fails to main­ tain the property such that the action ad­ versely affects the security, the plan may be terminated and the balance accelerated. Illegal use of the property by the consumer would permit termination and acceleration if it sub­ jects the property to seizure. If one of two consumers obligated on a plan dies, the credi­ tor may terminate the plan and accelerate the balance if the security is adversely affected. If the consumer moves out of the dwelling that secures the plan and that action adversely af­ fects the security, the creditor may terminate a plan and accelerate the balance. Paragraph 5b(f)(3) 1. Scope of provision. In general, a creditor may not change the terms of a plan after it is opened. For example, a creditor may not in­ crease any fee or impose a new fee once the plan has been opened, even if the fee is charged by a third party, such as a credit re­ porting agency, for a service. The change-ofterms prohibition applies to all features of a plan, not only those required to be disclosed under this section. For example, this provision applies to charges imposed for late payment, although this fee is not required to be dis­ closed under section 226.5b(d)(7). 2.

Charges not covered. There are three charges not covered by this provision. A cred­ itor may pass on increases in taxes since such charges are imposed by a governmental body and are beyond the control of the creditor. In addition, a creditor may pass on increases in 1. Impairment of security. A creditor may ter­ minate a plan and accelerate the balance if the consumer’s action or inaction adversely affects the creditor’s security for the plan, or any right of the creditor in that security. Action or inaction by third parties does not, in itself, permit the creditor to terminate and accelerate. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 54

§ 226.5b Regulation 1 mmentary premiums for property insurance that are ex­ cluded from the finance charge under section 226.4(d)(2), since such insurance provides a benefit to the consumer independent of the use of the line and is often maintained notwith­ standing the line. A creditor also may pass on increases in premiums for credit insurance that are excluded from the finance charge under section 226.4(dXl), since the insurance is vol­ untary and provides a benefit to the consumer. Paragraph 5b(f)(3)(i) 1. Changes provided for in agreement. A creditor may provide in the initial agreement that further advances will be prohibited or the credit line reduced during any period in which the maximum annual percentage rate is reached. A creditor also may provide for other specific changes to take place upon the occur­ rence of specific events. Both the triggering event and the resulting modification must be stated with specificity. For example, in homeequity plans for employees, the agreement could provide that a specified higher rate or margin will apply if the borrower’s employ­ ment with the creditor ends. A contract could contain a stepped-rate or stepped-fee schedule providing for specified changes in the rate or the fees on certain dates or after a specified period of time. A creditor also may provide in the initial agreement that it will be entitled to a share of the appreciation in the value of the property as long as the specific appreciation share and the specific circumstances which re­ quire the payment of it are set forth. A con­ tract may permit a consumer to switch among minimum-payment options during the plan. 2. Prohibited provisions. A creditor may not include a general provision in its agreement permitting changes to any or all of the terms of the plan. For example, creditors may not include boilerplate language in the agreement stating that they reserve the right to change the fees imposed under the plan. In addition, a creditor may not include any “triggering events” or responses that the regulation ex­ pressly addresses in a manner different from that provided in the regulation. For example, an agreement may not provide that the margin in a variable-rate plan will increase if there is a material change in the consumer’s financial circumstances, because the regulation specifies that temporarily freezing the line or lowering the credit limit is the permissible response tc a material change in the consumer’s financial circumstances. Similarly a contract cannot contain a provision allowing the creditor to freeze a line due to an insignificant decline in property value since the regulation allows that response only for a significant decline. Paragraph 5b(f)(3)(ii) 1. Substitution of index. A creditor may change the index and margin used under the plan if the original index becomes unavaila­ ble, as long as historical fluctuations in the original and replacement indices were substan­ tially similar, and as long as the replacement index and margin will produce a rate similar to the rate that was in effect at the time the original index became unavailable. If the re­ placement index is newly established and therefore does not have any rate history, it may be used if it produces a rate substantially similar to the rate in effect when the original index became unavailable.

Paragraph 5b(f)(3)(iii) 1. Changes by written agreement. A creditor may change the terms of a plan if the con­ sumer expressly agrees in writing to the change at the time it is made. For example, a consumer and a creditor could agree in writ­ ing to change the repayment terms from inter­ est-only payments to payments that reduce the principal balance. The provisions of any such agreement are governed by the limitations in section 226.5b(f). For example, a mutual agreement could not provide for future annual percentage rate changes based on the move­ ment of an index controlled by the creditor or for termination and acceleration under circum­ stances other than those specified in the regu­ lation. By contrast, a consumer could agree to a new credit limit for the plan, although the agreement could not permit the creditor to later change the credit limit except by a sub­ sequent written agreement or in the circum­ stances described in section 226.5b(f)(3)(vi). 2. Written agreement. The change must be agreed to in writing by the consumer. Credi­ Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 55

Regulation Z Commentary § 226.5b tors are not permitted to assume consent be­ cause the consumer uses an account, even if use of an account would otherwise constitute acceptance of a proposed change under state law.

Paragraph 5b(f)(3)(iv) 1. Beneficial changes. After a plan is opened, a creditor may make changes that unequivo­ cally benefit the consumer. Under this provi­ sion, a creditor may offer more options to consumers, as long as existing options remain. For example, a creditor may offer the con­ sumer the option of making lower monthly payments or could increase the credit limit. Similarly, a creditor wishing to extend the length of the plan on the same terms may do so. Creditors are permitted to temporarily re­ duce the rate or fees charged during the plan (though a change-in-terms notice may be re­ quired under section 226.9(c) when the rate or fees are returned to their original level). Cred­ itors also may offer an additional means of access to the line, even if fees are associated with using the device, provided the consumer retains the ability to use prior access devices on the original terms.

Paragraph 5b(f)(3)(v) 1. Insignificant changes. A creditor is permit­ ted to make insignificant changes after a plan is opened. This rule accommodates operational and similar problems, such as changing the address of the creditor for purposes of sending payments. It does not permit a creditor to change a term such as a fee charged for late payments.

2. Examples of insignificant changes. Credi­ tors may make minor changes to features such as the billing cycle date, the payment-due date (as long as the consumer does not have a di­ minished grace period if one is provided), and the day of the month on which index values are measured to determine changes to the rate for variable-rate plans. A creditor also may change its rounding practice in accordance with the tolerance rules set forth in section 226.14 (for example, stating an exact APR of 14.3333 percent as 14.3 percent, even if it had previously been stated as 14.33 percent). A creditor may change the balance-computation method it uses only if the change produces an insignificant difference in the finance charge paid by the consumer. For example, a creditor may switch from using the average-daily-bal­ ance method (including new transactions) to the daily-balance method (including new transactions).

Paragraph 5b(f)(3)(vi) 1. Suspension of credit or reduction of credit limit. A creditor may prohibit additional ex­ tensions of credit or reduce the credit limit in the circumstances specified in this section of the regulation. In addition, as discussed under section 226.5b(f)(3)(i), a creditor may contrac­ tually reserve the right to take such actions when the maximum annual percentage rate is reached. A creditor may not take these actions under other circumstances, unless the creditor would be permitted to terminate the line and accelerate the balance as described in section 226.5b(f)(2). The creditor’s right to reduce the credit limit does not permit reducing the limit below the amount of the outstanding balance if this would require the consumer to make a higher payment.

2. Temporary nature of suspension or reduc­ tion. Creditors are permitted to prohibit addi­ tional extensions of credit or reduce the credit limit only while one of the designated circum­ stances exists. When the circumstance justify­ ing the creditor’s action ceases to exist, credit privileges must be reinstated, assuming that no other circumstance permitting such action exists at that time.

3. Imposition of fees. If not prohibited by state law, a creditor may collect only bona fide and reasonable appraisal and credit-report fees if such fees are actually incurred in in­ vestigating whether the condition permitting the freeze continues to exist. A creditor may not, in any circumstances, impose a fee to re­ instate a credit line once the conditiqn has been determined not to exist. 4. Reinstatement of credit privileges. Creditors are responsible for ensuring that credit privi­ leges are restored as soon as reasonably possi­ ble after the condition that permitted the cred­ itor’s action ceases to exist. One way a Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 56

§ 226.5b Regulation Z Commentary creditor can meet this responsibility is to monitor the line on an ongoing basis to deter­ mine when the condition ceases to exist. The creditor must investigate the condition fre­ quently enough to assure itself that the condi­ tion permitting the freeze continues to exist. The frequency with which the creditor must investigate to determine whether a condition continues to exist depends upon the specific condition permitting the freeze. As an alterna­ tive to such monitoring, the creditor may shift the duty to the consumer to request reinstate­ ment of credit privileges by providing a notice in accordance with section 226.9(c)(3). A creditor may require a reinstatement request to be in writing if it notifies the consumer of this requirement on the notice provided under sec­ tion 226.9(c)(3). Once the consumer requests reinstatement, the creditor must promptly in­ vestigate to determine whether the condition allowing the freeze continues to exist. Under this alternative, the creditor has a duty to in­ vestigate only upon the consumer’s request. 5. Suspension of credit privileges following request by consumer. A creditor may honor a specific request by a consumer to suspend credit privileges. If the consumer later re­ quests that the creditor reinstate credit privi­ leges, the creditor must do so provided no other circumstance justifying a suspension ex­ ists at that time. If two or more consumers are obligated under a plan and each has the abil­ ity to take advances, the agreement may per­ mit any of the consumers to direct the creditor not to make further advances. A creditor may require that all persons obligated under a plan request reinstatement.

6. Significant decline defined. What consti­ tutes a significant decline for purposes of sec­ tion 226.5b(f)(3)(vi)(A) will vary according to individual circumstances. In any event, if the value of the dwelling declines such that the initial difference between the credit limit and the available equity (based on the property’s appraised value for purposes of the plan) is reduced by 50 percent, this constitutes a sig­ nificant decline in the value of the dwelling for purposes of section 226.5b(f)(3)(vi)(A). For example, assume that a house with a first mortgage of $50,000 is appraised at $100,000 and the credit limit is $30,000. The difference between the credit limit and the available eq­ uity is $20,000, half of which is $10,000. The creditor could prohibit further advances or re­ duce the credit limit if the value of the prop­ erty declines from $100,000 to $90,000. This provision does not require a creditor to obtain an appraisal before suspending credit privi­ leges, although a significant decline must oc­ cur before suspension can occur. 7. Material change in financial circumstances. Two conditions must be met for section 226.5b(f)(3)(vi)(B) to apply. First, there must be a “material change” in the consumer’s fi­ nancial circumstances, such as a significant decrease in the consumer’s income. Second, as a result of this change, the creditor must have a reasonable belief that the consumer will be unable to fulfill the payment obliga­ tions of the plan. A creditor may, but does not have to, rely on specific evidence (such as the failure to pay other debts) in concluding that the second part of the test has been met. A creditor may prohibit further advances or re­ duce the credit limit under this section if a consumer files for or is placed in bankruptcy. 8. Default of a material obligation. Creditors may specify events that would qualify as a default of a material obligation under section 226.5b(f)(3)(vi)(C). For example, a creditor may provide that default of a material obliga­ tion will exist if the consumer moves out of the dwelling or permits an intervening lien to be filed that would take priority over future advances made by the creditor. 9. Government limits on the annual percent­ age rate. Under section 226.5b(f)(3) (vi)(D), a creditor may prohibit further advances or re­ duce the credit limit if, for example, a state usury law is enacted which prohibits a credi­ tor from imposing the agreed-upon annual percentage rate.

5b(g) Refund of Fees 1. Refund of fees required. If any disclosed term, including any term provided upon re­ quest pursuant to section 226.5b(d), changes between the time the early disclosures are pro­ vided to the consumer and the time the plan is opened, and the consumer as a result decides to not enter into the plan, a creditor must re­ Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 57

Regulation Z Commentary § 226.6 fund all fees paid by the consumer in connec­ tion with the application. All fees, including credit-report fees and appraisal fees, must be refunded whether such fees are paid to the creditor or directly to third parties. A con­ sumer is entitled to a refund of fees under these circumstances whether or not terms are guaranteed by the creditor under section 226.5b(d)(2)(i).

2. Variable-rate plans. The right to a refund of fees does not apply to changes in the an­ nual percentage rate resulting from fluctua­ tions in the index value in a variable-rate plan. Also, if the maximum annual percentage rate is expressed as an amount over the initial rate, the right to refund of fees would not ap­ ply to changes in the cap resulting from fluc­ tuations in the index value. 3. Changes in terms. If a term, such as the maximum rate, is stated as a range in the early disclosures, and the term ultimately ap­ plicable to the plan falls within that range, a change does not occur for purposes of this section. If, however, no range is used and the term is changed (for example, a rate cap of 6 rather than 5 percentage points over the initial rate), the change would permit the consumer to obtain a refund of fees. If a fee imposed by the creditor is stated in the early disclosures as an estimate and the fee changes, the con­ sumer could elect to not enter into the agree­ ment and would be entitled to a refund of fees. On the other hand, if fees imposed by third parties are disclosed as estimates and those fees change, the consumer is not entitled to a refund of fees paid in connection with the application. Creditors must, however, use the best information reasonably available in pro­ viding disclosures about such fees. 4. Timing of refunds and relation to other provisions. The refund of fees must be made as soon as reasonably possible after the credi­ tor is notified that the consumer is not enter­ ing into the plan because of the changed term, or that the consumer wants a refund of fees. The fact that an application fee may be re­ funded to some applicants under this provision does not render such fees finance charges under section 226.4(c)(1) of the regulation. 5b(h) Imposition of Nonrefundable Fees 1. Collection of fees after consumer receives disclosures. A fee may be collected after the consumer receives the disclosures and bro­ chure and before the expiration of three days, although the fee must be refunded if, within three days of receiving the required informa­ tion, the consumer decides not to enter into the agreement. In such a case, the consumer must be notified that the fee is refundable for three days. The notice must be clear and con­ spicuous and in writing, and may be included with the disclosures required under section 226.5b(d) or as an attachment to them. If dis­ closures and brochure are mailed to the con­ sumer, footnote lOd of the regulation provides that a nonrefundable fee may not be imposed until six business days after the mailing. 2. Collection of fees before consumer receives disclosures. An application fee may be col­ lected before the consumer receives the dis­ closures and brochure (for example, when an application contained in a magazine is mailed in with an application fee) provided that it re­ mains refundable until three business days af­ ter the consumer receives the section 226.5b disclosures. No other fees except a refundable membership fee may be collected until after the consumer receives the disclosures required under section 226.5b.

3. Relation to other provisions. A fee col­ lected before disclosures are provided may be­ come nonrefundable except that, under section 226.5b(g), it must be refunded if the consumer elects not to enter into the plan because of a change in terms. (Of course, all fees must be refunded if the consumer later rescinds under section 226.15.) SECTION 226.6—Initial Disclosure Statement 1. Consistent terminology. Language on the initial and periodic disclosure statements must be close enough in meaning to enable the consumer to relate the two sets of disclosures; however, the language need not be identical. For example, in making the disclosure under section 226.6(a)(3), the creditor may refer to the “outstanding balance at the end of the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 58

§ 226.6 Regulation Z Commentary billing cycle,” while the disclosure for section 226.7(i) refers to the “ending balance” or “new balance.”

2. Separate initial disclosures permitted. In a certain open-end credit program involving more than one creditor—a card issuer of travel-and-entertainment cards and a financial institution—the consumer has the option to pay the card issuer directly or to transfer to the financial institution all or part of the amount owing. In this case, the creditors may send separate initial disclosure statements. 6(a) Finance Charge Paragraph 6(a)(1) 1. When finance charges accrue. Creditors may provide a general explanation about fi­ nance charges beginning to run and need not disclose a specific date. For example, a disclo­ sure that the consumer has 30 days from the closing date to pay the new balance before finance charges will accme on the account would describe when finance charges begin to run.

2. Free-ride periods. In disclosing whether or not a free-ride period exists, the creditor need not use “free period,” “free-ride period,” or any other particular descriptive phrase or term. For example, a statement that “the fi­ nance charge begins on the date the transac­ tion is posted to your account” adequately discloses that no free-ride period exists. In the same fashion, a statement that “finance charges will be imposed on any new purchases only if they are not paid in full within 25 days after the close of the billing cycle” indicates that a free-ride period exists in the interim.

Paragraph 6(a)(2) 1. Range of balances. The range of balances disclosure is inapplicable:

• If only one periodic rate may be applied to the entire account balance • If only one periodic rate may be applied to the entire balance for a feature (for exam­ ple, cash advances), even though the bal­ ance for another feature (purchases) may be subject to two rates (a 1.5 percent peri­ odic rate on purchase balances of $0-$500, while balances above $500 are subject to a 1 percent periodic rate). Of course, the creditor must give a range of balances dis­ closure for the purchase feature. 2. Variable-rate disclosures—coverage. This section covers open-end credit plans under which rate changes are part of the plan and are tied to an index or formula. A creditor would use variable-rate disclosures (and thus be excused from the requirement of giving a change-in-terms notice when rate increases oc­ cur as disclosed) for plans involving rate changes such as the following: • Rate changes that are tied to the rate the creditor pays on its six-month money mar­ ket certificates • Rate changes that are tied to Treasury bill rates • Rate changes that are tied to changes in the creditor’s commercial lending rate In contrast, the creditor’s contract reservation to increase the rate without reference to such an index or formula (for example, a plan that simply provides that the creditor reserves the right to raise its rates) would not be consid­ ered a variable-rate plan for Truth in Lending disclosure purposes. (See the rule in section 226.5b(f)(l) applicable to home-equity plans, however, which prohibits “rate-reservation” clauses.) Moreover, an open-end credit plan in which the employee receives a lower rate con­ tingent upon employment (that is, with the rate to be increased upon termination of em­ ployment) is not a variable-rate plan. (With regard to such employee preferential-rate plans, however, see comment 9(c)-1, which provides that if the specific change that would occur is disclosed on the initial disclosure statement, no notice of a change in terms need be given when the term later changes as disclosed.) 3. Variable-rate plan—rate(s) in effect. In dis­ closing the rate(s) in effect at the time of the initial disclosures (as is required by section 226.6(a)(2)), the creditor may use an insert showing the current rate; may give the rate as of a specified date and then update the disclo­ sure from time to time, for example, each cal- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 59

Regulation Z Commentary § 226.6 endar month; or may disclose an estimated rate under section 226.5(c). 4. Variable-rate plan—additional disclosures required. In addition to disclosing the rates in effect at the time of the initial disclosures, the disclosures under footnote 12 also must be made.

5. Variable-rate plan—index. The index to be used must be clearly identified; the creditor need not give, however, an explanation of how the index is determined or provide in­ structions for obtaining it. 6. Variable-rate plan—circumstances for in­ crease. Circumstances under which the rate(s) may increase include, for example: • An increase in the Treasury bill rate • An increase in the Federal Reserve dis­ count rate The creditor must disclose when the increase will take effect; for example: 3• “An increase will take effect on the day that the Treasury bill rate increases,” or • “An increase in the Federal Reserve dis- O count rate will take effect on the first day of the creditor’s billing cycle.” 7. Variable-rate plan—limitations on increase. In disclosing any limitations on rate increases, limitations such as the maximum increase per year or the maximum increase over the dura­ tion of the plan must be disclosed. When there are no limitations, the creditor may, but need not, disclose that fact. (A maximum in­ terest rate must be included in dwelling-se­ cured open-end credit plans under which the interest rate may be changed. See section 226.30 and the commentary to that section.) Legal limits such as usury or rate ceilings under state or federal statutes or regulations need not be disclosed. Examples of limitations that must be disclosed include: “The rate on the plan will not exceed 25 percent annual percentage rate.” • “Not more than V2 percent increase in the annual percentage rate per year will occur.”

8. Variable-rate plan—effects of increase. Ex­ amples of effects that must be disclosed include:

• Any requirement for additional collateral if the annual percentage rate increases beyond a specified rate • Any increase in the scheduled minimum periodic payment amount 9. Variable-rate plan—change-in-terms notice not required. No notice of a change in terms is required for a rate increase under a varia­ ble-rate plan as defined in comment 6(a)(2)-2. 10. Discounted variable-rate plans. In some variable-rate plans, creditors may set an initial interest rate that is not determined by the in­ dex or formula used to make later interest rate adjustments. Typically, this initial rate is lower than the rate would be if it were calcu­ lated using the index or formula. • For example, a creditor may calculate in­ terest rates according to a formula using the six-month Treasury bill rate plus a 2 percent margin. If the current Treasury bill rate is 10 percent, the creditor may forgo the 2 percent spread and charge only 10 percent for a limited time, instead of set­ ting an initial rate of 12 percent, or the creditor may disregard the index or formula and set the initial rate at 9 percent. • When creditors use an initial rate that is not calculated using the index or formula for later rate adjustments, the initial disclo­ sure statement should reflect: (1) the initial rate (expressed as a periodic rate and a corresponding annual percentage rate), to­ gether with a statement of how long it will remain in effect; (2) the current rate that would have been applied using the index or formula (also expressed as a periodic rate and a corresponding annual percentage rate); and (3) the other variable-rate infor­ mation required by footnote 12 to section 226.6(a)(2).

• In disclosing the current periodic and annu­ al percentage rates that would be applied using the index or formula, the creditor may use any of the disclosure options de­ scribed in comment 6(a)(2)-3. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 60

§ 226.6 Regulation Z Commentary Paragraph 6(a)(3) 1. Explanation of balance-computation method. A shorthand phrase such as “previ­ ous-balance method” does not suffice in ex­ plaining the balance computation method. (See appendix G-l for model clauses.) 2. Allocation of payments. Disclosure about the allocation of payments and other credits is not required. For example, the creditor need not disclose that payments are applied to late charges, overdue balances, and finance charges before being applied to the principal balance; or in a multifeatured plan, that payments are applied first to finance charges, then to purchases, and then to cash advances. (See comment 7-1 for definition of multifeatured plan.) Paragraph 6(a)(4) 1. Finance charges. In addition to disclosing the periodic rate(s) under section 226.6(a) (2), disclosure is required of any other type of fi­ nance charge that may be imposed, such as minimum, fixed, transaction, and activity charges; required insurance; or appraisal or credit report fees (unless excluded from the finance charge under section 226.4(c)(7).) 6(b) Other Charges 1. General; examples of other charges. Under section 226.6(b), significant charges related to the plan (that are not finance charges) must also be disclosed. For example: i.

Late-payment and over-the-credit-limit charges.

ii. Fees for providing documentary evidence of transactions requested under section 226.13 (Billing-Error Resolution). iii. Charges imposed in connection with real estate transactions such as title, appraisal, and credit-report fees (see section 226.4(c)(7)).

iv. A tax imposed on the credit transaction by a state or other governmental body, such as a documentary stamp tax on cash advances (see the commentary to section 226.4(a)).

v.

A membership or participation fee for a package of services that includes an openend credit feature, unless the fee is re­ quired whether or not the open-end credit feature is included. For example, a mem­ bership fee to join a credit union is not an “other charge,” even if membership is required to apply for credit. vi. Automated teller machine (ATM) charges described in comment 4(a)-5 that are not finance charges.

vii. Charges imposed for the termination of an open-end credit plan.

2. Exclusions. The following are examples of charges that are not “other charges”: • Fees charged for documentary evidence of transactions for income tax purposes • Amounts payable by a consumer for collec­ tion activity after default; attorney’s fees, whether or not automatically imposed; foreclosure costs; post-judgment interest rates imposed by law; and reinstatement or reissuance fees • Premiums for voluntary credit life or disa­ bility insurance, or for property insurance, that are not part of the finance charge • Application fees under section 226.4(c)(1) • A monthly service charge for a checking account with overdraft protection that is applied to all checking accounts, whether or not a credit feature is attached • Charges for submitting as payment a check that is later returned unpaid (see commen­ tary to section 226.4(c)(2) • Charges imposed on a cardholder by an in­ stitution other than the card issuer for the use of the other institution’s ATM in a shared or interchange system (See also comment 7(b)-2.) • Taxes and filing or notary fees excluded from the finance charge under section 226.4(e) 6(c) Security Interests 1. General. Disclosure is not required about the type of security interest, or about the cred­ itor’s rights with respect to that collateral. Ir other words, the creditor need not expand on the term “security interest.” Also, since no specified terminology is required, the creditor may designate its interests by using, for exam- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 61

Regulation Z Commentary § 226.6 pie, “pledge,” “lien,”

iof “security interest”).

or “mortgage” (instead 2. Identification of property. Identification of the collateral by type is satisfied by stating, for example, “motor vehicle” or “household appliances.” (Creditors should be aware, how­ ever, that the federal credit practices rules, as well as some state laws, prohibit certain se­ curity interests in household goods.) The cred­ itor may, at its option, provide a more specific identification (for example, a model and serial number.) * rr 3. Spreader clause. The fact that collateral for preexisting credit extensions with the institu­ tion is being used to secure the present obli­ gation constitutes a security interest and must be disclosed. (Such security interests may be known as “spreader” or “dragnet” clauses, or as “cross-collateralization” clauses.) A spe­ cific identification of that collateral is unnec­ essary, but a reminder of the interest arising from the prior indebtedness is required. This may be accomplished by using language such s “collateral securing other loans with us may also secure this loan.” At the creditor’s option, a more specific description of the property involved may be given. \. Additional collateral. If collateral is re­ quired when advances reach a certain amount, the creditor should disclose the information available at the time of the initial disclosures. For example, if the creditor knows that a se­ curity interest will be taken in household goods if the consumer’s balance exceeds $1,000, the creditor should disclose accord­ ingly. If the creditor knows that security will be required if the consumer’s balance exceeds $1,000, but the creditor does not know what security will be required, the creditor must disclose on the inital disclosure statement that security will be required if the balance ex­ ceeds $1,000, and the creditor must provide a change-in-terms notice under section 226.9(c) at the time the security is taken. (See com­ ment 6(c)-2.) 3. Collateral from third party. In certain situ­ ations, the consumer’s obligation may be se­ cured by collateral belonging to a third party. For example, an open-end credit plan may be secured by an interest in property owned by the consumer’s parents. In such cases, the se­ curity interest is taken in connection with the plan and must be disclosed, even though the property encumbered is owned by someone other than the consumer.

6(d) Statement of Billing Rights See the commentary to appendix G-3. 6(e) Home-Equity Plan Information 1. Additional disclosures required. For homeequity plans, creditors must provide several of the disclosures set forth in section 226.5b(d) along with the disclosures required under sec­ tion 226.6. Creditors also must disclose a list of the conditions that permit the creditor to terminate the plan, freeze or reduce the credit limit, and implement specified modifications to the original terms. (See comment 5b(d)(4)(iii)-l.) 2. Form of disclosures. The home-equity dis­ closures provided under this section must be in a form the consumer can keep, and are governed by section 226.5(a)(1). The segrega­ tion standard set forth in section 226.5b(a) does not apply to home-equity disclosures provided under section 226.6. 3. Disclosure of payment and variable-rate examples. The payment-example disclosure in section 226.5b(d)(5)(iii) and the variable-rate information in section 226.5b(d)(12)(viii), (x), (xi), and (xii) need not be provided with the disclosures under section 226.6 if: • The disclosures under section 226.5b(d) were provided in a form the consumer could keep; and • The disclosures of the payment example under section 226.5b(d)(5)(iii), the maxi­ mum-payment example under section 226.5b(d)(12)(x) and the historical table under section 226.5b(d)(12)(xi) included a representative payment example for the cat­ egory of payment options the consumer has chosen.

For example, if a creditor offers three pay­ ment options (one for each of the categories described in the commentary to section 226.5b(d)(5)), describes all three options in its early disclosures, and provides all of the dis- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 62

§ 226.6 Regulation Z Commentary closures in a retainable form, that creditor need not provide the section 226.5b(d)(5)(iii) or 226.5b(d)(12) disclosures again when the account is opened. If the creditor showed only one of the three options in the early disclo­ sures (which would be the case with a sepa­ rate disclosure form rather than a combined form, as discussed under section 226.5b(a)), the disclosures under section 226.5b(d)(5)(iii) and 226.5b(d)(12)(viii), (x), (xi) and (xii) must be given to any consumer who chooses one of the other two options. If the section 226.5b(d)(5)(iii) and 226.5b(d)(12) disclosures are provided with the second set of disclo­ sures, they need not be transaction-specific, but may be based on a representative example of the category of payment option chosen. 4. Disclosures for the repayment period. The creditor must provide disclosures about both the draw and repayment phases when giving the disclosures under section 226.6. Specifi­ cally, the creditor must make the disclosures in section 226.6(e), state the corresponding annual percentage rate (as required in section 226.6(a)(2)), and provide the variable-rate in­ formation required in footnote 12 for the re­ payment phase. To the extent the correspond­ ing annual percentage rate, the information in footnote 12, and any other required disclo­ sures are the same for the draw and repay­ ment phase, the creditor need not repeat such information, as long as it is clear that the in­ formation applies to both phases. References Statute: § 127(a) Other sections: §§ 226.4, 226.5, 226.7, 226.9, 226.14, and appendix G Previous regulation: § 226.7(a) and interpreta­ tion § 226.706 1981 changes: Section 226.6 implements the amended statute which requires disclosure of the fact that no free period exists. Disclosures about the minimum periodic payment and the Comparative Index of Credit Cost have been eliminated. The security interest disclosures have been simplified. “Other charges” no longer include voluntary credit life or disabil­ ity insurance, required property insurance pre­ miums, default charges, or fees for collection activity. Disclosures for variable rate plans are now required by the regulation, replacing in­ terpretation section 226.707. The regulation no longer specifies the exact language to be used for the billing rights notice; creditors may use any version “substantially similar” to the one in appendix G.

SECTION 226.7—Periodic Statement 1. Multifeatured plans. Some plans involve a number of different features, such as purchases, cash advances, or overdraft check­ ing. Groups of transactions subject to different finance charge terms because of the dates on which the transactions took place are treated like different features for purposes of disclo­ sures on the periodic statements. The com­ mentary includes some special rules for mul­ tifeatured plans.

2. Separate periodic statements permitted. In a certain open-end credit program involving more than one creditor—a card issuer of travel-and-entertainment cards and a financial institution—the consumer has the option tc pay the card issuer directly or to transfer to the financial institution all or part of the amount owing. In this case, the creditors may send separate periodic statements that reflec the separate obligations owed to each. 7(a) Previous Balance 1. Credit balances. If the previous balance is a credit balance, it must be disclosed in such a way so as to inform the consumer that it is a credit balance, rather than a debit balance. 2. Multifeatured plans. In a multifeatured plan, the previous balance may be disclosed either as an aggregate balance for the account or as separate balances for each feature (for example, a previous balance for purchases and a previous balance for cash advances). If sep­ arate balances are disclosed, a total previous balance is optional.

3. Accrued finance charges allocated from payments. Some open-end credit plans provid< that the amount of the finance charge that has accrued since the consumer’s last payment is directly deducted from each new payment, rather than being separately added to each Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 63

Regulation Z Commentary § 226.7 statement and reflected as an increase in the obligation. In such a plan, the previous bal­ ance need not reflect finance charges accrued since the last payment.

7(b) Identification of Transactions 1. Multifeatured plans. In identifying transac­ tions under section 226.7(b) for multifeatured plans, creditors may, for example, choose to arrange transactions by feature (such as dis­ closing sale transactions separately from cash advance transactions) or in some other clear manner, such as by arranging the transactions in general chronological order. 2. Automated teller machine (ATM) charges imposed by other institutions in shared or in­ terchange systems. A charge imposed on the cardholder by an institution other than the card issuer for the use of the other institu­ tion’s ATM in a shared or interchange system and included by the terminal-operating institu­ tion in the amount of the transaction need not be separately disclosed on the periodic statement.

J 7(c) Credits 1. Identification—sufficiency. The creditor need not describe each credit by type (re­ turned merchandise, rebate of finance charge, etc.)—“credit” would suffice—except if the creditor is using the periodic statement to sat­ isfy the billing-error correction notice require­ ment. (See the commentary to section 226.13(e) and (f).) 2. Format. A creditor may list credits relating to credit extensions (payments, rebates, etc.) together with other types of credits (such as deposits to a checking account), as long as the entries are identified so as to inform the con­ sumer which type of credit each entry represents.

3. Date. If only one date is disclosed (that is, the crediting date as required by the regula­ tion), no further identification of that date is necessary. More than one date may be dis­ closed for a single entry, as long as it is clear which date represents the date on which credit was given.

4. Totals Where the creditor lists the credits made to the account during the billing cycle, the creditor need not disclose total figures for the amounts credited.

7(d) Periodic Rates 1. Disclosure of periodic rates—whether or not actually applied. Any periodic rate that may be used to compute finance charges (and its corresponding annual percentage rate) must be disclosed whether or not it is applied dur­ ing the billing cycle. For example: • If the consumer’s account has both a purchase feature and a cash advance fea­ ture, the creditor must disclose the rate for each, even if the consumer only makes purchases on the account during the billing cycle.

• If the rate varies (such as when it is tied to a particular index), the creditor must dis­ close each rate in effect during the cycle for which the statement was issued. 2. Disclosure of periodic rates required only if imposition possible. With regard to the peri­ odic rate disclosure (and its corresponding an­ nual percentage rate), only rates that could have been imposed during the billing cycle re­ flected on the periodic statement need to be disclosed. For example:

• If the creditor is changing rates effective during the next billing cycle (either be­ cause it is changing terms or because of a variable-rate plan), the rates required to be disclosed under section 226.7(d) are only those in effect during the billing cycle re­ flected on the periodic statement. For ex­ ample, if the monthly rate applied during May was 1.5 percent, but the creditor will increase the rate to 1.8 percent effective June 1, 1.5 percent (and its corresponding annual percentage rate) is the only required disclosure under section 226.7(d) for the periodic statement reflecting the May ac­ count activity.

• If the consumer has an overdraft line that might later be expanded upon the consum­ er’s request to include secured advances, the rates for the secured advance feature need not be given until such time as the consumer has requested and received ac­ cess to the additional feature. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 64

§ 226.7 Regulation Z Commentary • If rates applicable to a particular type of transaction changed after a certain date and the old rate is only being applied to trans­ actions that took place prior to that date, the creditor need not continue to disclose the old rate for those consumers that have no outstanding balances to which that rate could be applied.

3. Multiple rates—same transaction. If two or more periodic rates are applied to the same balance for the same type of transaction (for example, if the finance charge consists of a monthly periodic rate of 1.5 percent applied to the outstanding balance and a required credit life insurance component calculated at 0.1 percent per month on the same outstanding balance), the creditor may do either of the following:

• Disclose each periodic rate, the range of balances to which it is applicable, and the corresponding annual percentage rate for each (for example, 1.5 percent monthly, 18 percent annual percentage rate; 0.1 percent monthly, 1.2 percent annual percentage rate) • Disclose one composite periodic rate (that is, 1.6 percent per month) along with the applicable range of balances and corre­ sponding annual percentage rate 4. Corresponding annual percentage rate. In disclosing the annual percentage rate that cor­ responds to each periodic rate, the creditor may use “corresponding annual percentage rate,” “nominal annual percentage rate,” “corresponding nominal annual percentage rate,” or similar phrases.

5. Rate same as actual annual percentage rate. When the corresponding rate is the same as the actual annual percentage rate (historical rate) required to be disclosed (§ 226.7(g)), the creditor need disclose only one annual per­ centage rate, but must use the phrase “annual percentage rate.”

6. Ranges of balances. See comment 6(a)(2)- 1.

7(e) Balance on Which Finance Charge Computed 1. Limitation to periodic rates. Section 226.7(e) only requires disclosure of the bal­ ance^) to which a periodic rate was applied and does not apply to balances on which other kinds of finance charges (such as transaction charges) were imposed. For example, if a con­ sumer obtains a $1,500 cash advance subject to both a 1 percent transaction fee and a 1 percent monthly periodic rate, the creditor need only disclose the balance subject to the monthly rate (which might include portions of earlier cash advances not paid off in previous cycles).

2. Split rates applied to balance ranges. If split rates were applied to a balance because different portions of the balance fall within two or more balance ranges, the creditor need not separately disclose the portions of the bal­ ance subject to such different rates since the range of balances to which the rates apply has been separately disclosed. For example, a creditor could disclose a balance of $700 for purchases even though a monthly periodic rate of 1.5 percent applied to the first $500, and a monthly periodic rate of 1 percent to the re­ mainder. This option to disclose a combined balance does not apply when the finance charge is computed by applying the split rates to each day’s balance (in contrast, for exam­ ple, to applying the rates to the average dail> balance). In that case, the balances must be disclosed using any of the options that are available if two or more daily rates are im­ posed. (See comment 7(e)-5.) 3. Monthly rate on average daily balance. If a creditor computes a finance charge on the average daily balance by application of a monthly periodic rate or rates, the balance is adequately disclosed if the statement gives the amount of the average daily balance on which the finance charge was computed and also states how the balance is determined. 4. Multifeatured plans. In a multifeatured plan, the creditor must disclose a separate bal­ ance (or balances, as applicable) to which a periodic rate was applied for each feature or group of features subject to different periodic rates or different balance computation meth-' ods. Separate balances are not required, how­ ever, merely because a “free-ride” period is available for some features but not others. A Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 65

Regulation Z Commentary § 226.7 total balance for the entire plan is optional. This does not affect how many balances the creditor must disclose—or may disclose— within each feature. (See, for example, com­ ment 7(e)-5.) 5. Daily rate on daily balance. If the finance charge is computed on the balance each day by application of one or more daily periodic rates, the balance on which the finance charge was computed may be disclosed in any of the following ways for each feature: If a single daily periodic rate is imposed, the balance to which it is applicable may be stated as:

—a balance for each day in the billing cycle —a balance for each day in the billing cycle on which the balance in the account changes —the sum of the daily balances during the billing cycle —the average daily balance during the billing cycle, in which case the creditor shall explain that the average daily balance is or can be multiplied by the number of days in the billing cycle and the periodic rate applied to the product to determine the amount of the finance charge If two or more daily periodic rates may be imposed, the balances to which the rates are applicable may be stated as: —a balance for each day in the billing cycle —a balance for each day in the billing cycle on which the balance in the account changes —two or more average daily balances, each applicable to the daily periodic rates imposed for the time that those rates were in effect, as long as the ' creditor explains that the finance charge is or may be determined by (1) multiplying each of the average balances by the number of days in the billing cycle (or if the daily rate varied during the cycle, by multiplying by the number of days the applicable rate was in effect), (2) multiplying each of the results by the applicable daily periodic rate, and (3) adding these products together.

6. Explanation of balance-computation method. See the commentary to section 226.6(a)(3).

7. Information to compute balance. In con­ nection with disclosing the finance charge bal­ ance, the creditor need not give the consumer all of the information necessary to compute the balance if that information is not other­ wise required to be disclosed. For example, if current purchases are included from the date they are posted to the account, the posting date need not be disclosed. 8. Nondeduction of credits. The creditor need not specifically identify the total dollar amount of credits not deducted in computing the finance charge balance. Disclosure of the amount of credits not deducted is accom­ plished by listing the credits (§ 226.7(c)) and indicating which credits will not be deducted in determining the balance (for example, “Credits after the 15th of the month are not deducted in computing the finance charge.”). 9. Use of one balance-computation method explanation when multiple balances disclosed. Sometimes the creditor will disclose more than one balance to which a periodic rate was applied, even though each balance was com­ puted using the same balance-computation method. For example, if a plan involves purchases and cash advances that are subject to different rates, more than one balance must be disclosed, even though the same computa­ tion method is used for determining the bal­ ance for each feature. In these cases, one ex­ planation of the balance-computation method is sufficient. Sometimes the creditor separately discloses the portions of the balance that are subject to different rates because different por­ tions of the balance fall within two or more balance ranges, even when a combined bal­ ance disclosure would be permitted under comment 7(e)-2. In these cases, one explana­ tion of the balance-computation method is also sufficient (assuming, of course, that all portions of the balance were computed using the same method).

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 66

§ 226.7 Regulation Z Commentary 7(f) Amount of Finance Charge 1. Total. A total finance charge amount for the plan is not required.

2. Itemization—types of finance charges. Each type of finance charge (such as periodic rates, transaction charges, and minimum charges) imposed during the cycle must be separately itemized; for example, disclosure of only a combined finance charge attributable to both a minimum charge and transaction charges would not be permissible. Finance charges of the same type may be disclosed, however, in­ dividually or as a total. For example, five transaction charges of $1 may be listed sepa­ rately or as $5.

3. Itemization—different periodic rates. Whether different periodic rates are applicable to different types of transactions or to differ­ ent balance ranges, the creditor may give the finance charge attributable to each rate or may give a total finance charge amount. For exam­ ple, if a creditor charges 1.5 percent per month on the first $500 of a balance and 1 percent per month on amounts over $500, the creditor may itemize the two components ($7.50 and $1.00) of the $8.50 charge, or may disclose $8.50.

4. Multifeatured plans. In a multifeatured plan, in disclosing the amount of the finance charge attributable to the application of peri­ odic rates no total periodic rate disclosure for the entire plan need be given. 5. Finance charges not added to account. A finance charge that is not included in the new balance because it is payable to a third party (such as required life insurance) must still be shown on the periodic statement as a finance charge.

6. Finance charges other than periodic rates. See comment 6(a)(4)-1 for examples. 7. Accrued finance charges allocated from payments. Some plans provide that the amount of the finance charge that has accrued since the consumer’s last payment is directly de­ ducted from each new payment, rather than being separately added to each statement and therefore reflected as an increase in the obli­ gation. In such a plan, no disclosure is required of finance charges that have accrued since the last payment.

8. Start-up fees. Points, loan fees, and similar finance charges relating to the opening of the account that are paid prior to the issuance of the first periodic statement need not be dis­ closed on the periodic statement. If, however, these charges are financed as part of the plan, including charges that are paid out of the first advance, the charges must be disclosed as part of the finance charge on the first periodic statement. However, they need not be factored into the annual percentage rate. (See footnote 33 in the regulation.) 7(g) Annual Percentage Rate 1. Rate same as corresponding annual per­ centage rate. See comment 7(d)-5. 2. Multifeatured plans. In a multifeatured plan, the actual annual percentage rate that re­ flects the finance charge imposed during the cycle may be separately stated for each fea­ ture or may be described as a composite for the whole plan.

7(h) Other Charges 1. Identification. In identifying any “other charges” actually imposed during the billing cycle, the type is adequately described as “late charge” or “membership fee,” for ex­ ample. Similarly, “closing costs” or “settle­ ment costs,” for example, may be used to de­ scribe charges imposed in connection with real estate transactions that are excluded from the finance charge under section 226.4(c)(7), if the same term (such as “closing costs”) was used in the initial disclosures and if the creditor chose to itemize and individually dis­ close the costs included in that term. Even though the taxes and filing or notary fees ex­ cluded from the finance charge under section 226.4(e) are not required to be disclosed as “other charges” under section 226.6(b), these charges may be included in the amount shown as “closing costs” or “settlement costs” on the periodic statement, if the charges were itemized and disclosed as part of the “closing costs” or “settlement costs” on the initial dis­ closure statement. (See comment 6(b)-1 for examples of “other charges.”) Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 67

Regulation Z Commentary § 226.7 2. Date. The date of imposing or debiting “other charges” need not be disclosed. 3. Total. Disclosure of the total amount of other charges is optional.

4. Itemization—types of “other charges”. Each type of “other charge” (such as latepayment chaises, over-the-credit-limit charges, ATM fees that are not finance charges, and membership fees) imposed during the cycle must be separately itemized; for example, dis­ closure of only a total of “other charges” at­ tributable to both an over-the-credit-limit charge and a late-payment charge would not be permissible. “Other charges” of the same type may be disclosed, however, individually or as a total. For example, three ATM fees of $1 may be listed separately or as $3. 7(i) Closing Date of Billing Cycle; New Balance 1. Credit balances. See comment 7(a)-1. . Multifeatured plans. In a multifeatured lan, the new balance may be disclosed for each feature or for the plan as a whole. If separate new balances are disclosed, a total iew balance is optional.

3. Accrued finance charges allocated from payments. Some plans provide that the amount of the finance charge that has accrued since the consumer’s last payment is directly de­ ducted from each new payment, rather than being separately added to each statement and therefore reflected as an increase in the obli­ gation. In such a plan, the new balance need not reflect finance charges accrued since the last payment 7(j) Free-Ride Period 1. Wording. Although the creditor is required to indicate any time period the consumer may have to pay the balance outstanding without incurring additional finance charges, no sperific wording is required, so long as the lan­ guage used is consistent with that used on the initial disclosure statement For example, “To avoid additional finance charges, pay the new balance before ” would suffice.

7(k) Address for Notice of Billing Errors 1. Wording. The periodic statement must con­ tain the address for consumers to use in as­ serting billing errors under section 226.13. Since all disclosures must be “clear,” the statement should indicate the general purpose for the address, although no elaborate expla­ nation or particular wording is required. 2. Telephone number. A telephone number may be included, but the address for billingerror inquiries, which is the required disclo­ sure, must be clear and conspicuous. One way to ensure that the address is clear and con­ spicuous is to include a precautionary instruc­ tion that telephoning will not preserve the consumer’s billing-error rights. Both of the billing rights statements in appendix G contain such a precautionary instruction, so that a creditor could, by including either of these statements with each periodic statement, en­ sure that the required address is provided in a clear and conspicuous manner. References Statute: § 127(b) Previous regulation: § 226.7(b)(1) and inter­ pretation § 226.701, 226.703, 226.706, and 226.707 Other sections: §§ 226.4 through 226.6, 226.8, 226.14, and appendix G 1981 changes: Under § 226.7, required termi­ nology is no longer mandated except for the terms “finance charge” and “annual percent­ age rate.” The requirement in the previous regulation about the location of disclosures has been deleted.

Under the revised section 226.7, disclosure of credits to the account no longer have to indicate the type of credit. A short disclosure for variable-rate plans must be included on the periodic statement. Disclosures relating to multifeatured accounts have been clarified. Section 226.7 now specifically requires a periodic statement disclosure of “other charges” (nonfinance charges related to the plan) that are actually imposed during the bill­ ing cycle.

Disclosures about minimum charges that might be imposed on the account and about Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 68

§ 226.7 Regulation Z Commentary the Comparative Index of Credit Cost have been deleted.

SECTION 226.8—Identification of Transactions 1. Application of identification rules. Section 226.8 deals with the requirement (imposed by section 226.7(b)) for identification of each credit transaction made during the billing cy­ cle. The rules for identifying transactions on periodic statements vary, depending on whether:

• The transaction involves sale credit (purchases) or nonsale credit (cash ad­ vances, for example) • An actual copy of the credit document re­ flecting the transaction accompanies the statement (this is the distinction between so-called “country club” and “descriptive” billing) • The creditor and seller are the same or re­ lated persons 4. Actual copy. An actual copy does not in­ clude a recreated document. It includes, example, a duplicate, carbon, or photographic copy, but does not include a so-called “fac­ simile draft” in which the required informa­ tion is typed, printed, or otherwise recreated. If a facsimile draft is used, the creditor must follow the rules that apply when a copy of the credit document is not furnished. 5. Same or related persons. For purposes of identifying transactions, the term “same or re­ lated persons” refers to, for example: • Franchised or licensed sellers of a credi­ tor’s product or service • Sellers who assign or sell open-end sales accounts to a creditor or arrange for such credit under a plan that allows the consum­ er to use the credit only in transactions with that seller A seller is not related to the creditor merely because the seller and the creditor have an agreement authorizing the seller to honor the creditor’s credit card.

2. Sale credit. The term “sale credit” refers to a purchase in which the consumer uses a credit card or otherwise directly accesses an open-end line of credit (see comment 8-3 if access is by means of a check) to obtain goods or services from a merchant, whether or not the merchant is the card issuer. “Sale credit” even includes:

• Premiums for voluntary credit life insur­ ance whether sold by the card issuer or an­ other person • The purchase of funds-transfer services (such as telegrams) from an intermediary 3. Nonsale credit. The term “nonsale credit” refers to any form of loan credit including, for example:

• Cash advances • Overdraft checking • The use of a “supplemental credit device” in the form of a check or draft or the use of the overdraft feature of a debit card, even if such use is in connection with a purchase of goods or services • Miscellaneous debits to remedy mispostings, returned checks, and similar entries 6. Transactions resulting from promotional material. In describing transactions with thirdparty sellers resulting from promotional mate­ rial mailed by the creditor, creditors may use the rules either for “related” or for “nonrelated” sellers and creditors. 7. Credit insurance offered through the credi­ tor. When credit insurance that is not part of the finance charge (for example, voluntary credit life insurance) is offered to the con­ sumer through the creditor but is actually pro­ vided by another company, the creditor has the option of identifying the premiums in one of two ways on the periodic statement. The creditor may describe the premiums using ei­ ther the rule in section 226.8(a)(2) for “re­ lated” sellers and creditors, or the rule in sec­ tion 226.8(a)(3) for “nonrelated” sellers and creditors. This means, therefore, that the cred­ itor may identify the insurance either by pro­ viding, under section 226.8(a)(2), a brief iden­ tification of the services provided (for example, “credit life insurance”), or by dis­ closing, under section 226.8(a)(3), the name and address of the company providing the in­ surance (for example, ABC Insurance Com- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 69

Regulation Z Commentary § 226.8 pany, New York, New York). In either event, .he creditor would, of course, also provide the amount and the date of the transaction. transaction date either the invoice date, the debiting date, or the date the order was placed by telephone.

8. Transactions involving creditors and sellers with corporate connections. In a credit card plan established for use primarily with sellers that have no corporate connection with the creditor, the creditor may describe all transac­ tions under the plan by using the rules in sec­ tion 226.8(a)(3)—creditor and seller not same or related persons—including transactions in­ volving a seller that has a corporate connec­ tion with the creditor. In other credit card plans, the creditor may describe transactions involving a seller that has a corporate connec­ tion with the creditor, such as subsidiary-par­ ent, using the rules in section 226.8(a)(3) where it is unlikely that the consumer would know of the corporate connection between the creditor and the seller—for example, where the names of the creditor and the seller are not similar, and the periodic statement is is­ sued in the name of the creditor only. 8(a) Sale Credit 4. Transactions not billed in full. If sale trans­ actions are not billed in full on any single statement, but are billed periodically in precomputed installments, the first periodic statement reflecting the transaction must show either the full amount of the transaction to­ gether with the date the transaction actually took place; or the amount of the first install­ ment that was debited to the account together with the date of the transaction or the date on which the first installment was debited to the account. In any event, subsequent periodic statements should reflect each installment due, together with either any other identifying in­ formation required by section 226.8(a) (such as the seller’s name and address in a threeparty situation) or other appropriate identify­ ing information relating the transaction to the first billing. The debiting date for the particu­ lar installment, or the date the transaction took place, may be used as the date of the transac­ tion on these subsequent statements. 1. Date—disclosure of only one date. If only the required date is disclosed for a transaction, he creditor need not identify it as the “trans­ action date.” If the creditor discloses more than one date (for example, the transaction date and the posting date), the creditor must identify each.

2. Date—disclosure of month and day only. The month and day are sufficient disclosure of the date on which the transaction took place, unless the posting of the transaction is delayed so long that the year is needed for a clear disclosure to the consumer. 3. When transaction takes place. If the con­ sumer conducts the transaction in person, the date of the transaction is the calendar date on which the consumer made the purchase or or­ der, or secured the advance. For transactions billed to the account on an ongoing basis (other than installments to pay a precomputed amount), the date of the transaction is the date on which the amount is debited to the ac­ count. This might include, for example, monthly insurance premiums. For mail or tele­ phone orders, a creditor may disclose as the 8(a)(1) Copy of Credit Document Provided 1. Format. The information required by sec­ tion 226.8(a)(1) may appear either on the copy of the credit document reflecting the transaction or on the periodic statement. 8(a)(2) Copy of Credit Document Not Provided—Creditor and Seller Same or Related Person(s) 1. Property identification—sufficiency of description. The “brief identification” provi­ sion in section 226.8(a)(2) requires a designa­ tion that will enable the consumer to reconcile the periodic statement with the consumer’s own records. In determining the sufficiency of the description, the following rules apply: • While item-by-item descriptions are not necessary, reasonable precision is required. For example, “merchandise,” “miscellane­ ous,” “second-hand goods,” or “promo­ tional items” would not suffice. • A reference to a department in a sales es­ tablishment that accurately conveys the identification of the types of property or Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 70

§ 226.8 Regulation Z Commentary services available in the department is suf­ ficient—for example, “jewelry,” “sporting goods.”

2. Property identification—number or symbol. The “brief identification” may be made by disclosing on the periodic statement a number or symbol that is related to an identification list printed elsewhere on the statement. 3. Property identification—additional docu­ ment. In making the “brief identification” re­ quired by section 226.8(a)(2), the creditor may identify the property by describing the trans­ action on a document accompanying the peri­ odic statement (for example, on a facsimile draft). (See also footnote 17.) 4. Small creditors. Under footnote 18, which provides a further identification alternative to a creditor with fewer than 15,000 accounts, the creditor need count only its own accounts and not others serviced by the same data processor or other shared-service provider. 5. Date of transaction—foreign transactions. In a foreign transaction, the debiting date may be considered the transaction date. 8(a)(3) Copy of Credit Document Not Provided—Creditor and Seller Not Same or Related Person(s) 1. Seller’s name. The requirement contem­ plates that the seller’s name will appear on the periodic statement in essentially the same form as it appears on transaction documents provided to the consumer at the time of the sale. The seller’s name may also be disclosed as, for example:

• A more complete spelling of the name that was alphabetically abbreviated on the re­ ceipt or other credit document • An alphabetical abbreviation of the name on the periodic statement even if the name appears in a more complete spelling on the receipt or other credit document. Terms that merely indicate the form of a business entity, such as “Inc.,” “Co.,” or “Ltd.,” may always be omitted.

2. Location of transaction. The disclosure of the location where the transaction took place generally requires an indication of both the city, and the state or foreign country. If the seller has multiple stores or branches wit that city, the creditor need not identify the specific branch at which the sale occurred. 3. No fixed location. When no meaningful ad­ dress is available because the consumer did not make the purchase at any fixed location of the seller, the creditor:

• May omit the address • May provide some other identifying desig­ nation, such as “aboard plane,” “ABC Airways Flight,” “customer’s home,” “telephone order,” or “mail order” 4. Date of transaction—foreign transactions. See comment 8(a)(2)-5.

8(b) Nonsale Credit 1. Date of transaction. If only one of the re­ quired dates is disclosed for a transaction, the creditor need not identify it. If the creditor discloses more than one date (for example, transaction date and debiting date), the credi­ tor must identify each.

2. Amount of transaction. If credit is extended under an overdraft checking account plan or by means of a debit card with an overdraft feature, the amount to be disclosed is that o the credit extension, not the face amount of the check or the total amount of the debit/ credit transaction.

3. Amount—disclosure on cumulative basis. If credit is extended under an overdraft checking account plan or by means of a debit card with an overdraft feature, the creditor may disclose the amount of the credit extensions on a cu­ mulative daily basis, rather than the amount attributable to each check or each use of the debit/credit card.

4. Identification of transaction type. The cred­ itor may identify a transaction by describing the type of advance it represents, such as cash advance, loan, overdraft loan, or any readily understandable trade name for the credit program.

References Statute: § 127(b)(2) Previous regulation: § 226.7(k) Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 71

Regulation Z Commentary § 226.9 Other sections: § 226.7 1981 changes: Section 226.8 has been stream­ lined and reorganized to facilitate its use. Technical detail has been deleted from the regulation for inclusion in the commentary. The regulation implements the amended sec­ tion 127(bX2) of the act by providing for pro­ tection from civil liability under certain cir­ cumstances when required information is not provided and by reducing disclosure responsi­ bilities for certain small creditors. For descrip­ tive billing of nonsale transactions, the regula­ tion now permits the use of the debiting date in all cases.

SECTION 226.9—Subsequent Disclosure Requirements 9(a) Furnishing Statement of Billing Rights 9(a)(1) Annual Statement t * 1. General. The creditor may provide the an­ nual billing rights statement: • By sending it in one billing period per year to each consumer that gets a periodic state­ ment for that period or • By sending a copy to all of its account holders sometime during the calendar year but not necessarily all in one billing period (for example, sending the annual notice in connection with renewal cards or when im­ posing annual membership fees). 2. Substantially similar. See the commentary to appendix G-3.

9(a)(2) Alternative Summary Statement 1. Changing from long-form to short-form statement and vice versa. If the creditor has been sending the long-form annual statement, and subsequently decides to use the alternative summary statement, the first summary state­ ment must be sent no later than 12 months after the last long-form statement was sent. Conversely, if the creditor wants to switch to the long-form, the first long-form statement must be sent no later than 12 months after the last summary statement.

2. Substantially similar. See the commentary to appendix G-4.

9(b) Disclosures for Supplemental Credit Devices and Additional Features 1. Credit device—examples. “Credit device” includes, for example, a blank check, payeedesignated check, blank draft or order, or au­ thorization form for issuance of a check; it does not include a check issued payable to a consumer representing loan proceeds or the disbursement of a cash advance. 2. Credit feature—examples. A new credit “feature” would include, for example: • The addition of overdraft checking to an existing account (although the regular checks that could trigger the overdraft fea­ ture are not themselves “devices”) • The option to use an existing credit card to secure cash advances, when previously the card could only be used for purchases Paragraph 9(b)(1) 1. Same finance charge terms. If the new means of accessing the account is subject to the same finance charge terms as those previ­ ously disclosed, the creditor: • Need only provide a reminder that the new device or feature is covered by the earlier disclosures (For example, in mailing spe­ cial checks that directly access the credit line, the creditor might give a disclosure such as “Use this as you would your XYZ card to obtain a cash advance from our bank”) or • May remake the section 226.6(a) finance charge disclosures.

Paragraph 9(b)(2) 1. Different finance charge terms. If the fi­ nance charge terms are different from those previously disclosed, the creditor may satisfy the requirement to give the finance charge terms either by giving a complete set of new initial disclosures reflecting the terms of the added device or feature or by giving only the finance charge disclosures for the added de­ vice or feature.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 72

§ 226.9 Regulation Z Commentary 9(c) Change in Terms 1. “Changes ” initially disclosed. No notice of a change in terms need be given if the spe­ cific change is set forth initially, such as: rate increases under a properly disclosed variablerate plan, a rate increase that occurs when an employee has been under a preferential rate agreement and terminates employment, or an increase that occurs when the consumer has been under an agreement to maintain a certain balance in a savings account in order to keep a particular rate and the account balance falls below the specified minimum. In contrast, no­ tice must be given if the contract allows the creditor to increase the rate at its discretion but does not include specific terms for an in­ crease (for example, when an increase may occur under the creditor’s contract reservation right to increase the periodic rate). The rules in section 226.5b(f) relating to home-equity plans, however, limit the ability of a creditor to change the terms of such plans. 2. State law issues. Examples of issues not addressed by section 226.9(c) because they are controlled by state or other applicable law include:

• The types of changes a creditor may make • How changed terms affect existing bal­ ances, such as when a periodic rate is changed and the consumer does not pay off the entire existing balance before the new rate takes effect 3. Change in billing cycle. Whenever the creditor changes the consumer’s billing cycle, it must give a change-in-terms notice if the change either affects any of the terms required to be disclosed under section 226.6 or in­ creases the minimum payment, unless an ex­ ception under section 226.9(c)(2) applies; for example, the creditor must give advance no­ tice if the creditor initially disclosed a 25-day free-ride period on purchases and the con­ sumer will have fewer days during the billing cycle change.

9(c)(1) Written Notice Required 1. Affected consumers. Change-in-terms no­ tices need only go to those consumers who may be affected by the change. For example, a change in the periodic rate for check over­ draft credit need not be disclosed to consum­ ers who do not have that feature on their accounts.

2. Timing—effective date of change. The rule that the notice of the change in terms be pro­ vided at least 15 days before the change takes effect permits midcycle changes when there is clearly no retroactive effect, such as the impo­ sition of a transaction fee. Any change in the balance computation method, in contrast, would need to be disclosed at ieast 15 days prior to the billing cycle in which the change is to be implemented.

3. Timing—advance notice not required. Ad­ vance notice of 15 days is not necessary—that is, a notice of change in terms is required, but it may be mailed or delivered as late as the effective date of the change—in two circumstances:

• If there is an increased periodic rate or any other finance charge attributable to the con­ sumer’s delinquency or default • If the consumer agrees to the particular change. This provision is intended for use in the unusual instance when a consumer substitutes collateral or when the creditor can advance additional credit only if al change relatively unique to that consumer is made, such as the consumer’s providing additional security or paying an increased minimum-payment amount. Therefore, the following are not “agreements” between the consumer and the creditor for purposes of section 226.9(c)(1): the consumer’s gen­ eral acceptance of the creditor’s contract reservation of the right to change terms; the consumer’s use of the account (which might imply acceptance of its terms under state law); and the consumer’s acceptance of a unilateral term change that is not par­ ticular to that consumer, but rather is of general applicability to consumers with that type of account.

4. Form of change-in-terms notice. A com­ plete new set of the initial disclosures contain­ ing the changed term complies with section 226.9(c) if the change is highlighted in some way on the disclosure statement, or if the dis­ closure statement is accompanied by a letter Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 73

Regulation Z Commentary § 226.9 or some other insert that indicates or draws ttention to the term change. 5. Security interest change—form of notice. A copy of the security agreement that describes the collateral securing the consumer’s account may be used as the notice, when the term change is the addition of a security interest or the addition or substitution of collateral. 6. Changes to home-equity plans entered into on or after November 7, 1989. Section 226.9(c) applies when, by written agreement under section 226.5b(f)(3)(iii), a creditor changes the terms of a home equity plan—entered into on or after November 7, 1989—at or before its scheduled expiration, for example, by renewing a plan on terms dif­ ferent from those of the original plan. In dis­ closing the change:

• If the index is changed, the maximum an­ nual percentage rate is increased (to the limited extent permitted by section 226.30), or a variable-rate feature is added to a fixed-rate plan, the creditor must include the disclosures required by section 226.5b(d)(12)(x) and (d)(12)(xi), unless these disclosures are unchanged from those given earlier.

If the minimum payment requirement is changed, the creditor must include the dis­ closures required by section 226.5b(d) (5)(iii) (and, in variable-rate plans, the dis­ closures required by section 226.5b(d) (12)(x) and (d)(12Xxi)) unless the disclo­ sures given earlier contained representative examples covering the new minimum pay­ ment requirement. (See the commentary to section 226.5b(d)(5)(iii), (d)(12)(x), and (d)(12)(xi) for a discussion of representa­ tive examples.) When the terms are changed pursuant to a written agreement as described in section 226.5b(f)(3)(iii), the advance-notice require­ ment does not apply.

_ 9(c)(2) Notice Not Required 1. Changes not requiring notice. The follow­ ing are examples of changes that do not re­ quire a change-in-terms notice: • A change in the consumer’s credit limit • A change in the name of the credit card or credit card plan • The substitution of one insurer for another • A termination or suspension of credit privi­ leges • Changes arising merely by operation of law; for example, if the creditor’s security interest in a consumer’s car automatically extends to the proceeds when the consumer sells the car 2. Skip features. If a credit program allows consumers to skip or reduce one or more pay­ ments during the year, or involves temporary reductions in finance charges, no notice of the change in terms is required either prior to the reduction or upon resumption of the higher rates or payments if these features are ex­ plained on the initial disclosure statement (in­ cluding an explanation of the terms upon re­ sumption). For example, a merchant may allow consumers to skip the December pay­ ment to encourage holiday shopping, or a teacher’s credit union may not require pay­ ments during summer vacation. Otherwise, the creditor must give notice prior to resuming the original schedule or rate, even though no notice is required prior to the reduction. The change-in-terms notice may be combined with the notice offering the reduction. For example, the periodic statement reflecting the reduction or skip feature may also be used to notify the consumer of the resumption of the original schedule or rate, either by stating explicitly when the higher payment or charges resume or by indicating the duration of the skip op­ tion. Language such as “You may skip your October payment,” or “We will waive your finance charges for January” may serve as the change-in-terms notice.

9(c)(3) Notice for Home-Equity Plans 1. Written request for reinstatement. If a cred­ itor requires the request for reinstatement of credit privileges to be in writing, the notice under section 226.9(c)(3) must state that fact. 2. Notice not required. A creditor need not provide a notice under this paragraph if, pur­ suant to the commentary to section 226.5b(f)(2), a creditor freezes a line or Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 74

§ 226.9 Regulation Z Commentary reduces a credit line rather than terminating a plan and accelerating the balance. 9(d) Finance Charge Imposed at Time of Transaction 1. Disclosure prior to imposition. A person imposing a finance charge at the time of hon­ oring a consumer’s credit card must disclose the amount of the charge, or an explanation of how the charge will be determined, prior to its imposition. This must be disclosed before the consumer becomes obligated for property or services that may be paid for by use of a credit card. For example, disclosure must be given before the consumer has dinner at a res­ taurant, stays overnight at a hotel, or makes a deposit guaranteeing the purchase of property or services.

9(e) Disclosures Upon Renewal of Credit or Charge Card 1. Coverage. This paragraph applies to credit and charge card accounts of the type subject to 226.5a. (See section 226.5a(a)(3) and the accompanying commentary for discussion of the types of accounts subject to section 226.5a.) The disclosure requirements are trig­ gered when a card issuer imposes any annual or other periodic fee on such an account, whether or not the card issuer originally was required to provide the application and solici­ tation disclosures described in section 226.5a. 2. Form. The disclosures under this paragraph must be clear and conspicuous, but need not appear in a tabular format or in a prominent location. The disclosures need not be in a form the cardholder can retain. 3. Terms at renewal. Renewal notices must reflect the terms actually in effect at the time of renewal. For example, a card issuer that offers a preferential annual percentage rate to employees during their employment must send a renewal notice to employees disclosing the lower rate actually charged to employees (al­ though the card issuer also may show the rate charged to the general public). 4. Variable rate. If the card issuer cannot de­ termine the rate that will be in effect if the cardholder chooses to renew a variable-rate account, the card issuer may disclose the rate in effect at the time of mailing or delivery of the renewal notice. Alternatively, the card is­ suer may use the rate as of a specified date (and then update the rate from time to time, for example, each calendar month) or use an estimated rate under section 226.5(c). 5. Renewals more frequent than annual. If a renewal fee is billed more often than annually, the renewal notice should be provided each time the fee is billed. In this instance, the fee need not be disclosed as an annualized amount. Alternatively, the card issuer may provide the notice no less than once every 12 months if the notice explains the amount and frequency of the fee that will be billed during the time period covered by the disclosure, and also discloses the fee as an annualized amount. The notice under this alternative also must state the consequences of a cardholder’s decision to terminate the account after the re­ newal-notice period has expired. For example, if a $2 fee is billed monthly but the notice is given annually, the notice must inform the cardholder that the monthly charge is $2, the annualized fee is $24, and $2 will be billed to the account each month for the coming year unless the cardholder notifies the card issuer. If the cardholder is obligated to pay an^ amount equal to the remaining unpaid monthly charges if the cardholder terminates the account during the coming year but after the first month, the notice must disclose the fact.

6. Terminating credit availability. Card issuers have some flexibility in determining the pro­ cedures for how and when an account may be terminated. However, the card issuer must clearly disclose the time by which the card­ holder must act to terminate the account to avoid paying a renewal fee. State and other applicable law govern whether the card issuer may impose requirements such as specifying that the cardholder’s response be in writing or that the outstanding balance be repaid in full upon termination.

7. Timing of termination by cardholder. When a card issuer provides notice under section 226.9(e)(1), a cardholder must be given at least 30 days or one billing cycle, whichever Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 75

Regulation Z Commentary § 226.9 is less, from the date the notice is mailed or delivered to make a decision whether to termi­ nate an account. When notice is given under section 226.9(e)(2), a cardholder has 30 days from mailing or delivery to decide to termi­ nate an account.

8. Timing of notices. A renewal notice is deemed to be provided when mailed or deliv­ ered. Similarly, notice of termination is deemed to be given when mailed or delivered. 9. Prompt reversal of renewal fee upon termi­ nation. In a situation where a cardholder has provided timely notice of termination and a renewal fee has been billed to a cardholder’s account, the card issuer must reverse or other­ wise withdraw the fee promptly. Once a card­ holder has terminated an account, no addi­ tional action by the cardholder may be required.

9(e)(3) Notification on Periodic Statements 1. Combined disclosures. If a single disclo­ sure is used to comply with both sections 226.9(e) and 226.7, the periodic statement must comply with the rules in section 226.5a and 226.7. For example, the words “grace pe­ riod” must be used and the name of the baluice-calculation method must be identified (if listed in section 226.5a(g)) to comply with the requirements of section 226.5a, even though the use of those terms would not otherwise be required for periodic statements under section 226.7. A card issuer may include some of the renewal disclosures on a periodic statement and others on a separate document so long as there is some reference indicating that they re­ late to one another. All renewal disclosures must be provided to a cardholder at the same time.

2. Preprinted notices on periodic statements. A card issuer may preprint the required infor­ mation on its periodic statements. A card is­ suer that does so, however, using the advancenotice option under section 226.9(e)(1), must make clear on the periodic statement when the preprinted renewal disclosures are applicable. For example, the card issuer could include a special notice (not preprinted) at the appropri­ ate time that the renewal fee will be billed in the following billing cycle, or could show the renewal date as a regular (preprinted) entry on all periodic statements.

9(f) Change in Credit Card Account Insurance Provider 1. Coverage. This paragraph applies to credit card accounts of the type subject to section 226.5a if credit insurance (typically life, disa­ bility, and unemployment insurance) is offered on the outstanding balance of such an ac­ count. (Credit card accounts subject to section 226.9(f) are the same as those subject to sec­ tion 226.9(e); see comment 9(e)-1.) Charge card accounts are not covered by this para­ graph. In addition, the disclosure requirements of this paragraph apply only where the card issuer initiates the change in insurance provid­ ers. For example, if the card issuer’s current insurance provider is merged into or acquired by another company, these disclosures would not be required. Disclosures also need not be given in cases where card issuers pay for credit insurance themselves and do not sepa­ rately charge the cardholder. 2. No increase in rate or decrease in cover­ age. The requirement to provide the disclosure arises when the card issuer changes the pro­ vider of insurance, even if there will be no increase in the premium rate charged the con­ sumer and no decrease in coverage under the insurance policy.

3. Form of notice. If a substantial decrease in coverage will result from the change in prov­ iders, the card issuer either must explain the decrease or refer to an accompanying copy of the policy or group certificate for details of the new terms of coverage. (See the commen­ tary to appendix G-13.) 4. Discontinuation of insurance. In addition to stating that the cardholder may cancel the in­ surance, the card issuer may explain the effect the cancellation would have on the con­ sumer’s credit card plan.

5. Mailing by third party. Although the card issuer is responsible for the disclosures, the insurance provider or another third party may furnish the disclosures on the card issuer’s behalf.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 76

§ 226.9 Regulation Z Commentary Paragraph 9(f)(3) Substantial Decrease in Coverage 1. Determination. Whether a substantial de­ crease in coverage will result from the change in providers is determined by the two-part test in section 226.9(f)(3): first, whether the de­ crease is in a significant term of coverage; and second, whether the decrease might rea­ sonably be expected to affect a cardholder’s decision to continue the insurance. If both conditions are met, the decrease must be dis­ closed in the notice.

References Statute: §1 27(a)(7) Other sections: §§ 226.4 through 226.7 and appendix G Previous regulation: § 226.7(d) through (f) and (j) and interpretation § 226.705 and 226.708 1981 changes: Section 226.9(a) implements the statutory change that the long-form state­ ment of billing rights be provided only once a year. The provision now permits two rather than one means of providing the long-form statement to consumers. The verbatim text of the annual statement is no longer required; creditors may use any version “substantially similar” to the one in appendix G. If the cred­ itor elects to use the alternative summary statement, the new regulation no longer re­ quires that the long-form statement be sent upon receiving a billing-error notice and at the consumer’s request. The rules in section 226.708 on switching the type of billing-rights statement used have been modified. Under section 226.9(b) disclosure require­ ments have been streamlined when supple­ mental credit devices or new credit features are added to an existing open-end plan. Section 226.9(c) substantially changes the change-in-terms rules. Change-in-terms disclo­ sures must now be made 15 days before the effective date of the change, rather than 15 days before the billing cycle in which the change will take effect. The kinds of changes that will trigger disclosures have been re­ duced: change-in-terms notices are no longer required for the types of changes described in section 226.9(c)(2). But the provision reverses interpretation section 226.705, which indicated that certain changes in the balance computa­ tion method did not require disclosure because they could result in lowered finance charges; now, any change in the balance computation method requires disclosure. When a finance charge is imposed at the time of a transaction, section 226.9(d) only re­ quires disclosure of the finance charge at point-of-sale; the amount financed and annual percentage rate figured in accordance with the closed-end credit provisions need no longer be disclosed. Furthermore, the finance charge dis­ closure now may be made orally by the per­ son honoring the card.

SECTION 226.10—Prompt Crediting of Payments 10(a) General Rule 1. Crediting date. Section 226.10(a) does not require the creditor to post the payment to the consumer’s account on a particular date; the creditor is only required to credit the payment as of the date of receipt.

2. Date of receipt. The “date of receipt” is the date that the payment instrument or other means of completing the payment reaches the creditor. For example:

• Payment by check is received when the creditor gets it, not when the funds are collected.

• In a payroll deduction plan in which funds are deposited to an asset account held by the creditor, and from which payments are made periodically to an open-end credit ac­ count, payment is received on the date when it is debited to the asset account (rather than on the date of the deposit), provided the payroll deduction method is voluntary and the consumer retains use of the funds until the contractual payment date.

• If the consumer elects to have payment made by a third-party payor such as a fi­ nancial institution, through a preauthorized payment or telephone bill-payment arrange­ ment, payment is received when the credi­ tor gets the third-party payor’s check or other transfer medium, such as an electron- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 77

Regulation Z Commentary § 226.11 ic fund transfer, as long as the payment meets the creditor’s requirements as speci­ fied under section 226.10(b). draft, or other similar instrument in proper­ ly negotiable form, or by electronic fund transfer if the creditor and consumer have so agreed 10(b) Specific Requirements for Payments References 1. Payment requirements. The creditor may specify requirements for making payments, such as:

• Requiring that payments be accompanied by the account number or the payment stub • Setting a cut-off hour for payment to be received, or set different hours for payment by mail and payments made in person • Specifying that only checks or money or­ ders should be sent by mail • Specifying that payment is to be made in U.S. dollars • Specifying one particular address for re­ ceiving payments, such as a post office box The creditor may be prohibited, however, from specifying payment for preauthorized electronic fund transfer. (See section 913 of the Electronic Fund Transfer Act.) 2. Payment requirements—limitations. Re­ quirements for making payments must be rea­ sonable; it should not be difficult for most consumers to make conforming payments. For example, it would not be reasonable to require that all payments be made in person between 10 a.m. and 11 a.m., since this would require consumers to take time off from their jobs to deliver payments.

3. Acceptance of nonconforming payments. If the creditor accepts a nonconforming payment (for example, payment at a branch office, when it had specified that payment be sent to headquarters), finance charges may accrue for the period between receipt and crediting of payments.

4. Implied guidelines for payments. In the ab­ sence of specified requirements for making payments (see section 226.10(b)): Payments may be made at any location where the creditor conducts business Payments may be made any time during the creditor’s normal business hours Payment may be by cash, money order, Statute: § 164 Other sections: § 226.7 Previous regulation: § 226.7(g) 1981 changes: Much of the explanatory detail of the previous regulation is now in the com­ mentary. The revised regulation gives the creditor five days in which to credit noncon­ forming payments, whereas the previous regu­ lation required the crediting of such payments promptly, with an outside limit of five days. The five days in which to credit are available whenever the creditor accepts payment that does not conform to the creditor’s disclosed specifications, in contrast to the previous regu­ lation, which only allowed deferred crediting for payments made at the wrong location. SECTION 226.11—Treatment of Credit Balances 1. Timing of refund. The creditor may also fulfill its obligations under section 226.11 by: • Refunding any credit balance to the con­ sumer immediately • Refunding any credit balance prior to re­ ceiving a written request (under section 226.11(b)) from the consumer • Making a good faith effort to refund any credit balance before six months have passed. If that attempt is unsuccessful, the creditor need not try again to refund the credit balance at the end of the six-month period.

2. Amount of refund. The phrase “any part of the credit balance remaining in the account” in section 226.11(b) and (c) means the amount of the credit balance at the time the creditor is required to make the refund. The creditor may take into consideration intervening purchases or other debits to the consumer’s account (in­ cluding those that have not yet been reflected on a periodic statement) that decrease or elim­ inate the credit balance.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 78

§ 226.11 Regulation Z Commentary Paragraph 11(b) 1. Written requests—standing orders. The creditor is not required to honor standing or­ ders requesting refunds of any credit balance that may be created on the consumer’s account.

Paragraph 11(c) 1. Good faith effort to refund. The creditor must take positive steps to return any credit balance that has remained in the account for over six months. This includes, if necessary, attempts to trace the consumer through the consumer’s last known address or telephone number, or both.

2. Good faith effort unsuccessful. Section 226.11 imposes no further duties on the credi­ tor if a good faith effort to return the balance is unsuccessful. The ultimate disposition of the credit balance (or any credit balance of $1 or less) is to be determined under other appli­ cable law.

References Statute: § 165 Previous regulation: § 226.7(h) 1981 changes: Under the previous regulation, the creditor’s duty to refund credit balances applied only to “excess payments”; section 226.11 of the revised regulation implements the amendments to section 165 of the statute which impose refunding duties on the creditor whatever the source of the credit balance. The revised regulation permits the creditor, in computing the refund, to take account of in­ tervening debits, not just the difference be­ tween the previous balance and the overpay­ ment as is provided in the previous regulation. The revised regulation gives the creditor seven business days in which to make the refund after receiving the consumer’s written request, whereas the previous regulation required the creditor to make the refund promptly, with an outside limit of five business days. This provi­ sion also implements the amended statute by requiring a good faith effort to refund the credit balance after six months. SECTION 226.12—Special Credit Card Provisions 1. Scope. Sections 226.12(a) and (b) deal with the issuance and liability rules for credit cards, whether the card is intended for con­ sumer, business, or any other purposes. Sec­ tions 226.12(a) and (b) are exceptions to the general rule that the regulation applies only to consumer credit. (See sections 226.1 and 226.3.) 12(a) Issuance of Credit Cards Paragraph 12(a)(1) 1. Explicit request. A request or application for a card must be explicit. For example, a request for overdraft privileges on a checking account does not constitute an application for a credit card with overdraft checking features. 2. Addition of credit features. If the consumer has a non-credit card, the addition of credit features to the card (for example, the granting of overdraft privileges on a checking account when the consumer already has a check guar­ antee card) constitutes issuance of a credit card.

3. Variance of card from request. The request or application need not correspond exactly to the card that is issued. For example: • The name of the card requested may be different when issued • The card may have features in addition to those reflected in the request or application 4. Permissible form of request. The request or application may be oral (in response to a tele­ phone solicitation by a card issuer, for exam­ ple) or written.

5. Time of issuance. A credit card may be is­ sued in response to a request made before any cards are ready for issuance (for example, if a new program is established), even if there is some delay in issuance.

6. Persons to whom cards may be issued. A card issuer may issue a credit card to the per­ son who requests it and to anyone else for whom that person requests a card and who will be an authorized user on the requester’s account. In other words, cards may be sent to Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 79

Regulation Z Commentary § 226.12 consumer A on A’s request, and also (on A’s request) to consumers B and C, who will be authorized users on A’s account. In these cir­ cumstances, the following rules apply: • The additional cards may be imprinted in either A’s name or in the names of B and C.

• No liability for unauthorized use (by per­ sons other than B and C), not even the $50, may be imposed on B or C since they are merely users and not “cardholders” as that term is defined in section 226.2 and used in section 226.12(b); of course, liabili­ ty of up to $50 for unauthorized use of B’s and C’s cards may be imposed on A. • Whether B and C may be held liable for their own use, or on the account generally, is a matter of state or other applicable law. 7. Issuance of non-credit cards. The issuance of an unsolicited device that is not, but may become, a credit card, is not prohibited provided:

• the device has some substantive purpose other than obtaining credit, such as access to non-credit services offered by the issuer; • it cannot be used as a credit card when issued; and • a credit capability will be added only on the recipient’s request.

For example, the card issuer could send a check guarantee card on an unsolicited basis, but could not add a credit feature to that card without the consumer’s specific request. The reencoding of a debit card or other existing card that had no credit privileges when issued would be appropriate after the consumer has specifically requested a card with credit privi­ leges. Similarly, the card issuer may add a [ credit feature, for example, by reprogramming the issuer’s computer program or automated teller machines, or by a similar program ( adjustment.

8. Unsolicited issuance of PINs. A card issuer may issue personal identification numbers (PINs) to existing credit cardholders without a specific request from the cardholders, provided the PINs cannot be used alone to obtain credit. For example, the PINs may be neces­ sary if consumers wish to use their existing credit cards at automated teller machines or at merchant locations with point-of-sale termi­ nals that require PINs.

Paragraph 12(a)(2) 1. Renewal. “Renewal” generally contem­ plates the regular replacement of existing cards because of, for example, security rea­ sons or new technology or systems. It also includes the reissuance of cards that have been suspended temporarily, but does not in­ clude the opening of a new account after a previous account was closed. 2. Substitution—examples. “Substitution” en­ compasses the replacement of one card with another because the underlying account rela­ tionship has changed in some way—such as when the card issuer has:

• Changed its name • Changed the name of the card • Changed the credit or other features avail­ able on the account. For example, the orig­ inal card could be used to make purchases and obtain cash advances at teller win­ dows. The substitute card might be usable, in addition, for obtaining cash advances through automated teller machines. (If the substitute card constitutes an access device, as defined in Regulation E, then the Regu­ lation E issuance rules would have to be followed.) The “substitution” of one card with another on an unsolicited basis is not permissible, however, where in conjunction with the substitution an additional credit card account is opened and the consumer is able to make new purchases or advances under both the original and the new ac­ count with the new card. For example, if a retail card issuer replaces its credit card with a combined reatiler/bank card, each of the creditors maintains a separate account, and both accounts can be accessed for new transactions by use of the new credit card, the card cannot be provided to a consumer without solicitation.

• Substituted a card user’s name on the sub­ stitute card for the cardholder’s name ap­ pearing on the original card • Changed the merchant base. However, the new card must be honored by at least one Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 80

§ 226.12 Regulation Z Commentary of the persons that honored the original card.

3. Substitution—successor card issuer. “Sub­ stitution” also occurs when a successor card issuer replaces the original card issuer (for ex­ ample, when a new card issuer purchases the accounts of the original issuer and issues its own card to replace the original one). A per­ missible substitution exists even if the original issuer retains the existing receivables and the new card issuer acquires the right only to fu­ ture receivables, provided use of the original card is cut off when use of the new card be­ comes possible.

4. Substitution—non-credit-card plan. A credit card that replaces a retailer’s open-end credit plan not involving a credit card is not consid­ ered a substitute for the retailer’s plan—even if the consumer used the retailer’s plan. A credit card cannot be issued in these circum­ stances without a request or application. 5. One-for-one rule. An accepted card may be replaced by no more than one renewal or sub­ stitute card. For example, the card issuer may not replace a credit card permitting purchases and cash advances with two cards, one for the purchases and another for the cash advances. 6. One-for-one rule—exception. The regula­ tion does not prohibit the card issuer from re­ placing a debit/credit card with a credit card and another card with only debit functions (or debit functions plus an associated overdraft capability), since the latter card could be is­ sued on an unsolicited basis under Regulation E.

7. Methods of terminating replaced card. The card issuer need not physically retrieve the original card, provided the old card is voided in some way; for example:

• The issuer includes with the new card a notification that the existing card is no longer valid and should be destroyed immediately.

• The original card contained an expiration date.

• The card issuer, in order to preclude use of the card, reprograms computers or issues instructions to authorization centers. 8. Incomplete replacement. If a consumer has duplicate credit cards on the same account (card A—one type of bank credit card, for ex­ ample), the card issuer may not replace the duplicate cards with one card A and one card B (card B—another type of bank credit card) unless the consumer requests card B. 9^ Multiple entities. Where multiple entities share responsibilities with respect to a credit card issued by one of them, the entity that issued the card may replace it on an unsolic­ ited basis, if that entity terminates the original card by voiding it in some way, as described in comment 12(a)(2)-7. The other entity or en­ tities may not issue a card on an unsolicited basis in these circumstances. 12(b) Liability of Cardholder for Unauthorized Use 1. Meaning of “cardholder." For purposes of this provision, “cardholder” includes any per­ son (including organizations) to whom a credit card is issued for any purpose, including busi­ ness. When a corporation is the cardholder, required disclosures should be provided to the corporation (as opposed to an employee user). 2. Imposing liability. A card issuer is not re­ quired to impose liability on a cardholder for' the unauthorized use of a credit card; if the card issuer does not seek to impose liability, the issuer need not conduct any investigation of the cardholder’s claim.

3. Reasonable investigation. If a card issuer seeks to impose liability when a claim of un­ authorized use is made by a cardholder, the card issuer must conduct a reasonable investi­ gation of the claim. In conducting its investi­ gation, the card issuer may reasonably request the cardholder’s cooperation. The card issuer may not automatically deny a claim based solely on the cardholder’s failure or refusal to comply with a particular request; however, if the card issuer otherwise has no knowledge of facts confirming the unauthorized use, the lack of information resulting from the cardholder’s failure or refusal to comply with a particular request may lead the card issuer reasonably to terminate the investigation. The procedures in­ volved in investigating claims may differ, but actions such as the following represent steps Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 81

Regulation Z Commentary § 226.12 that a card issuer may take, as appropriate, in conducting a reasonable investigation: i.

Reviewing the types or amounts of purchases made in relation to the card­ holder’s previous purchasing pattern. ii.

Reviewing where the purchases were de­ livered in relation to the cardholder’s res­ idence or place of business. iii. Reviewing where the purchases were made in relation to where the cardholder resides or has normally shopped. iv. Comparing any signature on credit slips for the purchases to the signature of the cardholder or an authorized user in the card issuer’s records, including other credit slips.

v.

Requesting documentation to assist in the verification of the claim.

vi. Requesting a written, signed statement from the cardholder or authorized user. vii. Requesting a copy of a police report, if one was filed.

viii. Requesting information regarding the cardholder’s knowledge of the person who allegedly used the card or of that person’s authority to do so. o12(b)(1) Limitation on Amount 12(b)(2) Conditions of Liability 1. Issuer’s option not to comply. A card is­ suer that chooses not to impose any liability on cardholders for unauthorized use need not comply with the disclosure and identification requirements discussed below. Paragraph 12(b)(2)(H) 1. Disclosure of liability and means of notify­ ing issuer. The disclosures referred to in sec­ tion 226.12(b)(2)(ii) may be given, for exam­ ple, with the initial disclosures under section 226.6, on the credit card itself, or on periodic statements. They may be given at any time preceding the unauthorized use of the card. Paragraph 12(b)(2)(iii) 1. Means of identifying cardholder or user. To fulfill the condition set forth in section 226.12(b)(2)(iii), the issuer must provide some method whereby the cardholder or the author­ ized user can be identified. This could include, for example, signature, photograph, or finger­ print on the card, or electronic or mechanical confirmation.

2. Identification by magnetic strip. Unless a magnetic strip (or similar device not readable without physical aids) must be used in con­ junction with a secret code or the like, it would not constitute sufficient means of iden­ tification. Sufficient identification also does not exist if a “pool” or group card, issued to a corporation and signed by a corporate agent who will not be a user of the card, is intended to be used by another employee for whom no means of identification is provided. 3. Transactions not involving card. The card­ holder may not be held liable under section 226.12(b) when the card itself (or some other sufficient means of identification of the card­ holder) is not presented. Since the issuer has not provided a means to identify the user under these circumstances, the issuer has not fulfilled one of the conditions for imposing li­ ability. For example, when merchandise is or­ dered by telephone by a person without au­ thority to do so, using a credit card account number or other number only (which may be widely available), no liability may be imposed on the cardholder.

12(b)(3) Notification to Card Issuer 1. How notice must be provided. Notice given in a normal business manner—for example, by mail, telephone, or personal visit—is effec­ tive even though it is not given to, or does 1. Meaning of “authority.” Footnote 22 de­ fines unauthorized use in terms of whether the user has “actual, implied, or apparent author­ ity.” Whether such authority exists must be determined under state or other applicable law.

2. Liability limits—dollar amounts. As a gen­ eral rule, the cardholder’s liability for a series of unauthorized uses cannot exceed either $50 or the value obtained through the unauthorized use before the card issuer is notified, which­ ever is less.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 82

§ 226.12 Regulation Z Commentary not reach, some particular person within the issuer’s organization. Notice also may be ef­ fective even though it is not given at the ad­ dress or phone number disclosed by the card issuer under section 226.12(b)(2)(ii). 2. Who must provide notice. Notice of loss, theft, or possible unauthorized use need not be initiated by the cardholder. Notice is sufficient so long as it gives the “pertinent informa­ tion,” which would include the name or card number of the cardholder and an indication that unauthorized use has or may have occurred.

3. Relationship to section 226.13. The liability protections afforded to cardholders in section 226.12 do not depend upon the cardholder’s following the error-resolution procedures in section 226.13. For example, the written-noti­ fication and time-limit requirements of section 226.13 do not affect the section 226.12 protections.

12(b)(5) Business Use of Credit Cards 1. Agreement for higher liability for business use cards. The card issuer may not rely on section 226.12(b)(5) if the business is clearly not in a position to provide 10 or more cards to employees (for example, if the business has only 3 employees). On the other hand, the is­ suer need not monitor the personnel practices of the business to make sure that it has at least 10 employees at all times. 2. Unauthorized use by employee. The protec­ tion afforded to an employee against liability for unauthorized use in excess of the limits set in section 226.12(b) applies only to unau­ thorized use by someone other than the em­ ployee. If the employee uses the card in an unauthorized manner, the regulation sets no restriction on the employee’s potential liability for such use.

12(c) Right of Cardholder to Assert Claims or Defenses Against Card Issuer 1. Relationship to section 226.13. The section 226.12(c) credit card “holder in due course” provision deals with the consumer’s right to assert against the card issuer a claim or de­ fense consenting property or services purchased with a credit card, if the merchant has been unwilling to resolve the dispute. Even though certain merchandise disputes, such as nondelivery of goods, may also constitute “billing errors” under section 226.13, that section operates independently of section 226.12(c). The cardholder whose asserted bill­ ing error involves undelivered goods may in­ stitute the error-resolution procedures of sec­ tion 226.13; but whether or not the cardholder has done so, the cardholder may assert claims or defenses under section 226.12(c). Con­ versely, the consumer may pay a disputed bal­ ance and thus have no further right to assert claims and defenses, but still may assert a billing error if notice of that billing error is given in the proper time and manner. An as­ sertion that a particular transaction resulted from unauthorized use of the card could also be both a “defense” and a billing error. 2. Claims and defenses assertible. Section 226.12(c) merely preserves the consumer’s right to assert against the card issuer any claims or defenses that can be asserted against the merchant. It does not determine what claims or defenses are valid as to the merchant; this determination must be made under state or other applicable law. 12(c)(1) General Rule 1. Situations excluded and included. The con­ sumer may assert claims or defenses only when the goods or services are “purchased with the credit card.” This could include: • Mail or telephone orders, if the purchase is charged to the credit card account But it would exclude:

• Use of a credit card to obtain a cash ad­ vance, even if the consumer then uses the money to purchase goods or services. Such a transaction would not involve “property or services purchased with the credit card.” • The purchase of goods or services by use of a check accessing an overdraft account and a credit card used solely for identifica­ tion of the consumer. (On the other hand, if the credit card is used to make partial payment for the purchase and not merely for identification, the right to assert claims Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 83

Regulation Z Commentary § 226.12 or defenses would apply to credit extended via the credit card, although not to the credit extended on the overdraft line.) Purchases made by use of a check-guaran­ tee card in conjunction with a cash-advance check (or by cash-advance checks alone). See footnote 24. A cash-advance check is a check that, when written, does not draw on an asset account; instead, it is charged en­ tirely to an open-end credit account. Purchases effected by use of either a check guarantee card or a debit card when used to draw on overdraft credit lines (see foot­ note 24). The debit card exemption applies whether the card accesses an asset account via point-of-sale terminals, automated teller machines, or in any other way, and wheth­ er the card qualifies as an “access device” under Regulation E or is only a paperbased debit card. If a card serves both as an ordinary credit card and also as check guarantee or debit card, a transaction will be subject to this rule on asserting claims and defenses when used as an ordinary credit card, but not when used as a checkguarantee or debit card.

12(c)(2) Adverse Credit Reports Prohibited 1. Scope of prohibition. Although an amount in dispute may not be reported as delinquent until the matter is resolved: • That amount may be reported as disputed. • Nothing in this provision prohibits the card issuer from undertaking its normal collec­ tion activities for delinquent accounts. 12(c)(3) Limitations Paragraph 12( c)( 3 )(ii) 1. Geographic limitation. The question of where a transaction occurs (as in the case of mail or telephone orders, for example) is to be determined under state or other applicable law.

2. Merchant honoring card. The exceptions (stated in footnote 26) to the amount and geo­ graphic limitations do not apply if the merchant merely honors, or indicates through signs or advertising that it honors, a particular credit card.

12(d) Offsets by Card Issuer Prohibited Paragraph 12(d)(1) 1. “Holds" on accounts. “Freezing” or plac­ ing a hold on funds in the cardholder’s de­ posit account is the functional equivalent of an offset and would contravene the prohibition in section 226.12(d)(1), unless done in the context of one of the exceptions specified in section 226.12(d)(2). For example, if the terms of a security agreement permitted the card issuer to place a hold on the funds, the hold would not violate the offset prohibition. Similarly, if an order of a bankruptcy court required the card issuer to turn over deposit account funds to the trustee in bankruptcy, the issuer would not violate the regulation by placing a hold on the funds in order to com­ ply with the court order.

2. Funds intended as deposits. If the con­ sumer tenders funds as a deposit (to a check­ ing account, for example), the card issuer may not apply the funds to repay indebtedness on the consumer’s credit card account. Paragraph 12(c)(3)(i) 1. Resolution with merchant. The consumer must have tried to resolve the dispute with the merchant. This does not require any special procedures or correspondence between them, and is a matter for factual determination in each case. The consumer is not required to seek satisfaction from the manufacturer of the goods involved. When the merchant is in bankruptcy proceedings, the consumer is not required to file a claim in those proceedings. 3. Types of indebtedness; overdraft accounts. The offset prohibition applies to any indebted­ ness arising from transactions under a credit card plan, including accrued finance charges and other charges on the account. The prohi­ bition also applies to balances arising from transactions not using the credit card itself but taking place under plans that involve credit cards. For example, if the consumer writes a check that accesses an overdraft line of credit, the resulting indebtedness is subject to the off­ set prohibition since it is incurred through a Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 84

§ 226.12 Regulation Z Commentary credit card plan, even though the consumer did not use an associated check guarantee or debit card.

4. When prohibition applies in case of termi­ nation of account. The offset prohibition ap­ plies even after the card issuer terminates the cardholder’s credit card privileges, if the in­ debtedness was incurred prior to termination. If the indebtedness was incurred after termina­ tion, the prohibition does not apply. Paragraph 12(d)(2) 1. Security interest—limitations. In order to qualify for the exception stated in section 226.12(d)(2), a security interest must be af­ firmatively agreed to by the consumer and must be disclosed in the issuer’s initial disclo­ sures under section 226.6. The security inter­ est must not be the functional equivalent of a right of offset; as a result, routinely including in agreements contract language indicating that consumers are giving a security interest in any deposit accounts maintained with the is­ suer does not result in a security interest that falls within the exception in section 226.12(d)(2). For a security interest to qualify for the exception under section 226.12(d)(2) the following conditions must be met: • The consumer must be aware that granting a security interest is a condition for the credit card account (or for more favorable account terms) and must specifically intend to grant a security interest in a deposit ac­ count. Indicia of the consumer’s awareness and intent could include, for example: — Separate signature or initials on the agreement indicating that a security interest is being given.

—Placement of the security agreement on a separate page, or otherwise separating the security interest provisions from other contract and disclosure provisions. —Reference to a specific amount of deposited funds or to a specific deposit account number.

• The security interest must be obtainable and enforceable by creditors generally. If other creditors could not obtain a security interest in the consumer’s deposit accounts to the same extent as the card issuer, the security interest is prohibited by section 226.12(d)(2).

2. Security interest—after-acquired property. As used in section 226.12(d), the term “secur­ ity interest” does not exclude (as it does for other Regulation Z purposes) interests in afteracquired property. Thus, a consensual security interest in deposit-account funds, including funds deposited after the granting of the se­ curity interest, would constitute a permissible exception to the prohibition on offsets. 3. Court order. If the card issuer obtains a judgment against the cardholder, and if state and other applicable law and the terms of the judgment do not so prohibit, the card issuer may offset the indebtedness against the card­ holder’s deposit account.

Paragraph 12(d)(3) 1. Automatic payment plans—scope of excep­ tion. With regard to automatic debit plans under section 226.12(d)(3), the following rules apply:

• The cardholder’s authorization must be in writing and signed or initialed by the card­ holder.

• The authorizing language need not appear directly above or next to the cardholder’s signature or initials, provided it appears on the same document and that it clearly spells out the terms of the automatic debit plan.

• If the cardholder has the option to accept or reject the automatic debit feature (such option may be required under section 913 of the Electronic Fund Transfer Act), the fact that the option exists should be clearly indicated.

2. Automatic payment plans—additional ex­ ceptions. The following practices are not pro­ hibited by section 226.12(d)(1): • Automatically deducting charges for partic­ ipation in a program of banking services (one aspect of which may be a credit card plan) • Debiting the cardholder’s deposit account on the cardholder’s specific request rather than on an automatic periodic basis (for example, a cardholder might check a box Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 85

Regulation Z Commentary § 226.13 on the credit card bill stub, requesting the issuer to debit the cardholder’s account to pay that bill) 12(e) Prompt Notification of Returns and Crediting of Refunds Paragraph 12(e)(1) 1. Normal channels. The term “normal chan­ nel” refers to any network or interchange sys­ tem used for the processing of the original charge slips (or equivalent information con­ cerning the transactions).

the notification to the card issuer, not just the cardholder.

Section 226.12(d) on offsets clarifies that the offset prohibition does not apply to con­ sensual security interests. The separate promptness standard which used to apply in addition to the seven-business-day and threebusiness-day standards has been deleted from section 226.12(e) on prompt notification of re­ turns. Section 226.12(f) now clarifies rules on clearing accounts.

Section 226.12(g), dealing with the relation­ ship of the regulation to Regulation E (Elec­ tronic Fund Transfers), has been added. Paragraph 12(e)(2) 1. Crediting account. The card issuer need not actually post the refund to the consumer’s ac­ count within three business days after receiv­ ing the credit statement, provided that it cred­ its the account as of a date within that time period.

References Statute: §§ 103(1), 132, 133, 135, 162, 166, 167, 169, and 170 Other sections: § 226.13 Other regulations: Regulation E (12 CFR 205) Previous regulation: § 226.13 1981 changes: The issuance rules in section 226.12(a) make clear that cards may be sent to the person making the request and also to any other person for whom a card is re­ quested, except that no liability for unautho­ rized use may be imposed on persons who are only authorized users.

The principal differences in section 226.12(b) about conditions of liability are as follows: the requirement that the cardholder be given a postage-paid, preaddressed card or envelope for notification of loss or theft has been deleted (corresponding to an amendment to the act); the required disclosures of maxi­ mum liability and of means of notification have been simplified; and the required provi­ sion of a means of identification has been changed in that the issuer now may provide a means to identify either the cardholder or the authorized user. Finally, anyone may provide SECTION 226.13—Billing-Error Resolution 1. General prohibitions. Footnote 27 prohibits a creditor from responding to a consumer’s billing-error allegation by accelerating the debt or closing the account, and reflects pro­ tections authorized by section 161(d) of the Truth in Lending Act and section 701 of the Equal Credit Opportunity Act. The footnote also alerts creditors that failure to comply with the error-resolution procedures may re­ sult in the forfeiture of disputed amounts as prescribed in section 161(e) of the act. (Any failure to comply may also be a violation sub­ ject to the liability provisions of section 130 of the act.) 2. Charges for error resolution. If a billing error occurred, whether as alleged or in a dif­ ferent amount or manner, the creditor may not impose a charge related to any aspect of the error-resolution process (including charges for documentation or investigation) and must credit the consumer’s account if such a charge was assessed pending resolution. Since the act grants the consumer error-resolution rights, the creditor should avoid any chilling effect on the good faith assertion of errors that might result if charges are assessed when no billing error has occurred.

13(a) Definition of Billing Error Paragraph 13(a)(1) 1. Actual, implied, or apparent authority. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 86

§ 226.13 Regulation Z Commentary Whether use of a credit card or open-end credit plan is authorized is determined by state or other applicable law.

Paragraph 13(a)(3) 1. Coverage. Section 226.13(a)(3) covers dis­ putes about goods or services that are “not accepted” or “not delivered . . . as agreed” ; for example:

• The appearance on a periodic statement of a purchase, when the consumer refused to take delivery of goods because they did not comply with the contract • Delivery of property or services different from that agreed upon • Delivery of the wrong quantity • Late delivery • Delivery to the wrong location Section 226.13(a)(3) does not apply to a dis­ pute relating to the quality of property or ser­ vices that the consumer accepts. Whether ac­ ceptance occurred is determined by state or other applicable law.

Paragraph 13(a)(5) 1. Computational errors. In periodic state­ ments that are combined with other informa­ tion, the error-resolution procedures are trig­ gered only if the consumer asserts a com putational billing error in the credit-related portion of the periodic statement. For example:

• If a bank combines a periodic statement re­ flecting the consumer’s credit card transac­ tions with the consumer’s monthly checking statement, a computational error in the checking account portion of the combined statement is not a billing error. Paragraph 13(a)(6) 1. Documentation requests. A request for doc­ umentation such as receipts or sales slips, un­ accompanied by an allegation of an error under section 226.13(a) or a request for addi­ tional clarification under section 226.13(a)(6), does not trigger the error-resolution proce­ dures. For example, a request for documenta­ tion merely for purposes such as tax preparation or recordkeeping does not trigger the error-resolution procedures. 13(b) Billing-Error Notice 1. Withdrawal. The consumer’s withdrawal of a billing-error notice may be oral or written. Paragraph 13(b)(1) 1. Failure to send periodic statement—timing. If the creditor has failed to send a periodic statement, the 60-day period runs from the time the statement should have been sent. Once the statement is provided, the consumer has another 60 days to assert any billing er­ rors reflected on it.

2. Failure to reflect credit—timing. If the peri­ odic statement fails to reflect a credit to the account, the 60-day period runs from transmit­ tal of the statement on which the credit should have appeared.

3. Transmittal. If a consumer has arranged for periodic statements to be held at the financial institution until called for, the statement is “transmitted” when it is first made available to the consumer.

Paragraph 13(b)(2) 1. Identity of the consumer. The billing error notice need not specify both the name and the account number if the information supplied enables the creditor to identify the consumer’s name and account.

13(c) Time for Resolution; General Procedures 1. Temporary or provisional corrections. A creditor may temporarily correct the con­ sumer’s account in response to a billing-error notice but is not excused from complying with the remaining error-resolution procedures within the time limits for resolution. 2. Correction without investigation. A creditor may correct a billing error in the manner and amount asserted by the consumer without the investigation or the determination normally re­ quired. The creditor must comply, however, with all other applicable provisions. If a credi- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 87

Regulation Z Commentary § 226.13 tor follows this procedure, no presumption is created that a billing error occurred. Paragraph 13(c)(2) 1. Time for resolution. The phrase “two com­ plete billing cycles” means two actual billing cycles occurring after receipt of the billing er­ ror notice, not a measure of time equal to two billing cycles. For example, if a creditor on a monthly billing cycle receives a billing error notice mid-cycle, it has the remainder of that cycle plus the next two full billing cycles to resolve the error.

13(d) Rules Pending Resolution 1. Disputed amount. “Disputed amount” is the dollar amount alleged by the consumer to be in error. When the allegation concerns the description or identification of the transaction (such as the date or the seller’s name) rather than a dollar amount, the disputed amount is the amount of the transaction or charge that corresponds to the disputed transaction identi­ fication. If the consumer alleges a failure to ( send a periodic statement under section 226.13(a)(7), the disputed amount is the entire balance owing.

13(d)(1) Consumer’s Right to Withhold Disputed Amount; Collection Action Prohibited 1. Prohibited collection actions. During the error-resolution period, the creditor is prohib­ ited from trying to collect the disputed amount from the consumer. Prohibited collec­ tion actions include, for example, instituting court action, taking a lien, or instituting at­ tachment proceedings.

2. Right to withhold payment. If the creditor reflects any disputed amount or related finance or other charges on the periodic statement, and is therefore required to make the disclo­ sure under footnote 30, the creditor may com­ ply with that disclosure requirement by indi­ cating that payment of any disputed amount is not required pending resolution. Making a dis­ closure that only refers to the disputed amount would, of course, in no way affect the con­ sumer’s right under section 226.13(d)(1) to withhold related finance and other charges. The disclosure under footnote 30 need not ap­ pear in any specific place on the periodic statement, need not state the specific amount that the consumer may withhold, and may be preprinted on the periodic statement. 3. Imposition of additional charges on undis­ puted amounts. The consumer’s withholding of the disputed amount from the total bill can­ not subject undisputed balances (including new purchases or cash advances made during the present or subsequent cycles) to the impo­ sition of finance or other charges. For exam­ ple, if on an account with a free-ride period (that is, an account in which paying the new balance in full allows the consumer to avoid the imposition of additional finance charges), a consumer disputes a $2 item out of a total bill of $300 and pays $298 within the freeride period, the consumer would not lose the free ride as to any undisputed amounts, even if the creditor determines later that no billing error occurred. Furthermore, finance or other charges may not be imposed on any new purchases or advances that, absent the unpaid disputed balance, would not have finance or other charges imposed on them. Finance or other charges that would have been incurred even if the consumer had paid the disputed amount would not be affected. 4. Automatic payment plans—coverage. The coverage of this provision is limited to the card issuer’s intrainstitutional payment plans. It does not apply to:

• Inter-institutional payment plans that permit a cardholder to pay automatically any cred­ it card indebtedness from an asset account not held by the card issuer receiving pay­ ment • Intra-institutional automatic payment plans offered by financial institutions that are not credit card issuers 5. Automatic payment plans—time of notice. While the card issuer does not have to restore or prevent the debiting of a disputed amount if the billing-error notice arrives after the three-business-day cut-off, the card issuer must, however, prevent the automatic debit of any part of the disputed amount that is still outstanding and unresolved at the time of the next scheduled debit date.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 88

§ 226.13 Regulation Z Commentary 13(d)(2) Adverse Credit Reports Prohibited 1. Report of dispute. Although the creditor must not issue an adverse credit report be­ cause the consumer fails to pay the disputed amount or any related charges, the creditor may report that the amount or the account is in dispute. Also, the creditor may report the account as delinquent if undisputed amounts remain unpaid.

2. ‘‘Person.’’ During the error-resolution pe­ riod, the creditor is prohibited from making an adverse credit report about the disputed amount to any person—including employers, insurance companies, other creditors, and credit bureaus.

3. Creditor’s agent. Whether an agency rela­ tionship exists between a creditor and an is­ suer of an adverse credit report is determined by state or other applicable law. 13(e) Procedures if Billing Error Occurred as Asserted 1. Correction of error. The phrase “as appli­ cable” means that the necessary corrections vary with the type of billing error that oc­ curred. For example, a misidentified transac­ tion (or a transaction that is identified by one of the alternative methods in section 226.8) is cured by properly identifying the transaction and crediting related finance and any other charges imposed. The creditor is not required to cancel the amount of the underlying obliga­ tion incurred by the consumer. 2. Form of correction notice. The written cor­ rection notice may take a variety of forms. It may be sent separately, or it may be included on or with a periodic statement that is mailed within the time for resolution. If the periodic statement is used, the amount of the billing error must be specifically identified. If a sepa­ rate billing-error correction notice is provided, the accompanying or subsequent periodic statement reflecting the corrected amount may simply identify it as “credit.” 13(f) Procedures if Different Billing Error or No Billing Error Occurred 1. Different billing error.

Examples of a “different billing error” include: • Differences in the amount of an error (for example, the customer asserts a $55.00 er­ ror but the error was only $53.00) • Differences in other particulars asserted by the consumer (such as when a consumer asserts that a particular transaction never occurred, but the creditor determines that only the seller’s name was disclosed incorrectly) 2. Form of creditor’s explanation. The written explanation (which also may notify the con­ sumer of corrections to the account) may take a variety of forms. It may be sent separately, or it may be included on or with a periodic statement that is mailed within the time for resolution. If the creditor uses the periodic statement for the explanation and correc­ tion^), the corrections must be specifically identified. If a separate explanation, including the correction notice, is provided, the enclosed or subsequent periodic statement reflecting the corrected amount may simply identify it as a “credit.” The explanation may be combined with the creditor’s notice to the consumer of amounts still owing, which is required under section 226.13(g)(1), provided it is sent within the time limit for resolution. (See commentary to section 226.13(e).) 13(g) Creditor’s Rights and Duties After Resolution Paragraph 13(g)(1) 1. Amounts owed by consumer. Amounts the consumer still owes may include both mini­ mum periodic payments and related finance and other charges that accrued during the res­ olution period. As explained in the commen­ tary to section 226.13(d)(1), even if the credi­ tor later determines that no billing error occurred, the creditor may not include finance or other charges that are imposed on undis­ puted balances solely as a result of a con­ sumer’s withholding payment of a disputed amount.

2. Time of notice. The creditor need not send the notice of amount owed within the time period for resolution, although it is under a duty to send the notice promptly after resolu­ tion of the alleged error. If the creditor com- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 89

Regulation Z Commentary § 226.13 bines the notice of the amount owed with the explanation required under section 226.13 (f)(1), the combined notice must be provided within the time limit for resolution. Paragraph 13(g)(2) 1. The creditor need not allow any free-ride period disclosed under sections 226.6(a)(1) and 226.7(j) to pay the amount due under sec­ tion 226.13(g)(1) if no error occurred and the consumer was not entitled to a free-ride pe­ riod at the time the consumer asserted the error.

Paragraph 13(g)(3) O o 1. Time for payment. The consumer has a minimum of 10 days to pay (measured from the time the consumer could reasonably be ex­ pected to have received notice of the amount owed) before the creditor may issue an ad­ verse credit report; if an initially disclosed free-ride period allows the consumer a longer time in which to pay, the consumer has the benefit of that longer period. Paragraph 13(g)(4) 1. Credit reporting.

Under section 226.13(g)(4)(i) and (iii) the creditor’s addi­ tional credit reporting responsibilities must be accomplished promptly. The creditor need not establish costly procedures to fulfill this re­ quirement. For example, a creditor that reports to a credit bureau on scheduled updates need not transmit corrective information by an un­ scheduled computer or magnetic tape; it may provide the credit bureau with the correct in­ formation by letter or other commercially rea­ sonable means when using the scheduled up­ date would not be “prompt.” The creditor is not responsible for ensuring that the credit bu­ reau corrects its information immediately. }o 2. Adverse report to credit bureau. If a credi­ tor made an adverse report to a credit bureau that disseminated the information to other creditors, the creditor fulfills its section 226.13(g)(4)(ii) obligations by providing the consumer with the name and address of the credit bureau.

13(i) Relation to Electronic Fund Transfer Act and Regulation E 1. Coverage. Credit extended directly from a non-overdraft credit line is governed solely by Regulation Z, even though a combined credit card/access device is used to obtain the extension.

2. Incidental credit under agreement. Credit extended incident to an electronic fund trans­ fer under an agreement between the consumer and the financial institution is governed by section 226.13(i), which provides that certain error resolution procedures in both this regula­ tion and Regulation E apply. Incidental credit that is not extended under an agreement be­ tween the consumer and the financial institu­ tion is governed solely by the error-resolution procedures in Regulation E. For example: • Credit inadvertently extended incident to an electronic fund transfer is governed solely by the Regulation E error-resolution proce­ dures, if the bank and the consumer do not have an agreement to extend credit when the consumer’s account is overdrawn. 3. Application to debit/credit transac­ tions—examples. If a consumer withdraws money at an automated teller machine and ac­ tivates an overdraft credit feature on the checking account:

• An error asserted with respect to the trans­ action is subject, for error-resolution pur­ poses, to the applicable Regulation E provisions (such as timing and notice) for the entire transaction.

• The creditor need not provisionally credit the consumer’s account, under section 205.1 l(c)(2)(i) of Regulation E, for any portion of the unpaid extension of credit. • The creditor must credit the consumer’s ac­ count under section 205.11(e) with any fi­ nance or other charges incurred as a result of the alleged error.

• The provision of section 226.13(d) and (g) apply only to the credit portion of the transaction.

References Statute: §§ 161 and 162 Other sections: §§ 226.6 through 226.8 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 90

§ 226.13 Regulation Z Commentary Other regulations: Regulation E (12 CFR 205) Previous regulation: §§ 226.2(j) and (cc), and 226.14 1981 changes: Section 226.13 reflects several substantive changes from the previous regula­ tion and a complete restructuring of the errorresolution provisions. The new organization, for example, arranges the creditor’s responsi­ bilities in chronological sequence. Section 226.13(a)(7) implements amended section 161(b) of the act and provides that the creditor’s failure to send a periodic statement to the consumer’s current address is a billing error, unless the creditor received written no­ tice of the address change fewer than 20 days (instead of 10 days) before the end of the bill­ ing cycle.

Several provisions regarding the creditor’s duties after a billing error is alleged have been revised. The previous regulation immu­ nized a creditor from liability for inadvertently taking collection action or making an adverse credit report within two days after receiving a billing-error notice; these provisions are de­ leted from the revised regulation. The revised regulation no longer requires placement “on the face” of the periodic statement of the dis­ closure about payment of disputed amounts. The revised regulation changes the rule in the previous regulation that a card issuer must prevent or restore an automatic debit of a dis­ puted amount if it receives a billing-error no­ tice within 16 days after transmitting the peri­ odic statement that reflects the alleged error. Under the revised regulation, the card issuer must prevent an automatic debit if it receives a billing-error notice up to 3 days before the scheduled payment date (provided that the no­ tice is received within the 60 days for the consumer to assert the error). SECTION 226.14—Determination of Annual Percentage Rate 14(a) General Rule 1. Tolerance. The tolerance of l/» of 1 per­ centage point above or below the annual percentage rate applies to any required disclosure of the annual percentage rate. The disclosure of the annual percentage rate is required in sections 226.6, 226.7, 226.9, 226.15, 226.16, and 226.26.

2. Rounding. The regulation does not require that the annual percentage rate be calculated to any particular number of decimal places; rounding is permissible within the l/s of 1 per­ cent tolerance. For example, an exact annual percentage rate of 14.33333 percent may be stated as 14.33 percent or as 14.3 percent, or even as 14'A percent; but it could not be stated as 14.2 percent or 14 percent, since each varies by more than the permitted tolerance.

3. Periodic rates. No explicit tolerance exists for any periodic rate as such; a disclosed peri­ odic rate may vary from precise accuracy (for example, due to rounding) only to the extent that its annualized equivalent is within the tol­ erance permitted by section 226.14(a). Further, a periodic rate need not be calculated to any particular number of decimal places. 4. Finance charges. The regulation does not prohibit creditors from assessing finance charges on balances that include prior, unpaid finance charges; state or other applicable law may do so, however.

5. Good faith reliance on faulty calculation tools. Footnote 31a absolves a creditor of lia­ bility for an error in the annual percentage rate or finance charge that resulted from a cor­ responding error in a calculation tool used in good faith by the creditor. Whether or not the creditor’s use of the tool was in good faith must be determined on a case-by-case basis, but the creditor must in any case have taken reasonable steps to verify the accuracy of the tool, including any instructions, before using it. Generally, the footnote is available only for errors directly attributable to the calculation tool itself, including software programs; it is not intended to absolve a creditor of liability for its own errors, or for errors arising from improper use of the tool, from incorrect data entry, or from misapplication of the law. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 91

Regulation Z Commentary § 226.14 14(b) Annual Percentage Rate for Section 226.5a and 226.5b Disclosures, for Initial Disclosures and for Advertising Purposes 1. Corresponding annual percentage rate computation. For purposes of sections 226.5a, 226.5b, 226.6 and 226.16, the annual percent­ age rate is determined by multiplying the peri­ odic rate by the number of periods in the year. This computation reflects the fact that, in such disclosures, the rate (known as the corre­ sponding annual percentage rate) is prospec­ tive and does not involve any particular fi­ nance charge or periodic balance. This computation also is used to determine any an­ nual percentage rate for oral disclosures under section 226.26(a).

14(c) Annual Percentage Rate for Periodic Statements 1. General rule. Section 226.14(c) requires disclosure of the corresponding annual per­ centage rate for each periodic rate (under sec­ tion 226.7(d)). It is figured by multiplying ( each periodic rate by the number of periods per year. This disclosure is like that provided on the initial disclosure statement. The peri­ odic statement also must reflect (under section 226.7(g)) the annualized equivalent of the rate actually applied during a particular cycle (the historical rate); this rate may differ from the corresponding annual percentage rate because of the inclusion of fixed, minimum, or trans­ action charges. Sections 226.14(c)(1) through (c)(4) state the computation rules for the his­ torical rate.

2. Periodic rates. Section 226.14(c)(1) applies if the only finance charge imposed is due to the application of a periodic rate to a balance. The creditor may compute the annual percent­ age rate either:

by multiplying each periodic rate by the number of periods in the year or by the “quotient” method. This method re­ fers to a composite annual percentage rate when different periodic rates apply to dif­ ferent balances. For example, a particular plan may involve a periodic rate of IV2 percent on balances up to $500, and 1 per­ cent on balances over $500. If, in a given cycle, the consumer has a balance of $800, the finance charge would consist of $7.50 (500 X .015) plus $3.00 (300 X .01), for a total finance charge of $10.50. The annu­ al percentage rate for this period may be disclosed either as 18 percent on $500 and 12 percent on $300, or as 15.75 percent on a balance of $800 (the quotient of $10.50 divided by $800, multiplied by 12). 3. Charges not based on periodic rates. Sec­ tion 226.14(c)(2) applies if the finance charge imposed includes a charge not due to the ap­ plication of a periodic rate (other than a charge relating to a specific transaction). For example, if the creditor imposes a minimum $1 finance charge on all balances below $50, and the consumer’s balance was $40 in a par­ ticular cycle, the creditor would disclose an annual percentage rate of 30 percent (1/40 X 12).

4. No balance. Footnote 32 to section 226.14(c)(2) would apply not only when mini­ mum charges are imposed on an account with no balance, but also to a plan in which a peri­ odic rate is applied to advances from the date of the transaction. For example, if on May 19 the consumer pays the new balance in full from a statement dated May 1 and has no fur­ ther transactions reflected on the June 1 state­ ment, that statement would reflect a finance charge with no account balance. 5. Transaction charges. Section 226.14(c)(3) transaction charges include, for example: • A loan fee of $10 imposed on a particular advance • A charge of 3 percent of the amount of each transaction The reference to avoiding duplication in the computation requires that the amounts of transactions on which transaction charges were imposed not be included both in the amount of total balances and in the “other amounts on which a finance charge was imposed” fig­ ure. For further explanation and examples of how to determine the components of this formula, see appendix F.

6. Daily rate with specific transaction charge. Section 226.14(c)(3) sets forth an acceptable method for calculating the annual percentage Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 92

§ 226.14 Regulation Z Commentary rate if the finance charge results from a charge relating to a specific transaction and the appli­ cation of a daily periodic rate. This section includes the requirement that the creditor fol­ low the rules in appendix F in calculating the annual percentage rate, especially footnote 1 to appendix F, which addresses the daily rate/ transaction charge situation by providing that the “average of daily balances” shall be used instead of the “sum of the balances.” 7. Charges related to opening, renewing, or continuing account. Footnote 33 is applicable to section 226.14(c)(2) and (c)(3). The charges involved here do not relate to a specific trans­ action or to specific activity on the account, but relate solely to the opening, renewing, or continuing of the account. For example, an annual fee to renew an open-end credit ac­ count that is a percentage of the credit limit on the account, or that is charged only to con­ sumers who have not used their credit card for a certain dollar amount in transactions dur­ ing the preceding year, would not be included in the calculation of the annual percentage rate, even though the fee may not be excluded from the finance charge under section 226.4(c)(4). (See comment 4(c)(4)-2). Inclu­ sion of these charges in the annual percentage rate calculation results in significant distor­ tions of the annual percentage rate and deliv­ ery of a possibly misleading disclosure to consumers. The rule in footnote 33 applies even if the loan fee, points, or similar charges are billed on a subsequent periodic statement or withheld from the proceeds of the first ad­ vance on the account.

8. Classification of charges. If the finance charge includes a charge not due to the appli­ cation of a periodic rate, the creditor must de­ termine the proper annual percentage rate computation method according to the type of charge imposed. If the charge is tied to a spe­ cific transaction (for example, 3 percent of the amount of each transaction), then the method in section 226.14(c)(3) must be used. If a fixed or minimum charge is applied, that is, one not tied to any specific transaction, then the formula in section 226.14(c)(2) is appropriate.

9. Small finance charges. Section 226.14(c) (4) gives the creditor an alternative to section 226.14(c)(2) and (c)(3) if small finance charges (50 cents or less) are involved; that is, if the finance charge includes minimum or fixed fees not due to the application of a peri­ odic rate and the total finance charge for the cycle does not exceed 50 cents. For example, while a monthly activity fee of 50 cents on a balance of $20 would produce an annual per­ centage rate of 30 percent under the rule in section 226.14(c)(2), the creditor may disclose an annual percentage rate of 18 percent if the periodic rate generally applicable to all bal­ ances is V/2 percent per month. This option is consistent with the provision in footnote 11 to sections 226.6 and 226.7 permitting the credi­ tor to disregard the effect of minimum charges in disclosing the ranges of balances to which periodic rates apply.

14(d) Calculations Where Daily Periodic Rate Applied 1. Quotient method. Section 226.14(d) ad­ dresses use of a daily periodic rate(s) to deter­ mine some or all of the finance charge and use of the quotient method to determine the annual percentage rate. Since the quotient formula in section 226.14(c)( 1 )(ii) does not work when a daily rate is being applied to a series of daily balances, section 226.14(d) gives the creditor two alternative ways to fig­ ure the annual percentage rate— either of which satisfies the requirement in section 226.7(g).

2. Daily rate with specific transaction charge. If the finance charge results from a charge re­ lating to a specific transaction and the applica­ tion of a daily periodic rate, see comment 14(c)-6 for guidance on an appropriate calcu­ lation method.

References Statute: § 107 Other sections: §§ 226.6, 226.7, 226.9, 226.15, 226.16, and 226.26.

Previous regulation: § 226.5(a) and interpreta­ tion §§ 226.501 and 226.506. 1981 changes: Section 226.14 reflects the stat­ utory amendment permitting a l/» of 1 percent tolerance for annual percentage rates. The re- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 93

Regulation Z Commentary § 226.15 vised regulation no longer reflects the provi­ sion dealing with finance charges imposed on specified ranges or brackets of balances. The revised regulation includes a footnote provid­ ing that loan fees, points, or similar charges unrelated to any specific transaction are not figured into the annual percentage rate computation.

SECTION 226.15—Right of Rescission 1. Transactions not covered. Credit extensions that are not subject to the regulation are not covered by section 226.15 even if the cus­ tomer’s principal dwelling is the collateral se­ curing the credit. For this purpose, “credit ex­ tensions” also would include the occurrences listed in comment 15(a)(l)-l. For example, the right of rescission does not apply to the opening of a business-purpose credit line, even though the loan is secured by the cus­ tomer’s principal dwelling.

15(a) Consumer’s Right to Rescind Paragraph 15(a)(1) 1. Occurrences subject to right. Under an open-end credit plan secured by the con­ sumer’s principal dwelling, the right of rescis­ sion generally arises with each of the follow­ ing occurrences:

• Opening the account • Each credit extension • Increasing the credit limit • Adding to an existing account a security interest in the consumer’s principal dwelling • Increasing the dollar amount of the security interest taken in the dwelling to secure the plan. For example, a consumer may open an account with a $10,000 credit limit, $5,000 of which is initially secured by the consumer’s principal dwelling. The con­ sumer has the right to rescind at that time and (except as noted in section 226.15(a)( 1 )(ii)) with each extension on the account. Later, if the creditor decides that it wants the credit line fully secured, and increases the amount of its interest in the consumer’s dwelling, the consumer has the right to rescind the increase. 2. Exceptions. Although the consumer gener­ ally has the right to rescind with each transac­ tion on the account, section 125(e) of the act provides an exception: the creditor need not provide the right to rescind at the time of each credit extension made under an open-end credit plan secured by the consumer’s princi­ pal dwelling to the extent that the credit ex­ tended is in accordance with a previously es­ tablished credit limit for the plan. This limited rescission option is available whether or not the plan existed prior to the effective date of the act.

3. Security interest arising from transaction. In order for the right of rescission to apply, the security interest must be retained as part of the credit transaction. For example: • A security interest that is acquired by a contractor who is also extending the credit in the transaction • A mechanic’s or materialman’s lien that is retained by a subcontractor or supplier of a contractor-creditor, even when the latter has waived its own security interest in the consumer’s home The security interest is not part of the credit transaction, and therefore the transaction is not subject to the right of rescission when, for example:

• A mechanic’s or materialman’s lien is ob­ tained by a contractor who is not a party to the credit transaction but merely is paid with the proceeds of the consumer’s cash advance • All security interests that may arise in con­ nection with the credit transaction are val­ idly waived • The creditor obtains a lien and completion bond that in effect satisfies all liens against the consumer’s principal dwelling as a re­ sult of the credit transaction Although liens arising by operation of law are not considered security interests for purposes of disclosure under section 226.2, that section specifically includes them in the definition for purposes of the right of rescission. Thus, even though an interest in the consumer’s principal Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 94

§ 226.15 Regulation Z Commentary dwelling is not a required disclosure under section 226.6(c), it may still give rise to the right of rescission.

4. Consumer. To be a consumer within the meaning of section 226.2, that person must at least have an ownership interest in the dwell­ ing that is encumbered by the creditor’s secur­ ity interest, although that person need not be a signatory to the credit agreement. For exam­ ple, if only one spouse enters into a secured plan, the other spouse is a consumer if the ownership interest of that spouse is subject to the security interest.

5. Principal dwelling. A consumer can only have one principal dwelling at a time. (But see comment 15(a)(l)-6.) A vacation or other second home would not be a principal dwelling. A transaction secured by a second home (such as a vacation home) that is not currently being used as the consumer’s princi­ pal dwelling is not rescindable, even if the consumer intends to reside there in the future. When a consumer buys or builds a new dwelling that will become the consumer’s principal dwelling within one year or upon completion of construction, the new dwelling is considered the principal dwelling if it secures the open-end credit line. In that case, the transaction secured by the new dwelling is a residential mortgage transaction and is not rescindable. For example, if a consumer whose principal dwelling is currently A builds B, to be occupied by the consumer upon com­ pletion of construction, an advance on an open-end line to finance B and secured by B is a residential mortgage transaction. Dwell­ ing, as defined in section 226.2, includes structures that are classified as personalty under state law. For example, a transaction se­ cured by a mobile home, trailer, or houseboat used as the consumer’s principal dwelling may be rescindable.

6. Special rule for principal dwelling. Not­ withstanding the general rule that consumers may have only one principal dwelling, when the consumer is acquiring or constructing a new principal dwelling, a credit plan or exten­ sion that is subject to Regulation Z and is secured by the equity in the consumer’s cur­ rent principal dwelling is subject to the right of rescission regardless of the purpose of that loan (for example, an advance to be used as a bridge loan). For example, if a consumer whose principal dwelling is currently A builds B, to be occupied by the consumer upon com­ pletion of construction, a loan to finance B and secured by A is subject to the right of rescission. Moreover, a loan secured by both A and B is, likewise, rescindable. 1. Consumer’s exercise of right. The con­ sumer must exercise the right of rescission in writing, but not necessarily on the notice sup­ plied under section 226.15(b). Whatever the means of sending the notification of rescis­ sion— mail, telegram, or other written means— the time period for the creditor’s per­ formance under section 226.15(d)(2) does not begin to run until the notification has been received. The creditor may designate an agent to receive the notification so long as the agent’s name and address appear on the notice provided to the consumer under section 226.15(b).

1. Rescission period. The period within which the consumer may exercise the right to rescindv runs for three business days from the last of three events:

• The occurrence that gives rise to the right of rescission • Delivery of all material disclosures that are relevant to the plan • Delivery to the consumer of the required rescission notice For example, an account is opened on Friday, June 1, and the disclosures and notice of the right to rescind were given on Thursday, May 31; the rescission period will expire at mid­ night of the third business day after June 1— that is, Tuesday, June 5. In another exam­ ple, if the disclosures are given and the ac­ count is opened on Friday, June 1, and the rescission notice is given on Monday, June 4, the rescission period expires at midnight of the third business day after June 4— that is, Thursday, June 7. The consumer must place the rescission notice in the mail, file it for Paragraph 15(a)(2) Paragraph 15(a)(3) Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 95

Regulation Z Commentary § 226.15 telegraphic transmission, or deliver it to the creditor’s place of business within that period in order to exercise the right. 2. Material disclosures. Footnote 36 sets forth the material disclosures that must be provided before the rescission period can begin to run. The creditor must provide sufficient informa­ tion to satisfy the requirements of section 226.6 for these disclosures. A creditor may satisfy this requirement by giving an initial disclosure statement that complies with the regulation. Failure to give the other required initial disclosures (such as the billing-rights statement) or the information required under section 226.5b does not prevent the running of the rescission period, although that failure may result in civil liability or administrative sanctions. The payment terms set forth in footnote 36 apply to any repayment phase set forth in the agreement. Thus, the payment terms described in section 226.6(e)(2) for any repayment phase as well as for the draw pe­ riod are “material disclosures.” 3. Material disclosures—variable-rate pro­ gram. For a variable-rate program, the mate­ rial disclosures also include the disclosures listed in footnote 12 to section 226.6(a)(2): the circumstances under which the rate may increase; the limitations on the increase; and the effect of an increase. The disclosures listed in footnote 12 to section 226.6(a)(2) for any repayment phase also are material disclo­ sures for variable-rate programs. 4. Unexpired right of rescission. When the creditor has failed to take the action necessary to start the three-day rescission period run­ ning, the right to rescind automatically lapses on the occurrence of the earliest of the fol­ lowing three events:

.

o The expiration of three years after the oc­ currence giving rise to the right of rescis­ sion Transfer of all the consumer’s interest in the property Sale of the consumer’s interest in the prop­ erty, including a transaction in which the consumer sells the dwelling and takes back a purchase money note and mortgage or re­ tains legal title through a device such as an installment-sale contract Transfer of all the consumer’s interest in­ cludes such transfers as bequests and gifts. A sale or transfer of the property need not be voluntary to terminate the right to rescind. For example, a foreclosure sale would terminate an unexpired right to rescind. As provided in section 125 of the act, the three-year limit may be extended by an administrative pro­ ceeding to enforce the provisions of section 226.15. A partial transfer of the consumer’s interest, such as a transfer bestowing co-own­ ership on a spouse, does not terminate the right of rescission.

Paragraph 15(a)(4) 1. Joint owners. When more than one con­ sumer has the right to rescind a transaction, any one of them may exercise that right and cancel the transaction on behalf of all. For example, if both a husband and wife have the right to rescind a transaction, either spouse acting alone may exercise the right and both are bound by the rescission. 15(b) Notice o f Right to Rescind 1. Who receives notice.

Each consumer enti­ tled to rescind must be given: • Two copies of the rescission notice • The material disclosures In a transaction involving joint owners, both of whom are entitled to rescind, both must receive the notice of the right to rescind and disclosures. For example, if both spouses are entitled to rescind a transaction, each must re­ ceive two copies of the rescission notice and one copy of the disclosures. 2. Format. The rescission notice may be physically separated from the material disclo­ sures or combined with the material disclo­ sures, so long as the information required to be included on the notice is set forth in a clear and conspicuous manner. See the model notices in appendix G.

3. Content. The notice must include all of the information outlined in section 226.15(b)(1) through (5). The requirement in section 226.15(b) that the transaction or occurrence be identified may be met by providing the date of the transaction or occurrence. The notice Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 96

§ 226.15 Regulation Z Commentary may include additional information related to the required information, such as: • A description of the property subject to the security interest • A statement that joint owners may have the right to rescind and that a rescission by one is effective for all • The name and address of an agent of the creditor to receive notice of rescission 4. Time of providing notice. The notice re­ quired by section 226.15(b) need not be given before the occurrence giving rise to the right of rescission. The creditor may deliver the no­ tice after the occurrence, but the rescission pe­ riod will not begin to ran until the notice is given. For example, if the creditor provides the notice on May 15, but disclosures were given and the credit limit was raised on May 10, the three-business-day rescission period will run from May 15.

15(c) Delay of Creditor’s Performance 1. General rule. Until the rescission period has expired and the creditor is reasonably sat­ isfied that the consumer has not rescinded, the creditor must not, either directly or through a third party:

• Disburse advances to the consumer • Begin performing services for the con­ sumer • Deliver materials to the consumer A creditor may, however, continue to allow transactions under an existing open-end credit plan during a rescission period that results solely from the addition of a security interest in the consumer’s principal dwelling. (See comment 15(c)-3 for other actions that may be taken during the delay period.) 2. Escrow. The creditor may disburse ad­ vances during the rescission period in a valid escrow arrangement. The creditor may not, however, appoint the consumer as “trustee” or “escrow agent” and distribute funds to the consumer in that capacity during the delay period.

3. Permissible actions. Section 226.15(c) does not prevent the creditor from taking other steps during the delay, short of beginning actual performance. Unless otherwise prohibited, such as by state law, the creditor may, for example:

• Prepare the cash advance check • Perfect the security interest • Accrue finance charges during the delay period 4. Performance by third party. The creditor is relieved from liability for failure to delay per­ formance if a third party with no knowledge that the rescission right has been activated provides materials or services, as long as any debt incurred for materials or services ob­ tained by the consumer during the rescission period is not secured by the security interest in the consumer’s dwelling. For example, if a consumer uses a bank credit card to purchase materials from a merchant in an amount be­ low the floor limit, the merchant might not contact the card issuer for authorization and therefore would not know that materials should not be provided.

5. Delay beyond rescission period. The credi­ tor must wait until it is reasonably satisfied that the consumer has not rescinded. For ex­ ample, the creditor may satisfy itself by doing one of the following:

Waiting a reasonable time after expiration of the rescission period to allow for deliv­ ery of a mailed notice Obtaining a written statement from the consumer that the right has not been exer­ cised.

When more than one consumer has the right to rescind, the creditor cannot reasonably rely on the assurance of only one consumer, be­ cause other consumers may exercise the right. 15(d) Effects of Rescission Paragraph 15(d)(1) 1. Termination of security interest. Any secur­ ity interest giving rise to the right of rescis­ sion becomes void when the consumer exer­ cises the right of rescission. The security interest is automatically negated, regardless of its status and whether or not it was recorded or perfected. Under section 226.15(d)(2), how­ ever, the creditor must take any action neces- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 97

Regulation Z Commentary § 226.15 sary to reflect the fact that the security interest 10 longer exists.

2. Extent of termination. The creditor’s secur­ ity interest is void only to the extent that it is related to the occurrence giving rise to the right of rescission. For example, upon rescission:

• If the consumer’s right to rescind is acti­ vated by the opening of a plan, any securi­ ty interest in the principal dwelling is void. • If the right arises due to an increase in the credit limit, the security interest is void as to the amount of credit extensions over the prior limit, but the security interest in amounts up to the original credit limit is unaffected.

• If the right arises with each individual credit extension, then the interest is void as to that extension, and other extensions are unaffected.

Paragraph 15(d)(2) 1. Refunds to consumer. The consumer cannot be required to pay any amount in the form of money or property either to the creditor or to O a third party as part of the occurrence subject ^o the right of rescission. Any amounts of this nature already paid by the consumer must be refunded. “Any amount” includes finance charges already accrued, as well as other charges such as broker fees, application and commitment fees, or fees for a title search or appraisal, whether paid to the creditor, paid by the consumer directly to a third party, or passed on from the creditor to the third party. It is irrelevant that these amounts may not re­ present profit to the creditor. For example: If the occurrence is the opening of the plan, the creditor must return any member­ ship or application fee paid. If the occurrence is the increase in a credit limit or the addition of a security interest, the creditor must return any fee imposed for a new credit report or filing fees. If the occurrence is a credit extension, the creditors must return fees such as applica­ tion, title, and appraisal or survey fees, as well as any finance charges related to the credit extension.

2. Amounts not refundable to consumer. Cred­ itors need not return any money given by the consumer to a third party outside of the oc­ currence, such as costs incurred for a building permit or for a zoning variance. Similarly, the term “any amount” does not apply to money or property given by the creditor to the con­ sumer; those amounts must be tendered by the consumer to the creditor under section 226.15(d)(3).

3. Reflection of security-interest termination. The creditor must take whatever steps are nec­ essary to indicate that the security interest is terminated. Those steps include the cancella­ tion of documents creating the security inter­ est, and the filing of release or termination statements in the public record. In a transac­ tion involving subcontractors or suppliers that also hold security interests related to the oc­ currence rescinded by the consumer, the credi­ tor must ensure that the termination of their security interests is also reflected. The 20-day period for the creditor’s action refers to the time within which the creditor must begin the process. It does not require all necessary steps to have been completed within that time, but the creditor is responsible for seeing the pro­ cess through to completion.

Paragraph 15(d)(3) 1. Property exchange. Once the creditor has fulfilled its obligation under section 226.15(d)(2), the consumer must tender to the creditor any property or money the creditor has already delivered to the consumer. At the consumer’s option, property may be tendered at the location of the property. For example, if fixtures or furniture have been delivered to the consumer’s home, the consumer may tender them to the creditor by making them available for pickup at the home, rather than physically returning them to the creditor’s premises. Money already given to the consumer must be tendered at the creditor’s place of business. For purpose of property exchange, the follow­ ing additional rules apply:

• A cash advance is considered money for purposes of this section even if the creditor knows what the consumer intends to purchase with the money.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 98

§ 226.15 Regulation Z Commentary • In a three-party open-end credit plan (that is, if the creditor and seller are not the same or related persons), extensions by the creditor that are used by the consumer for purchases from third-party sellers are con­ sidered to be the same as cash advances for purposes of tendering value to the cred­ itor, even though the transaction is a purchase for other purposes under the regu­ lation. For example, if a consumer exer­ cises the unexpired right to rescind after using a three-party credit card for one year, the consumer would tender the amount of the purchase price for the items charged to the account, rather than tendering the items themselves to the creditor. 2. Reasonable value. If returning the property would be extremely burdensome to the con­ sumer, the consumer may offer the creditor its reasonable value rather than returning the property itself. For example, if building mater­ ials have already been incorporated into the consumer’s dwelling, the consumer may pay their reasonable value.

Paragraph 15(d)(4) 1. Modifications. The procedures outlined in section 226.15(d)(2) and (d)(3) may be modi­ fied by a court. For example, when a con­ sumer is in bankruptcy proceedings and pro­ hibited from returning anything to the creditor, or when the equities dictate, a modi­ fication might be made.

15(e) Consumer’s Waiver of Right to Rescind 1. Need for waiver. To waive the right to re­ scind, the consumer must have a bona fide personal financial emergency that must be met before the end of the rescission period. The existence of the consumer’s waiver will not, of itself, automatically insulate the creditor from liability for failing to provide the right of rescission.

2. Procedure. To waive or modify the right to rescind, the consumer must give a written statement that specifically waives or modifies the right, and also includes a brief description of the emergency. Each consumer entitled to rescind must sign the waiver statement. In a transaction involving multiple consumers, such as a husband and wife using their home as collateral, the waiver must bear the signatures of both spouses.

15(f) Exempt Transactions 1. Residential mortgage transaction. Although residential mortgage transactions would sel­ dom be made on bona fide open-end credit plans (under which repeated transactions must be reasonably contemplated), an advance on an open-end plan could be for a downpayment for the purchase of a dwelling that would then secure the remainder of the line. In such a case, only the particular advance for the downpayment would be exempt from the re­ scission right.

2. State creditors. Cities and other political subdivisions of states acting as creditors are not exempt from section 226.15. 3. Spreader clause. When the creditor holds a mortgage or deed of trust on the consumer’s principal dwelling and that mortgage or deed of trust contains a “spreader clause” (also known as a “dragnet” or cross-collateraliza­ tion clause), subsequent occurrences such as the opening of a plan or individual credit ex­ tensions are subject to the right of rescission to the same degree as if the security interest were taken directly to secure the open-end plan, unless the creditor effectively waives its security interest under the spreader clause with respect to the subsequent open-end credit extensions.

Statute: §§ 113, 125, and 130 and the Hous­ ing and Community Development Technical Amendments Act of 1984 § 205 (Pub. L. 98- 479).

Other sections: § 226.2 and appendix G Previous regulation: § 226.9 1981 changes: Section 226.15 reflects the stat­ utory amendments of 1980, providing for a limited right of rescission when individual credit extensions are made in accordance with a previously established credit limit for an open-end credit plan. The 1980 amendments provided that this limited rescission right be available for a three-year trial period. How- References Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 99

Regulation Z Commentary § 226.16 ever, Pub. L. 98-479 now permanently exmpts such individual credit extensions from me right of rescission.

The right to rescind applies not only to real property used as the consumer’s principal dwelling, but to personal property as well. The regulation provides no specific text or format for the rescission notice. When a consumer exercises the right to re­ scind, the creditor now has 20 days to return a consumer’s money or property and take the necessary action to terminate the security in­ terest. The creditor has 20 days to take pos­ session of the money or property after the consumer’s tender before the consumer may keep it without further obligation. Under the revised regulation, the waiver provision has been relaxed. The lien status of the mortgage is irrelevant for purposes of the residential mortgage transaction exemption. The exemption for agricultural loans from the right to rescind has been deleted. 'ECTION 226.16—Advertising 1. Clear and conspicuous standard. Section 226.16 is subject to the general “clear and ■conspicuous” standard for subpart B (see secon 226.5(a)(1)) but prescribes no specific rules for the format of the necessary disclo­ sures. The credit terms need not be printed in a certain type size nor need they appear in any particular place in the advertisement. 2. Expressing the annual percentage rate in abbreviated form. Whenever the annual per­ centage rate is used in an advertisement for open-end credit, it may be expressed using a readily understandable abbreviation such as APR.

16(a) Actually Available Terms 1. General rule. To the extent that an adver­ tisement mentions specific credit terms, it may state only those terms that the creditor is actu­ ally prepared to offer. For example, a creditor nay not advertise a very low annual percent­ age rate that will not in fact be available at any time. Section 226.16(a) is not intended to inhibit the promotion of new credit programs, but to bar the advertising of terms that are not and will not be available. For example, a creditor may advertise terms that will be of­ fered for only a limited period, or terms that will become available at a future date. 2. Specific credit terms. “ Specific credit terms” is not limited to the disclosures re­ quired by the regulation but would include any specific components of a credit plan, such as the minimum periodic payment amount or seller’s points in a plan secured by real estate. 16(b) Advertisement of Terms That Require Additional Disclosures 1. Terms requiring additional disclosures. In section 226.16(b) the phrase “the terms re­ quired to be disclosed under section 226.6” refers to the terms in section 226.6(a) and 226.6(b).

2. Use of positive terms. An advertisement must state a credit term as a positive number in order to trigger additional disclosures. For example, “no annual membership fee” would not trigger the additional disclosures required by section 226.16(b). (See, however, the rules in section 226.16(d) relating to advertisements for home-equity plans.) 3. Implicit terms.

Section 226.16(b) applies even if the triggering term is not stated ex­ plicitly, but may be readily determined from the advertisement.

4. Membership fees. A membership fee is not a triggering term nor need it be disclosed under section 226.16(b)(3) if it is required for participation in the plan whether or not an open-end credit feature is attached. (See com­ ment 6(b)-1.) 5. Variable-rate plans. In disclosing the an­ nual percentage rate in an advertisement for a variable-rate plan, as required by section 226.16(b)(2), the creditor may use an insert showing the current rate, may give the rate as of a specified recent date, or may disclose an estimated rate under section 226.5(c). The ad­ ditional requirement in section 226.16(b)(2) to disclose the variable-rate feature may be satis­ fied by disclosing that “the annual percentage rate may vary” or a similar statement, but the advertisement need not include the informa- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 100

§ 226.16 Regulation Z Commentary tion required by footnote 12 to section 226.6(a)(2).

6. Discounted variable-rate plans—disclosure of the annual percentage rates. The advertised annual percentage rates for discounted varia­ ble-rate plans must, in accordance with com­ ment 6(a)(2)-10, include both the initial rate (with the statement of how long it will remain in effect) and the current indexed rate (with the statement that this second rate may vary). The options listed in comment 16(b)-5 may be used in disclosing the current indexed rate. 7. Triggering terms. The following are exam­ ples of terms that trigger additional disclosures:

• “Small monthly service charge on the re­ maining balance,” which describes how the amount of a finance charge will be deter­ mined.

• “ 12 percent Annual Percentage Rate” or “A $15 annual membership fee buys you $2,000 in credit,” which describe required disclosures using positive numbers. 8. Minimum, fixed, transaction, activity, or similar charge. The charges to be disclosed under section 226.16(b)(1) are those that are considered finance charges under section 226.4.

9. Deferred-billing and deferred-payment pro­ grams. Statements such as “Charge it— you won’t be billed until May” or “You may skip your January payment” are not in themselves triggering terms, since the timing for initial billing or for monthly payments are not terms required to be disclosed under section 226.6. However, a statement such as “No finance charge until May” or any other statement re­ garding when finance charges begin to accrue is a triggering term, whether appearing alone or in conjunction with a description of a de­ ferred-billing or deferred-payment program such as the examples above.

16(c) Catalogs and Multiple-Page Advertisements 1. Definition. The multiple-page advertise­ ments to which section 226.16(c) refers are advertisements consisting of a series of se­ quentially numbered pages— for example, a supplement to a newspaper. A mailing con­ sisting of several separate flyers or pieces c/' promotional material in a single envelope doe. not constitute a single multiple-page advertise­ ment for purposes of section 226.16(c). Paragraph 16(c)(1) 1. General. Section 226.16(c)(1) permits cred­ itors to put credit information together in one place in a catalog or multiple-page advertise­ ment. The rule applies only if the catalog or multiple-page advertisement contains one or more of the triggering terms from section 226.16(b).

Paragraph 16(c)(2) r 1. Table or schedule if credit terms depend on outstanding balance. If the credit terms of a plan vary depending on the amount of the bal­ ance outstanding, rather than the amount of any property purchased, a table or schedule complies with section 226.16(c)(2) if it in­ cludes the required disclosures for representa­ tive balances. For example, a creditor wouk disclose that a periodic rate of 1.5 percent applied to balances of $500 or less, and a 1 percent rate is applied to balances greater than $500.

w 16(d) Additional Requirements for Home-Equity Plans 1. Trigger terms. Negative as well as affirma­ tive references trigger the requirement for ad­ ditional information. For example, if a creditor states “no annual fee,” “no points,” or “we waive closing costs” in an advertisement, ad­ ditional information must be provided. (See comment 16(d)-4 regarding the use of a phrase such as “no closing costs.”) Inclusion of a statement such as “low fees,” however, would not trigger the need to state additional information. References to payment terms in­ clude references to the draw period or any re­ payment period, to the length of the plan, to how the minimum payments are determined and to the timing of such payments. 2. Fees to open the plan. Section 226.1^ (d)(l)(i) requires a disclosure of any fees im­ posed by the creditor or a third party to open the plan. In providing the fee information re- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 101

Regulation Z Commentary § 226.17 quired under this paragraph, the corresponding lies for disclosure of this information apply. For example, fees to open the plan may be stated as a range. Similarly, if property insur­ ance is required to open the plan, a creditor either may estimate the cost of the insurance or provide a statement that such insurance is required. (See the commentary to section 226.5b(d)(7) and (8).) 3. Statements of tax deductibility. An adver­ tisement referring to deductiblity for tax pur­ poses is not misleading if it includes a state­ ment such as “consult a tax advisor regarding the deductibility of interest.” 4. Misleading terms prohibited. Under section 226.16(d)(5), advertisements may not refer to home-equity plans as “free money” or use other misleading terms. For example, an ad­ vertisement could not state “no closing costs” or “we waive closing costs” if consumers may be required to pay any closing costs, such as recordation fees. In the case of prop­ erty insurance, however, a creditor may state, 'or example, “no closing costs” even if prop­ erty insurance may be required, as long as the creditor also provides a statement that such insurance may be required. (See the commentry to this section regarding fees to open a J a n . ) 5. Relation to other sections. Advertisements for home-equity plans must comply with all provisions in section 226.16, not solely the rules in section 226.16(d). If an advertisement contains information (such as the payment terms) that triggers the duty under section 226.16(d) to state the annual percentage rate, the additional disclosures in section 226.16(b) must be provided in the advertisement. While section 226.16(d) does not require a statement of fees to use or maintain the plan (such as membership fees and transaction charges), such fees must be disclosed under section 226.16(b)(1) and (3).

6. Inapplicability of closed-end rules. Adver­ tisements for home-equity plans are governed olely by the requirements in section 226.16, and not by the closed-end advertising rules in section 226.24. Thus, if a creditor states pay­ ment information about the repayment phase, this will trigger the duty to provide additional information under section 226.16, but not under section 226.24.

7. Balloon payment. In some programs, a bal­ loon payment will occur if only the minimum payments under the plan are made. If an ad­ vertisement for such a program contains any statement about a minimum periodic payment, the advertisement must also state that a bal­ loon payment will result (not merely that a balloon payment “may” result). (See com­ ment 5b(d)(5)(ii)-3 for guidance on items not required to be stated in the advertisement, and on situations in which the balloon-payment re­ quirement does not apply.) References Statute: §§ 141 and 143 Previous regulation: § 226.10(a) through (c) and interpretation § 226.1002 Other sections: §§ 226.2 and 226.6 1981 changes: Section 226.16 reflects the stat­ utory changes to section 143 of the act which reduce both the number of triggering terms and the additional disclosures required by the use of those terms. Membership or participa­ tion fees are included among the additional disclosures required when a triggering term is used. The substance of interpretation section 226.1002, requiring disclosure of representa­ tive amounts of credit in catalogs and multi­ ple-page advertisements, has been incorpo­ rated in simplified form in paragraph (c). SUBPART C—CLOSED-END CREDIT SECTION 226.17—General Disclosure Requirements 17(a) Form of Disclosures Paragraph 17(a)(1) 1. Clear and conspicuous. This standard re­ quires that disclosures be in a reasonably un­ derstandable form. For example, while the regulation requires no mathematical progres­ sion or format, the disclosures must be pre­ sented in a way that does not obscure the re­ lationship of the terms to each other. In addition, although no minimum type size is Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 102

§ 226.17 Regulation Z Commentary mandated, the disclosures must be legible, whether typewritten, handwritten, or printed by computer.

2. Segregation of disclosures. The disclosures may be grouped together and segregated from other information in a variety of ways. For example, the disclosures may appear on a sep­ arate sheet of paper or may be set off from other information on the contract or other documents:

• By outlining them in a box • By bold print dividing lines • By a different color background • By a different type style (The general segregation requirement de­ scribed in this subparagraph does not apply to the disclosures required under sections 226.19(b) and 226.20(c) although the disclo­ sures must be clear and conspicuous.) 3. Location. The regulation imposes no spe­ cific location requirements on the segregated disclosures. For example:

• They may appear on a disclosure statement separate from all other material. • They may be placed on the same document with the credit contract or other informa­ tion, so long as they are segregated from that information.

• They may be shown on the front or back of a document.

• They need not begin at the top of a page. • They may be continued from one page to another.

4. Content of segregated disclosures. Foot­ notes 37 and 38 contain exceptions to the re­ quirement that the disclosures under section 226.18 be segregated from material that is not directly related to those disclosures. Footnote 37 lists the items that may be added to the segregated disclosures, even though not di­ rectly related to those disclosures. Footnote 38 lists the items required under section 226.18 that may be deleted from the segregated dis­ closures and appear elsewhere. Any one or more of these additions or deletions may be combined and appear either together with or separate from the segregated disclosures. The itemization of the amount financed under sec­ tion 226.18(c), however, must be separate from the other segregated disclosures under section 226.18. If a creditor chooses to in elude the security-interest charges required to be itemized under sections 226.4(e) and 226.18(o) in the amount-financed itemization, it need not list these charges elsewhere. 5. Directly related. The segregated disclosures may, at the creditor’s option, include any in­ formation that is directly related to those dis­ closures. The following is directly related information:

i.

A description of a grace period after which a late-payment charge will be im­ posed. For example, the disclosure given under section 226.18(f) may state that a late charge will apply to “any payment received more than 15 days after the due date.”

ii.

A statement that the transaction is not se­ cured. For example, the creditor may add a category labelled “unsecured” or “not secured” to the security-interest disclo­ sures given under section 226.18(m). iii.

The basis for any estimates used in mak ing disclosures. For example, if the ma­ turity date of a loan depends solely on the occurrence of a future event, the creditor may indicate that the disclosure^** assume that event will occur at a certai. time.

iv.

The conditions under which a demand feature may be exercised. For example, in a loan subject to demand after five years, the disclosures may state that the loan will become payable on demand in five years.

v.

An explanation of the use of pronouns or other references to the parties to the transaction. For example, the disclosures may state, “ ‘You’ refers to the customer and ‘we’ refers to the creditor.” vi.

Instructions to the creditor or its employ­ ees on the use of a multiple-purpose form. For example, the disclosures may state, “Check box if applicable.” vii. A statement that the borrower may pay a minimum finance charge upon prepay ment in a simple-interest transaction. Foi example, when state law prohibits penal­ ties, but would allow a minimum finance charge in the event of prepayment, the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 103

Regulation Z Commentary § 226.17 viii.

IX.

x.

o xi.o xii.

xiii.

creditor may make the section 226.18(k)(l) disclosure by stating, “You may be charged a minimum finance charge.”

A brief reference to negative amortiza­ tion in variable-rate transactions. For ex­ ample, in the variable-rate disclosure, the creditor may include a short statement such as “Unpaid interest will be added to principal.” (See the commentary to section 226.18(f)( 1 )(iii).) A brief caption identifying the disclo­ sures. For example, the disclosures may bear a general title such as “Federal Truth in Lending Disclosures” or a de­ scriptive title such as “Real Estate Loan Disclosures.”

A statement that a due-on-sale clause or other conditions on assumption are con­ tained in the loan document. For exam­ ple, the disclosure given under section 226.18(q) may state, “Someone buying your home may, subject to conditions in the due-on-sale clause contained in the loan document, assume the remainder of the mortgage on the original terms.” If a state or federal law prohibits prepay­ ment penalties and excludes the charging of interest after prepayment from cover­ age as a penalty, a statement that the borrower may have to pay interest for some period after prepayment in full. The disclosure given under section 226.18(k) may state, for example, “If you prepay your loan on other than the regular installment date, you may be as­ sessed interest charges until the end of the month.”

More than one hypothetical example under section 226.18(f)(l)(iv) in transac­ tions with more than one variable-rate feature. For example, in a variable-rate transaction with an option permitting consumers to convert to a fixed-rate transaction, the disclosures may include an example illustrating the effects on the payment terms of an increase resulting from conversion in addition to the exam­ ple illustrating an increase resulting from changes in the index.

The disclosures set forth under section 226.18(f)(1) for variable-rate transactions subject to section 226.18(f)(2). xiv. A statement whether or not a subsequent purchaser of the property securing an ob­ ligation may be permitted to assume the remaining obligation on its original terms.

xv. A late-payment-fee disclosure under sec­ tion 226.18(/) on a single-payment loan. 6. Multiple-purpose forms. The creditor may design a disclosure statement that can be used for more than one type of transaction, so long as the required disclosures for individual transactions are clear and conspicuous. (See the commentary to appendices G and H for a discussion of the treatment of disclosures that do not apply to specific transactions.) Any disclosure listed in section 226.18 (except the itemization of the amount financed under sec­ tion 226.18(c)) may be included on a standard disclosure statement even though not all of the creditor’s transactions include those fea­ tures. For example, the statement may include: • The variable-rate disclosure under section 226.18(f) • The demand feature disclosure under sec­ tion 226.18(i) • A reference to the possibility of a security interest arising from a spreader clause, under section 226.18(m) • The assumption policy disclosure under section 226.18(q) • The required deposit disclosure under sec­ tion 226.18(r) 7. Balloon-payment financing with leasing characteristics. In certain credit sale or loan transactions, a consumer may reduce the dol­ lar amount of the payments to be made during the course of the transaction by agreeing to make, at the end of the loan term, a large final payment based on the expected residual value of the property. The consumer may have a number of options with respect to the final payment, including, among other things, retaining the property and making the final payment, refinancing the final payment, or transferring the property to the creditor in lieu of the final payment. Such transactions may have some of the characteristics of lease trans­ actions subject to Regulation M, but are con- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 104

§ 226.17 Regulation Z Commentary sidered credit transactions where the consumer assumes the indicia of ownership, including the risks, burdens and benefits of ownership upon consummation. These transactions are governed by the disclosure requirements of this regulation instead of Regulation M. Cred­ itors should not include in the segregated Truth in Lending disclosures additional infor­ mation. Thus, disclosures should show the large final payment in the payment schedule and should not, for example, reflect the other options available to the consumer at maturity. Paragraph 17(a)(2) 1. When disclosures must be more conspicu­ ous. The following rules apply to the require­ ment that the terms “annual percentage rate” and “ finance charge”

be shown more conspicuously:

• The terms must be more conspicuous only in relation to the other required disclosures under section 226.18. For example, when the disclosures are included on the contract document, those two terms need not be more conspicuous as compared to the head­ ing on the contract document or informa­ tion required by state law. • The terms need not be more conspicuous except as part of the finance charge and annual percentage rate disclosures under section 226.18(d) and (e), although they may, at the creditor’s option, be highlight­ ed wherever used in the required disclo­ sures. For example, the terms may, but need not, be highlighted when used in dis­ closing a prepayment penalty under section 226.18(k) or a required deposit under sec­ tion 226.18(r).

• The creditor’s identity under section 226.18(a) may, but need not, be more prominently displayed than the finance charge and annual percentage rate. • The terms need not be more conspicuous than figures (including, for example, num­ bers, percentages, and dollar signs). 2. Making disclosures more conspicuous. The terms “finance charge” and “annual percent­ age rate” may be made more conspicuous in any way that highlights them in relation to the other required disclosures. For example, the may be:

• Capitalized when other disclosures are printed in capital and lower case • Printed in larger type, bold print or differ­ ent type face • Printed in a contrasting color • Underlined • Set off with asterisks 17(b) Time of Disclosures 1. Consummation. As a general rule, disclo­ sures must be made before “consummation” of the transaction. The disclosures need not be given by any particular time before consum­ mation, except in certain mortgage transac­ tions and variable-rate transactions secured by the consumer’s principal dwelling with a term greater than one year under section 226.19. (See the commentary to section 226.2(a)(l: regarding the definition of consummation.) 2. Converting open-end to closed-end credit. Except for home-equity plans subject to sea^fe tion 226.5b in which the agreement provide for a repayment phase, if an open-end credit account is converted to a closed-end transac­ tion under a written agreement with the con­ sumer, the creditor must provide a set of closed-end credit disclosures before consum­ mation of the closed-end transaction. (See the commentary to section 226.19(b) for the tim­ ing rules for additional disclosures required upon the conversion to a variable-rate transac­ tion secured by a consumer’s principal dwell­ ing with a term greater than one year.) If con­ summation of the closed-end transaction occurs at the same time as the consumer en­ ters into the open-end agreement, the closedend credit disclosures may be given at the time of conversion. If disclosures are delayed until conversion and the closed-end transac­ tion has a variable-rate feature, disclosure should be based on the rate in effect at thd"^. time of conversion. (See the commentary to section 226.5 regarding conversion of closedend to open-end credit.) Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 105

Regulation Z Commentary § 226.17 17(c) Basis o f Disclosures and U se of Estimates Paragraph 17(c)(1) 1. Legal obligation. The disclosures shall re­ flect the credit terms to which the parties are legally bound as of the outset of the transac­ tion. In the case of disclosures required under section 226.20(c), the disclosures shall reflect the credit terms to which the parties are le­ gally bound when the disclosures are pro­ vided. The legal obligation is determined by applicable state law or other law. (Certain transactions are specifically addressed in this commentary. See, for example, the discussion of buydown transactions elsewhere in the commentary to section 226.17(c).) • The fact that a term or contract may later be deemed unenforceable by a court on the basis of equity or other grounds does not, by itself, mean that disclosures based on that term or contract did not reflect the le­ gal obligation.

2. Modification of obligation. The legal obli­ gation normally is presumed to be contained in the note or contract that evidences the agreement. But this presumption is rebutted if another agreement between the parties legally modifies that note or contract. If the parties informally agree to a modification of the legal obligation, the modification should not be re­ flected in the disclosures unless it rises to the level of a change in the terms of the legal obligation. For example:

• If the creditor offers a preferential rate, such as an employee preferred rate the dis­ closures should reflect the terms of the le­ gal obligation. (See the commentary to section 226.19(b) for an example of a pre­ ferred-rate transaction that is a variable-rate transaction.

• If the contract provides for a certain monthly payment schedule but payments are made on a voluntary payroll deduction plan or an informal principal-reduction agreement, the disclosures should reflect the schedule in the contract. • If the contract provides for regular monthly payments but the creditor informally per­ mits the consumer to defer payments from time to time, for instance, to take account of holiday seasons or seasonal employment, the disclosures should reflect the regular monthly payments.

3. Third-party buydowns. In certain transac­ tions, a seller or other third party may pay an amount, either to the creditor or to the con­ sumer, in order to reduce the consumer’s pay­ ments or buy down the interest rate for all or a portion of the credit term. For example, a consumer and a bank agree to a mortgage with an interest rate of 15 percent and level payments over 25 years. By a separate agree­ ment, the seller of the property agrees to sub­ sidize the consumer’s payments for the first two years of the mortgage, giving the con­ sumer an effective rate of 12 percent for that period.

• If the lower rate is reflected in the credit contract between the consumer and the bank, the disclosures must take the buydown into account. For example, the annual percentage rate must be a composite rate that takes account of both the lower initial rate and the higher subsequent rate, and the payment schedule disclosures must reflect the two payment levels. However, the amount paid by the seller would not be specifically reflected in the disclosures giv­ en by the bank, since that amount consti­ tutes seller’s points and thus is not part of the finance charge.

• If the lower rate is not reflected in the credit contract between the consumer and the bank and the consumer is legally bound to the 15 percent rate from the outset, the disclosures given by the bank must not re­ flect the seller buydown in any way. For example, the annual percentage rate and payment schedule would not take into ac­ count the reduction in the interest rate and payment level for the first two years result­ ing from the buydown.

4. Consumer buydowns. In certain transac­ tions, the consumer may pay an amount to the creditor to reduce the payments or obtain a lower interest rate on the transaction. Con­ sumer buydowns must be reflected in the dis­ closures given for that transaction. To illus­ trate, in a mortgage transaction, the creditor Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 106

§ 226.17 Regulation Z Commentary and consumer agree to a note specifying a 14 percent interest rate. However, in a separate document, the consumer agrees to pay an amount to the creditor at consummation, in return for a reduction in the interest rate to 12 percent for a portion of the mortgage term. The amount paid by the consumer may be de­ posited in an escrow account or may be re­ tained by the creditor. Depending upon the buydown plan, the consumer’s prepayment of the obligation may or may not result in a por­ tion of the amount being credited or refunded to the consumer. In the disclosures given for the mortgage, the creditor must reflect the terms of the buydown agreement. For example:

• The amount paid by the customer is a pre­ paid finance charge (even if deposited in an escrow account).

• A composite annual percentage rate must be calculated, taking into account both in­ terest rates, as well as the effect of the pre­ paid finance charge.

• The payment schedule must reflect the multiple payment levels resulting from the buydown.

The rules regarding consumer buydowns do not apply to transactions known as “lender buydowns.” In lender buydowns, a creditor pays an amount (either into an account or to the party to whom the obligation is sold) to reduce the consumer’s payments or interest rate for all or a portion of the credit term. Typically, these transactions are structured as a buydown of the interest rate during an ini­ tial period of the transaction with a higherthan-usual rate for the remainder of the term. The disclosures for lender buydowns should be based on the terms of the legal obligation between the consumer and the creditor. (See comment 17(c)(l)-3 for the analogous rules concering third-party buydowns.) 5. Split buydowns. In certain transactions, a third party (such as a seller) and a consumer both pay an amount to the creditor to reduce the interest rate. The creditor must include the portion paid by the consumer in the finance charge and disclose the corresponding multi­ ple payment levels and composite annual per­ centage rate. The portion paid by the third party and the corresponding reduction in inter­ est rate, however, should not be reflected in the disclosures unless the lower rate is re­ flected in the credit contract. (See the discus­ sion on third-party and consumer buydown transactions elsewhere in the commentary to section 226.17(c).) 6. Wraparound financing. Wraparound trans­ actions, usually loans, involve the creditor’s wrapping the outstanding balance on an ex­ isting loan and advancing additional funds to the consumer. The preexisting loan, which is wrapped, may be to the same consumer or to a different consumer. In either case, the con­ sumer makes a single payment to the new creditor, who makes the payments on the pre­ existing loan to the original creditor. Wrap­ around loans or sales are considered new sin­ gle-advance transactions, with an amount financed equalling the sum of the new funds advanced by the wrap creditor and the remain­ ing principal owed to the original creditor on the preexisting loan. In disclosing the itemiza­ tion of the amount financed, the creditor may use a label such as “the amount that will be paid to creditor X” to describe the remaining principal balance on the preexisting loan. This approach to Truth in Lending calculations has no effect on calculations required by other statutes, such as state usury laws. 7. Wraparound financing with balloon pay­ ments. For wraparound transactions involving a large final payment of the new funds before the maturity of the preexisting loan, the amount financed is the sum of the new funds and the remaining principal on the preexisting loan. The disclosures should be based on the shorter term of the wrap loan, with a large final payment of both the new funds and the total remaining principal on the preexisting loan (although only the wrap loan will actu­ ally be paid off at that time.) 8. Basis of disclosures in variable-rate trans­ actions. The disclosures for a variable-rate transaction must be given for the full term of the transaction and must be based on the terms in effect at the time of consummation. Creditors should base the disclosures only on the initial rate and should not assume that this rate will increase. For example, in a loan with Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 107

Regulation Z Commentary § 226.17 an initial rate of 10 percent and a 5 percent­ age points rate cap, creditors should base the disclosures on the initial rate and should not assume that this rate will increase 5 percent­ age points. However, in a variable-rate trans­ action with a seller buydown that is reflected in the credit contract, a consumer buydown, or a discounted or premium rate, disclosures should not be based solely on the initial terms. In those transactions, the disclosed an­ nual percentage rate should be a composite rate based on the rate in effect during the ini­ tial period and the rate that is the basis of the variable-rate feature for the remainder of the term. (See the commentary to section 226.17(c) for a discussion of buydown, dis­ counted, and premium transactions and the commentary to section 226.19(a)(2) for a dis­ cussion of the redisclosure in certain residen­ tial mortgage transactions with a variable-rate feature).

9. Use of estimates in variable-rate transac­ tions. The variable-rate feature does not, by itself, make the disclosures estimates. 10.

Discounted and premium variable-rate transactions. In some variable-rate transac­ tions, creditors may set an initial interest rate O that is not determined by the index or formula used to make later interest rate adjustments. Typically, this initial rate charged to consum­ ers is lower than the rate would be if it were calculated using the index or formula. How­ ever, in some cases the initial rate may be higher. In a discounted transaction, for exam­ ple, a creditor may calculate interest rates ac­ cording to a formula using the six-month Treasury bill rate plus a 2 percent margin. If the Treasury bill rate at consummation is 10 percent, the creditor may forgo the 2 percent spread and charge only 10 percent for a lim­ ited time, instead of setting an initial rate of 12 percent.

• When creditors use an initial interest rate that is not calculated using the index or formula for later rate adjustments, the dis­ closures should reflect a composite annual percentage rate based on the initial rate for as long as it is charged and, for the re­ mainder of the term, the rate that would have been applied using the index or formula at the time of consummation. The rate at consummation need not be used if a contract provides for a delay in the imple­ mentation of changes in an index value. For example, if the contract specifies that rate changes are based on the index value in effect 45 days before the change date, creditors may use the index value in effect not more than 45 days before consumma­ tion in calculating a composite annual per­ centage rate.

The effect of the multiple rates must also be reflected in the calculation and disclo­ sure of the finance charge, total of pay­ ments, and payment schedule. If a loan contains a rate or payment cap that would prevent the initial rate or pay­ ment, at the time of the first adjustment, from changing to the rate determined by the index or formula at consummation, the effect of that rate or payment cap should be reflected in the disclosures. Because these transactions involve irregular payment amounts, an annual percentage rate tolerance of XU of 1 percent applies, in accordance with section 226.22(a)(3) of the regulation.

Examples of discounted variable-rate trans­ actions include— —A 30-year loan for $100,000 with no prepaid finance charges and rates determined by the Treasury bill rate plus 2 percent. Rate and payment adjustments are made annually.

Although the Treasury bill rate at the time of consummation is 10 percent, the creditor sets the interest rate for one year at 9 percent, instead of 12 percent according to the formula. The disclosures should reflect a composite annual percentage rate of 11.63 percent based on 9 percent for one year and 12 percent for 29 years. Reflecting those two rate levels, the payment schedule should show payments of $804.62 and 348 payments of $1,025.31. The finance charge should be $266,463.32 and the total of payments $366,463.32.

—Same loan as above, except with a 2 percent rate cap on periodic adjustments. The disclosures should reflect a composite annual percentage rate of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 108

§ 226.17 Regulation Z Commentary 11.53 percent based on 9 percent for the first year, 11 percent for the second year, and 12 percent for the remaining 28 years. Reflecting those three rate levels, the payment schedule should show 12 payments of $804.62, 12 payments of $950.09, and 336 payments of $1,024.34. The finance charge should be $265,234.76, and the total of payments $365,234.76.

— Same loan as above, except with a 772 percent cap on payment adjustments. The disclosures should reflect a composite annual percentage rate of 11.64 percent, based on 9 percent for one year and 12 percent for 29 years. Because of the payment cap, five levels of payments should be reflected.

The payment schedule should show 12 payments of $804.62, 12 payments of $864.97, 12 payments of $929.84, 12 payments of $999.58, and 312 payments of $1,070.04. The finance charge should be $277,040.60, and the total of payments $377,040.60.

This paragraph does not apply to variable-rate loans in which the initial interest rate is set according to the index or formula used for later adjustments but is not set at the value of the index or formula at consummation. For example, if a creditor commits to an initial rate based on the formula on a date prior to consummation, but the index has moved dur­ ing the period between that time and consum­ mation, a creditor should base its disclosures on the initial rate.

11. Examples of variable-rate transactions. Variable-rate transactions include: • Renewable balloon-payment instruments where the creditor is both unconditionally obligated to renew the balloon-payment loan at the consumer’s option (or is obli­ gated to renew subject to conditions within the consumer’s control) and has the option of increasing the interest rate at the time of renewal. Disclosures must be based on the payment amortization (unless the specified term of the obligation with renewals is shorter) and on the rate in effect at the time of consummation of the transaction. (Examples of conditions within a consum­ er’s control include requirements that a consumer be current in payments or contin­ ue to reside in the mortgaged property. In contrast, setting a limit on the rate at which the creditor would be obligated to renew or reserving the right to change the credit standards at the time of renewal are examples of conditions outside a consum­ er’s control.) If, however, a creditor is not obligated to renew as described above, dis­ closures must be based on the term of the balloon-payment loan. Disclosures also must be based on the term of the balloonpayment loan in balloon-payment instru­ ments in which the legal obligation provides that the loan will be renewed by a “refinancing” of the obligation, as that term is defined by section 226.20(a). If it cannot be determined from the legal obli­ gation that the loan will be renewed by a “refinancing,” disclosures must be based either on the term of the balloon-payment loan or on the payment amortization, de­ pending on whether the creditor is uncon­ ditionally obligated to renew the loan as described above. (This discussion does not apply to construction loans subject to sec­ tion 226.17(c)(6).) • “Shared-equity” or “shared-appreciation” mortgages that have a fixed rate of interest and an appreciation share based on the consumer’s equity in the mortgaged proper­ ty. The appreciation share is payable in a lump sum at a specified time. Disclosures must be based on the fixed interest rate. (As discussed in the commentary to section 226.2, other types of shared-equity arrange­ ments are not considered “credit” and are not subject to Regulation Z.) • Preferred-rate loans where the terms of the legal obligation provide that the initial un­ derlying rate is fixed but will increase upon the occurrence of some event, such as an employee leaving the employ of the credi­ tor, and the note reflects the preferred rate. The disclosures are to be based on the pre­ ferred rate.

• “Price-level-adjusted mortgages” or other indexed mortgages that have a fixed rate of interest but provide for periodic adjust­ ments to payments and the loan balance to Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 109

Regulation Z Commentary § 226.17 reflect changes in an index measuring prices or inflation. Disclosures are to be based on the fixed interest rate. Graduated-payment mortgages and step-rate transactions without a variable-rate feature are not considered variable-rate transactions. 12. Graduated-payment adjustable-rate mort­ gages. These mortgages involve both a varia­ ble interest rate and scheduled variations in payment amounts during the loan term. For example, under these plans, a series of gradu­ ated payments may be scheduled before rate adjustments affect payment amounts, or the initial scheduled payment may remain con­ stant for a set period before rate adjustments affect the payment amount. In any case, the initial payment amount may be insufficient to cover the scheduled interest, causing negative amortization from the outset of the transac­ tion. In these transactions, the disclosures should treat these features as follows: • The finance charge includes the amount of negative amortization based on the assump­ tion that the rate in effect at consummation remains unchanged.

• The amount financed does not include the amount of negative amortization. • As in any variable-rate transaction, the an­ nual percentage rate is based on the terms in effect at consummation.

• The schedule of payments discloses the amount of any scheduled initial payments followed by an adjusted level of payments based on the initial interest rate. Since some mortgage plans contain limits on the amount of the payment adjustment, the payment schedule may require several dif­ ferent levels of payments, even with the as­ sumption that the original interest rate does not increase.

13. Growth-equity mortgages. Also referred to as payment-escalated mortgages, these mort­ gage plans involve scheduled payment in­ creases to prematurely amortize the loan. The initial payment amount is determined as for a long-term loan with a fixed interest rate. Pay­ ment increases are scheduled periodically, based on changes in an index. The larger pay­ ments result in accelerated amortization of the loan. In disclosing these mortgage plans, cred­ itors may either— • estimate the amount of payment increases, based on the best information reasonably available, or • disclose by analogy to the variable-rate dis­ closures in section 226.18(f)(1). (This discussion does not apply to growth-eq­ uity mortgages in which the amount of pay­ ment increases can be accurately determined at the time of disclosure. For these mortgages, as for graduated-payment mortgages, disclo­ sures should reflect the scheduled increases in payments.) 14. Reverse mortgages. Reverse mortgages, also known as reverse-annuity or home-eq­ uity-conversion mortgages, typically involve the disbursement of monthly advances to the consumer for a fixed period or until the occur­ rence of an event such as the consumer’s death. Repayment of the loan (generally a sin­ gle payment of principal and accrued interest) may be required to be made at the end of the disbursements or, for example, upon the death of the consumer. In disclosing these transac­ tions, creditors must apply the following rules, as applicable:

• If the reverse mortgage has a specified pe­ riod for disbursements but repayment is due only upon the occurrence of a future event such as the death of the consumer, the creditor must assume that disburse­ ments will be made until they are sched­ uled to end. The creditor must assume repayment will occur when disbursements end (or within a period following the final disbursement which is not longer than the regular interval between disbursements). This assumption should be used even though repayment may occur before or af­ ter the disbursements are scheduled to end. In such cases, the creditor may include a statement such as “The disclosures assume that you will repay the loan at the time our payments to you end. As provided in your agreement, your repayment may be re­ quired at a different time.” • If the reverse mortgage has neither a speci­ fied period for disbursements nor a speci­ fied repayment date and these terms will be Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 110

§ 226.17 Regulation Z Commentary determined solely by reference to future events, including the consumer’s death, the creditor may assume that the disbursements will end upon the consumer’s death (esti­ mated by using actuarial tables, for exam­ ple) and that repayment will be required at the same time (or within a period follow­ ing the date of the final disbursement which is not longer than the regular inter­ val for disbursements). Alternatively, the creditor may base the disclosures upon an­ other future event it estimates will be most likely to occur first. (If terms will be deter­ mined by reference to future events which do not include the consumer’s death, the creditor must base the disclosures upon the occurence of the event estimated to be most likely to occur first.) • In making the disclosures, the creditor must assume that all disbursements and ac­ crued interest will be paid by the consum­ er. For example, if the note has a nonrecourse provision providing that the consumer is not obligated for an amount greater than the value of the house, the creditor must nonetheless assume that the full amount to be disbursed will be repaid. In this case, however, the creditor may in­ clude a statement such as “The disclosures assume full repayment of the amount ad­ vanced plus accrued interest, although the amount you may be required to pay is lim­ ited by your agreement.”

• Some reverse mortgages provide that some or all of the appreciation in the value of the property will be shared between the consumer and the creditor. Such loans are considered variable-rate mortgages, as de­ scribed in comment 17(c)(1)—11, and the appreciation feature must be disclosed in accordance with section 226.18(f)(1). If the reverse mortgage has a variable interest rate, is written for a term greater than one year, and is secured by the consumer’s principal dwelling, the shared-appreciation feature must be described under section 226.19(b)(2)(vii).

15. Morris Plan transactions. When a deposit account is created for the sole purpose of ac­ cumulating payments and then is applied to satisfy entirely the consumer’s obligation in the transaction, each deposit made into the ac­ count is considered the same as a payment on a loan for purposes of making disclosures. 16. Number of transactions. Creditors have flexibility in handling credit extensions that may be viewed as multiple transactions. For example:

• When a creditor finances the credit sale of a radio and a television on the same day, the creditor may disclose the sales as either one or two credit sale transactions. • When a creditor finances a loan along with a credit sale of health insurance, the credi­ tor may disclose in one of several ways: a single credit sale transaction, a single loan transaction, or a loan and a credit sale transaction.

• The separate financing of a downpayment in a credit sale transaction may, but need not, be disclosed as two transactions (a credit sale and a separate transaction for the financing of the downpayment). 17. Special rules for tax refund-anticipation loans. Tax-refund loans, also known as re­ fund-anticipation loans (RALs), are transac­ tions in which a creditor will lend up to the amount of a consumer’s expected tax refund. RAL agreements typically require repayment upon demand, but also may provide that re­ payment is required when the refund is made. The agreements also typically provide that if the amount of the refund is less than the pay­ ment due, the consumer must pay the differ­ ence.

Repayment often is made by a preauthorized offset to a consumer’s account held with the creditor when the refund has been deposited by electronic transfer. Credi­ tors may charge fees for RALs in addition to fees for filing the consumer’s tax return elec­ tronically. In RAL transactions subject to the regulation the following special rules apply: • If, under the terms of the legal obligation, repayment of the loan is required when the refund is received by the consumer (such as by deposit into the consumer’s account), the disclosures should be based on the creditor’s estimate of the time the refund will be delivered even if the loan also con­ tains a demand clause. The practice of a creditor to demand repayment upon deliv- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 111

Regulation Z Commentary § 226.17 ery of refunds does not determine whether the legal obligation requires that repayment be made at that time; this determination must be made according to applicable state or other law. (See comment 17(c)(5)-1 for the rules regarding disclosures if the loan is payable solely on demand or is payable ei­ ther on demand or on an alternate maturity date.) • If the consumer is required to repay more than the amount borrowed, the difference is a finance charge unless excluded under sec­ tion 226.4. In addition, to the extent that any fees charged in connection with the loan (such as for filing the tax return elec­ tronically) exceed those fees for a compa­ rable cash transaction (that is, filing the tax return electronically without a loan), the difference must be included in the finance charge.

Paragraph 17(c)(2) 1. Basis for estimates. Disclosures may be es­ timated when the exact information is un­ known at the time disclosures are made. Infor­ mation is unknown if it is not reasonably available to the creditor at the time the disclo­ sures are made. The “reasonably available” zandard requires that the creditor, acting in good faith, exercise due diligence in obtaining information. For example, the creditor must at a minimum utilize generally accepted calcula­ tion tools but need not invest in the most so­ phisticated computer program to make a par­ ticular type of calculation. The creditor normally may rely on the representations of other parties in obtaining information. For ex­ ample, the creditor might look to the con­ sumer for the time of consummation, to insur­ ance companies for the cost of insurance, or to realtors for taxes and escrow fees. The creditor may utilize estimates in making dis­ closures even though the creditor knows that more precise information will be available by the point of consummation. However, new disclosures may be required under section ■J26.17(f) or 226.19.

2. Labelling estimates. Estimates must be des­ ignated as such in the segregated disclosures. Even though other disclosures are based on the same assumption on which a specific esti­ mated disclosure was based, the creditor has some flexibility in labelling the estimates. Generally, only the particular disclosure for which the exact information is unknown is la­ belled as an estimate. However, when several disclosures are affected because of the un­ known information, the creditor has the option of labelling either every affected disclosure or only the disclosure primarily affected. For ex­ ample, when the finance charge is unknown because the date of consummation is un­ known, the creditor must label the finance charge as an estimate and may also label as estimates the total of payments and the pay­ ment schedule. When many disclosures are es­ timates, the creditor may use a general state­ ment, such as “all numerical disclosures except the late payment disclosure are esti­ mates,” as a method to label those disclosures as estimates.

3. Simple-interest transactions. If consumers do not make timely payments in a simpleinterest transaction, some of the amounts cal­ culated for Truth in Lending disclosures will differ from amounts that consumers will actu­ ally pay over the term of the transaction. Creditors may label disclosures as estimates in these transactions. For example, because the finance charge and total of payments may be larger than disclosed if consumers make late payments, creditors may label the finance charge and total of payments as estimates. On the other hand, creditors may choose not to label disclosures as estimates and may base all disclosures on the assumption that payments will be made on time, disregarding any possi­ ble inaccuracies resulting from consumers’ payment patterns.

Paragraph 17(c)(3) 1. Minor variations. Section 226.17(c)(3) al­ lows creditors to disregard certain factors in calculating and making disclosures. For example:

• Creditors may ignore the effects of collect­ ing payments in whole cents. Because pay­ ments cannot be collected in fractional cents, it is often difficult to amortize exact­ ly an obligation with equal payments; the amount of the last payment may require Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 112

§ 226.17 Regulation Z Commentary adjustment to account for the rounding of the other payments to whole cents. • Creditors may base their disclosures on cal­ culation tools that assume that all months have an equal number of days, even if their practice is to take account of the variations in months for purposes of collecting inter­ est. For example, a creditor may use a cal­ culation tool based on a 360-day year, when it in fact collects interest by applying a factor of 1/365 of the annual rate to 365 days. This rule does not, however, autho­ rize creditors to ignore, for disclosure pur­ poses, the effects of applying 1/360 of an annual rate to 365 days.

2. Use of special rules. A creditor may utilize the special rules in section 226.17(c)(3) for purposes of calculating and making all disclo­ sures for a transaction or may, at its option, use the special rules for some disclosures and not others.

Paragraph 17(c)(4) 1. Payment-schedule irregularities. When one or more payments in a transaction differ from the others because of a long or short first pe­ riod, the variations may be ignored in disclos­ ing the payment schedule, finance charge, an­ nual percentage rate, and other terms. For example:

• A 36-month auto loan might be consum­ mated on June 8 with payments due on Ju­ ly 1 and the first of each succeeding month. The creditor may base its calcula­ tions on a payment schedule that assumes 36 equal intervals and 36 equal installment payments, even though a precise computa­ tion would produce slightly different amounts because of the shorter first period. .

By contrast, in the same example, if the first payment were not scheduled until Au­ gust 1, the irregular first period would ex­ ceed the limits in section 226.17(c)(4); the creditor could not use the special rule and could not ignore the extra days in the first period in calculating its disclosures. 2. Measuring odd periods. In determining whether a transaction may take advantage of the rule in section 226.17(c)(4), the creditor must measure the variation against a regular period. For purposes of that rule: • The first period is the period from the date on which the finance charge begins to be earned to the date of the first payment. • The term is the period from the date on which the finance charge begins to be earned to the date of the final payment. • The regular period is the most common in­ terval between payments in the transaction. In transactions involving regular periods that are monthly, semimonthly, or multiples of a month, the length of the irregular and regular periods may be calculated on the basis of ei­ ther the actual number of days or an assumed 30-day month. In other transactions, the length of the periods is based on the actual number of days.

3. Use of special rules. A creditor may utilize the special rules in section 226.17(c)(4) for purposes of calculating and making some dis­ closures but may elect not to do so for all of the disclosures. For example, the variations may be ignored in calculating and disclosing the annual percentage rate but taken into ac­ count in calculating and disclosing the finance charge and payment schedule. 4. Relation to prepaid finance charges. Pre'tiv paid finance charges, including “odd-days” or “per-diem” interest, paid prior to or at closing may not be treated as the first payment on a loan. Thus, creditors may not disregard an ir­ regularity in disclosing such finance charges. Paragraph 17(c)(5) 1. Demand disclosures. Disclosures for de­ mand obligations are based on an assumed one-year term, unless an alternate maturity date is stated in the legal obligation. Whether an alternate maturity date is stated in the legal obligation is determined by applicable law. An alternate maturity date is not inferred from an informal principal reduction agreement or a similar understanding between the parties. However, when the note itself specifies a prin cipal reduction schedule (for example, “pay­ able on demand or $2,000 plus interest quar­ terly”), an alternate maturity is stated and the disclosures must reflect that date. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 113

Regulation Z Commentary § 226.17 2. Future event as maturity date. An obliga­ tion whose maturity date is determined solely by a future event, as for example a loan pay­ able only on the sale of property, is not a demand obligation. Because no demand fea­ ture is contained in the obligation, demand disclosures under section 226.18(i) are inappli­ cable. The disclosures should be based on the creditor’s estimate of the time at which the specified event will occur, and may indicate the basis for the creditor’s estimate, as noted in the commentary to section 226.17(a). 3. Demand after stated period. Most demand transactions contain a demand feature that may be exercised at any point during the term, but certain transactions convert to de­ mand status only after a fixed period. For ex­ ample, in states prohibiting due-on-sale clauses, the Federal National Mortgage Asso­ ciation (FNMA) requires mortgages that it purchases to include a call option rider that may be exercised after 7 years. These mort­ gages are generally written as long-term obli­ gations but contain a demand feature that may % ^ b e exercised only within a 30-day period at 7 years. The disclosures for these transactions should be based upon the legally agreed-upon maturity date. Thus, if a mortgage containing the 7-year FNMA call option is written as a 20-year obligation, the disclosures should be based on the 20-year term, with the demand feature disclosed under section 226.18(i). 4. Balloon mortgages. Balloon payment mort­ gages, with payments based on a long-term amortization schedule and a large final pay­ ment due after a shorter term, are not demand obligations unless a demand feature is specifi­ cally contained in the contract. For example, a mortgage with a term of 5 years and a pay­ ment schedule based on 20 years would not be treated as a mortgage with a demand fea­ ture, in the absence of any contractual demand provisions. In this type of mortgage, disclo­ sures should be based on the 5-year term. Paragraph 17(c)(6) 1. Series of advances. Section 226.17(c) (6)(i) deals with a series of advances under an agreement to extend credit up to a certain amount. A creditor may treat all of the ad­ vances as a single transaction or disclose each advance as a separate transaction. If these ad­ vances are treated as one transaction and the timing and amounts of advances are unknown, creditors must make disclosures based on esti­ mates, as provided in section 226.17(c)(2). If the advances are disclosed separately, disclo­ sures must be provided before each advance occurs, with the disclosures for the first ad­ vance provided by consummation. 2. Construction loans. Section 226.17(c) (6)(ii) provides a flexible rule for disclosure of construction loans that may be permanently fi­ nanced. These transactions have two distinct phases, similar to two separate transactions. The construction loan may be for initial con­ struction or subsequent construction, such as rehabilitation or remodelling. The construction period usually involves several disbursements of funds at times and in amounts that are un­ known at the beginning of that period, with the consumer paying only accrued interest un­ til construction is completed. Unless the obli­ gation is paid at that time, the loan then con­ verts to permanent financing in which the loan amount is amortized just as in a standard mortgage transaction. Section 226.17(c)(6)(ii) permits the creditor to give either one com­ bined disclosure for both the construction fi­ nancing and the permanent financing, or a separate set of disclosures for the two phases. This rule is available whether the consumer is initially obligated to accept construction fi­ nancing only or is obligated to accept both construction and permanent financing from the outset. If the consumer is obligated on both phases and the creditor chooses to give two sets of disclosures, both sets must be given to the consumer initially, because both transac­ tions would be consummated at that time. (Appendix D provides a method of calculating the annual percentage rate and other disclo­ sures for construction loans, which may be used, at the creditor’s option, in disclosing construction financing.) 3. Multiple-advance construction loans. Sec­ tion 226.17(c)(6)(i) and (ii) are not mutually exclusive. For example, in a transaction that finances the construction of a dwelling that may be permanently financed by the same creditor, the construction phase may consist of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 114

§ 226.17 Regulation Z Commentary a series of advances under an agreement to extend credit up to a certain amount. In these cases, the creditor may disclose the construc­ tion phase as either one or more than one transaction and also disclose the permanent fi­ nancing as a separate transaction. 4. Residential mortgage transaction. See the commentary to section 226.2(a)(24) for a dis­ cussion of the effect of section 226.17(c)(6) on the definition of a residential mortgage transaction.

5. Allocation of points. When a creditor utilizes the special rule in section 226.17(c)(6) to disclose credit extensions as multiple trans­ actions, buyer’s points or similar amounts im­ posed on the consumer must be allocated for purposes of calculating disclosures. While such amounts should not be taken into ac­ count more than once in making calculations, they may be allocated between the transac­ tions in any manner the creditor chooses. For example, if a construction-permanent loan is subject to five points imposed on the con­ sumer and the creditor chooses to disclose the two phases separately, the five points may be allocated entirely to the construction loan, en­ tirely to the permanent loan, or divided in any manner between the two. However, the entire five points may not be applied twice, that is, to both the construction and the permanent phases.

17(d) Multiple Creditors; Multiple Consumers 1. Multiple creditors. If a credit transaction involves more than one creditor: • The creditors must choose which of them will make the disclosures.

• A single, complete set of disclosures must be provided, rather than partial disclosures from several creditors.

• All disclosures for the transaction must be given, even if the disclosing creditor would not otherwise have been obligated to make a particular disclosure. For example, if one of the creditors is the seller, the total sale price disclosure under section 226.18(j) must be made, even though the disclosing creditor is not the seller.

2. Multiple consumers. When two consumers are joint obligors with primary liability on an obligation, the disclosures may be given to ei­ ther one of them. If one consumer is merely a surety or guarantor, the disclosures must be given to the principal debtor. In rescindable transactions, however, separate disclosures must be given to each consumer who has the right to rescind under section 226.23, although the disclosures required under section 226.19(b) need only be provided to the con­ sumer who expresses an interest in a variablerate loan program.

17(e) Effect of Subsequent Events 1. Events causing inaccuracies. Inaccuracies in disclosures are not violations if attributable to events occurring after the disclosures are made. For example, when the consumer fails to fulfill a prior commitment to keep the col­ lateral insured and the creditor then provides the coverage and charges the consumer for it, such a change does not make the original dis­ closures inaccurate. The creditor may, how­ ever, be required to make new disclosures under sections 226.17(f) or 226.19 if the events occurred between disclosure and con­ summation or under section 226.20 if the events occurred after consummation. 17(f) Early Disclosures 1. Change in rate or other terms. Redis­ closure is required for changes that occur be­ tween the time disclosures are made and con­ summation if the annual percentage rate in the consummated transaction exceeds the limits prescribed in section 226.22(a) (Vs of 1 per­ centage point in regular transactions and '/4 of 1 percentage point in irregular transactions). Redisclosure is also required, even if the an­ nual percentage rate is within the permitted tolerance, if the disclosures were not based on estimates in accordance with section 226.17(c)(2) and labelled as such. To illustrate:

i.

If disclosures are made in a regular trans­ action on July 1, the transaction is con­ summated on July 15, and the actual annual percentage rate varies by more than Vs of 1 percentage point from the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 115

Regulation Z Commentary § 226.17 disclosed annual percentage rate, the creditor must either redisclose the changed terms or furnish a complete set of new disclosures before consummation. Redisclosure is required even if the dis­ closures made on July 1 are based on es­ timates and marked as such. If disclosures are made on July 1, the transaction is consummated on July 15, and the finance charge increased by $35 but the disclosed annual percentage rate is within the permitted tolerance, the creditor must at least redisclose the changed terms that were not marked as estimates. (See section 226.18(d) and footnote 41 of this part.) If early disclosures are marked as esti­ mates and the disclosed annual percent­ age rate is within tolerance at consummation, the creditor need not redisclose the changed terms (including the annual percentage rate). 2. Variable rate. The addition of a variablerate feature to the credit terms, after early dis­ closures are given, requires new disclosures. 3. Content of new disclosures. If redisclosure is required, the creditor has the option of ei­ ther providing a complete set of new disclo­ sures or providing disclosures of only the terms that vary from those originally dis­ closed. (See the commentary to section 226.19(a)(2).) 4. Special rules. In residential mortgage trans­ actions subject to section 226.19, the creditor must redisclose if, between the delivery of the required early disclosures and consummation, the annual percentage rate changes by more than a stated tolerance. When subsequent events occur after consummation, new disclo­ sures are required only if there is a refinanc­ ing or an assumption within the meaning of section 226.20.

17(g) Mail or Telephone Orders—Delay in Disclosures 1. Conditions for use. When the creditor re­ ceives a mail or telephone request for credit, the creditor may delay making the disclosures until the first payment is due if the following conditions are met:

• The credit request is initiated without faceto-face or direct telephone solicitation. (Creditors may, however, use the special rule when credit requests are solicited by mail.) • The creditor has supplied the specified credit information about its credit terms ei­ ther to the individual consumer or to the public generally. That information may be distributed through advertisements, cata­ logs, brochures, special mailers, or similar means.

2. Insurance. The location requirements for the insurance disclosures under section 226.18(n) permit them to appear apart from the other disclosures. Therefore, a creditor may mail an insurance authorization to the consumer and then prepare the other disclo­ sures to reflect whether or not the authoriza­ tion is completed by the consumer. Creditors may also disclose the insurance cost on a unit-cost basis, if the transaction meets the re­ quirements of section 226.17(g). 17(h) Series of Sales—Delay in Disclosures 1. Applicability. The creditor may delay the disclosures for individual credit sales in a se­ ries of such sales until the first payment is due on the current sale, assuming the two conditions in this paragraph are met. If those conditions are not met, the general timing rules in section 226.17(b) apply. 2. Basis of disclosures. Creditors structuring disclosures for a series of sales under section 226.17(h) may compute the total sale price as either:

• The cash price for the sale plus that por­ tion of the finance charge and other charges applicable to that sale; or • The cash price for the sale, other charges applicable to the sale, and the total finance charge and outstanding principal. 17(i) Interim Student Credit Extensions 1. Definition. Student credit plans involve ex­ tensions of credit for education purposes Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 116

§ 226.17 Regulation Z Commentary where the repayment amount and schedule are not known at the time credit is advanced. These plans include loans made under any student credit plan, whether government or private, where the repayment period does not begin immediately. (Certain student credit plans that meet this definition are exempt from Regulation Z. See section 226.3(f). Creditors in interim student credit extensions need not disclose the terms set forth in this paragraph at the time the credit is actually ex­ tended but must make complete disclosures at the time the creditor and consumer agree upon the repayment schedule for the total obliga­ tion. At that time, a new set of disclosures must be made of all applicable items under section 226.18.

they would be for a refinancing. Any unearned portion of the finance charge must be reflected in the new finance charge and an­ nual percentage rate, and is not added to the new amount financed. In itemizing the amount financed under section 226.18(c), the creditor may combine the principal balances remaining on the interim extensions at the time of con­ solidation and categorize them as the amount paid on the consumer’s account. 4. Approved student credit forms. See the commentary to appendix H regarding disclo­ sure forms approved for use in certain student credit programs.

References 2. Basis of disclosures. The disclosures given at the time of execution of the interim note should reflect two annual percentage rates, one for the interim period and one for the repayment period. The use of section 226.170) in making disclosures does not, by itself, make those disclosures estimates. Any portion of the finance charge, such as statu­ tory interest, that is attributable to the interim period and is paid by the student (either as a prepaid finance charge, periodically during the interim period, in one payment at the end of the interim period, or capitalized at the begin­ ning of the repayment period) must be re­ flected in the interim annual percentage rate. Interest subsidies, such as payments made by either a state or the federal government on an interim loan, must be excluded in computing the annual percentage rate on the interim obli­ gation, when the consumer has no contingent liability for payment of those amounts. Any finance charges that are paid separately by the student at the outset or withheld from the pro­ ceeds of the loan are prepaid finance charges. An example of this type of charge is the loan guarantee fee. The sum of the prepaid finance charges is deducted from the loan proceeds to determine the amount financed and included in the calculation of the finance charge. 3. Consolidation. Consolidation of the interim student credit extensions through a renewal note with a set repayment schedule is treated as a new transaction with disclosures made as Statute: §§ 121, 122, 124, and 128, and the Higher Education Act of 1965 (20 USC 1071) as amended by Public Law 97-35, August 13, Other sections: § 226.2 and appendix H Previous regulation: §§ 226.6 and 226.8 1981 changes: With few exceptions, the dis­ closures must now appear apart from all other information and may not be interspersed with that information. The disclosures must be based on the legal obligation between the par­ ties, rather than any side agreement. The assumed maturity period for demand loans has been increased from six months to one year. Any alternate maturity date must be stated in the legal obligation rather than in­ ferred from the documents, in order to form a basis for disclosures.

In multiple-advance transactions, a series of advances up to a certain amount and construc­ tion loans that may be permanently financed may be disclosed, at the creditor’s option, as either a single transaction or several transac­ tions. Appendix D is applicable only to multi­ ple advances for the construction of a dwell­ ing, whereas its predecessor, interpretation section 226.813, could be used for all multi­ ple-advance transactions.

If disclosures are made before the date of consummation, the creditor need not provide updated disclosures at consummation unless the annual percentage rate has changed be­ yond certain limits or a variable rate feature has been added.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 117

Regulation Z Commentary § 226.18 SECTION 226.18—Content of Disclosures 1. As applicable. The disclosures required by this section need be made only as applicable. Any disclosure not relevant to a particular transaction may be eliminated entirely. For example:

• In a loan transaction, the creditor may de­ lete disclosure of the total sale price. • In a credit sale requiring disclosure of the total sale price under section 226.18(j), the creditor may delete any reference to a downpayment where no downpayment is involved.

Where the amounts of several numerical dis­ closures are the same, the “as applicable” language also permits creditors to combine the terms, so long as it is done in a clear and conspicuous manner. For example: o o In a transaction in which the amount fi­ nanced equals the total of payments, the creditor may disclose “amount financed/ total of payments,” together with descrip­ tive language, followed by a single amount. However, if the terms are separated on the disclosure statement and separate space is provided for each amount, both disclosures must be completed, even though the same amount is entered in each space. 2. Format. See the commentary to section 226.17 and appendix H for a discussion of the format to be used in making these disclosures, as well as acceptable modifications. 18(a) Creditor term “amount financed” and a descriptive ex­ planation similar to the phrase in the regulation.

2. Rebates and loan premiums. In a loan transaction, the creditor may offer a premium in the form of cash or merchandise to pro­ spective borrowers. Similarly, in a credit sale transaction, a seller’s or manufacturer’s rebate may be offered to prospective purchasers of the creditor’s goods or services. At the credi­ tor’s option, these amounts may be either re­ flected in the Truth in Lending disclosures or disregarded in the disclosures. If the creditor chooses to reflect them in the section 226.18 disclosures, rather than disregard them, they may be taken into account in any manner as part of those disclosures.

Paragraph 18(b)(1) 1. Downpayments. A downpayment is defined in section 226.2(a)(18) to include, at the credi­ tor’s option, certain deferred downpayments or pickup payments. A deferred downpayment that meets the criteria set forth in the defini­ tion may be treated as part of the downpay­ ment, at the creditor’s option. • Deferred downpayments that are not treated as part of the downpayment (either because they do not meet the definition or because the creditor simply chooses not to treat them as downpayments) are included in the amount financed.

• Deferred downpayments that are treated as part of the downpayment are not part of the amount financed under section 226.18(b)(1).

1. Identification of creditor. The creditor mak­ ing the disclosures must be identified. This disclosure may, at the creditor’s option, ap­ pear apart from the other disclosures. Use of the creditor’s name is sufficient, but the credi­ tor may also include an address and/or tele­ phone number. In transactions with multiple creditors, any one of them may make the dis­ closures; the one doing so must be identified. 18(b) Amount Financed 1. Disclosure required. The net amount of credit extended must be disclosed using the Paragraph 18(b)(2) 1. Adding other amounts. Fees or other charges that are not part of the finance charge and that are financed rather than paid sepa­ rately at consummation of the transaction are included in the amount financed. Typical ex­ amples are real estate settlement charges and premiums for voluntary credit life and disabil­ ity insurance excluded from the finance charge under section 226.4. This paragraph does not include any amounts already accounted for under section 226.18(b)(1), such as taxes, tag and title fees, or the costs of accessories or Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 118

§ 226.18 Regulation Z Commentary service policies that the creditor includes in the cash price.

Paragraph 18(b)(3) 1. Prepaid finance charges. Prepaid finance charges that are paid separately in cash or by check should be deducted under section 226.18(b)(3) in calculating the amount fi­ nanced. To illustrate:

• A consumer applies for a loan of $2,500 with a $40 loan fee. The face amount of the note is $2,500 and the consumer pays the loan fee separately by cash or check at closing. The principal loan amount for pur­ poses of section 226.18(b)(1) is $2,500 and $40 should be deducted under section 226.18(b)(3), thereby yielding an amount financed of $2,460.

In some instances, as when loan fees are fi­ nanced by the creditor, finance charges are in­ corporated in the face amount of the note. Creditors have the option, when the charges are not add-on or discount charges, of deter­ mining a principal loan amount under section 226.18(b)(1) that either includes or does not include the amount of the finance charges. (Thus the principal loan amount may, but need not, be determined to equal the face amount of the note.) When the finance charges are included in the principal loan amount, they should be deducted as prepaid finance charges under section 226.18(b)(3). When the finance charges are not included in the principal loan amount, they should not be deducted under section 226.18(b)(3). The fol­ lowing examples illustrate the application of section 226.18(b) to this type of transaction. Each example assumes a loan request of $2,500 with a loan fee of $40; the creditor assesses the loan fee by increasing the face amount of the note to $2,540. • If the creditor determines the principal loan amount under section 226.18(b)(1) to be $2,540, it has included the loan fee in the principal loan amount and should deduct $40 as a prepaid finance charge under sec­ tion 226.18(b)(3), thereby obtaining an amount financed of $2,500.

• If the creditor determines the principal loan amount under section 226.18(b)(1) to be $2,500, it has not included the loan fee in the principal loan amount and should not deduct any amount under section 226.18(b)(3), thereby obtaining an amount financed of $2,500.

The same rules apply when the creditor does not increase the face amount of the note by the amount of the charge but collects the charge by withholding it from the amount ad­ vanced to the consumer. To illustrate, the fol­ lowing examples assume a loan request of $2,500 with a loan fee of $40; the creditor prepares a note for $2,500 and advances $2,460 to the consumer.

• If the creditor determines the principal loan amount under section 226.18(b)(1) to be $2,500, it has included the loan fee in the principal loan amount and should deduct $40 as a preapid finance charge under sec­ tion 226.18(b)(3), thereby obtaining an amount financed of $2,460.

• If the creditor determines the principal loan amount under section 226.18(b)(1) to be $2,460, it has not included the loan fee in the principal loan amount and should not deduct any amount under section 226.18 (b)(3), thereby obtaining an amount fi­ nanced of $2,460.

Thus in the examples where the creditor de­ rives the net amount of credit by determining a principal loan amount that does not include the amount of the finance charge, no subtrac­ tion is appropriate. Creditors should note, however, that although the charges are not subtracted as prepaid finance charges in those examples, they are nonetheless finance charges and must be treated as such. 2. Add-on or discount charges. All finance charges must be deducted from the amount of credit in calculating the amount financed. If the principal loan amount reflects finance charges that meet the definition of a prepaid finance charge in section 226.2, those charges are included in the section 226.18(b)(1) amount and deducted under section 226.18(b)(3). However, if the principal loan amount includes finance charges that do not meet the definition of a prepaid finance charge, the section 226.18(b)(1) amount must exclude those finance charges. The following Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 119

Regulation Z Commentary § 226.18 examples illustrate the application of section '.26.18(b) to these types of transactions. Each example assumes a loan request of $1,000 for one year, subject to a 6 percent precomputed interest rate, with a $10 loan fee paid sepa­ rately at consummation.

• The creditor assesses add-on interest of $60 which is added to the $1,000 in loan pro­ ceeds for an obligation with a face amount of $1,060. The principal for purposes of section 226.18(b)(1) is $1,000, no amounts are added under section 226.18(b)(2), and the $10 loan fee is a prepaid finance charge to be deducted under section 226.18(b)(3). The amount financed is $990. • The creditor assesses discount interest of $60 and distributes $940 to the consumer, who is liable for an obligation with a face amount of $1,000. The principal under sec­ tion 226.18(b)(1) is $940, which results in an amount financed of $930, after deduc­ tion of the $10 prepaid finance charge under section 226.18(b)(3). O The creditor assesses $60 in discount inter­ est by increasing the face amount of the obligation to $1,060, with the consumer re­ ceiving $1,000. The principal under section 226.18(b)(1) is thus $1,000 and the amount financed $990, after deducting the $10 pre­ paid finance charge under section 226.18(b)(3).

18(c) Itemization of Amount Financed 1. Disclosure required. The creditor has two alternatives in complying with section 226.18(c):

• The creditor may inform the consumer, on the segregated disclosures, that a written itemization of the amount financed will be provided on request, furnishing the itemiza­ tion only if the customer in fact requests it. • The creditor may provide an itemization as a matter of course, without notifying the consumer of the right to receive it or wait­ ing for a request.

Vhether given as a matter of course or only on request, the itemization must be provided at the same time as the other disclosures re­ quired by section 226.18, although separate from those disclosures.

2. Additional information. Section 226.18(c) establishes only a minimum standard for the material to be included in the itemization of the amount financed. Creditors have consider­ able flexibility in revising or supplementing the information listed in section 226.18(c) and shown in model form H-3, although no changes are required. The creditor may, for example, do one or more of the following: • Include amounts that reflect payments not part of the amount financed. For example, escrow items and certain insurance premi­ ums may be included, as discussed in the commentary to section 226.18(g). • Organize the categories in any order. For example, the creditor may rearrange the terms in a mathematical progression that depicts the arithmetic relationship of the terms.

• Add categories. For example, in a credit sale, the creditor may include the cash price and the downpayment.

• Further itemize each category. For exam­ ple, the amount paid directly to the con­ sumer may be subdivided into the amount given by check and the amount credited to the consumer’s savings account. • Label categories with different language from that shown in section 226.18(c). For example, an amount paid on the consum­ er’s account may be revised to specifically identify the account as “your auto loan with us.”

• Delete, leave blank, mark “N/A” or other­ wise note inapplicable categories in the itemization. For example, in a credit sale with no prepaid finance charges or amounts paid to others, the amount financed may consist of only the cash price less downpayment. In this case, the itemization may be composed of only a single category and all other categories may be eliminated. 3. Amounts appropriate to more than one cat­ egory. When an amount may appropriately be placed in any of several categories and the creditor does not wish to revise the categories shown in section 226.18(c), the creditor has considerable flexibility in determining where to show the amount. For example: • In a credit sale, the portion of the purchase Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 120

§ 226.18 Regulation Z Commentary price being financed by the creditor may be viewed as either an amount paid to the consumer or an amount paid on the con­ sumer’s account.

4. RESPA transactions. The Real Estate Set­ tlement Procedures Act (RESPA) requires creditors to provide good faith estimates of closing costs. Transactions subject to RESPA are exempt from the requirements of section 226.18(c), when the creditor complies with the good faith estimates requirement of RESPA. The itemization of the amount financed need not be given, even though the content and timing of the good faith estimates under RESPA differ from the section 226.18(c) requirement.

Paragraph 18(c)(l)(i) 1. Amounts paid to consumer. This encom­ passes funds given to the consumer in the form of cash or a check, including joint pro­ ceeds checks, as well as funds placed in an asset account. It may include money in an in­ terest-bearing account even if that amount is considered a required deposit under section 226.18(r). For example, in a transaction with total loan proceeds of $500, the consumer re­ ceives a check for $300 and $200 is required by the creditor to be put into an interest-bear­ ing account. Whether or not the $200 is a re­ quired deposit, it is part of the amount fi­ nanced. At the creditor’s option, it may be broken out and labelled in the itemization of the amount financed.

Paragraph 18(c)(1)(H) 1. Amounts credited to consumer’s account. The term “consumer’s account” refers to an account in the nature of a debt with that cred­ itor. It may include, for example, an unpaid balance on a prior loan, a credit sale balance or other amounts owing to that creditor. It does not include asset accounts of the con­ sumer such as savings or checking accounts. Paragraph 18(c)(l)(iii) 1. Amounts paid to others. This includes, for example, tag and title fees; amounts paid to insurance companies for insurance premiums; security interest fees, and amounts paid to credit bureaus, appraisers or public officials. When several types of insurance premiums ar financed, they may, at the creditor’s option, be combined and listed in one sum, labelled “in­ surance” or similar term. This includes, but is not limited to, different types of insurance premiums paid to one company and different types of insurance premiums paid to different companies. Except for insurance companies and other categories noted in footnote 40, third parties must be identified by name. Paragraph 18(c)(l)(iv) 1. Prepaid finance charge. Prepaid finance charges that are deducted under section 226.18(b)(3) must be disclosed under this sec­ tion. The prepaid finance charges must be shown as a total amount but may, at the cred­ itor’s option, also be further itemized and de­ scribed. All amounts must be reflected in this total, even if portions of the prepaid finance charge are also reflected elsewhere. For exam­ ple, if at consummation the creditor collects interim interest of $30 and a credit report fee of $10, a total prepaid finance charge of $4i must be shown. At the creditor’s option, the credit report fee paid to a third party may also be shown elsewhere as an amount included it section 226.18(c)( 1 )(iii). The creditor ma also further describe the two components the prepaid finance charge, although no itemization of this element is required by sec­ tion 226.18(c)(l)(iv).

i 2. Prepaid mortgage insurance premiums. RESPA requires creditors to give consumers a settlement statement disclosing the costs asso­ ciated with mortgage loan transactions. In­ cluded on the settlement statement are mort­ gage insurance premiums collected at settlement, which are prepaid finance charges. In calculating the total amount of prepaid fi­ nance charges, creditors should use the amount for mortgage insurance listed on the line for mortgage insurance on the settlement statement (line 1002 on HUD-1 or HUD 1-A), without adjustment, even if the actual amount collected at settlement may vary because o RESPA’s escrow-accounting rules. Figures for mortgage insurance disclosed in conformance with RESPA shall be deemed to be accurate for purposes of Regulation Z. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 121

Regulation Z Commentary § 226.18 i J 18(d) Finance Charge 1. Disclosure required. The creditor must dis­ close the finance charge as a dollar amount, using the term “finance charge,” and must in­ clude a brief description similar to that in sec­ tion 226.18(d). The creditor may, but need not, further modify the descriptor for variablerate transactions with a phrase such as “which is subject to change.” The finance charge must be shown on the disclosures only as a total amount; the elements of the finance charge must not be itemized in the segregated disclosures, although the regulation does not prohibit their itemization elsewhere. 2. Tolerance. A tolerance for the finance charge is provided in footnote 41 of this part. When a miscalculation of the amount fi­ nanced, or of some other numerical disclosure for which the regulation provides no specific tolerance, results from an error in a finance charge, the miscalculated amount financed or other numerical disclosure does not violate the act or the regulation if the finance charge dis­ closed under section 226.18(d) is within the permissible tolerance under footnote 41 of this part.

18(e) Annual Percentage Rate 1. Disclosure required. The creditor must dis­ close the cost of the credit as an annual rate, using the term “annual percentage rate,” plus a brief descriptive phrase comparable to that used in section 226.18(e). For variable-rate transactions, the descriptor may be further modified with a phrase such as “which is sub­ ject to change.” Under section 226.17(a), the terms “annual percentage rate” and “finance charge” must be more conspicuous than the other required disclosures.

2. Exception. Footnote 42 provides an excep­ tion for certain transactions in which no an­ nual percentage rate disclosure is required. 18(f) Variable Rate 1. Coverage. The requirements of section 226.18(f) apply to all transactions in which the terms of the legal obligation allow the creditor to increase the rate originally dis­ closed to the consumer. It includes not only increases in the interest rate but also increases in other components, such as the rate of re­ quired credit life insurance. The provisions, however, do not apply to increases resulting from delinquency (including late payment), default, assumption, acceleration or transfer of the collateral. Section 226.18(f)(1) applies to variable-rate transactions that are not secured by the consumer’s principal dwelling and to those that are secured by the principal dwell­ ing but have a term of one year or less. Sec­ tion 226.18(f)(2) applies to variable- rate transactions that are secured by the con­ sumer’s principal dwelling and have a term greater than one year. Moreover, transactions subject to section 226.18(f)(2) are subject to the special early-disclosure requirements of section 226.19(b). (However, “shared-equity” or “shared-appreciation” mortgages are sub­ ject to the disclosure requirements of section 226.18(f)(1) and not to the requirements of sections 226.18(f)(2) and 226.19(b) regardless of the general coverage of those sections.) Creditors are permitted under footnote 43 to substitute in any variable-rate transaction the disclosures required under section 226.19(b) for those disclosures ordinarily required under section 226.18(f)(1). Creditors who provide variable-rate disclosures under section 226.19(b) must comply with all of the require­ ments of that section, including the timing of disclosures, and must also provide the disclo­ sures required under section 226.18(f)(2). Creditors utilizing footnote 43 may, but need not, also provide disclosures pursuant to sec­ tion 226.20(c). (Substitution of disclosures under section 226.18(f)(1) in transactions sub­ ject to section 226.19(b) is not permitted under the footnote.) Paragraph 18(f)(1) 1. Terms used in disclosure. In describing the variable-rate feature, the creditor need not use any prescribed terminology. For example, lim­ itations and hypothetical examples may be de­ scribed in terms of interest rates rather than annual percentage rates. The model forms in appendix H provide examples of ways in which the variable-rate disclosures may be made.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 122

§ 226.18 Regulation Z Commentary Paragraph 18(f)(l)(i) 1. Circumstances. The circumstances under which the rate may increase include identifica­ tion of any index to which the rate is tied, as well as any conditions or events on which the increase is contingent.

• When no specific index is used, any identi­ fiable factors used to determine whether to increase the rate must be disclosed. • When the increase in the rate is purely dis­ cretionary, the fact that any increase is within the creditor’s discretion must be dis­ closed.

• When the index is internally defined (for example, by that creditor’s prime rate), the creditor may comply with this requirement by either a brief description of that index or a statement that any increase is in the discretion of the creditor. An externally de­ fined index, however, must be identified. 2. Conversion feature. In variable-rate trans­ actions with an option permitting consumers to convert to a fixed-rate transaction, the con­ version option is a variable-rate feature that must be disclosed. In making disclosures under section 226.18(f)(1), creditors should disclose the fact that the rate may increase upon conversion; identify the index or formula used to set the fixed rate; and state any limita­ tions on and effects of an increase resulting from conversion that differ from other varia­ ble-rate features. Because section 226.18 (f)(l)(iv) requires only one hypothetical exam­ ple (such as an example of the effect on pay­ ments resulting from changes in the index), a second hypothetical example need not be given.

Paragraph 18(f)(1)(H) 1. Limitations. This includes any maximum imposed on the amount of an increase in the rate at any time, as well as any maximum on the total increase over the life of the transac­ tion. When there are no limitations, the credi­ tor may, but need not, disclose that fact. Limi­ tations do not include legal limits in the nature of usury or rate ceilings under state or federal statutes or regulations. (See section 226.30 for the rule requiring that a maximum interest rate be included in certain variablerate transactions.) Paragraph 18(f)(l)(iii) 1. Effects. Disclosure of the effect of an in­ crease refers to an increase in the number or amount of payments or an increase in the final payment. In addition, the creditor may make a brief reference to negative amortization that may result from a rate increase. (See the com­ mentary to section 226.17(a)(1) regarding di­ rectly related information.) If the effect cannot be determined, the creditor must provide a statement of the possible effects. For example, if the exercise of the variable-rate feature may result in either more or larger payments, both possibilities must be noted. Paragraph 18(f)(l)(iv) 1. Hypothetical example. The example may, at the creditor’s option, appear apart from the other disclosures. The creditor may provide either a standard example that illustrates the terms and conditions of that type of credit of­ fered by that creditor or an example that di­ rectly reflects the terms and conditions of the particular transaction. In transactions with more than one variable-rate feature, only one{ hypothetical example need be provided. (See the commentary to section 226.17(a)(1) re­ garding disclosure of more than one hypothet­ ical example as directly related information.) 2. Hypothetical example not required. The creditor need not provide a hypothetical exam­ ple in the following transactions with a varia­ ble-rate feature:

• Demand obligations with no alternate ma­ turity date • Interim student credit extensions • Multiple-advance construction loans dis­ closed pursuant to appendix D, part I Paragraph 18(f)(2) 1. Disclosure required. In variable-rate trans­ actions that have a term greater than one year and are secured by the consumer’s principal dwelling, the creditor must give special early disclosures under section 226.19(b) in addition to the later disclosures required under section Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 123

Regulation Z Commentary § 226.18 226.18(f)(2). The disclosures under section 226.18(f)(2) must state that the transaction has a variable-rate feature and that variable-rate disclosures have been provided earlier. (See the commentary to section 226.17(a)(1) re­ garding the disclosure of certain directly re­ lated information in addition to the variablerate disclosures required under section 226.18(f)(2).) 18(g) Payment Schedule 1. Amounts included in repayment schedule. The repayment schedule should reflect all components of the finance charge, not merely the portion attributable to interest. A prepaid finance charge, however, should not be shown in the repayment schedule as a separate pay­ ment. The payments may include amounts be­ yond the amount financed and finance charge. For example, the disclosed payments may, at the creditor’s option, reflect certain insurance premiums where the premiums are not part of either the amount financed or the finance O charge, as well as real estate escrow amounts such as taxes added to the payment in mort­ gage transactions.

2. Deferred downpayments. As discussed in the commentary to section 226.2(a)(18), de­ ferred downpayments or pickup payments that meet the conditions set forth in the definition of downpayment may be treated as part of the downpayment. Even if treated as a downpay­ ment, that amount may nevertheless be dis­ closed as part of the payment schedule, at the creditor’s option.

Paragraph 18(g)(1) 1. Demand obligations. In demand obligations with no alternate maturity date, the creditor has the option of disclosing only the due dates or periods of scheduled interest payments in the first year (for example, “interest payable quarterly” or “interest due the first of each month”). The amounts of the interest pay­ ments need not be shown.

Paragraph 18(g)(2) 1. Abbreviated disclosure. The creditor may disclose an abbreviated payment schedule when the amount of each regularly scheduled payment (other than the first or last payment) includes an equal amount to be applied on principal and a finance charge computed by application of a rate to the decreasing unpaid balance. This option is also available when mortgage-guarantee insurance premiums, paid either monthly or annually, cause variations in the amount of the scheduled payments, reflect­ ing the continual decrease or increase in the premium due. In addition, in transactions where payments vary because interest and principal are paid at different intervals, the two series of payments may be disclosed sep­ arately and the abbreviated payment schedule may be used for the interest payments. For example, in transactions with fixed quarterly principal payments and monthly interest pay­ ments based on the outstanding principal bal­ ance, the amount of the interest payments will change quarterly as principal declines. In such cases the creditor may treat the interest and principal payments as two separate series of payments, separately disclosing the number, amount, and due dates of principal payments, and, using the abbreviated payment schedule, the number, amount, and due dates of interest payments. This option may be used when in­ terest and principal are scheduled to be paid on the same date of the month as well as on different dates of the month. The creditor us­ ing this alternative must disclose the dollar amount of the highest and lowest payments and make reference to the variation in payments.

2. Combined payment-schedule disclosures. Creditors may combine the option in this paragraph with the general payment-schedule requirements in transactions where only a por­ tion of the payment schedule meets the condi­ tions of section 226.18(g)(2). For example, in a graduated-payment mortgage where pay­ ments rise sharply for five years and then de- 3. Total number of payments. In disclosing the number of payments for transactions with more than one payment level, creditors may but need not disclose as a single figure the total number of payments for all levels. For example, in a transaction calling for 108 pay­ ments of $350, 240 payments of $335, and 12 payments of $330, the creditor need not state that there will be a total of 360 payments. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 124

§ 226.18 Regulation Z Commentary cline over the next 25 years because of de­ creasing mortgage insurance premiums, the first five years would be disclosed under the general rule in section 226.18(g) and the next 25 years according to the abbreviated schedule in section 226.18(g)(2).

period. In demand obligations in which the disclosures are based on an assumed maturity of one year under section 226.17(c)(5), that fact must also be stated. Appendix H contains model clauses that may be used in making this disclosure.

3. Effect on other disclosures. Section 226.18(g)(2) applies only to the payment schedule disclosure. The actual amounts of payments must be taken into account in calcu­ lating and disclosing the finance charge and the annual percentage rate.

18(h) Total of Payments 1. Disclosure required. The total of payments must be disclosed using that term, along with a descriptive phrase similar to the one in the regulation. The descriptive explanation may be revised to reflect a variable-rate feature with a brief phrase such as “based on the current an­ nual percentage rate which may change.” 2. Calculation of total of payments. The total of payments is the sum of the payments dis­ closed under section 226.18(g). For example, if the creditor disclosed a deferred portion of the downpayment as part of the payment schedule, that payment must be reflected in the total disclosed under this paragraph. 3. Exception. Footnote 44 permits creditors to omit disclosure of the total of payments in single-payment transactions. This exception does not apply to a transaction calling for a single payment of principal combined with pe­ riodic payments of interest. 4. Demand obligations. In demand obligations with no alternate maturity date, the creditor may omit disclosure of payment amounts under section 226.18(g)(1). In those transac­ tions, the creditor need not disclose the total of payments.

18(i) Demand Feature 1. Disclosure requirements. The disclosure re­ quirements of this provision apply not only to transactions payable on demand from the out­ set, but also to transactions that are not pay­ able on demand at the time of consummation but convert to a demand status after a stated 2. Covered demand features. The type of de­ mand feature triggering the disclosures re­ quired by section 226.18(i) includes only those demand features contemplated by the parties as part of the legal obligation. For ex­ ample, this provision does not apply to trans­ actions that convert to a demand status as a result of the consumer’s default. A due-onsale clause is not considered a demand fea­ ture. A creditor may, but need not, treat its contractual right to demand payment of a loan made to its executive officers as a demand feature to the extent that the contractual right is required by Regulation O (12 CFR 215.5) or other federal law.

3. Relationship to payment schedule disclo­ sures. As provided in section 226.18(g)(1), in demand obligations with no alternate maturity date, the creditor need only disclose the due dates or payment periods of any scheduled in terest payments for the first year. If the de­ mand obligation states an alternate maturity, however, the disclosed payment schedule must reflect that stated term; the special rule in sec­ tion 226.18(g)(1) is not available. 18(j) Total Sale Price 1. Disclosure required. In a credit sale trans­ action, the “total sale price” must be dis­ closed using that term, along with a descrip­ tive explanation similar to the one in the regulation. For variable-rate transactions, the descriptive phrase may, at the creditor’s op­ tion, be modified to reflect the variable-rate feature. For example, the descriptor may read: “The total cost of your purchase on credit, which is subject to change, including your downpayment of . . . .” The reference to a downpayment may be eliminated in transac­ tions calling for no downpayment. 2. Calculation of total sale price. The figure to be disclosed is the sum of the cash price, other charges added under section Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 125

Regulation Z Commentary § 226.18 226.18(b)(2), and the finance charge disclosed under section 226.18(d).

18(k) Prepayment 1. Disclosure required. The creditor must give a definitive statement of whether or not a pen­ alty will be imposed or a rebate will be given. • The fact that no penalty will be imposed may not simply be inferred from the ab­ sence of a penalty disclosure; the creditor must indicate that prepayment will not re­ sult in a penalty.

• If a penalty or refund is possible for one type of prepayment, even though not for all, a positive disclosure is required. This applies to any type of prepayment, whether voluntary or involuntary as in the case of prepayments resulting from acceleration. • Any difference in rebate or penalty policy, depending on whether prepayment is vol­ untary or not, must not be disclosed with the segregated disclosures. 2. Rebate-penalty disclosure. A single trans­ action may involve both a precomputed fi­ nance charge and a finance charge computed by application of a rate to the unpaid balance (for example, mortgages with mortgage-guar­ antee insurance). In these cases, disclosures about both prepayment rebates and penalties are required. Sample form H-15 in appendix H illustrates a mortgage transaction in which both rebate and penalty disclosures are necessary.

3. Prepaid finance charge. The existence of a prepaid finance charge in a transaction does not, by itself, require a disclosure under sec­ tion 226.18(k). A prepaid finance charge is not considered a penalty under section 226.18(k)(l), nor does it require a disclosure under section 226.18(k)(2). At its option, however, a creditor may consider a prepaid finance charge to be under section 226.18(k)(2). If a disclosure is made under section 226.18(k)(2) with respect to a prepaid O finance charge or other finance charge, the creditor may further identify that finance charge. For example, the disclosure may state that the borrower “will not be entitled to a refund of the prepaid finance charge” or some other term that describes the finance charge. Paragraph 18(h)(1) 1. Penalty. This applies only to those transac­ tions in which the interest calculation takes account of all scheduled reductions in princi­ pal, as well as transactions in which interest calculations are made daily. The term “pen­ alty” as used here encompasses only those charges that are assessed strictly because of the prepayment in full of a simple-interest ob­ ligation, as an addition to all other amounts. Items which are penalties include, for example:

• Interest charges for any period after pre­ payment in full is made. (See the commen­ tary to section 226.17(a)(1) regarding disclosure of interest charges assessed for periods after prepayment in full as directly related information.) • A minimum finance charge in a simple-in­ terest transaction. (See the commentary to section 226.17(a)(1) regarding the disclo­ sure of a minimum finance charge as di­ rectly related information.) Items which are not penalties include, for example:

• Loan-guarantee fees • Interim interest on a student loan Paragraph 18(h)(2) 1. Rebate of finance charge. This applies to any finance charges that do not take account of each reduction in the principal balance of an obligation. This category includes, for example:

• Precomputed finance charges such as add­ on charges • Charges that take account of some but not all reductions in principal, such as mort­ gage guarantee insurance assessed on the basis of an annual declining balance, when the principal is reduced on a monthly basis No description of the method of computing earned or unearned finance charges is required or permitted as part of the segregated disclo­ sures under this section.

18(/) Late Payment 1. Definition. This paragraph requires a dis- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 126

§ 226.18 Regulation Z Commentary closure only if charges are added to individual delinquent installments by a creditor who oth­ erwise considers the transaction ongoing on its original terms. Late payment charges do not include:

• The right of acceleration • Fees imposed for actual collection costs, such as repossession charges or attorney’s fees • Deferral and extension charges • The continued accrual of simple interest at the contract rate after the payment due date. However, an increase in the interest rate is a late payment charge to the extent of the increase.

2. Content of disclosure. Many state laws au­ thorize the calculation of late charges on the basis of either a percentage or a specified dol­ lar amount and permit imposition of the lesser or greater of the two charges. The disclosure made under section 226.18(/) may reflect this alternative. For example, stating that the charge in the event of a late payment is 5 percent of the late amount, not to exceed $5.00, is sufficient. Many creditors also permit a grace period during which no late charge will be assessed; this fact may be disclosed as directly related information. (See the commen­ tary to section 226.17(a).) 18(m) Security Interest 1. Purchase-money transactions. When the collateral is the item purchased as part of, or with the proceeds of, the credit transaction, section 226.18(m) requires only a general identification such as “the property purchased in this transaction.” However, the creditor may identify the property by item or type in­ stead of identifying it more generally with a phrase such as “the property purchased in this transaction.” For example, a creditor may identify collateral as “a motor vehicle,” or as “the property purchased in this transaction.” Any transaction in which the credit is being used to purchase the collateral is considered a purchase-money transaction and the abbrevi­ ated property identification may be used, whether the obligation is treated as a loan or a credit sale.

2. Non-purchase-money transactions. In nonpurchase-money transactions, the property subject to the security interest must be identi­ fied by item or type. This disclosure is satis­ fied by a general disclosure of the category of property subject to the security interest, such as “motor vehicles,” “securities,” “certain household items,” or “household goods.” (Creditors should be aware, however, that the federal credit practices rules, as well as some state laws, prohibit certain security interests in household goods.) At the creditor’s option, however, a more precise identification of the property or goods may be provided. 3. Mixed collateral. In some transactions in which the credit is used to purchase the col­ lateral, the creditor may also take other prop­ erty of the consumer as security. In those cases, a combined disclosure must be pro­ vided, consisting of an identification of the purchase-money collateral consistent with comment 18(m)-l and a specific identification of the other collateral consistent with com­ ment 18(m)-2.

4. After-acquired property. An after-acquired property clause is not a security interest to be disclosed under section 226.18(m). 5. Spreader clause. The fact that collateral for preexisting credit with the institution is being used to secure the present obligation consti­ tutes a security interest and must be disclosed. (Such security interests may be known as “spreader” or “dragnet” clauses, or as “cross-collateralization” clauses.) A specific identification of that collateral is unnecessary but a reminder of the interest arising from the prior indebtedness is required. The disclosure may be made by using language such as “col­ lateral securing other loans with us may also secure this loan.” At the creditor’s option, a more specific description of the property in­ volved may be given.

6. Terms used in disclosure. No specified ter­ minology is required in disclosing a security interest. Although the disclosure may, at the creditor’s option, use the term “security inter­ est,” the creditor may designate its interest by using, for example, “pledge,” “lien,” or “mortgage.”

7. Collateral from third party. In certain Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 127

Regulation Z Commentary § 226.18 transactions, the consumer’s obligation may be D secured by collateral belonging to a third party. For example, a loan to a student may be secured by an interest in the property of the student’s parents. In such cases, the secur­ ity interest is taken in connection with the transaction and must be disclosed, even though the property encumbered is owned by someone other than the consumer. 18(n) Insurance 18(o) Certain Security Interest Charges O l. Format. No special format is required for these disclosures; under section 226.4(e), taxes and fees paid to government officials with re­ spect to a security interest may be aggregated, O or may be broken down by individual charge. For example, the disclosure could be labelled “filing fees and taxes,” and all funds dis­ bursed for such purposes may be aggregated in a single disclosure. This disclosure may ap­ pear, at the creditor’s option, apart from the other required disclosures. The inclusion of this information on a statement required under the Real Estate Settlement Procedures Act is sufficient disclosure for purposes of Truth in Lending.

18(p) Contract Reference 1. Content. Creditors may substitute, for the phrase “appropriate contract document,” a reference to specific transaction documents in which the additional information is found, O such as “promissory note” or “retail install­ ment sale contract.” A creditor may, at its op­ tion, delete inapplicable items in the contract reference, as for example when the contract documents contain no information regarding the right of acceleration.

18(q) Assumption Policy 1. Policy statement. In many mortgages, the creditor cannot determine, at the time disclo­ sure must be made, whether a loan may be assumable at a future date on its original terms. For example, the assumption clause commonly used in mortgages sold to the Fed­ eral National Mortgage Association and the Federal Home Loan Mortgage Corporation conditions an assumption on a variety of fac­ tors such as the creditworthiness of the subse­ quent borrower, the potential for impairment of the lender’s security, and execution of an assumption agreement by the subsequent bor­ rower. In cases where uncertainty exists as to the future assumability of a mortgage, the dis­ closure under section 226.18(q) should reflect that fact. In making disclosures in such cases, the creditor may use phrases such as “subject to conditions,” “under certain circumstances,” or “depending on future conditions.” The creditor may provide a brief reference to more specific criteria such as a due-on-sale clause, although a complete explanation of all condi­ tions is not appropriate. For example, the dis­ closure may state, “Someone buying your home may be allowed to assume the mortgage on its original terms, subject to certain condi­ tions, such as payment of an assumption fee.” See comment 17(a)(l)-5 for an example of a reference to a due-on-sale clause. 2. Original terms. The phrase “original terms” for purposes of section 226.18(q) does not preclude the imposition of an assumption fee, but a modification of the basic credit agreement, such as a change in the contract interest rate, represents different terms. 18(r) Required Deposit 1. Disclosure required. The creditor must in­ form the consumer of the existence of a re­ quired deposit. (Appendix H provides a model clause that may be used in making that disclo­ sure.) Footnote 45 describes three types of de­ posits that need not be considered required de­ posits. Use of the phrase “need not” permits creditors to include the disclosure even in cases where there is doubt as to whether the deposit constitutes a required deposit. 2. Pledged-account mortgages. In these trans- 1. Location. This disclosure may, at the credi­ tor’s option, appear apart from the other dis­ closures. It may appear with any other infor­ mation, including the amount-financed itemization, any information prescribed by state law, or other supplementary material. When this information is disclosed with the other segregated disclosures, however, no ad­ ditional explanatory material may be included. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 128

§ 226.18 Regulation Z Commentary actions, a consumer pledges as collateral funds that the consumer deposits in an ac­ count held by the creditor. The creditor with­ draws sums from that account to supplement the consumer’s periodic payments. Creditors may treat these pledged accounts as required deposits or they may treat them as consumer buydowns in accordance with the commentary to section 226.17(c)(1).

3. Escrow accounts. The escrow exception in footnote 45 applies, for example, to accounts for such items as maintenance fees, repairs, or improvements, whether in a realty or a nonrealty transaction. (See the commentary to section 226.17(c)(1) regarding the use of es­ crow accounts in consumer buydown transactions.) 4. Interest-bearing accounts. When a deposit earns at least 5 percent interest per year, no disclosure is required under section 226.18 (r). This exception applies whether the deposit is held by the creditor or by a third party. 5. Morris Plan transactions. A deposit under a Morris Plan, in which a deposit account is created for the sole purpose of accumulating payments and this is applied to satisfy entirely the consumer’s obligation in the transaction, is not a required deposit.

6. Examples of amounts excluded. The fol­ lowing are among the types of deposits that need not be treated as required deposits: • Requirement that a borrower be a customer or a member even if that involves a fee or a minimum balance • Required property insurance escrow on a mobile home transaction • Refund of interest when the obligation is paid in full • Deposits that are immediately available to the consumer • Funds deposited with the creditor to be dis­ bursed (for example, for construction) before the loan proceeds are advanced • Escrow of condominium fees • Escrow of loan proceeds to be released when the repairs are completed References Statute: § 128, the Gam-St Germain Depository Institutions Act of 1982 (Pub. L. 97-320) and the Real Estate Settlement Procedures Act (12 USC 2602) Other sections: §§ 226.2, 226.17, and appen­ dix H Other regulations: 12 CFR 545.6-2(a) and 12 CFR 29 Previous regulation: §§ 226.4 and 226.8 1981 changes: Five of the required disclosures must be explained to the consumer in a man­ ner similar to the descriptive phrases shown in the regulation. A written itemization of the amount financed need not be provided unless the consumer requests it. The finance charge must be provided in all transactions, including real estate transactions, but must be shown only as a total amount. The disclosed finance charge is considered accurate if it is within a specified range.

The variable-rate hypothetical is required in all variable-rate transactions and may be either general or transaction-specific. The penalty and rebate disclosures in the event of prepay­ ment have been modified and combined. The requirement of an explanation of how the re­ bates or penalties are computed has been eliminated. The late-payment disclosure has also been narrowed to include only charges imposed before maturity for late payments. The information required in the security in­ terest disclosure has been decreased by the de­ letion of the type of security interest and a reduction in the property description require­ ment. The disclosure of the required deposit is limited to a statement that the annual percent­ age rate does not reflect the required deposit; the presence of a required deposit has no ef­ fect on the annual percentage rate. Two disclosure requirements have been added: a reference to the contract documents for additional information and, in a residential mortgage transaction, a statement of the credi­ tor’s assumption policy.

SECTION 226.19—Certain Residential Mortgage Transactions 19(a)(1) Time of Disclosure 1. Coverage. This section requires early dis­ closure of credit terms in residential mortgage Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 129

Regulation Z Commentary § 226.19 transactions that are also subject to the Real O Estate Settlement Procedures Act (RESPA) and its implementing Regulation X, adminis­ tered by the Department of Housing and Ur­ ban Development (HUD). To be covered by this section, a transaction must be both a resi­ dential mortgage transaction under section 226.2(a) and a federally related mortgage loan under RESPA. “Federally related mortgage loan” is defined under RESPA (12 USC 2602) and Regulation X (24 CFR 3500.5(b)), and is subject to any interpretations by HUD. 2. Timing and use of estimates. Truth in Lending disclosures must be given (a) before consummation or (b) within three business days after the creditor receives the consumer’s written application, whichever is earlier. The three-day period for disclosing credit terms coincides with the time period within which creditors subject to RESPA must provide good faith estimates of settlement costs. If the cred­ itor does not know the precise credit terms, the creditor must base the disclosures on the O best information reasonably available and in­ dicate that the disclosures are estimates under section 226.17(c)(2). If many of the disclo­ sures are estimates, the creditor may include a statement to that effect (such as “all numeri­ cal disclosures except the late-payment disclo­ sure are estimates”) instead of separately la­ belling each estimate. In the alternative, the creditor may label as an estimate only the items primarily affected by unknown informa­ tion. (See the commentary to section 226.17(c)(2).) The creditor may provide ex­ planatory material concerning the estimates and the contingencies that may affect the ac­ tual terms, in accordance with the commen­ tary to section 226.17(a)(1).) 3. Written application. Creditors may rely on RESPA and Regulation X (including any in­ terpretations issued by HUD) in deciding whether a “written application” has been re­ ceived. In general, Regulation X requires dis­ closures “to every person from whom the Lender receives or for whom it prepares a O written application on an application form or forms normally used by the Lender for a Fed­ erally Related Mortgage Loan” (24 CFR 3500.6(a)). An application is received when it reaches the creditor in any of the ways ap­ plications are normally transmitted—by mail, hand delivery, or through an intermediary agent or broker. (See comment 19(b)-3 for guidance in determining whether or not the transaction involves an intermediary agent or broker.) If an application reaches the creditor through an intermediary agent or broker, the application is received when it reaches the creditor, rather than when it reaches the agent or broker.

4. Exceptions. The creditor may determine within the three-day period that the applica­ tion will not or cannot be approved on the terms requested, as, for example, when a con­ sumer applies for a type or amount of credit that the creditor does not offer, or the con­ sumer’s application cannot be approved for some other reason. In that case, the creditor need not make the disclosures under this sec­ tion. If the creditor fails to provide early dis­ closures and the transaction is later consum­ mated on the original terms, the creditor will be in violation of this provision. If, however, the consumer amends the application because of the creditor’s unwillingness to approve it on its original terms, no violation occurs for not providing disclosures based on the original terms. But the amended application is a new application subject to this section. 5. Itemization of amount financed. In many residential mortgage transactions, the itemiza­ tion of the amount financed required by sec­ tion 226.18(c) will contain items, such as origination fees or points, that also must be disclosed as part of the good faith estimates of settlement costs required under RESPA. Creditors furnishing the RESPA good faith es­ timates need not give consumers any itemiza­ tion of the amount financed, either with the disclosures provided within three days after application or with the disclosures given at consummation or settlement.

19(a)(2) Redisclosure Required 1. Conditions for redisclosure. Creditors must make new disclosures if the annual percentage rate at consummation differs from the estimate originally disclosed by more than Vs of 1 per­ centage point in regular transactions or 'At of 1 percentage point in irregular transactions, as Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 130

§ 226.19 Regulation Z Commentary defined in section 226.22. The creditor must also redisclose if a variable rate feature is added to the credit terms after the original disclosures have been made. The creditor has the option of redisclosing information under other circumstances, if it wishes to do so. 2. Content of new disclosures. If redisclosure is required, the creditor may provide a com­ plete set of new disclosures, or may redisclose only the terms that vary from those originally disclosed. If the creditor chooses to provide a complete set of new disclosures, the creditor may but need not highlight the new terms, provided that the disclosures comply with the format requirements of section 226.17(a). If the creditor chooses to disclose only the new terms, all the new terms must be disclosed. For example, a different annual percentage rate will almost always produce a different fi­ nance charge, and often a new schedule of payments; all of these changes would have to be disclosed. If, in addition, unrelated terms such as the amount financed or prepayment penalty vary from those originally disclosed, the accurate terms must be disclosed. How­ ever, no new disclosures are required if the only inaccuracies involve estimates other than the annual percentage rate, and no variable rate feature has been added. 3. Timing. Redisclosures, when necessary, must be given no later than “consummation or settlement.” “Consummation” is defined in section 226.2(a). “Date of settlement” is de­ fined in Regulation X (24 CFR 3500.2(a)) and is subject to any interpretations issued under RESPA and Regulation X.

4. Basis of disclosures. In some cases, a cred­ itor may delay redisclosure until settlement, which may be at a time later than consumma­ tion. If a creditor chooses to redisclose at set­ tlement, disclosures may be based on the terms in effect at settlement, rather than at consummation. For example, in a variable-rate transaction, a creditor may choose to base dis­ closures on the terms in effect at settlement despite the general rule in the commentary to section 18(f) that variable-rate disclosures should be based on the terms in effect at consummation.

19(b) Certain Variable-Rate Transactions 1. Coverage. Section 226.19(b) applies to all closed-end variable-rate transactions that are secured by the consumer’s principal dwelling and have a term greater than one year. The requirements of this section apply not only to transactions financing the initial acquisition of the consumer’s principal dwelling, but also to any other closed-end variable-rate transaction secured by the principal dwelling. Closed-end variable-rate transactions that are not secured by the principal dwelling, or are secured by the principal dwelling but have a term of one year or less, are subject to the disclosure re­ quirements of section 226.18(f)(1) rather than those of section 226.19(b). (Furthermore, “shared-equity” or “shared-appreciation” mortgages are subject to the disclosure re­ quirements of section 226.18(f)(1) rather than those of section 226.19(b) regardless of the general coverage of those sections.) For pur­ poses of this section, the term of a variablerate demand loan is determined in accordance with the commentary to section 226.17(c)(5). In determining whether a construction loan that may be permanently financed by the same creditor is covered under this section, the creditor may treat the construction and the permanent phases as separate transactions with distinct terms to maturity or as a single com­ bined transaction. For purposes of the disclo­ sures required under section 226.18, the credi­ tor may nevertheless treat the two phases either as separate transactions or as a single combined transaction in accordance with sec­ tion 226.17(c)(6). Finally, in any assumption of a variable-rate transaction secured by the consumer’s principal dwelling with a term greater than one year, disclosures need not be provided under sections 226.18(f)(2)(ii) or 226.19(b).

2. Timing. A creditor must give the disclo­ sures required under this section at the time an application form is provided or before the consumer pays a nonrefundable fee, whichever is earlier. In cases where a creditor receives a written application through an intermediary agent or broker, however, footnote 45b pro­ vides a substitute timing rule requiring the creditor to deliver the disclosures or place them in the mail not later than three business Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 131

Regulation Z Commentary § 226.19 O days after the creditor receives the consumer’s written application. (See comment 19(b)-3 for guidance in determining whether or not the transaction involves an intermediary agent or broker.) This three-day rule also applies where the creditor takes an application over the tele­ phone. If, however, the consumer merely re­ quests an application over the telephone, the creditor must include the early disclosures re­ quired under this section with the application that is sent to the consumer. In cases where the creditor solicits applications through the mail, the creditor must also send the disclo­ sures required under this section if an applica­ tion form is included with the solicitation. In cases where an open-end credit account will convert to a closed-end transaction subject to this section under a written agreement with the consumer, disclosures under this section may be given at the time of conversion. (See the commentary to section 226.20(a) for infor­ mation on the timing requirements for 226.19(b)(2) disclosures when a variable-rate feature is later added to a transaction.) 3. Intermediary agent or broker. In certain transactions involving an “intermediary agent or broker,” a creditor may delay providing © disclosures. A creditor may not delay provid­ ing disclosures in transactions involving either a legal agent (as determined by applicable law) or any other third party that is not an “intermediary agent or broker.” In determin­ ing whether or not a transaction involves an “intermediary agent or broker” the following factors should be considered: • The number of applications submitted by the broker to the creditor as compared to the total number of applications received by the creditor. The greater the percentage of total loan applications submitted by the broker in any given period of time, the less likely it is that the broker would be consid­ ered an “intermediary agent or broker” of the creditor during the next period. • The number of applications submitted by the broker to the creditor as compared to the total number of applications received by the broker. (This factor is applicable on­ ly if the creditor has such information.) The greater the percentage of total loan ap­ plications received by the broker that is submitted to a creditor in any given period of time, the less likely it is that the broker would be considered an “intermediary agent or broker” of the creditor during the next period.

• The amount of work (such as document preparation) the creditor expects to be done by the broker on an application based on the creditor’s prior dealings with the broker and on the creditor’s requirements for ac­ cepting applications, taking into considera­ tion the customary practice of brokers in a particular area. The more work that the creditor expects the broker to do on an ap­ plication, in excess of what is usually ex­ pected of a broker in that area, the less likely it is that the broker would be consid­ ered an “intermediary agent or broker” of the creditor.

An example of an “intermediary agent or bro­ ker” is a broker who, customarily within a brief time after receiving an application, in­ quires about the credit terms of several credi­ tors with whom the broker does business and submits the application to one of them. The broker is responsible for only a small percent­ age of the applications received by that credi­ tor. During the time the broker has the appli­ cation, it might request a credit report and an appraisal (or even prepare an entire loan pack­ age if customary in that particular area). 4. Other variable-rate regulations. Transac­ tions in which the creditor is required to com­ ply with and has complied with the disclosure requirements of the variable-rate regulations of other federal agencies are exempt from the requirements of section 226.19(b), by virtue of footnote 45a, and are exempt from the re­ quirements of section 226.20(c), by virtue of footnote 45c. Those variable-rate regulations include the regulations issued by the Federal Home Loan Bank Board and those issued by the Department of Housing and Urban Devel­ opment. The exception in footnotes 45a and 45c is also available to creditors that are re­ quired by state law to comply with the federal variable-rate regulations noted above and to creditors that are authorized by title VIII of the Depository Institutions Act of 1982 (12 USC 3801 et seq.) to make loans in accor­ dance with those regulations. Creditors using Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 132

§ 226.19 Regulation Z Commentary this exception should comply with the timing requirements of those regulations rather than the timing requirements of Regulation Z in making the variable-rate disclosures. 5. Examples of variable-rate transactions. The following transactions, if they have a term greater than one year and are secured by the consumer’s principal dwelling, constitute variable-rate transactions subject to the disclo­ sure requirements of section 226.19(b). • Renewable balloon-payment instruments where the creditor is both unconditionally obligated to renew the balloon-payment loan at the consumer’s option (or is obli­ gated to renew subject to conditions within the consumer’s control) and has the option of increasing the interest rate at the time of renewal. (See comment 17(c)(l)-ll for a discussion of conditions within a consum­ er’s control in connection with renewable balloon-payment loans.) • Preferred-rate loans where the terms of the legal obligation provide that the initial un­ derlying rate is fixed but will increase upon the occurrence of some event, such as an employee leaving the employ of the credi­ tor, and the note reflects the preferred rate. The disclosures under section 226.19(b)(1) and 226.19(b)(2)(v), (viii), (ix), (x) and (xiii) are not applicable to such loans. • “Price-level-adjusted mortgages” or other indexed mortgages that have a fixed rate of interest but provide for periodic adjust­ ments to payments and the loan balance to reflect changes in an index measuring prices or inflation. The disclosures under section 226.19(b)(1) are not applicable to such loans, nor are the following provi­ sions to the extent they relate to the deter­ mination of the interest rate by the addition of a margin, changes in the interest rate, or interest-rate discounts: Section 226.19 (b)(2)(i), (iii), (iv), (v), (vi), (vii), (viii), (ix), and (x). (See comments 20(c)-2 and 30-1 regarding the inapplicability of varia­ ble-rate adjustment notices and interest-rate limitations to price-level-adjusted or similar mortgages.) Graduated-payment mortgages and step-rate transactions without a variable-rate feature are not considered variable-rate transactions. Paragraph 19(b)(1) 1. Substitutes. Creditors who wish to use pub­ lications other than the Consumer Handbook on Adjustable Rate Mortgages must make a good faith determination that their brochures are suitable substitutes to the Consumer Hand­ book. A substitute is suitable if it is, at a min­ imum, comparable to the Consumer Handbook in substance and comprehensiveness. Creditors are permitted to provide more detailed infor­ mation than is contained in the Consumer Handbook.

2. Applicability. The Consumer Handbook need not be given for variable-rate transac­ tions subject to this section in which the un­ derlying interest rate is fixed. (See comment 19(b)-4 for an example of a variable-rate transaction where the underlying interest rate is fixed.) Paragraph 19(b)(2) 1. Disclosure for each variable-rate program. A creditor must provide disclosures to the consumer that fully describe each of the credi­ tor’s variable-rate loan programs in which the consumer expresses an interest. If a program is made available only to certain customers of an institution, a creditor need not provide dis­ closures for that program to other consumers who express a general interest in a creditor’s ARM programs. Disclosures must be given at the time an application form is provided or before the consumer pays a nonrefundable fee, whichever is earlier. If program disclosures cannot be provided because a consumer ex­ presses an interest in individually negotiating loan terms that are not generally offered, dis­ closures reflecting those terms may be pro­ vided as soon as reasonably possible after the terms have been decided upon, but not later than the time a nonrefundable fee is paid. If a consumer who has received program disclo­ sures subsequently expresses an interest in other available variable-rate programs subject to section 226.19(b)(2), or the creditor and consumer decide on a program for which the consumer has not received disclosures, the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 133

Regulation Z Commentary § 226.19 O creditor must provide appropriate disclosures as soon as reasonably possible. The creditor, of course, is permitted to give the consumer information about additional programs subject to section 226.19(b) initially. 2. Variable-rate loan program defined. If the identification, the presence or absence, or the exact value of a loan feature must be dis­ closed under this section, variable-rate loans that differ as to such features constitute sepa­ rate loan programs. For example, separate loan programs would exist based on differ­ ences in any of the following loan features: • The index or other formula used to calcu­ late interest rate adjustments • The rules relating to changes in the index value, interest rate, payments, and loan balance • The presence or absence of, and the amount of, rate or payment caps • The presence of a demand feature • The possibility of negative amortization O * The possibility of interest rate carryover • The frequency of interest rate and payment adjustments • The presence of a discount feature O In addition, if a loan feature must be taken into account in preparing the disclosures re­ quired by section 226.19(b)(2)(viii) and (x), variable-rate loans that differ as to that feature constitute separate programs under section 226.19(b)(2). If, however, a representative value may be given for a loan feature or the feature need not be disclosed under section 226.19(b)(2), variable-rate loans that differ as to such features do not constitute separate loan programs. For example, separate loan programs would not exist based on differences in the following loan features: • The amount of a discount • The amount of a margin 3. Form of program disclosures. A creditor may provide separate program disclosure forms for each ARM program it offers or a single disclosure form that describes multiple programs. A disclosure form may consist of more than one page. For example, a creditor may attach a separate page containing the his­ torical payment example for a particular pro­ gram. A disclosure form describing more than one program need not repeat information ap­ plicable to each program that is described. For example, a form describing multiple programs may disclose the information applicable to all of the programs in one place with the various program features (such as options permitting conversion to a fixed rate) disclosed sepa­ rately. The form, however, must state if any program feature that is described is available only in conjunction with certain other program features. Both the separate- and multiple-program disclosures may illustrate more than one loan maturity or payment amortization—for example, by including multiple-payment and loan-balance columns in the historical pay­ ment example. Disclosures may be inserted or printed in the Consumer Handbook (or a suit­ able substitute) as long as they are identified as the creditor’s loan-program disclosures. 4. As applicable. The disclosures required by this section need only be made as applicable. Any disclosure not relevant to a particular transaction may be eliminated. For example, if the transaction does not contain a demand fea­ ture, the disclosure required under section 226.19(b)(2)(xi) need not be given. As used in this section, “payment” refers only to a pay­ ment based on the interest rate, loan balance, and loan term and does not refer to payment of other elements such as mortgage insurance premiums.

5. Revisions. A creditor must revise the dis­ closures required under this section once a year as soon as reasonably possible after the new index value becomes available. Revisions to the disclosures also are required when the loan program changes.

Paragraph 19(b)(2)(i) 1. Change in interest rate, payment, or term. A creditor must disclose the fact that the terms of the legal obligation permit the credi­ tor, after consummation of the transaction, to increase (or decrease) the interest rate, pay­ ment, or term of the loan initially disclosed to the consumer. For example, the disclosures for a variable-rate program in which the interest rate and payment (but not loan term) can change might read, “Your interest rate and Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 134

§ 226.19 Regulation Z Commentary payment can change yearly.” In transactions where the term of the loan may change due to rate fluctuations, the creditor must state that fact.

Paragraph 19(b)(2)(H) 1. Identification of index or formula. If a creditor ties interest rate changes to a particu­ lar index, this fact must be disclosed, along with a source of information about the index. For example, if a creditor uses the weekly av­ erage yield on U.S. Treasury securities ad­ justed to a constant maturity as its index, the disclosure might read, “Your index is the weekly average yield on U.S. Treasury securi­ ties adjusted to a constant maturity of one year published weekly in the Wall Street Jour­ nal. ” If no particular index is used, the credi­ tor must briefly describe the formula used to calculate interest rate changes. 2. Changes at creditor’s discretion. If interest rate changes are at the creditor’s discretion, this fact must be disclosed. If an index is in­ ternally defined, such as by a creditor’s prime rate, the creditor should either briefly describe that index or state that interest rate changes are at the creditor’s discretion. Paragraph 19(b)(2)(iii) 1. Determination of interest rate and payment. This provision requires an explanation of how the creditor will determine the consumer’s in­ terest rate and payment. In cases where a creditor bases its interest rate on a specific index and adjusts the index through the addi­ tion of a margin, for example, the disclosure might read, “Your interest rate is based on the index plus a margin, and your payment will be based on the interest rate, loan balance, and remaining loan term.” In transactions where paying the periodic payments will not fully amortize the outstanding balance at the end of the loan term and where the final pay­ ment will equal the periodic payment plus the remaining unpaid balance, the creditor must disclose this fact. For example, the disclosure might read, “Your periodic payments will not fully amortize your loan and you will be re­ quired to make a single payment of the peri­ odic payment plus the remaining unpaid balance at the end of the loan term.” The creditor, however, need not reflect any irregu­ lar final payment in the historical example or in the disclosure of the initial and maximum rates and payments. If applicable, the creditor should also disclose that the rate and payment will be rounded.

Paragraph 19(b)(2)(iv) 1. Current margin value and interest rate. Be­ cause the disclosures can be prepared in ad­ vance, the interest rate and margin may be several months old when the disclosures are delivered. A statement, therefore, is required alerting consumers to the fact that they should inquire about the current margin value applied to the index and the current interest rate. For example, the disclosure might state, “Ask us for our current interest rate and margin.” Paragraph 19(b)(2)(v) 1. Discounted and premium interest rate. In some variable-rate transactions, creditors may set an initial interest rate that is not deter­ mined by the index or formula used to make later interest rate adjustments. Typically, this initial rate charged to consumers is lower than the rate would be if it were calculated using the index or formula. However, in some cases the initial rate may be higher. If the initial interest rate will be a discount or a premium rate, creditors must alert the consumer to this fact. For example, if a creditor discounted a consumer’s initial rate, the disclosure might state, “Your initial interest rate is not based on the index used to make later adjustments.” (See the commentary to section 226.17(c)(1) for a further discussion of discounted and pre­ mium variable-rate transactions). In addition, the disclosure must suggest that consumers in­ quire about the amount that the program is currently discounted. For example, the disclo­ sure might state, “Ask us for the amount our adjustable-rate mortgages are currently dis­ counted.” In a transaction with a consumer buydown or with a third-party buydown that will be incorporated in the legal obligation, the creditor should disclose the program as a discounted variable-rate transaction, but need not disclose additional information regarding the buydown in its program disclosures. (See Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 135

Regulation Z Commentary § 226.19 the commentary to section 226.19(b)(2)(viii) O for a discussion of how to reflect the discount or premium in the historical example.) Paragraph 19(b)(2)(vi) 1. Frequency. The frequency of interest rate and payment adjustments must be disclosed. If interest rate changes will be imposed more frequently or at different intervals than pay­ ment changes, a creditor must disclose the fre­ quency and timing of both types of changes. For example, in a variable-rate transaction where interest rate changes are made monthly, but payment changes occur on an annual ba­ sis, this fact must be disclosed. In certain ARM transactions, the interval between loan closing and the initial adjustment is not known and may be different from the regular interval for adjustments. In such cases, the creditor may disclose the initial adjustment period as a range of the minimum and maxi­ mum amount of time from consummation or closing. For example, the creditor might state: “The first adjustment to your interest rate and payment will occur no sooner than 6 months and no later than 18 months after closing. Subsequent adjustments may occur once each year after the first adjustment.” (See comnents 19(b)(2)(viii)-7 and 19(b)(2)(x)-4 for guidance on other disclosures when this alter­ native disclosure rule is used.) Paragraph 19(b)(2)(vii) 1. Rate and payment caps. The creditor must disclose limits on changes (increases or de­ creases) in the interest rate or payment. If an initial discount is not taken into account in applying overall or periodic rate limitations, that fact must be disclosed. If separate overall or periodic limitations apply to interest rate increases resulting from other events, such as the exercise of a fixed-rate conversion option or leaving the creditor’s employ, those limita­ tions must also be stated. Limitations do not include legal limits in the nature of usury or rate ceilings under state or federal statutes or egulations. (See section 226.30 for the rule ^requiring that a maximum interest rate be in­ cluded in certain variable-rate transactions.) The creditor need not disclose each periodic or overall rate limitation that is currently available. As an alternative, the creditor may disclose the range of the lowest and highest periodic and overall rate limitations that may be applicable to the creditor’s ARM transac­ tions. For example, the creditor might state: “The limitation on increases to your interest rate at each adjustment will be set at an amount in the following range: between 1 and 2 percentage points at each adjustment. The limitation on increases to your interest rate over the term of the loan will be set at an amount in the following range: between 4 and 7 percentage points above the initial interest rate.” A creditor using this alternative rule must include a statement in its program dis­ closures suggesting that the consumer ask about the overall rate limitations currently of­ fered for the creditor’s ARM programs. (See comments 19(b)(2)(viii)-6 and 19(b)(2)(x)-3 for an explanation of the additional require­ ments for a creditor using this alternative rule for disclosure of periodic and overall rate limitations.) 2. Negative amortization and interest-rate carryover. A creditor must disclose, where ap­ plicable, the possibility of negative amortiza­ tion. For example, the disclosure might state, “If any of your payments is not sufficient to cover the interest due, the difference will be added to your loan amount.” Loans that pro­ vide for more than one way to trigger nega­ tive amortization are separate variable-rate programs requiring separate disclosures. (See the commentary to section 226.19(b)(2) for a discussion on the definition of a variable-rate loan program and the format for disclosure.) If a consumer is given the option to cap monthly payments that may result in negative amortization, the creditor must fully disclose the rules relating to the option, including the effects of exercising the option (such as nega­ tive amortization will occur and the principal loan balance will increase); however, the dis­ closure in section 226.19(b)(2)(viii) need not be provided.

3. Conversion option. If a loan program per­ mits consumers to convert their variable-rate loans to fixed-rate loans, the creditor must dis­ close that the interest rate may increase if the consumer converts the loan to a fixed-rate loan. The creditor must also disclose the rules Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 136

§ 226.19 Regulation Z Commentary relating to the conversion feature, such as the period during which the loan may be con­ verted, that fees may be charged at conver­ sion, and how the fixed rate will be deter­ mined. The creditor should identify any index or other measure or formula used to determine the fixed rate and state any margin to be added. In disclosing the period during which the loan may be converted and the margin, the creditor may use information applicable to the conversion feature during the six months pre­ ceding preparation of the disclosures and state that the information is representative of con­ version features recently offered by the credi­ tor. The information may be used until the program disclosures are otherwise revised. Al­ though the rules relating to the conversion op­ tion must be disclosed, the effect of exercising the option should not be reflected elsewhere in the disclosures, such as in the historical exam­ ple or in the calculation of the initial and maximum interest rate and payments. 4. Preferred-rate loans. Section 226.19(b) ap­ plies to preferred-rate loans, where the rate will increase upon the occurrence of some event, such as an employee leaving the credi­ tor’s employ, whether or not the underlying rate is fixed or variable. In these transactions, the creditor must disclose the event that would allow the creditor to increase the rate such as that the rate may increase if the em­ ployee leaves the creditor’s employ. The cred­ itor must also disclose the rules relating to termination of the preferred rate, such as that fees may be charged when the rate is changed and how the new rate will be determined. Paragraph 19(b)(2)(viii) 1. Index movement. This section requires a creditor to provide an historical example, based on a $10,000 loan amount originating in 1977, showing how interest rate changes im­ plemented according to the terms of the loan program would have affected payments and the loan balance at the end of each year dur­ ing a 15-year period. (In all cases, the creditor need only calculate the payments and loan balance for the term of the loan. For example, in a five-year loan, a creditor would show the payments and loan balance for the five-year term, from 1977 to 1981, with a zero loan balance reflected for 1981. For the remaining ten years, 1982-1991, the creditor need only show the remaining index values, margin, and interest rate and must continue to reflect all significant loan-program terms such as rate limitations affecting them.) Pursuant to this section, the creditor must provide a history of index values for the preceding 15 years. Ini­ tially, the disclosures would give the index values from 1977 to the present. Each year thereafter, the revised program disclosures should include an additional year’s index value until 15 years of values are shown. If the values for an index have not been avail­ able for 15 years, a creditor need only go back as far as the values are available in giv­ ing a history and payment example. In all cases, only one index value per year need be shown. Thus, in transactions where interest rate adjustments are implemented more fre­ quently than once per year, a creditor may assume that the interest rate and payment re­ sulting from the index value chosen will stay in effect for the entire year for purposes of calculating the loan balance as of the end of the year and for reflecting other loan program terms. In cases where interest rate changes are at the creditor’s discretion (see the commen tary to section 226.19(b)(2)(ii)), the creditoi must provide a history of the rates imposed for the preceding 15 years, beginning with the rates in 1977. In giving this history, the credi­ tor need only go back as far as the creditor’s rates can reasonably be determined. 2. Selection of index values. The historical ex­ ample must reflect the method by which index values are determined under the program. If a creditor uses an average of index values or any other index formula, the history given should reflect those values. The creditor should select one date or, when an average of single values is used as an index, one period and should base the example on index values measured as of that same date or period for each year shown in the history. A date or pe­ riod at any time during the year may be se lected, but the same date or period must be used for each year in the historical example. For example, a creditor could use values for the first business day in July or for the first Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 137

Regulation Z Commentary § 226.19 week ending in July for each of the 15 years shown in the example.

3. Selection of margin. For purposes of the disclosure required under section 226.19 (b)(2)(viii), a creditor may select a representa­ tive margin that has been used during the six months preceding preparation of the disclo­ sures, and should disclose that the margin is one that the creditor has used recently. The margin selected may be used until a creditor revises the disclosure form. 4. Amount of discount or premium. For pur­ poses of the disclosure required under section 226.19(b)(2)(viii), a creditor may select a dis­ count or premium (amount and term) that has been used during the six months preceding preparation of the disclosures, and should dis­ close that the discount or premium is one that the creditor has used recently. The discount or premium should be reflected in the historical example for as long as the discount or pre­ mium is in effect. A creditor may assume that a discount that would have been in effect for any part of a year was in effect for the full year for purposes of reflecting it in the histori­ cal example. For example, a 3-month discount may be treated as being in effect for the entire 'irst year of the example; a 15-month discount may be treated as being in effect for the first two years of the example. In illustrating the effect of the discount or premium, creditors should adjust the value of the interest rate in the historical example, and should not adjust the margin or index values. For example, if during the six months preceding preparation of the disclosures the fully indexed rate would have been 10 percent but the first year’s rate under the program was 8 percent, the creditor would discount the first interest rate in the historical example by 2 percentage points. 5. Term of the loan. In calculating the pay­ ments and loan balances in the historical ex­ ample, a creditor need not base the disclosures on each term to maturity or payment amorti­ zation that it offers. Instead, disclosures for \RMs may be based upon terms to maturity or payment amortizations of 5, 15, and 30 years, as follows: ARMs with terms or amor­ tizations from over 1 year to 10 years may be based on a 5-year term or amortization; ARMs with terms or amortizations from over 10 years to 20 years may be based on a 15year term or amortization; and ARMs with terms or amortizations over 20 years may be based on a 30-year term or amortization. Thus, disclosures for ARMs offered with any term from over 1 year to 40 years may be based solely on terms of 5, 15, and 30 years. Of course, a creditor may always base the dis­ closures on the actual terms or amortizations offered. If the creditor bases the disclosures on 5-, 15-, or 30-year terms or payment amor­ tizations as provided above, the term or pay­ ment amortization used in making the disclo­ sure must be stated.

6. Rate caps. A creditor using the alternative rule described in comment 19(b)(2)(vii)-l for disclosure of rate limitations must base the historical example upon the highest periodic and overall rate limitations disclosed under section 226.19(b)(2)(vii). In addition, the cred­ itor must state the limitations used in the his­ torical example. (See comment 19(b)(2)(x)-3 for an explanation of the use of the highest rate limitation in other disclosures.) 7. Frequency of adjustments. In certain trans­ actions, creditors may use the alternative rule described in comment 19(b)(2)(vi)-l for dis­ closure of the frequency of rate and payment adjustments. In such cases, the creditor may assume for purposes of the historical example that the first adjustment occurred at the end of the first full year in which the adjustment could occur. For example, in an ARM in which the first adjustment may occur between 6 and 18 months after closing and annually thereafter, the creditor may assume that the first adjustment occurred at the end of the first year in the historical example. (See comment 19(b)(2)(x)-4 for an explanation of how to compute the maximum interest rate and pay­ ment when the initial adjustment period is not known.) Paragraph 19(b)(2)(ix) 1. Calculation of payments. A creditor is re­ quired to include a statement on the disclosure form that explains how a consumer may cal­ culate his or her actual monthly payments for a loan amount other than $10,000. The exam- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 138

§ 226.19 Regulation Z Commentary pie should be based upon the most recent pay­ ment shown in the historical example. How­ ever, in transactions in which the latest payment shown in the historical example is not for the latest year of index values shown (such as in a five-year loan), a creditor may provide additional examples based on the ini­ tial and maximum payments disclosed under section 226.19(b)(2)(x). The creditor, how­ ever, is not required to calculate the con­ sumer’s payments. (See the model clauses in appendix H-4(C).) Paragraph 19(b)(2)(x) 1. Initial and maximum interest rate and pay­ ment. The disclosure form must state the ini­ tial and maximum interest rates and payments for a $10,000 loan originated at the most re­ cent interest rate (index value plus margin) shown in the historical example. In calculating the maximum payments under this paragraph, a creditor should assume that the interest rate increases as rapidly as possible under the loan program, and the maximum payment disclosed should reflect the amortization of the loan dur­ ing this period. Thus, in a loan with 2 per­ centage point annual (and 5 percentage point overall) interest rate limitations or “caps,” the maximum interest rate would be 5 percentage points higher than the most recent rate shown in the historical example. Moreover, the loan would not reach the maximum interest rate until the fourth year because of the 2 percent­ age point annual rate limitations, and the max­ imum payment disclosed would reflect the amortization of the loan during this period. If the loan program includes a discounted or pre­ mium initial interest rate, the most recent rate shown in the historical example should be ad­ justed by the amount of the discount or pre­ mium reflected elsewhere in the disclosure for purposes of the requirements of this para­ graph. Furthermore, this disclosure should state the amount by which the most recent rate has been adjusted. (See the commentary to section 226.19(b)(2)(viii) regarding disclo­ sure of the amount of a discount or premium.) The creditor may use an interest rate applica­ ble to the program that is more recent than the latest rate shown in the historical example. 2. Term of the loan. In calculating the initial and maximum payments, the creditor need not base the disclosures on each term to maturity or payment amortization offered under the program. Instead, the creditor may follow the rules set out in comment 19(b)(2)(viii)-5. In calculating the initial and maximum payment, the terms to maturity or payment amortiza­ tions selected for the purpose of making dis­ closures under section 226.19(b)(2)(viii) must be used. In addition, creditors must state the term or payment amortization used in making the disclosures under this section. 3. Rate caps. A creditor using the alternative rule for disclosure of interest rate limitations described in comment 19(b)(2)(vii)-l must calculate the maximum interest rate and pay­ ments based upon the highest periodic and overall rate limitations disclosed under section 226.19(b)(2)(vii). In addition, the creditor must state the rate limitations used in calculat­ ing the maximum interest rate and payment. (See comment 19(b)(2)(viii)-6 for an explana­ tion of the use of the highest rate limitation in other disclosures.) 4. Frequency of adjustments. In certain trans­ actions, a creditor may use the alternative rule for disclosure of the frequency of rate and payment adjustments described in comment 19(b)(2)(vi)-l. In such cases, the creditor must base the calculations of the initial and maxi­ mum rates and payments upon the earliest possible first adjustment disclosed under sec­ tion 226.19(b)(2)(vi). (See comment 19(b) (2)(viii)-7 for an explanation of how to dis­ close the historical example when the initial adjustment period is not known.) Paragraph 19(b)(2)(xi) 1. Demand feature. If a variable-rate loan subject to section 226.19(b) requirements con­ tains a demand feature, as discussed in the commentary to section 226.18(i), this fact must be disclosed. (Pursuant to section 226.18(i), creditors would also disclose the demand feature in the standard disclosures given later.) Paragraph 19(b)(2)(xii) 1. Adjustment notices. A creditor must dis- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 139

Regulation Z Commentary § 226.20 close to the consumer the type of information that will be contained in subsequent notices of adjustments and when such notices will be provided. (See the commentary to section 226.20(c) regarding notices of adjustments.) For example, the disclosure might state, “You will be notified at least 25, but no more than 120, days before the due date of a payment at a new level. This notice will contain informa­ tion about the index and interest rates, pay­ ment amount, and loan balance.” In transac­ tions where there may be interest rate adjustments without accompanying payment adjustments in a year, the disclosure might read, “You will be notified once each year during which interest rate adjustments, but no payment adjustments, have been made to your loan. This notice will contain information about the index and interest rates, payment amount, and loan balance.”

Paragraph 19(b)(2)(xiii) m 1. Multiple loan programs. A creditor that of­ fers multiple variable-rate loan programs is re­ quired to have disclosures for each variabled ate loan program subject to section 26.19(b)(2). Unless disclosures for all of its variable-rate programs are provided initially, the creditor must inform the consumer that other closed-end variable-rate programs exist and that disclosure forms are available for these additional loan programs. For example, the disclosure form might state, “Information on other adjustable-rate mortgage programs is available upon request.”

References * ’ U Statute: § 128(b)(2) and the Real Estate Set­ tlement Procedures Act (12 USC 2602) Other sections: §§ 226.2, 226.17, and 226.22 Other regulations: Regulation X (24 CFR 3500.2(a), 3500.5(b), and 3500.6(a)) revious regulation: None 1981 changes: This section implements sec­ tion 128(b)(2), a new provision that requires early disclosure of credit terms in certain mortgage transactions.

SECTION 226.20—Subsequent Disclosure Requirements 20(a) Refinancings 1. Definition. A refinancing is a new transac­ tion requiring a complete new set of disclo­ sures. Whether a refinancing has occurred is determined by reference to whether the origi­ nal obligation has been satisfied or extin­ guished and replaced by a new obligation, based on the parties’ contract and applicable law. The refinancing may involve the consoli­ dation of several existing obligations, dis­ bursement of new money to the consumer or on the consumer’s behalf, or the rescheduling of payments under an existing obligation. In any form, the new obligation must completely replace the prior one.

• Changes in the terms of an existing obliga­ tion, such as the deferral of individual in­ stallments, will not constitute a refinancing unless accomplished by the cancellation of that obligation and the substitution of a new obligation.

• A substitution of agreements that meets the refinancing definition will require new dis­ closures, even if the substitution does not substantially alter the prior credit terms. 2. Exceptions. A transaction is subject to sec­ tion 226.20(a) only if it meets the general def­ inition of a refinancing. Section 226.20(a)(1) through (5) lists five events that are not treated as refinancings, even if they are ac­ complished by cancellation of the old obliga­ tion and substitution of a new one. 3. Variable rate. If a variable-rate feature was properly disclosed under the regulation, a rate change in accord with those disclosures is not a refinancing. For example, a renewable bal­ loon-payment mortgage that was disclosed as a variable-rate transaction is not subject to new disclosure requirements when the varia­ ble-rate feature is invoked. However, even if it is not accomplished by the cancellation of the old obligation and substitution of a new one, a new transaction subject to new disclo­ sures results if the creditor either: • Increases the rate based on a variable-rate Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 140

§ 226.20 Regulation Z Commentary feature that was not previously disclosed, or • Adds a variable-rate feature to the obligation.

If either of these two events occurs in a trans­ action secured by a principal dwelling with a term longer than one year, the disclosures re­ quired under section 226.19(b) also must be given at that time.

4. Unearned finance charge. In a transaction involving precomputed finance charges, the creditor must include in the finance charge on the refinanced obligation any unearned portion of the original finance charge that is not re­ bated to the consumer or credited against the underlying obligation. For example, in a trans­ action with an add-on finance charge, a credi­ tor advances new money to a consumer in a fashion that extinguishes the original obliga­ tion and replaces it with a new one. The cred­ itor neither refunds the unearned finance charge on the original obligation to the con­ sumer nor credits it to the remaining balance on the old obligation. Under these circum­ stances, the unearned finance charge must be included in the finance charge on the new ob­ ligation and reflected in the annual percentage rate disclosed on refinancing. Accrued but un­ paid finance charges are included in the amount financed in the new obligation. 5. Coverage. Section 226.20(a) applies only to refinancings undertaken by the original creditor or a holder or servicer of the original obligation. A “refinancing” by any other per­ son is a new transaction under the regulation, not a refinancing under this section. Paragraph 20(a)(1) 1. Renewal. This exception applies both to obligations with a single payment of principal and interest and to obligations with periodic payments of interest and a final payment of principal. In determining whether a new obli­ gation replacing an old one is a renewal of the original terms or a refinancing, the credi­ tor may consider it a renewal even if: • Accrued unpaid interest is added to the principal balance • Changes are made in the terms of renewal resulting from the factors listed in section 226.17(c)(3) • The principal at renewal is reduced by a curtailment of the obligation Paragraph 20(a)(2) 1. Annual-percentage-rate reduction. A reduc­ tion in the annual percentage rate with a cor­ responding change in the payment schedule is not a refinancing. If the annual percentage rate is subsequently increased (even though it re­ mains below its original level) and the in­ crease is effected in such a way that the old obligation is satisfied and replaced, new dis­ closures must then be made.

2. Corresponding change. A corresponding change in the payment schedule to implement a lower annual percentage rate would be a shortening of the maturity, or a reduction in the payment amount or the number of pay­ ments of an obligation. The exception in sec­ tion 226.20(a)(2) does not apply if the matur­ ity is lengthened, or if the payment amount or number of payments is increased beyond that remaining on the existing transaction. Paragraph 20(a)(3) 1. Court agreements. This exception includes^** for example, agreements such as reaffirma­ tions of debts discharged in bankruptcy, settle­ ment agreements, and post-judgment agree­ ments. (See the commentary to section 226.2(a)(14) for a discussion of court-ap­ proved agreements that are not considered “credit.”) Paragraph 20(a)(4) 1. Workout agreements. A workout agreement is not a refinancing unless the annual percent­ age rate is increased or additional credit is ad­ vanced beyond amounts already accrued plus insurance premiums.

Paragraph 20(a)(5) 1. Insurance renewal. The renewal of option a O insurance added to an existing credit transac­ tion is not a refinancing, assuming that appro­ priate Truth in Lending disclosures were pro­ vided for the initial purchase of the insurance. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 141

Regulation Z Commentary § 226.20 2 0 ( b ) A s s u m p t io n s 1. General definition. An assumption as de­ fined in section 226.20(b) is a new transaction and new disclosures must be made to the sub­ sequent consumer. An assumption under the regulation requires the following three elements:

O ' • A residential mortgage transaction • An express acceptance of the subsequent consumer by the creditor • A written agreement The assumption of a nonexempt consumer credit obligation requires no disclosures unless all three elements are present. For example, an automobile dealer need not provide Truth in Lending disclosures to a customer who as­ sumes an existing obligation secured by an automobile. However, a residential mortgage transaction with the elements described in sec­ tion 226.20(b) is an assumption that calls for new disclosures; the disclosures must be given whether or not the assumption is accompanied by changes in the terms of the obligation. (See comment 2(a)(24)-5 for a discussion of assumptions that are not considered residential mortgage transactions.) r# Existing residential mortgage transaction. A transaction may be a residential mortgage transaction as to one consumer and not to the other consumer. In that case, the creditor must look to the assuming consumer in determining whether a residential mortgage transaction ex­ ists. To illustrate:

• The original consumer obtained a mortgage to purchase a home for vacation purposes. The loan was not a residential mortgage transaction as to that consumer. The mort­ gage is assumed by a consumer who will use the home as a principal dwelling. As to that consumer, the loan is a residential mortgage transaction. For purposes of sec­ tion 226.20(b), the assumed loan is an “ex­ isting residential mortgage transaction” requiring disclosures, if the other criteria for an assumption are met.

3. Express agreement. “Expressly agrees” means that the creditor’s agreement must re­ late specifically to the new debtor and must unequivocally accept that debtor as a primary obligor. The following events are not con­ strued to be express agreements between the creditor and the subsequent consumer: • Approval of creditworthiness • Notification of a change in records • Mailing of a coupon book to the subse­ quent consumer • Acceptance of payments from the new con­ sumer 4. Retention of original consumer. The reten­ tion of the original consumer as an obligor in some capacity does not prevent the change from being an assumption, provided the new consumer becomes a primary obligor. But the mere addition of a guarantor to an obligation for which the original consumer remains pri­ marily liable does not give rise to an assump­ tion. However, if neither party is designated as the primary obligor but the creditor accepts payment from the subsequent consumer, an assumption exists for purposes of section 226.20(b).

5. Status of parties. Section 226.20(b) applies only if the previous debtor was a consumer and the obligation is assumed by another con­ sumer. It does not apply, for example, when an individual takes over the obligation of a corporation.

6. Disclosures. For transactions that are as­ sumptions within this provision, the creditor must make disclosures based on the “remain­ ing obligation.” For example: • The amount financed is the remaining prin­ cipal balance plus any arrearages or oth­ er accrued charges from the original transaction.

• If the finance charge is computed from time to time by application of a percentage rate to an unpaid balance, in determining the amount of the finance charge and the annual percentage rate to be disclosed, the creditor should disregard any prepaid fi­ nance charges paid by the original obligor but must include in the finance charge any prepaid finance charge imposed in connec­ tion with the assumption.

• If the creditor requires the assuming con­ sumer to pay any charges as a condition of the assumption, those sums are prepaid fi­ Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 142

§ 226.20 Regulation Z Commentary nance charges as to that consumer, unless exempt from the finance charge under sec­ tion 226.4.

If a transaction involves add-on or discount finance charges, the creditor may make abbre­ viated disclosures, as outlined in section 226.20(b)(1) through (5). Creditors providing disclosures pursuant to this section for as­ sumptions of variable-rate transactions secured by the consumer’s principal dwelling with a term longer than one year need not provide new disclosures under sections 226.18(f)(2)(ii) or 226.19(b). In such transactions, a creditor may disclose the variable-rate feature solely in accordance with section 226.18(f)(1). 7. Abbreviated disclosures. The abbreviated disclosures permitted for assumptions of trans­ actions involving add-on or discount finance charges must be made clearly and conspicu­ ously in writing in a form that the consumer may keep. However, the creditor need not comply with the segregation requirement of section 226.17(a)(1). The terms “annual per­ centage rate” and “total of payments,” when disclosed according to section 226.20(b)(4) and (5), are not subject to the description re­ quirements of section 226.18(e) and (h). The term “annual percentage rate” disclosed under section 226.20(b)(4) need not be more con­ spicuous than other disclosures. 20(c) Variable-Rate Adjustments 1. Timing of adjustment notices. This section requires a creditor (or a subsequent holder) to provide certain disclosures in cases where an adjustment to the interest rate is made in a variable-rate transaction subject to section 226.19(b). There are two timing rules, de­ pending on whether payment changes accom­ pany interest rate changes. A creditor is re­ quired to provide at least one notice each year during which interest rate adjustments have occurred without accompanying payment ad­ justments. For payment adjustments, a creditor must deliver or place in the mail notices to borrowers at least 25, but not more than 120, calendar days before a payment at a new level is due. The timing rules also apply to the no­ tice required to be given in connection with the adjustment to the rate and payment that follows conversion of a transaction subject to section 226.19(b) to a fixed-rate transaction. (In cases where an open-end account is con­ verted to a closed-end transaction subject to section 226.19(b), the requirements of this section do not apply until adjustments are made following conversion.) 2. Exceptions. Section 226.20(c) does not ap­ ply to “shared-equity,” “shared-appreciation,” or price-level-adjusted or similar mortgages. 3. Basis of disclosures. The disclosures re­ quired under this section shall reflect the terms of the parties’ legal obligation, as re­ quired under section 226.17(c)(1). Paragraph 20(c)(1) 1. Current and prior interest rates. The re­ quirements under this paragraph are satisfied by disclosing the interest rate used to compute the new adjusted payment amount (“current rate”) and the adjusted interest rate that was disclosed in the last adjustment notice, as well as all other interest rates applied to the trans­ action in the period since the last notice (“prior rates”). (If there has been no prior ad­ justment notice, the prior rates are the interest rate applicable to the transaction at consum­ mation, as well as all other interest rates ap­ plied to the transaction in the period since consummation.) If no payment adjustment has been made in a year, the current rate is the new adjusted interest rate for the transaction, and the prior rates are the adjusted interest rate applicable to the loan at the time of the last adjustment notice, and all other rates ap­ plied to the transaction in the period between the current and last adjustment notices. In dis­ closing all other rates applied to the transac­ tion during the period between notices, a cred­ itor may disclose a range of the highest and lowest rates applied during that period. Paragraph 20(c)(2) 1. Current and prior index values. This sec­ tion requires disclosure of the index or formula values used to compute the current and prior interest rates disclosed in section 226.20(c)(1). The creditor need not disclose the margin used in computing the rates. If the prior interest rate was not based on an index Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 143

Regulation Z Commentary § 226.21 or formula value, the creditor also need not disclose the value of the index that would oth­ erwise have been used to compute the prior interest rate.

Paragraph 20(c)(3) 1. Unapplied index increases. The require­ ment that the consumer receive information about the extent to which the creditor has for­ gone any increase in the interest rate is appli­ cable only to those transactions permitting in­ terest rate carryover. The amount of increase that is forgone at an adjustment is the amount that, subject to rate caps, can be applied to future adjustments independently to increase, or offset decreases in, the rate that is deter­ mined according to the index or formula. Paragraph 20(c)(4) 1. Contractual effects of the adjustment. The ► contractual effects of an interest rate adjust­ ment must be disclosed including the payment due after the adjustment is made whether or tot the payment has been adjusted. In transac­ tions where paying the periodic payments will not fully amortize the outstanding balance at the end of the loan term and where the final ayment will equal the periodic payment plus the remaining unpaid balance, the amount of the adjusted payment must be disclosed if such payment has changed as a result of the rate adjustment. A contractual effect of a rate adjustment would include, for example, dism closure of any change in the term or maturity of the loan if the change resulted from the rate adjustment. A statement of the loan bal­ ance also is required. The balance required to be disclosed is the balance on which the new -< adjusted payment is based. If no payment ad­ justment is disclosed in the notice, the balance disclosed should be the loan balance on which the payment disclosed under section 226.20 (c)(5) is based, if applicable, or the balance at the time the disclosure is prepared. ? ’aragraph 20(c)(5) 1. Fully amortizing payment. This paragraph requires a disclosure only when negative amortization occurs as a result of the adjust­ ment. A disclosure is not required simply be­ cause a loan calls for non-amortizing or par­ tially amortizing payments. For example, in a transaction with a five-year term and pay­ ments based on a longer amortization sched­ ule, and where the final payment will equal the periodic payment plus the remaining un­ paid balance, the creditor would not have to disclose the payment necessary to fully amor­ tize the loan in the remainder of the five-year term. A disclosure is required, however, if the payment disclosed under section 226.20(c)(4) is not sufficient to prevent negative amortiza­ tion in the loan. The adjustment notice must state the payment required to prevent negative amortization. (This paragraph does not apply if the payment disclosed in section 226.20(c)(4) is sufficient to prevent negative amortization in the loan but the final payment will be a different amount due to rounding.) References Statute: None Other sections: § 226.2 Previous regulations: § 226.8(j) through (/), and interpretation §§ 226.807, 226.811, 226.814, and 226.817.

1981 changes: While the previous regulation treated virtually any change in terms as a refi­ nancing requiring new disclosures, this regula­ tion limits refinancings to transactions in which the entire original obligation is extin­ guished and replaced by a new one. Redis­ closure is no longer required for deferrals or extensions.

The assumption provision retains the sub­ stance of section 226.8(k) and interpretation section 226.807 of the previous regulation, but limits its scope to residential mortgage transactions.

SECTION 226.21—Treatment of Credit Balances 1. Credit balance. A credit balance arises whenever the creditor receives or holds funds in an account in excess of the total balance due from the consumer on that account. A balance might result, for example, from the debtor’s paying off a loan by transmitting funds in excess of the total balance owed on the account, or from the early payoff of a loan Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 144

§ 226.21 Regulation Z Commentary entitling the consumer to a rebate of insurance premiums and finance charges. However, sec­ tion 226.21 does not determine whether the creditor in fact owes or holds sums for the consumer. For example, if a creditor has no obligation to rebate any portion of precom­ puted finance charges on prepayment, the con­ sumer’s early payoff would not create a credit balance with respect to those charges. Simi­ larly, nothing in this provision interferes with any rights the creditor may have under the contract or under state law with respect to set-off, cross-collateralization, or similar provisions.

2. Total balance due. The phrase “total bal­ ance due” refers to the total outstanding bal­ ance. Thus, this provision does not apply where the consumer has simply paid an amount in excess of the payment due for a given period.

226.21 imposes no further duties on the credi­ tor if a good faith effort to return the balance is unsuccessful. The ultimate disposition of the credit balance (or any credit balance of $1 or less) is to be determined under other appli­ cable law.

References Statute: § 165 Other sections: None Previous regulation: None 1981 changes: This section implements sec­ tion 165 of the act, which was expanded by the 1980 statutory amendments to apply to closed-end as well as open-end credit. SECTION 226.22—Determination of the Annual Percentage Rate 3. Timing of refund. The creditor may also fulfill its obligation under this section by: • Refunding any credit balance to the con­ sumer immediately • Refunding any credit balance prior to a written request from the consumer • Making a good faith effort to refund any credit balance before six months have passed. If that attempt is unsuccessful, the creditor need not try again to refund the credit balance at the end of the six-month period.

Paragraph 21(b) 1. Written requests—standing orders. The creditor is not required to honor standing or­ ders requesting refunds of any credit balance that may be created on the consumer’s account.

Paragraph 21(c) 1. Good faith effort to refund. The creditor must take positive steps to return any credit balance that has remained in the account for over six months. This includes, if necessary, attempts to trace the consumer through the consumer’s last known address or telephone number, or both.

2. Good faith effort unsuccessful. Section 22(a) Accuracy of the Annual Percentage Rate Paragraph 22(a)(1) 1. Calculation method. The regulation recog­ nizes both the actuarial method and the United States Rule Method (U.S. Rule) as measure of an exact annual percentage rate. Bot methods yield the same annual percentage rate when payment intervals are equal. They differ in their treatment of unpaid accrued interest. o 2. Actuarial method. When no payment is made, or when the payment is insufficient to pay the accumulated finance charge, the actua­ rial method requires that the unpaid finance charge be added to the amount financed and thereby capitalized. Interest is computed on interest since in succeeding periods the inter­ est rate is applied to the unpaid balance in­ cluding the unpaid finance charge. Appendix J provides instructions and examples for calcu­ lating the annual percentage rate using the ac­ tuarial method.

3. U.S. Rule. The U.S. Rule produces no -#■ compounding of interest in that any unpaid accrued interest is accumulated separately and is not added to principal. In addition, under the U.S. Rule, no interest calculation is made until a payment is received. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 145

Regulation Z Commentary § 226.22 4. Basis for calculations. When a transaction involves “step rates” or “split rates”—that is, different rates applied at different times or to different portions of the principal balance—a single composite annual percentage rate must be calculated and disclosed for the entire transaction. Assume, for example, a step-rate transaction in which a $10,000 loan is repay­ able in five years at 10 percent interest for the first two years, 12 percent for years 3 and 4, and 14 percent for year 5. The monthly pay­ ments are $210.71 during the first two years of the term, $220.25 for years 3 and 4, and $222.59 for year 5. The composite annual per­ centage rate, using a calculator with a “dis­ counted cash flow analysis” or “internal rate of return” function, is 10.75 percent. 5. Good faith reliance on faulty calculation tools. Footnote 45d absolves a creditor of lia­ bility for an error in the annual percentage rate or finance charge that resulted from a cor­ responding error in a calculation tool used in good faith by the creditor. Whether or not the creditor’s use of the tool was in good faith must be determined on a case-by-case basis, but the creditor must in any case have taken reasonable steps to verify the accuracy of the tool, including any instructions, before using l. Generally, the footnote is available only for errors directly attributable to the calculation tool itself, including software programs; it is not intended to absolve a creditor of liability for its own errors, or for errors arising from improper use of the tool, from incorrect data entry, or from misapplication of the law. Paragraph 22(a)(2) 1. Regular transactions. The annual percent­ age rate for a regular transaction is considered accurate if it varies in either direction by not more than '/s of 1 percentage point from the actual annual percentage rate. For example, when the exact annual percentage rate is de­ termined to be 10 Vs percent, a disclosed an­ nual percentage rate from 10 percent to IOV4 a percent, or the decimal equivalent, is deemed Jo comply with the regulation. Paragraph 22(a)(3) 1. Irregular transactions. The annual percent­ age rate for an irregular transaction is consid­ ered accurate if it varies in either direction by not more than V4 of 1 percentage point from the actual annual percentage rate. This toler­ ance is intended for more complex transac­ tions that do not call for a single advance and a regular series of equal payments at equal intervals. The V4 of 1 percentage point toler­ ance may be used, for example, in a construc­ tion loan where advances are made as con­ struction progresses, or in a transaction where payments vary to reflect the consumer’s sea­ sonal income. It may also be used in transac­ tions with graduated payment schedules where the contract commits the consumer to several series of payments in different amounts. It does not apply, however, to loans with varia­ ble-rate features where the initial disclosures are based on a regular amortization schedule over the life of the loan, even though pay­ ments may later change because of the varia­ ble-rate feature.

2 2 ( b ) C o m p u ta tio n T o o ls Paragraph 22(b)(1) 1. Board tables. Volumes I and II of the Board’s Annual Percentage Rate Tables pro­ vide a means of calculating annual percentage rates for regular and irregular transactions, re­ spectively. An annual percentage rate com­ puted in accordance with the instructions in the tables is deemed to comply with the regu­ lation, even where use of the tables produces a rate that falls outside the general standard of accuracy. To illustrate:

• Volume I may be used for single-advance transactions with completely regular pay­ ment schedules or with payment schedules that are regular except for an odd first pay­ ment, odd first period or odd final pay­ ment. When used for a transaction with a large final balloon payment, volume I may produce a rate that is considerably higher than the exact rate produced using a com­ puter program based directly on appendix J. However, the volume I rate—produced using certain adjustments in that vol­ ume—is considered to be in compliance. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 146

§ 226.22 Regulation Z Commentary Paragraph 22(b)(2) 1. Other calculation tools. Creditors need not use the Board tables in calculating the annual percentage rates. Any computation tools may be used, so long as they produce annual per­ centage rates within Vs or '/4 of 1 percentage point, as applicable, of the precise actuarial or U.S. Rule annual percentage rate. References Statute: § 107 Other sections: § 226.17(c)(4) and appendix J Previous regulation: § 226.5(b) through (e) 1981 changes: The section now provides a larger tolerance (lh of 1 percentage point) for irregular transactions.

22(c) Single Add-On Rate Transactions 1. General rule. Creditors applying a single add-on rate to all transactions up to 60 months in length may disclose the same an­ nual percentage rate for all those transactions, although the actual annual percentage rate var­ ies according to the length of the transaction. Creditors utilizing this provision must show the highest of those rates. For example: • An add-on rate of 10 percent converted to an annual percentage rate produces the fol­ lowing actual annual percentage rates at various maturities: at 3 months, 14.94 per­ cent; at 21 months, 18.18 percent; and at 60 months, 17.27 percent. The creditor must disclose an annual percentage rate of 18.18 percent (the highest annual percent­ age rate) for any transaction up to five years, even though that rate is precise only for a transaction of 21 months. 22(d) Certain Transactions Involving Ranges of Balances 1. General rule. Creditors applying a fixed dollar finance charge to all balances within a specified range of balances may understate the annual percentage rate by up to 8 percent of that rate by disclosing for all those balances the annual percentage rate computed on the median balance within that range. For example:

• If a finance charge of $9 applies to all bal­ ances between $91 and $100, an annual percentage rate of 10 percent (the rate on the median balance) may be disclosed as the annual percentage rate for all balances, even though a $9 finance charge applied to the lowest balance ($91) would actually produce an annual percentage rate of 10.7 percent.

SECTION 226.23—Right of Rescission 1. Transactions not covered. Credit extensions that are not subject to the regulation are not covered by section 226.23 even if a cus­ tomer’s principal dwelling is the collateral se­ curing the credit. For example, the right of rescission does not apply to a business-purpose loan, even though the loan is secured by the customer’s principal dwelling. 23(a) Consumer’s Right to Rescind Paragraph 23(a)(1) 1. Security interest arising from transaction. In order for the right of rescission to apply, the security interest must be retained as part of the credit transaction. For example: • A security interest that is acquired by contractor who is also extending the credit in the transaction • A mechanic’s or materialman’s lien that is retained by a subcontractor or supplier of the contractor-creditor, even when the latter has waived its own security interest in the consumer’s home The security interest is not part of the credit transaction and therefore the transaction is not subject to the right of rescission when, for example:

• A mechanic’s or materialman’s lien is ob­ tained by a contractor who is not a party to the credit transaction but is merely paid with the proceeds of the consumer’s un­ secured bank loan • All security interests that may arise in con­ nection with the credit transaction are val­ idly waived • The creditor obtains a lien and completion bond that in effect satisfies all liens against Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 147

Regulation Z Commentary § 226.23 the consumer’s principal dwelling as a re­ sult of the credit transaction Although liens arising by operation of law are not considered security interests for purposes of disclosure under section 226.2, that section specifically includes them in the definition for purposes of the right of rescission. Thus, even though an interest in the consumer’s principal dwelling is not a required disclosure under section 226.18(m), it may still give rise to the right of rescission.

2. Consumer. To be a consumer within the meaning of section 226.2, that person must at least have an ownership interest in the dwell­ ing that is encumbered by the creditor’s secur­ ity interest, although that person need not be a signatory to the credit agreement. For exam­ ple, if only one spouse signs a credit contract, the other spouse is a consumer if the owner­ ship interest of that spouse is subject to the security interest.

3. Principal dwelling. A consumer can only have one principal dwelling at a time. (But see comment 23(a)(l)-4.) A vacation or other second home would not be a principal dwell­ ing. A transaction secured by a second home (such as a vacation home) that is not currently ing used as the consumer’s principal dwell­ ing is not rescindable, even if the consumer intends to reside there in the future. When a consumer buys or builds a new dwelling that will become the consumer’s principal dwelling within one year or upon completion of con­ struction, the new dwelling is considered the principal dwelling if it secures the acquisition or construction loan. In that case, the transac­ tion secured by the new dwelling is a residen­ tial mortgage transaction and is not rescind­ able. For example, if a consumer whose principal dwelling is currently A builds B, to be occupied by the consumer upon completion of construction, a construction loan to finance B and secured by B is a residential mortgage transaction. “Dwelling,” as defined in section 226.2, includes structures that are classified as personalty under state law. For example, a transaction secured by a mobile home, trailer, or houseboat used as the consumer’s principal dwelling may be rescindable. (si withstanding the general rule that consumers may have only one principal dwelling, when the consumer is acquiring or constructing a new principal dwelling, any loan subject to Regulation Z and secured by the equity in the consumer’s current principal dwelling (for ex­ ample, a bridge loan) is subject to the right of rescission regardless of the purpose of that loan. For example, if a consumer whose prin­ cipal dwelling is currently A builds B, to be occupied by the consumer upon completion of construction, a construction loan to finance B and secured by A is subject to the right of rescission. A loan secured by both A and B is, likewise, rescindable.

5. Addition of a security interest. Under foot­ note 47, the addition of a security interest in a consumer’s principal dwelling to an existing obligation is rescindable even if the existing obligation is not satisfied and replaced by a new obligation, and even if the existing obli­ gation was previously exempt (because it was credit over $25,000 not secured by real prop­ erty or a consumer’s principal dwelling). The right of rescission applies only to the added security interest, however, and not to the orig­ inal obligation. In those situations, only the section 226.23(b) notice need be delivered, not new material disclosures; the rescission period will begin to run from the delivery of the notice.

Paragraph 23(a)(2) 1. Consumer’s exercise of right. The con­ sumer must exercise the right of rescission in writing but not necessarily on the notice sup­ plied under section 226.23(b). Whatever the means of sending the notification of rescis­ sion—mail, telegram or other written means—the time period for the creditor’s per­ formance under section 226.23(d)(2) does not begin to run until the notification has been received. The creditor may designate an agent to receive the notification so long as the agent’s name and address appear on the notice provided to the consumer under section 226.23(b).

Paragraph 23(a)(3) 4. Special rule for principal dwelling. Not- 1. Rescission period.

The period within Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 148

§ 226.23 Regulation Z Commentary which the consumer may exercise the right to rescind runs for three business days from the last of three events:

• Consummation of the transaction • Delivery of all material disclosures • Delivery to the consumer of the required rescission notice For example, if a transaction is consummated on Friday, June 1, and the disclosures and no­ tice of the right to rescind were given on Thursday, May 31, the rescission period will expire at midnight of the third business day after June 1—that is, Tuesday, June 5. In an­ other example, if the disclosures are given and the transaction consummated on Friday, June 1. and the rescission notice is given on Mon­ day, June 4, the rescission period expires at midnight of the third business day after June 4—that is, Thursday, June 7. The consumer must place the rescission notice in the mail, file it for telegraphic transmission, or deliver it to the creditor’s place of business within that period in order to exercise the right. 2. Material disclosures. Footnote 48 sets forth the material disclosures that must be provided before the rescission period can begin to run. Failure to provide information regarding the annual percentage rate also includes failure to inform the consumer of the existence of a va­ riable-rate feature. Failure to give the other required disclosures does not prevent the run­ ning of the rescission period, although that failure may result in civil liability or adminis­ trative sanctions.

3. Unexpired right of rescission. When the creditor has failed to take the action necessary to start the three-business day rescission pe­ riod running, the right to rescind automatically lapses on the occurrence of the earliest of the following three events:

• The expiration of three years after consum­ mation of the transaction • Transfer of all the consumer’s interest in the property • Sale of the consumer’s interest in the prop­ erty, including a transaction in which the consumer sells the dwelling and takes back a purchase money note and mortgage or re­ tains legal title through a device such as an installment sale contract Transfer of all the consumer’s interest in­ cludes such transfers as bequests and gifts. A sale or transfer of the property need not be voluntary to terminate the right to rescind. For example, a foresclosure sale would terminate an unexpired right to rescind. As provided in section 125 of the act, the three-year limit may be extended by an administrative pro­ ceeding to enforce the provisions of this sec­ tion. A partial transfer of the consumer’s in­ terest, such as a transfer bestowing coownership on a spouse, does not terminate the right of rescission.

Paragraph 23(a)(4) 1. Joint owners. When more than one con­ sumer has the right to rescind a transaction, any one of them may exercise that right and cancel the transaction on behalf of all. For example, if both husband and wife have the right to rescind a transaction, either spouse acting alone may exercise the right and both are bound by the rescission. 23(b) Notice of Right to Rescind 1. Who receives notice. Each consumer tied to rescind must be given: enti- • Two copies of the rescission notice • The material disclosures In a transaction involving joint owners, both of whom are entitled to rescind, both must receive the notice of the right to rescind and disclosures. For example, if both spouses are entitled to rescind a transaction, each must re­ ceive two copies of the rescission notice and one copy of the disclosures. 2. Format. The notice must be on a separate piece of paper but may appear with other in­ formation such as the itemization of the amount financed. The material must be clear and conspicuous, but no minimum type size or other technical requirements are imposed. The notices in appendix H provide models that creditors may use in giving the notice. 3. Content. The notice must include all of the information outlined in section 226.23(b)(1) Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 149

Regulation Z Commentary § 226.23 through (5). The requirement in section 226.23(b) that the transaction be identified may be met by providing the date of the transaction. The creditor may provide a sepa­ rate form that the consumer may use to exer­ cise the right of rescission, or that form may be combined with the other rescission disclo­ sures, as illustrated in appendix H. The notice may include additional information related to the required information, such as: 4. Time of providing notice. The notice re­ quired by section 226.23(b) need not be given before consummation of the transaction. The creditor may deliver the notice after the trans­ action is consummated, but the rescission pe­ riod will not begin to run until the notice is given. For example, if the creditor provides the notice on May 15, but disclosures were given and the transaction was consummated on May 10, the three-business day rescission period will run from May 15. 23(c) Delay of Creditor’s Performance 2. Escrow. The creditor may disburse loan proceeds during the rescission period in a valid escrow arrangement. The creditor may not, however, appoint the consumer as “trus­ tee” or “escrow agent” and distribute funds to the consumer in that capacity during the delay period.

3. Actions during the delay period. Section 226.23(c) does not prevent the creditor from taking other steps during the delay, short of beginning actual performance. Unless other­ wise prohibited, such as by state law, the creditor may, for example:

• Prepare the loan check • Perfect the security interest • Prepare to discount or assign the contract to a third party • Accrue finance charges during the delay period 4. Delay beyond rescission period. The credi­ tor must wait until it is reasonably satisfied that the consumer has not rescinded. For ex­ ample, the creditor may satisfy itself by doing one of the following:

• Waiting a reasonable time after expiration of the rescission period to allow for deliv­ ery of a mailed notice • Obtaining a written statement from the consumer that the right has not been exercised When more than one consumer has the right to rescind, the creditor cannot reasonably rely on the assurance of only one consumer, be­ cause other consumers may exercise the right. 23(d) Effects of Rescission Paragraph 23(d)(1) 1. Termination of security interest. Any secur­ ity interest giving rise to the right of rescis­ sion becomes void when the consumer exer­ cises the right of rescission. The security interest is automatically negated regardless of its status and whether or not it was recorded or perfected. Under section 226.23(d)(2), how­ ever, the creditor must take any action neces­ sary to reflect the fact that the security interest no longer exists.

Paragraph 23(d)(2) 1. Refunds to consumer. The consumer cannot be required to pay any amount in the form of money or property either to the creditor or to a third party as part of the credit transaction. Any amounts of this nature already paid by the consumer must be refunded. “ Any amount” includes finance charges already ac­ crued, as well as other charges, such as broker fees, application and commitment fees, or fees • A description of the property subject to the security interest • A statement that joint owners may have the right to rescind and that a rescission by one is effective for all • The name and address of an agent of the creditor to receive notice of rescission 1. General rule. Until the rescission period has expired and the creditor is reasonably sat­ isfied that the consumer has not rescinded, the creditor must not, either directly or through a third party:

• Disburse loan proceeds to the consumer • Begin performing services for the con­ sumer • Deliver materials to the consumer Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 150

§ 226.23 Regulation Z Commentary for a title search or appraisal, whether paid to the creditor, paid directly to a third party, or passed on from the creditor to the third party. It is irrelevant that these amounts may not re­ present profit to the creditor. 2. Amounts not refundable to consumer. Cred­ itors need not return any money given by the consumer to a third party outside of the credit transaction, such as costs incurred for a build­ ing permit or for a zoning variance. Similarly, the term “any amount” does not apply to any money or property given by the creditor to the consumer; those amounts must be tendered by the consumer to the creditor under section 226.23(d)(3).

3. Reflection of security interest termination. The creditor must take whatever steps are nec­ essary to indicate that the security interest is terminated. Those steps include the cancella­ tion of documents creating the security inter­ est, and the filing of release or termination statements in the public record. In a transac­ tion involving subcontractors or suppliers that also hold security interests related to the credit transaction, the creditor must ensure that the termination of their security interests is also reflected. The 20-day period for the creditor’s action refers to the time within which the creditor must begin the process. It does not require all necessary steps to have been com­ pleted within that time, but the creditor is re­ sponsible for seeing the process through to completion.

Paragraph 23(d)(3) 1. Property exchange. Once the creditor has fulfilled its obligations under section 226.23(d)(2), the consumer must tender to the creditor any property or money the creditor has already delivered to the consumer. At the consumer’s option, property may be tendered at the location of the property. For example, if lumber or fixtures have been delivered to the consumer’s home, the consumer may tender them to the creditor by making them available for pick-up at the home, rather than physically returning them to the creditor’s premises. Money already given to the consumer must be tendered at the creditor’s place of business. 2. Reasonable value. If returning the property would be extremely burdensome to the con­ sumer, the consumer may offer the creditor its reasonable value rather than returning the property itself. For example, if building mater­ ials have already been incorporated into the consumer’s dwelling, the consumer may pay their reasonable value.

Paragraph 23(d)(4) 1. Modifications. The procedures outlined in section 226.23(d)(2) and (3) may be modified by a court. For example, when a consumer is in bankruptcy proceedings and prohibited from returning anything to the creditor, or when the equities dictate, a modification might be made.

23(e) Consumer’s Waiver of Right to Rescind 1. Need for waiver. To waive the right to re­ scind, the consumer must have a bona fide personal financial emergency that must be met before the end of the rescission period. The existence of the consumer’s waiver will not, of itself, automatically insulate the creditor from liability for failing to provide the right of rescission.

2. Procedure. To waive or modify the right to rescind, the consumer must give a written statement that specifically waives or modifies the right and also includes a brief description of the emergency. Each consumer entitled to rescind must sign the waiver statement. In a transaction involving multiple consumers, such as a husband and wife using their home as collateral, the waiver must bear the signatures of both spouses.

23(f) Exempt Transactions 1. Residential mortgage transaction. Any transaction to construct or acquire a principal dwelling, whether considered real or personal property, is exempt. (See the commentary to section 226.23(a).) For example, a credit transaction to acquire a mobile home or houseboat to be used as the consumer’s prin­ cipal dwelling would not be rescindable. 2. Lien status. The lien status of the mortgage is irrelevant for purposes of the exemption in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 151

Regulation Z Commentary § 226.23 a a section 226.23(f)(1); the fact that a loan has unior lien status does not by itself preclude ipplication of this exemption. For example, a home buyer may assume the existing first mortgage and create a second mortgage to fi­ nance the balance of the purchase price. Such a transaction would not be rescindable. 3. Combined-purpose transaction. A loan to acquire a principal dwelling and make im­ provements to that dwelling is exempt if treated as one transaction. If, on the other hand, the loan for the acquisition of the prin­ cipal dwelling and the subsequent advances for improvements are treated as more than one transaction, then only the transaction that fi­ nances the acquisition of that dwelling is exempt.

II 'ei 4.

New advances. The exemption in section 226.23(f)(2) applies only to refinancings (in­ cluding consolidations) by the original credi­ tor. The original creditor is the creditor to whom the written agreement was initially made payable. In a merger, consolidation, or cquisition, the successor institution is considred the original creditor for purposes of the exemption in section 226.23(f)(2). If the refi­ nancing involves a new advance of money, r y amount of the new advance is rescindable. .a determining whether there is a new ad­ vance, a creditor may rely on the amount fi­ nanced, refinancing costs, and other figures stated in the latest Truth in Lending disclo­ sures provided to the consumer and is not re­ quired to use, for example, more precise infor­ mation that may only become available when the loan is closed. For purposes of the right of rescission, a new advance does not include amounts attributed solely to the costs of the refinancing. These amounts would include sec­ tion 226.4(c)(7) charges (such as attorney’s fees and title examination and insurance fees, if bona fide and reasonable in amount), as well as insurance premiums and other charges that are not finance charges. (Finance charges on the new transaction—points, for exam­ ple—would not be considered in determining /hether there is a new advance of money in a refinancing since finance charges are not part of the amount financed.) To illustrate, if the sum of the outstanding principal balance plus the earned unpaid finance charge is $50,000 and the new amount financed is $51,000, then the refinancing would be exempt if the extra $1,000 is attributed solely to costs financed in connection with the refinancing that are not finance charges. Of course, if new advances of money are made (for example, to pay for home improvements) and the consumer exer­ cises the right of rescission, the consumer must be placed in the same position as he or she was in prior to entering into the new credit transaction. Thus, all amounts of money (which would include all the costs of the refi­ nancing) already paid by the consumer to the creditor or to a third party as part of the refi­ nancing would have to be refunded to the consumer.

(See the commentary to 226.23(d)(2) for a discussion of refunds to consumers.) A model rescission notice appli­ cable to transactions involving new advances appears in appendix H. The general rescission notice (model form H-8) is the appropriate form for use by creditors not considered origi­ nal creditors in refinancing transactions. 5. State creditors. Cities and other political subdivisions of states acting as creditors are not exempted from this section. 6. Multiple advances. Just as new disclosures need not be made for subsequent advances when treated as one transaction, no new re­ scission rights arise so long as the appropriate notice and disclosures are given at the outset of the transaction. For example, the creditor extends credit for home improvements secured by the consumer’s principal dwelling, with ad­ vances made as repairs progress. As permitted by section 226.17(c)(6), the creditor makes a single set of disclosures at the beginning of the construction period, rather than separate disclosures for each advance. The right of re­ scission does not arise with each advance. However, if the advances are treated as sepa­ rate transactions, the right of rescission ap­ plies to each advance.

7. Spreader clauses. When the creditor holds a mortgage or deed of trust on the consumer’s principal dwelling and that mortgage or deed of trust contains a “spreader clause,” subse­ quent loans made are separate transactions and are subject to the right of rescission. Those loans are rescindable unless the creditor effec- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 152

§ 226.23 Regulation Z Commentary tively waives its security interest under the spreader clause with respect to the subsequent transactions.

8. Converting open-end to closed-end credit. Under certain state laws, consummation of a closed-end credit transaction may occur at the time a consumer enters into the initial openend credit agreement. As provided in the com­ mentary to section 226.17(b), closed-end credit disclosures may be delayed under these circumstances until the conversion of the open-end account to a closed-end transaction. In accounts secured by the consumer’s princi­ pal dwelling, no new right of rescission arises at the time of conversion. Rescission rights under section 226.15 are unaffected. References Statute: §§ 113, 125, and 130 Other sections: § 226.2 and appendix H Previous regulation: § 226.9 1981 changes: The right to rescind applies not only to real property used as the consumer’s principal dwelling, but to personal property as well. The regulation provides no specific text or format for the notice of the right to rescind.

SECTION 226.24—Advertising 1. Clear and conspicuous standard. This sec­ tion is subject to the general “clear and con­ spicuous” standard for this subpart but prescribes no specific rules for the format of the necessary disclosures. The credit terms need not be printed in a certain type size nor need they appear in any particular place in the advertisement. For example, a merchandise tag that is an advertisement under the regula­ tion complies with this section if the neces­ sary credit terms are on both sides of the tag, so long as each side is accessible. 24(a) Actually Available Terms 1. General rule. To the extent that an adver­ tisement mentions specific credit terms, it may state only those terms that the creditor is actu­ ally prepared to offer. For example, a creditor may not advertise a very low annual percent­ age rate that will not in fact be available at any time. This provision is not intended to inhibit the promotion of new credit programs but to bar the advertising of terms that are not and will not be available. For example, a creditor may advertise terms that will be of­ fered for only a limited period, or terms that will become available at a future date. 24(b) Advertisement of Rate of Finance Charge 1. Annual percentage rate. Advertised rates must be stated in terms of an “annual percent­ age rate,” as defined in section 226.22. Even though state or local law permits the use of add-on, discount, time-price differential, or other methods of stating rates, advertisements must state them as annual percentage rates. Unlike the transactional disclosure of the an­ nual percentage rate under section 226.18(e), the advertised annual percentage rate need not include a descriptive explanation of the term and may be expressed using the abbreviation APR. The advertisement must state that the rate is subject to increase after consummation if that is the case, but the advertisement neec not describe the rate increase, its limits, or how it would affect the payment schedule. As under section 226.18(f), relating to disclosure,— of a variable rate, the rate increase disclosun requirement in this provision does not apply to any rate increase due to delinquency (in­ cluding late payment), default, acceleration, assumption, or transfer of collateral. 2. Simple or periodic rates. The advertise­ ment may not simultaneously state any other rate, except that a simple annual rate or peri­ odic rate applicable to an unpaid balance may appear along with (but not more conspicu­ ously than) the annual percentage rate. For example:

• In an advertisement for real estate, a sim­ ple interest rate may be shown in the same type size as the annual percentage rate for the advertised credit.

3. Buydowns. When a third party (such as a _ ^ seller) or a creditor wishes to promote th< availability of reduced interest rates (consumer or seller buydowns), the advertised annual percentage rate must be determined in accor­ dance with the rules in the commentary to Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 153

Regulation Z Commentary § 226.24 section 226.17(c) regarding the basis of trans­ itional disclosures for buydowns. The seller or creditor may advertise the reduced simple interest rate, provided the advertisement shows the limited term to which the reduced rate ap­ plies and states the simple interest rate appli­ cable to the balance of the term. The adver­ tisement may also show the effect of the buydown agreement on the payment schedule for the buydown period without triggering the additional disclosures under section 226.24(c) (2). For example, the advertisement may state that “with this buydown arrangement, your monthly payments for the first three years of the mortgage term will be only $350” or “this buydown arrangement will reduce your monthly payments for the first three years of the mortgage term by $150.”

4. Effective rates. In some transactions the consumer’s payments may be based upon an interest rate lower than the rate at which interest is accruing. The lower rate may be re­ ferred to as the effective rate, payment rate, or qualifying rate. A creditor or seller may ad­ vertise such rates by stating the term of the reduced payment schedule, the interest rate upon which the reduced payments are calcu- - Jated, the rate at which the interest is in fact .ccruing, and the annual percentage rate. The advertised annual percentage rate that must accompany this rate must take into account the interest that will accrue but will not be * paid during this period. For example, an ad­ vertisement may state, “An effective first-year interest rate of 10 percent. Interest being earned at 14 percent. Annual percentage rate 15 percent.”

5. Discounted variable-rate transactions. The advertised annual percentage rate for dis­ counted variable-rate transactions must be de­ termined in accordance with comment 17(c)(1)-10 regarding the basis of transac­ tional disclosures for such financing. A credi­ tor or seller may promote the availability of the initial rate reduction in such transactions y advertising the reduced initial rate, proided the advertisement shows the limited term to which the reduced rate applies. • Limits or caps on periodic rate or payment adjustments need not be stated. To illustrate using the second example in comment 17(c)(1)-10, the fact that the rate is pre­ sumed to be 11 percent in the second year and 12 percent for the remaining 28 years need not be included in the advertisement. • The advertisement may also show the ef­ fect of the discount on the payment sched­ ule for the discount period without triggering the additional disclosures under section 226.24(c). For example, the adver­ tisement may state that “with this discount, your monthly payments for the first year of the mortgage term will be only $577” or “this discount will reduce your monthly payments for the first year of mortgage term by $223.”

24(c) Advertisement of Terms That Require Additional Disclosures 1. General rule. Under section 226.24(c)(1), whenever certain triggering terms appear in credit advertisements, the additional credit terms enumerated in section 226.24(c)(2) must also appear. These provisions apply even if the triggering term is not stated explicitly but may be readily determined from the advertise­ ment. For example, an advertisement may state “80 percent financing available,” which is in fact indicating that a 20 percent downpayment is required.

Paragraph 24(c)(1) 1. Downpayment. The dollar amount of a downpayment or a statement of the downpay­ ment as a percentage of the price requires fur­ ther information. By virtue of the definition of “downpayment” in section 226.2, this trigger­ ing term is limited to credit sale transactions. It includes such statements as: • “Only 5 percent down”

• “As low as $100 down”

• “Total move-in costs of $800” This provision applies only if a downpayment is actually required; statements such as “no downpayment” or “no trade-in required” do not trigger the additional disclosures under this paragraph.

2. Payment period. The number of payments Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 154

§ 226.24 Regulation Z Commentary required or the total period of repayment in­ cludes such statements as:

• “48-month payment terms”

• “30-year mortgage”

• “Repayment in as many as 36 monthly installments”

But it does not include such statements as “pay weekly,” “monthly payment terms ar­ ranged,” or “take years to repay,” since these statements do not indicate a time period over which a loan may be financed. 3. Payment amount. The dollar amount of any payment includes statements such as: • “Payable in installments of $103” • “$25 weekly”

• “$1,200 balance payable in 10 equal installments”

In the last example, the amount of each pay­ ment is readily determinable, even though not explicitly stated. But statements such as “monthly payments to suit your needs” or “regular monthly payments” are not covered. 4. Finance charge. The dollar amount of the finance charge or any portion of it includes statements such as:

• “$500 total cost of credit” • “$2 monthly carrying charge” • “$50,000 mortgages, two points to the borrower”

In the last example, the $1,000 prepaid fi­ nance charge can be readily determined from the information given. Statements of the an­ nual percentage rate or statements that there is no particular charge for credit (such as “no closing costs”) are not triggering terms under this paragraph.

Paragraph 24(c)(2) 1. Disclosure of downpayment. The total downpayment as a dollar amount or percent­ age must be shown, but the word “downpay­ ment” need not be used in making this disclo­ sure. For example, “10 percent cash required from buyer” or “credit terms require mini­ mum $100 trade-in” would suffice. 2. Disclosure of repayment terms. While the phrase “terms of repayment” generally has the same meaning as the “payment schedule” required to be disclosed under sectior 226.18(g), section 226.24(c)(2)(ii) provides greater flexibility to creditors in making this disclosure for advertising purposes. Repay­ ment terms may be expressed in a variety of ways in addition to an exact repayment sched­ ule; this is particularly true for advertisements that do not contemplate a single specific trans­ action. For example:

• A creditor may use a unit-cost approach in making the required disclosure, such as “48 monthly payments of $27.83 per $1,000 borrowed.”

• In an advertisement for credit secured by a dwelling, when any series of payments var­ ies because of a graduated payment feature or because of the inclusion of mortgage in­ surance premiums, a creditor may state the number and timing of payments, the amounts of the largest and smallest of those payments, and the fact that other payments will vary between those amounts. 3. Annual percentage rate. The advertised an­ nual percentage rate may be expressed using the abbreviation APR. The advertisement must also state, if applicable, that the annual per­ centage rate is subject to increase afte consummation.

4. Use of examples. Footnote 49 authorizes the use of illustrative credit transactions to make the necessary disclosures under section 226.24(c)(2). That is, where a range of possi­ ble combinations of credit terms is offered, the advertisement may use examples of typical transactions, so long as each example contains all of the applicable terms required by section 226.24(c). The examples must be labelled as such and must reflect representative credit terms that are made available by the creditor to present and prospective customers. 24(d) Catalogs and Multiple-Page Advertisements 1. Definition. The multiple-page advertise­ ments to which this section refers are adver tisements consisting of a series of sequentially numbered pages—for example, a supplement to a newspaper. A mailing consisting of sev­ eral separate flyers or pieces of promotional Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 155

Regulation Z Commentary § 226.25 material in a single envelope does not consti­ tute a single multiple-page advertisement for purposes of section 226.24(d). 2. General. Section 226.24(d) permits credi­ tors to put credit information together in one place in a catalog or multiple-page advertise­ ment. The rule applies only if the catalog or multiple-page advertisement contains one or more of the triggering terms from section 226.24(c)(1). A list of different annual per­ centage rates applicable to different balances, for example, does not trigger further disclo­ sures under section 226.24(c)(2) and so is not covered by section 226.24(d). 3. Representative examples. The table or schedule must state all the necessary informa­ tion for a representative sampling of amounts of credit. This must reflect amounts of credit the creditor actually offers, up to and includ­ ing the higher-priced items. This does not I

mean that the chart must make the disclosures for the single most expensive item the seller offers, but only that the chart cannot be lim­ ited to information about less expensive sales when the seller commonly offers a distinct level of more expensive goods or services. The range of transactions shown in the table ">r schedule in a particular catalog or multiple- >page advertisement need not exceed the range of transactions actually offered in that advertisement.

References Statute: §§ 141, 142, and 144 Other sections: §§ 226.2, 226.4, and 226.22 Previous regulation: § 226.10(a), (b), and (d) 1981 changes: This section retains the adver­ tising rules in a form very similar to the pre­ vious regulation, but with certain changes to reflect the 1980 statutory amendments. For ex­ ample, if triggering terms appear in any ad­ vertisement, the additional disclosures required no longer include the cash price. The special rule for FHA section 235 financing has been eliminated, as well as the rule for advertising credit payable in more than four installments with no identified finance charge. Interpreta­ tion section 226.1002, requiring disclosure of representative amounts of credit in catalogs and multiple-page advertisements, has been in­ corporated in simplified form in section 226.24(d).

Unlike the previous regulation, if the adver­ tised annual percentage rate is subject to in­ crease, that fact must now be disclosed. SUBPART D—MISCELLANEOUS SECTION 226.25—Record Retention 25(a) General Rule 1. Evidence of required actions. The creditor must retain evidence that it performed the re­ quired actions as well as made the required disclosures. This includes, for example, evi­ dence that the creditor properly handled ad­ verse credit reports in connection with amounts subject to a billing dispute under sec­ tion 226.13, and properly handled the re­ funding of credit balances under sections 226.11 and 226.21.

2. Methods of retaining evidence. Adequate evidence of compliance does not necessarily mean actual paper copies of disclosure state­ ments or other business records. The evidence may be retained on microfilm, microfiche, or by any other method that reproduces records accurately (including computer programs). The creditor need retain only enough information to reconstruct the required disclosures or other records. Thus, for example, the creditor need not retain each open-end periodic statement, so long as the specific information on each statement can be retrieved.

3. Certain variable-rate transactions. In vari­ able-rate transactions that are subject to the disclosure requirements of section 226.19(b), written procedures for compliance with those requirements as well as a sample disclosure form for each loan program represent ade­ quate evidence of compliance. (See comment 25(a)-2 pertaining to permissible methods of retaining the required disclosures.) 4. Home-equity plans. In home-equity plans that are subject to the requirements of section 226.5b, written procedures for compliance with those requirements as well as a sample disclosure form and contract for each homeequity program represent adequate evidence of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 156

§ 226.25 Regulation Z Commentary compliance. (See comment 25(a)-2 pertaining to permissible methods of retaining the re­ quired disclosures.) References Statute: §§ 105 and 108 Other sections: Appendix I Previous regulation: § 226.6(i) 1981 changes: Section 226.25 substitutes a uniform two-year record-retention rule for the previous requirement that certain creditors re­ tain records through at least one compliance examination. It also states more explicitly that the record-retention requirements apply to evi­ dence of required actions.

SECTION 226.26—Use of Annual Percentage Rate in Oral Disclosures 1. Application of rules. The restrictions of section 226.26 apply only if the creditor chooses to respond orally to the consumer’s request for credit cost information. Nothing in the regulation requires the creditor to supply rate information orally. If the creditor volun­ teers information (including rate information) through oral solicitations directed generally to prospective customers, as through a telephone solicitation, those communications may be ad­ vertisements subject to the rules in sections 226.16 and 226.24.

26(a) Open-End Credit 1. Information that may be given. The credi­ tor may state periodic rates in addition to the required annual percentage rate, but it need not do so. If the annual percentage rate is un­ known because transaction charges, loan fees, or similar finance charges may be imposed, the creditor must give the corresponding an­ nual percentage rate (that is, the periodic rate multiplied by the number of periods in a year, as described in sections 226.6(a)(2) and 226.7(d)). In such cases, the creditor may, but need not, also give the consumer information about other finance charges and other charges. 26(b) Closed-End Credit 1. Information that may be given. The credi­ tor may state other annual or periodic rates that are applied to an unpaid balance, along with the required annual percentage rate. This rule permits disclosure of a simple interest rate, for example, but not an add-on, discount, or similar rate. If the creditor cannot give a precise annual percentage rate in its oral re­ sponse because of variables in the transaction, it must give the annual percentage rate for a comparable sample transaction; in this case, other cost information may, but need not, be given. For example, the creditor may be una­ ble to state a precise annual percentage rate for a mortgage loan without knowing the ex­ act amount to be financed, the amount of loan fees or mortgage insurance premiums, or simi­ lar factors. In this situation, the creditor should state an annual percentage rate for a sample transaction; it may also provide infor­ mation about the consumer’s specific case, such as the contract interest rate, points, other finance charges, and other charges. References Statute: § 146 Other sections: §§ 226.6(a)(2) and 226.7(d) Previous regulation: Interpretation § 226.101 1981 changes: This section implements amended section 146 of the act, which added"** a provision dealing with oral disclosures, ana incorporates interpretation section 226.101. SECTION 226.27— Spanish-Language Disclosures 1. Subsequent disclosures. If a creditor in Pu­ erto Rico provides initial disclosures in Span­ ish, subsequent disclosures need not be in Spanish. For example, if the creditor gave Spanish-language initial disclosures, periodic statements and change-in-terms notices may be made in English.

2. Permissible uses. If a creditor other than in Puerto Rico provides translations of the re­ quired disclosures—either because it is re­ quired to do so by state, federal, or local law, or because it chooses to do so—the transla­ tions are not inconsistent per se with the dis­ closures under this regulation, and they may be provided as additional information. In both cases, the English language disclosures re- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 157

Regulation Z Commentary § 226.28 quired by this regulation must be clear and O conspicuous, and the closed-end disclosures in English must be properly segregated in accor­ dance with section 226.17(a)(1). References Statute: None Other sections: None Previous regulation: § 226.6(a) 1981 changes: No substantive change SECTION 226.28—Effect on State Laws 28(a) Inconsistent Disclosure Requirements 1. General. There are three sets of preemption criteria; one applies to the general disclosure and advertising rules of the regulation, and two apply to the credit-billing provisions. Sec­ tion 226.28 also provides for Board determi­ nations of preemption.

2. Rules for chapters 1, 2, and 3. The stan­ dard for judging whether state laws that cover the types of requirements in chapters 1 (Gen­ eral Provisions), 2 (Credit Transactions), and 3 (Credit Advertising) of the act are inconsistent (md therefore preempted, is contradiction of the federal law. Examples of laws that would be preempted include:

• A state law that requires use of the term “finance charge” but defines the term to include fees that the federal law excludes or to exclude fees the federal law includes • A state law that requires a label such as “nominal annual interest rate” to be used for what the federal law calls the “annual percentage rate”

3. Laws not contradictory to chapters 1, 2, and 3. Generally, state law requirements that call for the disclosure of items of information not covered by the federal law, or that require more detailed disclosures, do not contradict the federal requirements. Examples of laws that are not preempted include: A state law that requires disclosure of the minimum periodic payment for open-end credit, even though not required by section 226.7.

• A state law that requires contracts to con tain warnings such as: “Read this contract before you sign. Do not sign if any spaces are left blank. You are entitled to a copy of this contract.”

Similarly, a state law that requires itemization of the amount financed does not automatically contradict the permissive itemization under section 226.18(c). However, a state law re­ quirement that the itemization appear with the disclosure of the amount financed in the seg­ regated closed-end credit disclosures is incon­ sistent, and this location requirement would be preempted.

4. Creditor’s options. Before the Board makes a determination about a specific state law, the creditor has certain options. Since the prohibi­ tion against giving the state disclosures does not apply until the Board makes its determina­ tion, the creditor may choose to give state dis­ closures until the Board formally determines that the state law is inconsistent. (The Board will provide sufficient time for creditors to re­ vise forms and procedures as necessary to conform to its determinations.) • Under this first approach, as in all cases, the federal disclosures must be clear and conspicuous, and the closed-end disclosures must be properly segregated in accordance with section 226.17(a)(1).

• This ability to give state disclosures re­ lieves any uncertainty that the creditor might have prior to Board determinations of inconsistency.

As a second option, the creditor may apply the preemption standards to a state law, con­ clude that it is inconsistent, and choose not to give the state-required disclosures. However, nothing in section 226.28(a) provides the creditor with immunity for violations of state law if the creditor chooses not to make state disclosures and the Board later determines that the state law is not preempted. 5. Rules for correction of billing errors and regulation of credit reports. The preemption criteria for the fair credit billing provisions set forth in section 226.28 have two parts. With respect to the rules on correction of billing errors and regulation of credit reports (which Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 158

§ 226.28 Regulation Z Commentary are in section 226.13), section 226.28(a)(2)(i) provides that a state law is inconsistent and preempted if its requirements are different from the federal law. An exception is made, however, for state laws that allow the con­ sumer to inquire about an account and require the creditor to respond to such inquiries be­ yond the time limits in the federal law. Such a state law is not preempted with respect to the extra time period. For example, section 226.13 requires the consumer to submit a written notice of billing error within 60 days after transmittal of the periodic statement showing the alleged error. If a state law al­ lows the consumer 90 days to submit a notice, the state law remains in effect to provide the extra 30 days. Any state law disclosures con­ cerning this extended state time limit must re­ flect the qualifications and conform to the for­ mat specified in section 226.28(a)(2)(i). Examples of laws that would be preempted include:

• A state law that has a narrower or broader definition of “billing error” • A state law that requires the creditor to take different steps to resolve errors • A state law that provides different timing rules for error resolution (subject to the ex­ ception discussed above) 6. Rules for other fair credit billing provi­ sions. The second part of the criteria for fair credit billing relates to the other rules imple­ menting chapter 4 of the act (addressed in sections 226.4(c)(8), 226.5(b)(2)(ii), 226.6(d), 226.7(k), 226.9(a), 226.10, 226.11, 226.12(c) through (f), 226.13, and 226.21). Section 226.28(a)(2)(ii) provides that the test of incon­ sistency is whether the creditor can comply with state law without violating federal law. For example:

• A state law that allows the card issuer to offset the consumer’s credit-card indebted­ ness against funds held by the card issuer would be preempted, since section 226.12(d) prohibits such action. • A state law that requires periodic state­ ments to be sent more than 14 days before the end of a free-ride period would not be preempted.

• A state law that permits consumers to assert claims and defenses against the card issuer without regard to the $50 and 100-mile limitations of section 226.12(c) (3)(ii) would not be preempted. In the last two cases, compliance with state law would involve no violation of the federal law.

7. Who may receive a chapter 4 determina­ tion. Only states (through their authorized offi­ cials) may request and receive determinations on inconsistency with respect to the fair credit billing provisions.

8. Preemption determination—Arizona. Effec­ tive October 1, 1983, the Board has deter­ mined that the following provisions in the state law of Arizona are preempted by the federal law:

• Section 44—287 B.5—Disclosure of final cash price balance. This provision is pre­ empted in those transactions in which the amount of the final cash price balance is the same as the federal amount financed, since in such transactions the state law re­ quires the use of a term different from the federal term to represent the same amount. • Section 44—287 B.6—Disclosure of finance charge. This provision is preempted ir those transactions in which the amount ol the finance charge is different from the amount of the federal finance charge, since in such transactions the state law requires the use of the same term as the federal law to represent a different amount. • Section 44-287 B.7—Disclosure of the time balance. The time balance disclosure provision is preempted in those transactions in which the amount is the same as the amount of the federal total of payments, since in such transactions the state law re­ quires the use of a term different from the federal term to represent the same amount. 9. Preemption determination—Florida. Effec­ tive October 1, 1983, the Board has deter­ mined that the following provisions in the state law of Florida are preempted by the fed­ eral law:

• Sections 520.07(2)(f) and 520.34(2)(f)— Disclosure of amount financed. This disclo­ sure is preempted in those transactions in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 159

Regulation Z Commentary § 226.28 which the amount is different from the fed­ eral amount financed, since in such transac­ tions the state law requires the use of the same term as the federal law to represent a different amount.

• Sections 520.07(2)(g), 520.34(2)(g), and 520.35(2)(d)—Disclosure of finance charge and a description of its components. The finance charge disclosure is preempted in those transactions in which the amount of the finance charge is different from the fed­ eral amount, since in such transactions the state law requires the use of the same term as the federal law to represent a different amount. The requirement to describe or itemize the components of the finance charge, which is also included in these pro­ visions, is not preempted.

• Sections 520.07(2)(h) and 520.34(2)(h)— Disclosure of total of payments. The total of payments disclosure is preempted in those transactions in which the amount dif­ fers from the amount of the federal total of payments, since in such transactions the state law requires the use of the same term as the federal law to represent a different amount from the federal law. . Sections 520.07(2)(i) and 520.34(2)(i)— Disclosure of deferred payment price. This disclosure is preempted in those transac­ tions in which the amount is the same as the federal total sale price, since in such transactions the state law requires the use of a different term from the federal law to represent the same amount as the federal law.

10. Preemption determination—Missouri. Ef­ fective October 1, 1983, the Board has deter­ mined that the following provisions in the state law of Missouri are preempted by the federal law:

. Sections 365.070-6(9) and 408.260-5(6)— Disclosure of principal balance. This dis­ closure is preempted in those transactions in which the amount of the principal bal­ ance is the same as the federal amount fi­ nanced, since in such transactions the state law requires the use of a term different from the federal term to represent the same amount.

• Sections 365.070-6(10) and 408.260- 5(7)—Disclosure of time price differential and time charge, respectively. These dis­ closures are preempted in those transac­ tions in which the amount is the same as the federal finance charge, since in such transactions the state law requires the use of a term different from the federal law to represent the same amount.

• Sections 365.070-2 and 408.260-2—Use of the terms “time price differential” and “time charge” in certain notices to the buyer. In those transactions in which the state disclosure of the time price differen­ tial or time charge is preempted, the use of the terms in this notice also is preempted. The notice itself is not preempted. • Sections 365.070-6(11) and 408.260- 5(8)—Disclosure of time balance. The time balance disclosure is preempted in those transactions in which the amount is the same as the amount of the federal total of payments, since in such transactions the state law requires the use of a different term from the federal law to represent the same amount.

• Sections 365.070-6(12) and 408.260- 5(9)—Disclosure of time sale price. This disclosure is preempted in those transac­ tions in which the amount is the same as the federal total sale price, since in such transactions the state law requires the use of a different term from the federal law to represent the same amount.

11. Preemption determination—Mississippi. Effective October 1, 1984, the Board has de­ termined that the following provision in the state law of Mississippi is preempted by the federal law:

• Section 63-19-31 (2)(g)—Disclosure of fi­ nance charge. This disclosure is preempted in those cases in which the term “finance charge” would be used under state law to describe a different amount than the fi­ nance charge disclosed under federal law. 12. Preemption determination—South Caro­ lina. Effective October 1, 1984, the Board has determined that the following provision in the state law of South Carolina is preempted by the federal law:

• Section 37-10-102(c)—Disclosure of due- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 160

§ 226.28 Regulation Z Commentary on-sale clause. This provision is preempted, but only to the extent that the creditor is required to include the disclosure with the segregated federal disclosures. If the credi­ tor may comply with the state law by plac­ ing the due-on-sale notice apart from the federal disclosures, the state law is not preempted.

13. Preemption determination—Arizona. Ef­ fective October 1, 1986, the Board has deter­ mined that the following provision in the state law of Arizona is preempted by the federal law:

• Section 6-621A.2—Use of the term “the total sum of $_______ ” in certain notices provided to borrowers. This term describes the same item that is disclosed under feder­ al law as the “total of payments.” Since the state law requires the use of a different term than federal law to describe the same item, the state-required term is preempted. The notice itself is not preempted. (Note: The state disclosure notice that incor­ porated the above preempted term was amended on May 4, 1987, to provide that dis­ closures must now be made pursuant to the federal disclosure provisions.) 14. Preemption determination—Indiana. Ef­ fective October 1, 1988, the Board has deter­ mined that the following provision in the state law of Indiana is preempted by the federal law:

• Section 23-2-5-8—Inclusion of the loan broker’s fees and charges in the calculation of, among other items, the finance charge and annual percentage rate disclosed to po­ tential borrowers. This disclosure is incon­ sistent with sections 106(a) and 226.4(a) of the federal statute and regulation, respec­ tively, and is preempted in those instances where the use of the same term would dis­ close a different amount than that required to be disclosed under federal law. 15. Preemption determination—Wisconsin. Ef­ fective October 1, 1991, the Board has deter­ mined that the following provisions in the state law of Wisconsin are preempted by the federal law:

• Section 422.308(1)—The disclosure of the annual percentage rate in cases where the amount of the annual percentage rate dis­ closed to consumers under the state law differs from the amount that would be dis­ closed under federal law, since in those cases the state law requires the use of the same term as the federal law to represent a different amount than the federal law. • Section 766.565(5)—The provision permit­ ting a creditor to include in an open-end home-equity agreement authorization to de­ clare the account balance due and payable upon receiving notice of termination from a non-obligor spouse, since such provision is inconsistent with the purpose of the federal law.

28(b) Equivalent Disclosure Requirements 1. General. A state disclosure may be substi­ tuted for a federal disclosure only after the Board has made a finding of substantial simi­ larity. Thus, the creditor may not unilaterally choose to make a state disclosure in place of a federal disclosure, even if it believes that the state disclosure is substantially similar. Since the rule stated in section 226.28(b) does not extend to any requirement relating to the finance charge or annual percentage rate, no state provision on computation, description, or disclosure of these terms may be substituted for the federal provision.

28(d) Special Rule for Credit and Charge Cards 1. General. The standard that applies to pre­ emption of state laws as they affect transac­ tions of the type subject to sections 226.5a and 226.9(e) differs from the preemption stan­ dards generally applicable under the Truth in Lending Act. The Fair Credit and Charge Card Disclosure Act fully preempts state laws relating to the disclosure of credit information in consumer credit or charge card applications or solicitations. (For purposes of this section, a single credit or charge card application or solicitation that may be used to open either an account for consumer purposes or an account for business purposes is deemed to be a “con­ sumer credit or charge card application or so- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 161

Regulation Z Commentary § 226.29 O licitation.”) For example, a state law requiring disclosure of credit terms in direct-mail solici­ tations for consumer credit card accounts is preempted. A state law requiring disclosures in telephone applications for consumer credit card accounts also is preempted, even if it ap­ plies to applications initiated by the consumer rather than the issuer, because the state law relates to the disclosure of credit information in applications or solicitations within the gen­ eral field of preemption, that is, consumer credit and charge cards.

2. Limitations on field of preemption. Preemp­ tion under the Fair Credit and Charge Card Disclosure Act does not extend to state laws applying to types of credit other than openend consumer credit and charge card accounts. Thus, for example, a state law is not pre­ empted as it applies to disclosures in credit and charge card applications and solicitations solely for business-purpose accounts. On the other hand, state credit disclosure laws will not apply to a single application or solicitation O to open either an account for consumer pur­ poses or an account for business purposes. Such “dual purpose” applications and solicita­ tions are treated as “consumer credit or © charge card applications or solicitations” under this section and state credit disclosure laws applicable to them are preempted. Pre­ emption under this statute does not extend to state laws applicable to home-equity plans; preemption determinations in this area are based on the Home Equity Loan Consumer Protection Act, as implemented in section 226.5b of the regulation.

V ■ c 3. Laws not preempted. State laws relating to disclosures concerning credit and charge cards other than in applications, solicitations, or re­ newal notices are not preempted under section 226.28(d). In addition, state laws regulating the terms of credit and charge card accounts are not preempted, nor are laws preempted that regulate the form or content of informa­ tion unrelated to the information required to be disclosed under sections 226.5a and 226.9(e). Finally, state laws concerning the enforcement of the requirements of sections 226.5a and 226.9(e) and state laws prohibiting unfair or deceptive acts or practices concern­ ing credit and charge card applications, solici­ tations and renewals are not preempted. Ex­ amples of laws that are not preempted include:

• A state law that requires card issuers to offer a grace period or that prohibits cer­ tain fees in credit and charge card transac­ tions.

• A state retail-installment-sales law or a state plain-language law, except to the ex­ tent that it regulates the disclosure of credit information in applications, solicitations, and renewals of accounts of the type sub­ ject to sections 226.5a and 226.9(e). • A state law requiring notice of a consum­ er’s rights under antidiscrimination or simi­ lar laws or a state law requiring notice about credit information available from state authorities.

References Statute: §§ 111 and 171(a) and (c) Other sections: Appendix A Previous regulation: § 226.6(b) and (c), and interpretation § 226.604 1981 changes: Section 226.28 implements amended section 111 of the act. The test for preemption of state laws relating to disclosure and advertising is now whether the state law “contradicts” the federal, rather than whether state requirements are “different.” The revised regulation contains no counter­ part to section 226.6(c) of the previous regula­ tion concerning placement of inconsistent dis­ closures. It also reflects the statutory amendment providing that once the Board de­ termines that a state-required disclosure is in­ consistent with federal law, the creditor may not make the state disclosure. SECTION 226.29— State Exemptions 29(a) General Rule 1. Classes eligible. The state determines the classes of transactions for which it will re­ quest an exemption and makes its application for those classes. Classes might be, for exam­ ple, all open-end credit transactions, all openend and closed-end transactions, or all trans­ actions in which the creditor is a bank. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 162

§ 226.29 Regulation Z Commentary 2. Substantial similarity. The “substantially similar” standard requires that state statutory or regulatory provisions and state interpreta­ tions of those provisions be generally the same as the federal act and Regulation Z. This includes the requirement that state provisions for reimbursement to consumers for over­ charges be at least equivalent to those re­ quired in section 108 of the act. A state will be eligible for an exemption even if its law covers classes of transactions not covered by the federal law. For example, if a state’s law covers agricultural credit, this will not prevent the Board from granting an exemption for consumer credit, even though agricultural credit is not covered by the federal law. 3. Adequate enforcement. The standard requir­ ing adequate provision for enforcement gener­ ally means that appropriate state officials must be authorized to enforce the state law through procedures and sanctions comparable to those available to federal enforcement agencies. Fur­ thermore, state law must make adequate pro­ vision for enforcement of the reimbursement rules.

4. Exemptions granted. Effective October 1, 1982, the Board has granted the following ex­ emptions from portions of the revised Truth in Lending Act:

• Maine. Credit or lease transactions subject to the Maine Consumer Credit Code and its implementing regulations are exempt from chapters 2, 4 and 5 of the federal act. (The exemption does not apply to transac­ tions in which a federally chartered institu­ tion is a creditor or lessor.) • Connecticut. Credit transactions subject to the Connecticut Truth in Lending Act are exempt from chapters 2 and 4 of the feder­ al act. (The exemption does not apply to transactions in which a federally chartered institution is a creditor.) • Massachusetts. Credit transactions subject to the Massachusetts Truth in Lending Act are exempt from chapters 2 and 4 of the federal act. (The exemption does not apply to transactions in which a federally chartered institution is a creditor.) • Oklahoma. Credit or lease transactions sub­ ject to the Oklahoma Consumer Credit Code are exempt from chapters 2 and 5 of the federal act. (The exemption does not apply to sections 132 through 135 of the federal act, nor does it apply to transac­ tions in which a federally chartered institu­ tion is a creditor or lessor.) • Wyoming. Credit transactions subject to the Wyoming Consumer Credit Code are ex­ empt from chapter 2 of the federal act. (The exemption does not apply to transac­ tions in which a federally chartered institu­ tion is a creditor.) 29(b) Civil Liability 1. Not eligible for exemption. The provision that an exemption may not extend to sections 130 and 131 of the act assures that consumers retain access to both federal and state courts in seeking damages or civil penalties for vio­ lations, while creditors retain the defenses specified in those sections. References Statute: §§ 108, 123, and 171(b) Other sections: Appendix B Previous regulation: § 226.12 1981 changes: The procedures that states must follow to seek exemptions are now located in an appendix. Exemptions under the previous regulation will be automatically revoked on April 1, 1982, when compliance with the new regulation is mandatory.

SECTION 226.30—Limitation on Rates 1. Scope of coverage. The requirement of this section applies to consumer credit obligations secured by a dwelling (as “dwelling” is de­ fined in section 226.2(a)(19)) in which the an­ nual percentage rate may increase after con­ summation (or during the term of the plan, in the case of open-end credit) as a result of an increase in the interest rate component of the finance charge—whether those increases are tied to an index or formula or are within a creditor’s discretion. The section applies to credit sales as well as loans. Examples of credit obligations subject to this section include:

• Dwelling-secured credit obligations that re- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 163

Regulation Z Commentary § 226.30 quire variable-rate disclosures under the regulation because the interest rate may in­ crease during the term of the obligation. • Dwelling-secured open-end credit plans en­ tered into before November 7, 1989 (the effective date of the home-equity rules) that are not considered variable-rate obliga­ tions for purposes of disclosure under the regulation but where the creditor reserves the contractual right to increase the interest rate—periodic rate and corresponding an­ nual percentage rate—during the term of the plan.

In contrast, credit obligations in which there is no contractual right to increase the interest rate during the term of the obligation are not subject to this section. Examples include: • “Shared-equity” or “shared-appreciation” mortgage loans that have a fixed rate of interest and a shared-appreciation feature based on the consumer’s equity in the mortgaged property. (The appreciation share is payable in a lump sum at a speci­ fied time.) • Dwelling-secured fixed-rate closed-end bal­ loon-payment mortgage loans and dwell­ ing-secured fixed-rate open-end plans with a stated term that the creditor may renew at maturity. (Contrast with the renewable balloon-payment instrument described in comment 17(c)(l)-ll.) • Dwelling-secured fixed-rate closed-end multiple-advance transactions in which each advance is disclosed as a separate transaction.

• “Price-level-adjusted mortgages” or other indexed mortgages that have a fixed rate of interest but provide for periodic adjust­ ments to payments and the loan balance to reflect changes in an index measuring prices or inflation.

The requirement of this section does not apply to credit obligations entered into prior to De­ cember 9, 1987. Consequently, new advances under open-end credit plans existing prior to December 9, 1987, are not subject to this section.

2. Refinanced obligations. On or after Decem­ ber 9, 1987, when a credit obligation is refi­ nanced, as defined in section 226.20(a), the new obligation is subject to this section if it is dwelling-secured and allows for increases in the interest rate.

3. Assumptions. On or after December 9, 1987, when a credit obligation is assumed, as defined in section 226.20(b), the obligation becomes subject to this section if its is dwell­ ing-secured and allows for increases in the in­ terest rate.

4. Modifications of obligations. The modifica­ tion of an obligation, regardless of when the obligation was entered into, is generally not covered by this section. For example, increas­ ing the credit limit on a dwelling-secured, open-end plan with a variable interest rate en­ tered into before the effective date of the rule does not make the obligation subject to this section. If, however, a security interest in a dwelling is added on or after December 9, 1987, to a credit obligation that allows for in­ terest rate increases, the obligation becomes subject to this section. Similarly, if a varia­ ble-interest rate feature is added to a dwell­ ing-secured credit obligation, the obligation becomes subject to this section. 5. Land trusts. In some states, a land trust is used in residential real estate transactions. (See discussion in comment 3(a)-8).) If a con­ sumer-purpose loan that allows for interest rate increases is secured by an assignment of a beneficial interest in a land trust that holds title to a consumer’s dwelling, that loan is subject to this section.

6. Relationship to other sections. Unless oth­ erwise provided for in the commentary to this section, other provisions of the regulation such as definitions, exemptions, rules, and in­ terpretations, also apply to this section where appropriate. To illustrate:

• An adjustable-interest-rate business-purpose loan is not subject to this section even if the loan is secured by a dwelling because such credit extensions are not subject to the regulation. (See generally section 226.3(a).) • Creditors subject to this section are only those that fall within the definition of a creditor in section 226.2(a)(17). 7. Consumer credit contract. Creditors are re­ quired to specify a lifetime maximum interest Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 164

§ 226.30 Regulation Z Commentary rate in their credit contracts—the instrument that creates personal liability and generally contains the terms and conditions of the agreement (for example, a promissory note or home-equity line of credit agreement). In some states, the signing of a commitment let­ ter may create a binding obligation, for exam­ ple, constituting “consummation” as defined in section 226.2(a)(13). The maximum interest rate must be included in the credit contract, but a creditor may include the rate ceiling in the commitment instrument as well. 8. Manner of stating the maximum interest rate. The maximum interest rate must be stated in the credit contract either as a specific amount or in any other manner that would al­ low the consumer to easily ascertain, at the time of entering into the obligation, what the rate ceiling will be over the term of the obli­ gation. For example, the following statements would be sufficiently specific: • The maximum interest rate will not exceed X%.

• The interest rate will never be higher than X percentage points above the initial rate of Y%.

• The interest rate will not exceed X%, or X percentage points above [a rate to be deter­ mined at some future point in time], whichever is less.

• The maximum interest rate will not exceed X%, or the state usury ceiling, whichever is less.

The following statements would not comply with this section:

• The interest rate will never be higher than X percentage points over the prevailing market rate.

• The interest rate will never be higher than X percentage points above [a rate to be de­ termined at some future point in time]. • The interest rate will not exceed the state usury ceiling, which is currently X%. A creditor may state the maximum rate in terms of a maximum annual percentage rate that may be imposed. Under an open-end credit plan, this normally would be the corre­ sponding annual percentage rate. (See gener­ ally section 226.6(a)(2).) 9. Multiple interest rate ceilings. Creditors are not prohibited from setting multiple interest rate ceilings. For example, on loans with mul­ tiple variable-rate features, creditors may es­ tablish a maximum interest rate for each fea­ ture. To illustrate, in a variable-rate loan that has an option to convert to a fixed rate, a creditor may set one maximum interest rate for the initially imposed index-based variablerate feature and another for the conversion op­ tion. Of course, a creditor may establish one maximum interest rate applicable to all features.

10. Interest rate charged after default. State law may allow an interest rate after default higher than the contract rate in effect at the time of default; however, the interest rate after default is subject to a maximum interest rate set forth in a credit obligation that is other­ wise subject to this section. This rule applies only in situations in which a post-default agreement is still considered part of the origi­ nal obligation.

11. Increasing the maximum interest rate—general rule. Generally, a creditor may not increase the maximum interest rate origi­ nally set on a credit obligation subject to this section unless the consumer and the creditor enter into a new obligation. Therefore, under an open-end plan, a creditor may not increase the rate ceiling imposed merely because there is an increase in the credit limit. If an openend plan is closed and another opened, a new rate ceiling may be imposed. Furthermore, where an open-end plan has a fixed maturity and a creditor renews the plan at maturity, or enters into a closed-end credit transaction, a new maximum interest rate may be set at that time. If the open-end plan provides for a re­ payment phase, the maximum interest rate cannot be increased when the repayment phase begins unless the agreement provided for such an increase. For a closed-end credit transaction, a new maximum interest rate may be set only if the transaction is satisfied and replaced by a new obligation. (The exceptions in section 226.20(a)( 1)—(5) which limit what transactions are considered refinancings for purposes of disclosure do not apply with re­ spect to increasing a rate ceiling that has been Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 165

Regulation Z Commentary Appendix B imposed; if a transaction is satisfied and re­ placed, the rate ceiling may be increased.) 12. Increasing the maximum interest rate—assumption of an obligation. If an obli­ gation subject to this section is assumed by a new obligor and the original obligor is re­ leased from liability, the maximum interest rate set on the obligation may be increased as part of the assumption agreement. (This rule applies whether or not the transaction consti­ tutes an assumption as defined in section 226.20(b).) 13. Transition rules. Under footnote 50, if creditors properly include the maximum rate in their credit contracts, creditors need not re­ vise their truth in lending disclosure statement forms to add the disclosures about limitations on rate increases as part of the variable-rate disclosures, until October 1, 1988. On or after that date, creditors must have the maximum rate set forth in their credit contracts and, where applicable, as part of their truth in lending disclosures in the manner prescribed in the applicable sections of the regulation. References Statute: Competitive Equality Banking Act of 1987, Pub. L. No. 100-86, 101 Stat. 552 Other sections: §§ 226.6, 226.18, and 226.19 Previous regulation: None 1987 changes: This section implements sec­ tion 1204 of the Competitive Equality Bank­ ing Act of 1987, Pub. L. No. 100-86, 101 Stat. 552, which provides that, effective De­ cember 9, 1987, adjustable-rate mortgages must include a limitation on the interest rate that may apply during the term of the mort­ gage loan. An adjustable-rate mortgage loan is defined in section 1204 as “any loan secured by a lien on a one-to-four family dwelling unit, including a condominium unit, coopera­ tive housing unit, or mobile home, where the loan is made pursuant to an agreement under which the creditor may, from time to time, adjust the rate of interest.” The rule in this section incorporates section 1204 into Regula­ tion Z and limits the scope of section 1204 to dwelling-secured consumer credit subject to the Truth in Lending Act, in which a creditor has the contractual right to increase the inter­ est rate during the term of the credit obligation.

APPENDIX A—Effect on State Laws 1. Who may make requests. Appendix A sets forth the procedures for preemption determi­ nations. As discussed in section 226.28, which contains the standards for preemption, a re­ quest for a determination of whether a state law is inconsistent with the requirements of chapters 1, 2, or 3 may be made by creditors, states, or any interested party. However, only states may request and receive determinations in connection with the fair credit billing pro­ visions of chapter 4.

References Statute: §§111 and 171(a) Other sections: § 226.28 Previous regulation: §§ 226.6(b) and 226.70 (supplement V, § II) 1981 changes: The procedures in appendix A were largely adapted from supplement V, sec­ tion II of the previous regulation (§ 226.70), with changes made to streamline the procedures.

APPENDIX B— State Exemptions 1. General. Appendix B sets forth the proce­ dures for exemption applications. The exemp­ tion standards are found in section 226.29 and are discussed in the commentary to that section.

References Statute: §§ 123 and 171(b) Other sections: § 226.29 Previous regulation: §§ 226.12, 226.50 (sup­ plement II), 226.60 (supplement IV), and 226.70 (supplement V, § I) 1981 changes: The procedures in appendix B represent a combination and streamlining of the procedures set forth in the supplements to the previous regulation.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 166

Appendix C Regulation Z Commentary APPENDIX C—Issuance of Staff Interpretations 1. General. This commentary is the vehicle for providing official staff interpretations. In­ dividual interpretations generally will not be issued separately from the commentary. References Statute: §§ 105 and 130(f) Other sections: None Previous regulation: § 226.1(d) 1981 changes: Appendix C reflects the Board’s intention that this commentary serve as the vehicle for interpreting the regulation, rather than individual interpretive letters. APPENDIX D— Multiple-Advance Construction Loans 1. General rule. Appendix D provides a spe­ cial procedure that creditors may use, at their option, to estimate and disclose the terms of multiple-advance construction loans when the amounts or timing of advances is unknown at consummation of the transaction. This appen­ dix reflects the approach taken in section 226.17(c)(6)(ii), which permits creditors to provide separate or combined disclosures for the construction period and for the permanent financing, if any; i.e., the construction phase and the permanent phase may be treated as one transaction or more than one transaction. Appendix D may also be used in multipleadvance transactions other than construction loans, when the amounts or timing of ad­ vances is unknown at consummation. 2. Variable-rate multiple-advance loans. The hypothetical disclosure required in variablerate transactions by section 226.18(f)(l)(iv) is not required for multiple-advance loans dis­ closed pursuant to appendix D, part I. 3. Calculation of the total of payments. When disclosures are made pursuant to appendix D, the total of payments may reflect either the sum of the payments or the sum of the amount financed and the finance charge. 4. Annual percentage rate. Appendix D does not require the use of volume I of the Board’s Annual Percentage Rate Tables for calculation of the annual percentate rate. Creditors utiliz­ ing appendix D in making calculations and disclosures may use other computation tools to determine the estimated annual percentage rate, based on the finance charge and payment schedule obtained by use of the appendix. 5. Interest reserves. In a multiple-advance construction loan, a creditor may establish an “interest reserve” to ensure that interest is paid as it accrues by designating a portion of the loan to be used for paying the interest that accrues on the loan. An interest reserve is not treated as a prepaid finance charge, whether the interest reserve is the same as or different from the estimated interest figure calculated under appendix D.

• If a creditor permits a consumer to make interest payments as they become due, the interest reserve should be disregarded in the disclosures and calculations under ap­ pendix D.

• If a creditor requires the establishment of an interest reserve and automatically de­ ducts interest payments from the reserve amount rather than allow the consumer to make interest payments as they become due, the fact that interest will accrue on those interest payments as well as the other loan proceeds must be reflected in the cal­ culations and disclosures. To reflect the ef­ fects of such compounding, a creditor should first calculate interest on the com­ mitment amount (exclusive of the interest reserve) and then add the figure obtained by assuming that one-half of that interest is outstanding at the contract interest rate for the entire construction period. For example, using the example shown under paragraph A, part I of appendix D, the estimated in­ terest would be $1,117.68 ($1093.75 plus an additional $23.93 calculated by assum­ ing half of $1093.75 is outstanding at the contract interest rate for the entire con­ struction period), and the estimated annual percentage rate would be 21.18 percent. References Statute: None Other sections: §§ 226.17 and 226.22 Previous regulation: Interpretation § 226.813 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 167

Regulation Z Commentary Appendix G 1981 changes: The use of appendix D is lim- O ited to multiple-advance loans for construction purposes or analogous types of transactions. APPENDIX E—Rules for Card Issuers That Bill on a Transaction-by- Transaction Basis Statute: None Previous regulation: Interpretation § 226.709 Other sections: §§ 226.6 through 226.13, and 226.15 1981 changes: The rules in this appendix have been streamlined and clarified to indicate how certain card issuers that bill on a transaction basis may comply with the requirements of subpart B.

APPENDIX F—Annual Percentage Rate Computations for Certain Open-End Credit Plans 1. Daily rate with specific transaction charge. If the finance charge results from a charge re­ lating to a specific transaction and the applica­ tion of a daily periodic rate, see comment 14(c)-6 for guidance on an appropriate calcu­ lation method.

References Statute: § 107 Previous regulation: § 226.5(a)(3)(ii), footnote 5(a) ■» Other sections: § 226.14 1981 changes: This appendix incorporates a sixth example in which the transaction amount exceeds the amount of the balance subject to the periodic rate.

APPENDIXES G AND H—Open-End and Closed-End Model Forms and Clauses 1. Permissible changes. Although use of the o model forms and clauses is not required, cred­ itors using them properly will be deemed to be in compliance with the regulation with re­ gard to those disclosures. Creditors may make certain changes in the format or content of the forms and clauses and may delete any disclo­ sures that are inapplicable to a transaction or a plan without losing the act’s protection from liability. The rearrangement of the model forms and clauses may not be so extensive as to affect the substance, clarity, or meaningful sequence of the forms and clauses. Creditors making revisions with that effect will lose their protection from civil liability. Acceptable changes include, for example: • Using the first person, instead of the sec­ ond person, in referring to the borrower • Using “borrower” and “creditor” instead of pronouns • Rearranging the sequences of the disclo­ sures • Not using bold type for headings • Incorporating certain state “plain English” requirements • Deleting inapplicable disclosures by whit­ ing out, blocking out, filling in “N/A” (not applicable) or “0,” crossing out, leaving blanks, checking a box for applicable items, or circling applicable items. (This should permit use of multipurpose standard forms.) • Substituting appropriate references, such as “bank,” “we,” or a specific name, for “creditor” in the initial open-end dis­ closures • Using a vertical, rather than a horizontal, format for the boxes in the closed-end dis­ closures APPENDIX G—Open-End Model Forms and Clauses 1. Model G-l. The model disclosures in G-l (different balance computation methods) may be used in both the initial disclosures under section 226.6 and the periodic disclosures under section 226.7. As is clear from the models given, “shorthand” descriptions of the balance computation methods are not suffi­ cient. The phrase “a portion o f’ the finance charge should be included if the total finance charge includes other amounts, such as trans­ action charges, that are not due to the applica­ tion of a periodic rate. In addition, if unpaid finance charges are subtracted in calculating the balance, that fact must be stated so that the disclosure of the computation method is Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 168

Appendix G Regulation Z Commentary accurate. Only model G-l(b) contains a final sentence appearing in brackets which reflects the total dollar amount of payments and cred­ its received during the billing cycle. The other models do not contain this language because they reflect plans in which payments and cred­ its received during the billing cycle are sub­ tracted. If this is not the case, however, the language relating to payments and credits should be changed, and the creditor should add either the disclosure of the dollar amount as in model G-l(b) or an indication of which credits (disclosed elsewhere on the periodic statement) will not be deducted in determining the balance. (Such an indication may also sub­ stitute for the bracketed sentence in model G- 1(b).) (See the commentary to section 226.7(e).) 2. Model G-2. This model contains the notice of liability for unauthorized use of a credit card.

3. Models G-3 and G-4. These set out mod­ els for the long-form billing-error rights state­ ment (for use with the initial disclosures and as an annual disclosure or, at the creditor’s option, with each periodic statement) and the alternative billing-error rights statement (for use with each periodic statement), respec­ tively. Creditors must provide the billing-error rights statements in a form substantially simi­ lar to the models in order to comply with the regulation. The model billing-rights statements may be modified in any of the ways set forth in the first paragraph to the commentary on appendixes G and H. The models may, fur­ thermore, be modified by deleting inapplicable information, such as:

• The paragraph concerning stopping a debit in relation to a disputed amount, if the creditor does not have the ability to debit automatically the consumer’s savings or checking account for payment • The rights stated in the special rule for credit card purchases and any limitations on those rights The model billing rights statements also con­ tain optional language that creditors may use. For example, the creditor may: • Include a statement to the effect that notice of a billing error must be submitted on something other than the payment ticket or other material accompanying the periodic disclosures • Insert its address or refer to the address that appears elsewhere on the bill Additional information may be included on the statements as long as it does not detract from the required disclosures. For instance, in­ formation concerning the reporting of errors in connection with a checking account may be included on a combined statement as long as the disclosures required by the regulation re­ main clear and conspicuous.

4. Models G-5 through G-9. These models set out notices of the right to rescind that would be used at different times in an open-end plan. The last paragraph of each of the rescission model forms contains a blank for the date by which the consumer’s notice of cancellation must be sent or delivered. A parenthetical is included to address the situation in which the consumer’s right to rescind the transaction ex­ ists beyond three business days following the/ date of the transaction, for example, when the notice or material disclosures are delivered late or when the date of the transaction in paragraph 1 of the notice is an estimate. Th^ language of the parenthetical is not optional. See the commentary to section 226.2(a)(25) regarding the specificity of the security-inter­ est disclosure for model form G-7. 5. Models G- 10(A) through G- 10(C). Models G-10(A) and G- 10(B) illustrate the tabular format for providing the disclosures required under section 226.5a for applications and so­ licitations for credit cards other than charge cards. Model G-10(A) illustrates the permissi­ ble inclusion in the tabular format of all of the disclosures. Model G-10(B) contains only the disclosures required to be included in the table, while the three additional disclosures are shown outside of the table. The two forms also illustrate two different levels of detail in disclosing the grace period, and different ar­ rangements of the disclosures. Model G-10(C illustrates the tabular format disclosure for charge card applications and solicitations and reflects all of the disclosures in the table. Dis­ closures may be arranged in an order different Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 169

Regulation Z Commentary Appendix H from that in model forms G-10(A), (B), and (C); may be arranged vertically or horizon­ tally; need not be highlighted aside from be­ ing included in the table; and are not required to be in any particular type size. Various fea­ tures from different model forms may be com­ bined; for example, the shorter grace-period disclosure in model form G-10(B) may be used in any disclosure. While proper use of the model forms will be deemed in compli­ ance with the regulation, card issuers are per­ mitted to use headings and disclosures other than those in the forms (with an exception re­ lating to the use of “grace period”) if they are clear and concise and are substantially similar to the headings and disclosures con­ tained in model forms. For further discussion of requirements relating to form, see the com­ mentary to section 226.5a(a)(2). 6. Models G-ll and G-12. Model G-ll con­ tains clauses that illustrate the general disclo­ sures required under section 226.5a(e) in ap­ plications and solicitations made available to the general public. Model G-12 is a model clause for the disclosure required under sec­ tion 226.5a(f) when a charge card accesses an open-end plan offered by another creditor. Models G-13(A) and G-13(B). These model forms illustrate the disclosures required under section 226.9(f) when the card issuer changes the entity providing insurance on a credit card account. Model G-13(A) contains the items set forth in section 226.9(f)(3) as examples of significant terms of coverage that may be af­ fected by the change in insurance provider. The card issuer may either list all of these potential changes in coverage and place a check mark by the applicable changes, or list only the actual changes in coverage. Under either approach, the card issuer must either explain the changes or refer to an accompany­ ing copy of the policy or group certificate for details of the new terms of coverage. Model G-13(A) also illustrates the permissible com­ bination of the two notices required by section ' 226.9(f)—the notice required for a planned :hange in provider and the notice required once a change has occurred. This form may be modified for use in providing only the dis­ closures required before the change if the card issuer chooses to send two separate notices. Thus, for example, the references to the at­ tached policy or certificate would not be re­ quired in a separate notice prior to a change in the insurance provider since the policy or certificate need not be provided at that time. Model G-13(B) illustrates the disclosures re­ quired under section 226.9(f)(2) when the in­ surance provider is changed. APPENDIX H—Closed-End Model Forms and Clauses 1. Models H-l and H-2. Creditors may make several types of changes to closed-end model forms H-l (credit sale) and H-2 (loan) and still be deemed to be in compliance with the regulation, provided that the required disclo­ sures are made clearly and conspicuously. Permissible changes include the addition of the information permitted by footnote 37 to section 226.17 and “directly related” informa­ tion as set forth in the commentary to section 226.17(a).

The creditor may also delete or, on multi­ purpose forms, indicate inapplicable disclo­ sures, such as:

• The itemization of the amount financed op­ tion (See samples H-l2 through H-l5.) • The credit life and disability insurance dis­ closures (See samples H-ll and H-l2.) • The property insurance disclosures (See samples H-10 through H-l2, and H-l4.) • The “filing fees” and “nonfiling insur­ ance” disclosures (See samples H-ll and H-l 2.) • The prepayment penalty or rebate disclo­ sures (See samples H-l2 and H-14.) • The total sale price (See samples H-ll through H-l5.) Other permissible changes include: • Adding the creditor’s address or telephone number (See the commentary to section 226.18(a).) • Combining required terms where several numerical disclosures are the same, for in­ stance, if the “total of payments” equals the “total sale price” (See the commentary to section 226.18.) • Rearranging the sequence or location of the disclosures—for instance, by placing the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 170

Appendix H Regulation Z Commentary descriptive phrases outside the boxes con­ taining the corresponding disclosures, or by grouping the descriptors together as a glos­ sary of terms in a separate section of the segregated disclosures; by placing the pay­ ment schedule at the top of the form; or by changing the order of the disclosures in the boxes, including the annual percentage rate and finance charge boxes • Using brackets, instead of checkboxes, to indicate inapplicable disclosures • Using a line for the consumer to initial, rather than a checkbox, to indicate an elec­ tion to receive an itemization of the amount financed • Deleting captions for disclosures • Using a symbol, such as an asterisk, for estimated disclosures, instead of an “e” • Adding a signature line to the insurance disclosures to reflect joint policies • Separately itemizing the filing fees • Revising the late charge disclosure in ac­ cordance with the commentary to section 226.18(/) 2. Model H-3. Creditors have considerable flexibility in filling out model H-3 (itemization of the amount financed). Appropriate revi­ sions, such as those set out in the commentary to section 226.18(c), may be made to this form without loss of protection from civil lia­ bility for proper use of the model forms. 3. Models H-4 through H-7. The model clauses are not included in the model forms although they are mandatory for certain trans­ actions. Creditors using the model clauses when applicable to a transaction are deemed to be in compliance with the regulation with regard to that disclosure.

4. Model H-4(A). This model contains the va­ riable-rate model clauses applicable to transac­ tions subject to section 226.18(f)(1) and is in­ tended to give creditors considerable flexibility in structuring variable-rate disclo­ sures to fit individual plans. The information about circumstances, limitations, and effects of an increase may be given in terms of the contract interest rate or the annual percentage rate. Clauses are shown for hypothetical ex­ amples based on the specific amount of the transaction and based on a representative amount. Creditors may preprint the variablerate disclosures based on a representative amount for similar types of transactions, in­ stead of constructing an individualized exam­ ple for each transaction. In both representative examples and transaction-specific examples, creditors may refer either to the incremental change in rate, payment amount, or number of payments, or to the resulting rate, payment amount, or number of payments. For example, creditors may state that the rate will increase by 2 percent, with a corresponding $150 in­ crease in the payment, or creditors may state that the rate will increase to 16 percent, with a corresponding payment of $850. 5. Model H-4(B). This model clause illustrates the variable-rate disclosure required under sec­ tion 226.18(f)(2), which would alert consum­ ers to the fact that the transaction contains a variable-rate feature and that disclosures were provided earlier.

6. Model H-4(C). This model clause illus­ trates the early disclosures required generally under section 226.19(b). It includes informa­ tion on how the consumer’s interest rate is determined and how it can change over the term of the loan, and explains changes that may occur in the borrower’s monthly pay ment. The model clause also contains an ex­ ample of how to disclose historical changes in the index or formula values used to compute interest rates for the preceding 15 years. In addition, the model clause illustrates the dis­ closure of the initial and maximum interest rates and payments for a loan originated at the most recent rate shown in the historical example.

7. Model H-4(D). This model clause illus­ trates the adjustment notice required under section 226.20(c) and provides examples of payment-change notices and annual notices of interest rate changes.

8. Model H-5. This contains the demand fea­ ture clause.

9. Model H-6. This contains the assumptio clause.

10. Model H-7. This contains the required-deposit clause.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 171

Regulation Z Commentary Appendix H 11. Models H-8 and H-9. These models con­ tain the rescission notices for a typical closedend transaction and a refinancing, respectively. The last paragraph of each model form con­ tains a blank for the date by which the con­ sumer’s notice of cancellation must be sent or delivered. A parenthetical is included to ad­ dress the situation in which the consumer’s right to rescind the transaction exists beyond three business days following the date of the transaction, for example, where the notice or material disclosures are delivered late or where the date of the transaction in paragraph 1 of the notice is an estimate. The language of the parenthetical is not optional. See the commentary to section 226.2(a)(25) regarding the specificity of the security-interest disclo­ sure for model form H-9.

12. Sample forms. The sample forms (H-10 through H-15) serve a different purpose than the model forms. The samples illustrate vari­ ous ways of adapting the model forms to the individual transactions described in the com­ mentary to appendix H. The deletions and rearrangements shown relate only to the spe­ cific transactions described. As a result, the samples do not provide the general protection rom civil liability provided by the model forms and clauses.

13. Sample H-10. This sample illustrates an automobile credit sale. The cash price is $7,500 with a downpayment of $1,500. There is an 8 percent add-on interest rate and a term of three years, with 36 equal monthly pay­ ments. The credit life insurance premium and the filing fees are financed by the creditor. There is a $25 credit report fee paid by the consumer before consummation, which is a prepaid finance charge.

14. Sample H-ll. This sample illustrates an installment loan. The amount of the loan is $5,000. There is a 12 percent simple interest rate and a term of two years. The date of the transaction is expected to be April 15, 1981, with the first payment due on June 1, 1981. The first payment amount is labelled as an estimate since the transaction date is uncer­ tain. The odd days’ interest ($26.67) is col­ lected with the first payment. The remaining 23 monthly payments are equal. 15. Sample H-12. This sample illustrates a refinancing and consolidation loan. The amount of the loan is $5,000. There is a 15 percent simple interest rate and a term of three years. The date of the transaction is April 1, 1981, with the first payment due on May 1, 1981. The first 35 monthly payments are equal, with an odd final payment. The credit disability insurance premium is fi­ nanced. In calculating the annual percentage rate, the U.S. Rule has been used. Since an itemization of the amount financed is included with the disclosures, the statement regarding the consumer’s option to receive an itemiza­ tion is deleted.

16. Samples H-13 through H-15. These sam­ ples illustrate various mortgage transactions. They assume that the mortgages are subject to the Real Estate Settlement Procedures Act (RESPA). As a result, no option regarding the itemization of the amount financed has been included in the samples, because providing the good faith estimates of settlement costs re­ quired by RESPA satisfies Truth in Lending’s amount-financed itemization requirement. (See footnote 39 to section 226.18(c).) 17. Sample H-13. This sample illustrates a mortgage with a demand feature. The loan amount is $44,900, payable in 360 monthly installments at a simple interest rate of 14.75 percent. The 15 days of interim interest ($294.34) is collected as a prepaid finance charge at the time of consummation of the loan (April 15, 1981). In calculating the dis­ closure amounts, the minor-irregularities pro­ vision in section 226.17(c)(4) has been used. The property insurance premiums are not in­ cluded in the payment schedule. This disclo­ sure statement could be used for notes with the seven-year call option required by the Federal National Mortgage Association (FNMA) in states where due-on-sale clauses are prohibited.

18. Sample H-14. This sample disclosure form illustrates the disclosures under section 226.19(b) for a variable-rate transaction se­ cured by the consumer’s principal dwelling with a term greater than one year. The sample form shows a creditor how to adapt the model clauses in appendix H-4(C) to the creditor’s Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 172

Appendix H Regulation Z Commentary own particular variable-rate program. The sample disclosure form describes the features of a specific variable-rate mortgage program and alerts the consumer to the fact that infor­ mation on the creditor’s other closed-end vari­ able-rate programs is available upon request. It includes information on how the interest rate is determined and how it can change over time, and explains how the monthly payment can change based on a $10,000 loan amount, payable in 360 monthly installments, based on historical changes in the values for the weekly average yield on U.S. Treasury securities ad­ justed to a constant maturity of one year. In­ dex values are measured as of the first week ending in July for the years 1977 through 1987. This reflects the requirement that the in­ dex history be based on values for the same date or period each year beginning with index values for 1977. The sample disclosure also illustrates the requirement under section 226.19(b)(2)(x) that the initial and the maxi­ mum interest rates and payments be shown for a $10,000 loan originated at the most recent rate shown in the historical example. In the sample, the loan is assumed to have an initial interest rate of 9.71 percent (which was the interest rate in 1987 for the example shown) and to have 2 percentage point annual (and 5 percentage point overall) interest rate limita­ tions or caps. Thus, the maximum amount that the interest rate could rise under this program is 5 percentage points higher than the 9.71 percent initial rate to 14.71 percent, and the monthly payment could rise from $85.62 to a maximum of $123.31. The loan would not reach the maximum interest rate until its fourth year because of the 2 percentage point annual rate limitations, and the maximum pay­ ment disclosed reflects the amortization of the loan during that period. The sample form also illustrates how to provide consumers with a method for calculating their actual monthly payment for a loan amount other than $10,000.

19. Sample H-15. This sample illustrates a graduated payment mortgage with a five-year graduation period and a 772 percent yearly in­ crease in payments. The loan amount is $44,900, payable in 360 monthly installments at a simple interest rate of 14.75 percent. Two points ($898), as well as an initial mortgage guarantee insurance premium of $225.00, are included in the prepaid finance charge. The mortgage-guarantee insurance premiums are calculated on the basis of 74 of 1 percent of the outstanding principal balance under an an­ nual reduction plan. The abbreviated disclo­ sure permitted under section 226.18(g)(2) is used for the payment schedule for years 6 through 30. The prepayment disclosure refers to both penalties and rebates because informa­ tion about penalties is required for the simpleinterest portion of the obligation and informa­ tion about rebates is required for the mortgage insurance portion of the obligation. 20. HRSA-500-1 9-82. Pursuant to section 113(a) of the Truth in Lending Act, Form HRSA-500-1 9-82 issued by the U.S. Depart­ ment of Health and Human Services for cer­ tain student loans has been approved. The form may be used for all Health Education Assistance Loans (HEAL) with a variable in­ terest rate that are interim student credit ex­ tensions as defined in Regulation Z. 21. HRSA-500-2 9-82. Pursuant to section 113(a) of the Truth in Lending Act, Form HRSA-500-2 9-82 issued by the U.S. Depart­ ment of Health and Human Services for cer­ tain student loans has been approved. The form may be used for all HEAL loans with a fixed interest rate that are interim student credit extensions as defined in Regulation Z. 22. HRSA-502-1 9-82. Pursuant to section 113(a) of the Truth in Lending Act, Form HRSA-502-1 9-82 issued by the U.S. Depart­ ment of Health and Human Services for cer­ tain student loans has been approved. The form may be used for all HEAL loans with a variable interest rate in which the borrower has reached prepayment status and is making payments of both interest and principal. 23. HRSA-502-2 9-82. Pursuant to section 113(a) of the Truth in Lending Act, Form HRSA-502-2 9-82 issued by the U.S. Depart­ ment of Health and Human Services for cer­ tain student loans has been approved. The form may be used for all HEAL loans with a fixed interest rate in which the borrower has reached repayment status and is making pay­ ments of both interest and principal. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Page 173

Regulation Z Commentary Appendix J References Statute: §§ 105 and 130 Other sections: §§ 226.6, 226.7, 226.9, 226.12, 226.15, 226.18, and 226.23 Previous regulation: None 1981 changes: The model forms and clauses have no counterpart in the previous regulation. APPENDIX I—Federal Enforcement Agencies Statute: § 108 Other sections: None Previous regulation: § 226.1(b) 1981 changes: None APPENDIX J—Annual Percentage Rate Computations for Closed-End Credit Transactions 1. Use of appendix J. Appendix J sets forth the actuarial equations and instructions for calculating the annual percentage rate in closed-end credit transactions. While the for­ mulas contained in this appendix may be di­ rectly applied to calculate the annual percent­ age rate for an individual transaction, they nay also be utilized to program calculators and computers to perform the calculations. 2. Relation to Board tables. The Board’s An- < * nual Percentage Rate Tables also provide creditors with a calculation tool that applies the technical information in appendix J. An annual percentage rate computed in accor­ dance with the instructions in the tables is deemed to comply with the regulation. Vol­ ume I of the tables may be used for credit transactions involving equal payment amounts and periods, as well as for transactions involv­ ing any of the following irregularities: odd first period, odd first payment and odd last payment. Volume II of the tables may be used for transactions that involve any type of irreg­ ularities. These tables may be obtained from any Federal Reserve Bank or from the Board in Washington, D.C. 20551, upon request. References Statute: § 107 Other sections: § 226.22 Previous regulation: § 226.40 (supplement I) 1981 changes: Paragraph (b)(2) has been re­ vised to clarify that the term of the transaction never begins earlier than consummation of the transaction. Paragraph (b)(5)(vi) has been re­ vised to permit creditors in single-payment transactions in which the term is less than a year and is equal to a whole number of months, to use either the 12-month method or the 365-day method to compute the number of unit periods per year.

t Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis