May 2022 OBA Legal Briefs

• Please help us help you
• Lender credits on the TRID closing disclosure
• MLA and GAP
• Overdraft fees are not interest

Please help us help you

By Pauli D. Loeffler

You may have missed the notice on the Oklahoma Bankers Association’s webpage regarding issues the OBA Legal and Compliance team is experiencing with emails sent to us. Regardless of the fact that we hope to have the issue resolved shortly, we found that many bankers fail to provide vital contact information in their email signature blocks. This delays or prevents us from providing a quick response.

Specifically, the signature block needs to have not only your name and the name of the bank but also your email address, phone number (with extension, if any), and the city where you are located. There are times when a phone call to get additional information to answer a question is better than a series of emails. We certainly can look up the phone number for the main bank, but most banks have branches which results in making additional calls.

We appreciate your understanding and patience during the resolution of the email issue and look forward to answering your legal and compliance questions.

Lender credits on the TRID closing disclosure

By John S. Burnett

There are two types of lender credits that are disclosed under Regulation Z’s “TRID” disclosure requirements. In this discussion, we will review how those two types of lender credits should be used and disclosed.

First, however, let’s review what lender credits include. They are (1) payments, such as credits, rebates, and reimbursements, that a creditor provides to a consumer to offset closing costs the consumer will pay as part of the mortgage loan transaction; and (2) premiums in the form of cash that a creditor provides to a consumer in exchange for specific acts, such as for accepting a specific interest rate, or as an incentive, such as to attract consumers away from competing creditors.   (https://www.consumerfinance.gov/compliance/compliance-resources/mortgage-resources/tila-respa-integrated-disclosures/tila-respa-integrated-disclosure-faqs/#lender-credits)

Another way of separating lender credits into two types is to use the terms “specific lender credits” and “general lending credits.” These are the ways in which lender credits are disclosed that our discussion is focused on.

General lender credits

Your bank may decide, for example, that it will pay up to $1,000 in borrower third-party closing costs, without specifying which third-party costs are included. Because you want the lender credit to appear on the loan estimate, you show that lender credit as a negative amount in the estimated closing costs on page one and in section J on page 2. You also disclose your good faith estimates of closing costs for the loan your applicant has applied for – the origination charges, title work costs, taxes and recording fees, prepaids and all the rest –  that collectively will most likely be paid in connection with the loan, without indicating which of those costs your promised $1,000 will cover. The “calculating cash to close” box starts with the total closing costs reduced by the general lender credit, so it flows through to the Estimated Cash to Close – the approximation of what the applicant can expect to bring to (or receive from) the closing.

Note: Completing the loan estimate this way does present a risk that the closing costs to be covered end up totaling less than the general lender credit amount at closing time. Because lender credits are considered “negative closing costs,” a lender cannot reduce the general lender credit that appears on the loan estimate unless the lender credit is directly affected by a changed circumstance affecting the lender credit as part of the pricing of the loan. However, this is the usual way to complete a loan estimate when the lender intends to provide a general lender credit toward closing costs.

General lender credits for tolerance violations

We just discussed an example of a planned or intentional general lender credit. There’s also the chance that your bank will have to provide an unexpected general lender credit if its closing costs estimates fall short of the actual closing costs, and the differences are more than permitted under the tolerance limits in Regulation Z §§ 1026.19(e)(3)(i) and 1026.19(e)(3)(ii) — the zero percent and ten percent tolerance rules, respectively.

When a lender determines that it has exceeded the tolerance limits under either or both of those sections, it has to adjust the amount due to or from the consumer by the amount by which the tolerance limits were exceeded. A general lender credit (or an increase to a general lender credit already provided) is one way to get that done.

In such a case, the amount of the excess closing costs will appear (itself or as part of a Lender Credits amount) in three places on the closing disclosure:

1. On the Lender Credits line in section J on page 2, the amount of the excess closing costs will appear in parentheses in the label after the words “Lender Credits.” The statement in the parentheses will read “(Includes $XXX credit for increase in Closing Costs above legal limit)” and the total Lender Credit amount (including the excess closing costs and any other planned general lender credit) appears as a negative amount in the Borrower Paid At Closing column.
2. On the Total Closing Costs line of the Calculating Cash to Close table on page 3, if the actual closing costs exceed the estimated closing costs, and tolerance violations have occurred, the total amount of the tolerance violations will appear in a second bullet list entry in the “Did this change?” response, saying “Increase exceeds legal limits by $XXX. See Lender Credits on page 2.”
3. On page 1, on the Closing Costs line of the Costs at Closing table, the amount of the total tolerance violations (the amount to be credited in the general lender credit) appears as part of the Lender Credits after the minus sign and before the words “in Lender Credits,” so the statement to the right of the total closing costs figure reads: “Includes $XXXX.xx in Loan Costs + $XXXX.xx in Other Costs = $XXXX.xx in Lender Credits.”

Specific lender credits

If your bank wants to pay selected closing costs that consumers are typically charged as part of your residential mortgage lending strategy, there are two ways to prepare the loan estimate. You can simply omit those selected costs that the consumer will not be charged from the loan estimate completely (your applicants won’t be charged for these services, so they don’t have to be included on the loan estimate). Make sure you disclose any costs that the consumer will be charged (an application fee, for example).

Another way to complete the loan estimate is to include all the costs the lender estimates will be involved (including those the lender intends to absorb) and show a general lender credit. In that way, the consumer sees all those costs, but also sees the amount of those costs the lender plans to cover.

But this section is about specific lender credits, you’re thinking. That’s right, it is. Because when it’s time to issue the closing disclosure, you get down to specifics. For each loan cost or other cost on page 2 that the lender intends to cover, insert the amount of that cost in the Paid By Others column and (optionally) identify it as a lender credit by including “(L)” before the dollar amount (without the quotation marks, of course). That reduces the costs due from the consumer because there’s no cost for the service in the Borrower Paid column. You’ve correctly disclosed a specific lender credit. Now, do the same for each cost that the lender is absorbing.

Suppose that the loan estimate for the loan included a general lender credit. The total of specific lender credits and general lender credits on the closing disclosure must equal or exceed the amount of the general lender credit on the loan estimate. What do you do if you overestimated a cost on the loan estimate, or one of the services listed there was not used, and now your loan estimate has a general lender credit amount that’s $50 more than the total specific lender credits on the closing disclosure? You include a general lender credit of $50 on the closing disclosure in Section J on page 2 and in the Costs at Closing table at the bottom of page 1.

What about tolerance violations?

Earlier, we said that a lender can issue a loan estimate without including the costs that the lender intends to absorb. When it’s time for closing, you must include all costs, regardless of who pays them. We’ve described above the way to avoid tolerance violations, by putting the costs to be absorbed in the Paid by Others column on the closing disclosure.  Just to make it interesting, let’s assume that the lender did not intend to absorb the cost of the appraisal, and included that service on the loan estimate in section B as “not shoppable,” with a cost estimate of $750.  For whatever reason, the actual cost of the appraisal ends up at $900, and the lender did not elect to issue a revised loan estimate for a changed circumstance. So there is a $150 tolerance violation (it is a 0 percent tolerance service cost). Does the lender have to treat that as an “increase exceeding legal limits” and include that $150 in Section J and in the Costs at Closing table?

No. There’s an easier (and better, in this author’s view) way to handle it. Just break the cost of the appraisal into two parts: $750 goes in the Borrower Paid column and (L) $150 goes in the Paid by Others column.

The same strategy can be used for a cost omitted by mistake from the loan estimate or any other cost that would become a tolerance violation if paid by the consumer. If the lender is facing an excessive increase in 10-percent limit costs, enough costs to bring the “10 percent bucket” back to a 10 percent increase or less can be shifted from the Borrower Paid column to the Paid by Others column.

Whichever method is used, the total paid by the consumer will be the same. The only difference is how the lender credits are shown – as general or specific lender credits.

One important caveat – don’t use the specific lender credit method if you’re dealing with a prepaid finance charge. For some loan origination systems, doing so can alter the finance charge amounts and affect the APR.

 MLA and GAP

By Andy Zavoina

It is no surprise that the Department of Defense is not a fan of GAP coverage on loans to service members. When the Military Lending Act regulation (MLA) was revised and later clarified with guidance in Q&A form, the DoD essentially said that an automobile loan was exempt from MLA restrictions when the funds from the loan were used for the purchase of the collateral, but if there were additional funds such as for non-essential items, the loan would lose the exemption.

This could then require more disclosures on a loan and attention to the 36 percent Military Annual Percentage Rate (MAPR) cap which is the Annual Percentage Rate on steroids. The MAPR is inclusive of such fees as GAP and credit insurance and the 36 percent rate is easily within reach with these fees included. This is a reason those financing vehicles want the exclusion from disclosures and the 36 percent usury rate. The DoD dislikes GAP insurance as well as some other costs like credit life insurance. Many banks like them as they can be profitable for the banks especially in competitive low-rate environments.

The DoD views many costs as unnecessary and expensive to the service member borrower. Banks and auto dealers do make a profit on these add-ons and many of these serve a key and important role, when needed. As to insurance, more than once I have seen a service member who had no equity in the collateral be saved from a deficit balance when a car was totaled or an estate saved from a debt when a service member passed. If the insurance is never needed it may seem expensive. But for those who paid a fraction of what was later paid out in a claim, it was worthwhile. The DoD sees the payouts as an exception and greed, or unnecessary costs to a service member anyway, as the rule.

In 2016 the DoD attempted to clarify the wording of the MLA exemption requirements with Guidance instead of revising the regulation itself. In the text below you can read that the exemption was lost with certain additional items being financed, a hybrid loan, but not others. Cash out being included in the loan would clearly void the exemption. GAP was not directly discussed and many lenders believed it was an essential component of a loan.

Here is Question 2 from the original August 2016 Guidance from the DoD:

2. Does credit that a creditor extends for the purpose of purchasing personal property, which secures the credit, fall within the exception to “consumer credit” under 32 CFR 232.3(f)(2)(iii) where the creditor simultaneously extends credit in an amount greater than the purchase price?

Answer: No.  Section 232.3(f)(1) defines “consumer credit” as credit extended to a covered borrower primarily for personal, family, or household purposes that is subject to a finance charge or payable by written agreement in more than four installments. Section 232.3(f)(2) provides a list of exceptions to paragraph (f)(1), including an exception for any credit transaction that is expressly intended to finance the purchase of personal property when the credit is secured by the property being purchased.  A hybrid purchase money and cash advance loan is not expressly intended to finance the purchase of personal property, because the loan provides additional financing that is unrelated to the purchase.  To qualify for the purchase money exception from the definition of consumer credit, a loan must finance only the acquisition of personal property.  Any credit transaction that provides purchase money secured financing of personal property along with additional “cash-out” financing is not eligible for the exception under § 232.3(f)(2)(iii) and must comply with the provisions set forth in the MLA regulation

In December 2017 that question was modified to include the section on personal property as well as on vehicles. They mirror one another, and it always seemed odd they separated the two forms of collateral but treated them exactly the same, less the original Guidance which discussed just vehicles. The revised Guidance was more detailed as you can read below, and was specific to state GAP would in fact void the MLA exemption.

2. Does credit that a creditor extends for the purpose of purchasing a motor vehicle or personal property, which secures the credit, fall within the exception to “consumer credit” under 32 CFR 232.3(f)(2)(ii) or (iii) where the creditor simultaneously extends credit in an amount greater than the purchase price of the motor vehicle or personal property?

Answer: The answer will depend on what the credit beyond the purchase price of the motor vehicle or personal property is used to finance.  Generally, financing costs related to the object securing the credit will not disqualify the transaction from the exceptions, but financing credit-related costs will disqualify the transaction from the exceptions.

Section 232.3(f)(1) defines “consumer credit” as credit offered or extended to a covered borrower primarily for personal, family, or household purposes that is subject to a finance charge or payable by written agreement in more than four installments. Section 232.3(f)(2) provides a list of exceptions to paragraph (f)(1), including an exception for any credit transaction that is expressly intended to finance the purchase of a motor vehicle when the credit is secured by the vehicle being purchased and an exception for any credit transaction that is expressly intended to finance the purchase of personal property when the credit is secured by the property being purchased. 

 A credit transaction that finances the object itself, as well as any costs expressly related to that object, is covered by the exceptions in § 232.3(f)(2)(ii) and (iii), provided it does not also finance any credit-related product or service.  For example, a credit transaction that finances the purchase of a motor vehicle (and is secured by that vehicle), and also finances optional leather seats within that vehicle and an extended warranty for service of that vehicle is eligible for the exception under § 232.3(f)(2)(ii).  Moreover, if a covered borrower trades in a motor vehicle with negative equity as part of the purchase of another motor vehicle, and the credit transaction to purchase the second vehicle includes financing to repay the credit on the trade-in vehicle, the entire credit transaction is eligible for the exception under § 232.3(f)(2)(ii) because the trade-in of the first motor vehicle is expressly related to the purchase of the second motor vehicle.  Similarly, a credit transaction that finances the purchase of an appliance (and is secured by than appliance), and also finances the delivery and installation of that appliance, is eligible for the exception under § 232.3(f)(2)(iii).

 In contrast, a credit transaction that also finances a credit-related product or service rather than a product or service expressly related to the motor vehicle or personal property is not eligible for the exceptions under § 232.3(f)(2)(ii) and (iii).  For example, a credit transaction that includes financing for Guaranteed Auto Protection insurance or a credit insurance premium would not qualify for the exception under § 232.3(f)(2)(ii) or (iii).  Similarly, a hybrid purchase money and cash advance credit transaction is not expressly intended to finance the purchase of a motor vehicle or personal property because the credit transaction provides additional financing that is unrelated to the purchase.  Therefore, any credit transaction that provides purchase money secured financing of a motor vehicle or personal property along with additional “cash out” financing is not eligible for the exceptions under § 232.3(f)(2)(ii) and (iii) and must comply with the provisions set forth in the MLA regulation.

In this 2017 Guidance the DoD says a loan that finances the purchase of a motor vehicle and is secured by that vehicle can also finances optional leather seats, negative equity and an extended vehicle warranty as an example of a loan that would be eligible for the MLA exemption.  In contrast the Guidance used a credit transaction which includes financing for GAP insurance or a credit insurance premium as examples of a credit transaction that would not be exempt from the MLA.

Many banks and auto dealers stopped offering GAP coverage to those subject to the MLA, even when the loan was under the 36 percent usury cap. Some lenders’ systems were not ready to make all the other MLA disclosures that would be required. The wording of the MLA has been interpreted by some to understand that the MLA does not allow the financing to be secured by the purchased vehicle’s title. This caused further doubts as to lending to covered service members.

In 2019 many banking and vehicle trade groups tried to assist their members in dealing with the Guidance and the loss of exemptions citing reports of actual harm to the service members themselves as they now had limited options for loans and the ancillary products they historically had access to. Several trade organizations wrote and asked for clarity.

Then, in 2020, the DoD withdrew its earlier interpretation and it opened the window for GAP by removing the explicit statement that it voided the exemption.  The question was again re-phrased, now using just the term personal property apparently to include vehicles and other household items with the answer as follows:

2. Does credit that a creditor extends for the purpose of purchasing personal property, which secures the credit, fall within the exception to “consumer credit” under 32 CFR 232.3(f)(2)(iii) where the creditor simultaneously extends credit in an amount greater than the purchase price?

Answer: No. Section 232.3(f)(1) defines ‘‘consumer credit’’ as credit extended to a covered borrower primarily for personal, family, or household purposes that is subject to a finance charge or payable by written agreement in more than four installments. Section 232.3(f)(2) provides a list of exceptions to subparagraph (f)(1), including an exception for any credit transaction that is expressly intended to finance the purchase of personal property when the credit is secured by the property being purchased. A hybrid purchase money and cash advance loan is not expressly intended to finance the purchase of personal property, because the loan provides additional financing that is unrelated to the purchase. To qualify for the purchase money exception from the definition of consumer credit, a loan must finance only the acquisition of personal property. Any credit transaction that provides purchase money secured financing of personal property along with additional ‘‘cash- out’’ financing is not eligible for the exception under § 232.3(f)(2)(iii) and must comply with the provisions set forth in the MLA regulation.

So if the GAP example was removed, that must mean that financing the GAP product was now allowed, right? Many banks and other lenders jumped on that bandwagon and resumed financing such purchases. In the 2020 announcement what the DoD said was that it was withdrawing its answer because of “unforeseen technical issues” and, “absent additional analysis, (the DoD) takes no position on any of the arguments or assertions advanced as a basis for withdrawing” its 2017 guidance.

The on again, off again and still without clarity roller coaster brings us to today. A 2021 court case decided by the U.S. District Court for the Eastern District of Virginia involves the MLA and GAP. In Davidson v. United Auto Credit, Davidson was a covered borrower under the MLA when he purchased and financed a vehicle with GAP coverage included at a cost of $350. The complaint was that the retail installment contract violated the MLA because it did not disclose the MAPR plus it had other MLA defects.

The trial court ruled that GAP being added to the contract did not void the MLA exemption. The judge said the clear language in the law and regulation did not void the exemption while Davidson argued the 2016 Guidance was not affected by withdrawal of the 2017 revision and that the loan for the vehicle purchase was still subject to the MLA requirements. The judge found Davidson’s argument unpersuasive, stating that the GAP coverage was “inextricably” tied to the purchase of the vehicle.

So far, this is good news for the banks and other lenders. But the case has been appealed to the U.S. Court of Appeals for the Fourth Circuit. In January 2022 the Consumer Finance Protection Bureau (CFPB) filed an amicus brief in favor of Davidson. The CFPB takes the position that when GAP coverage is included in the vehicle’s financing the exemption is voided and the loan requires complete compliance with the MLA. The DoD,  joined in the CFPB’s amicus brief. The DoD said it “strongly concurs” with the CFPB on the issue. Now it is established that the CFPB as well as the DoD do not look favorably to the financing of GAP coverage on vehicle loans.

It is unknown what or when the court will rule. We have seen the CFPB take very proactive consumer protection positions and itself reversing Trump period provisions which were deemed “pro business.” The DoD controls and interprets 32 CFR 232. Many do not believe it would get back on the roller coaster and again revise its guidance, but its position is clear. GAP is not as prevalent, but this case is service member specific. I doubt we would see a retroactive reversal of loans with GAP coverage being impacted but as future plans are considered for loan products, banks with high volumes of loans to service members, with GAP may opt to temper any high sales penetration goals or at least recognize that what the DoD gave, it can take back.

Overdraft fees are not interest

By Andy Zavoina

It was a split decision at the U.S. Court of Appeals for the Tenth Circuit as it ruled on Walker v. BOKF, Nat’l Ass’n, (10th Cir. April 8, 2022). Oklahoma is in the Tenth Circuit. This court affirmed a lower court’s dismissal of a suit claiming that the bank was charging usurious interest on overdrafts.

In this case Walker created an overdraft in his checking account in the amount of $25. The bank paid the item and added to that a fee of $34.50. The bank also charges a daily fee of $6.50 per business day after five days that the account remains in the overdraft. This is disclosed as an “extended overdraft charge.” There were 36 daily overdraft charges accrued before the deposit account reached a positive balance. The original NSF fee plus 36 daily fees total to $268.50.

Walker maintains that these fees equate to interest charged on the original $25 overdraft and that this amount is usurious. BOKF is a national bank. The National Banking Act of 1864 allows a national bank to charge an interest rate no greater than the rate allowed by the state in which the bank is chartered. In the case of Oklahoma this allows a rate of 6 percent. Doing the math, 6 percent per annum on $25 is $.00411 per day which is a lot less than the fee charged by BOKF.

The bank moved for dismissal and the District Court granted that motion. The District Court held that overdraft fees are fees for deposit account services and were not interest and therefore not subject to the National Banking Act or the 6 percent rate allowed by the state. “Back in the day,” paper items were presented and reviewed against deposit balances and manual decisions were made to pay or return an item. There were people involved and hard costs in addition to the opportunity costs of the funds themselves. The process has been automated today but the theory remains the same.

The District Court’s ruling was appealed to the Tenth Circuit Court where there was a dissenting opinion. This argued that the banking regulation was not ambiguous and that overdraft fees do meet the definition of interest. The dissenting opinion maintains that  “When [the Bank] decides to cover a customer’s overdraft, it pays for the item and expects to be paid back. For example, despite [Plaintiff’s] inability to afford the original charge due to insufficient funds, [the Bank] made money available to him by purchasing the item for him. [The Bank] deducted the cost from [Plaintiff’s] account and charged him an overdraft fee, which it also deducted. But the bank expected to be paid back. By covering an overdraft, [the Bank] thus makes a temporary provision of money with the expectation of repayment. In other words, [the Bank] makes a loan.” Others may also see a daily fee as being a time-price differential or a cost for the use of the funds on that daily basis and consider that akin to an interest charge.

The majority of the Tenth Circuit judges did not agree. They affirmed the lower court’s findings based on Interpretive Letter 1082 issued in 2001, in which the OCC maintains that overdraft fees are designed to compensate the bank for “services directly connected with the maintenance of a deposit account,” and “therefore the bank was not creating a ‘debt’ that it then ‘collected’ by recovering the overdraft and the overdraft fee from the account.  Instead, the bank was ‘providing a service to its depositors’ that the accountholder had agreed to pay for.” So, the OCC determined 21 years ago that fees for “deposit account services” (under 12 CFR 7.4002(a)) were not interest and were fees for agreed upon services which were offered, accepted and performed. The majority agreed that IL 1082 was entitled to an “Auer deference” — agency’s interpretation of its own ambiguous regulation is controlling unless plainly erroneous or inconsistent with the regulation — because 12 CFR 7.4001(a) addresses interest and is ambiguous.