[Federal Register Volume 64, Number 65 (Tuesday, April 6, 1999)]
[Rules and Regulations]
[Pages 16614-16617]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-8413]


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FEDERAL RESERVE SYSTEM

12 CFR Part 226

[Regulation Z; Docket No. R-1029]


Truth in Lending

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Final rule; official staff interpretation.

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SUMMARY: The Board is publishing revisions to the official staff 
commentary to Regulation Z (Truth in Lending). The commentary applies 
and interprets the requirements of the regulation. The update addresses 
the prohibition against the issuance of unsolicited credit cards. It 
provides guidance on calculating payment schedules involving private 
mortgage insurance. In addition, the update discusses credit sale 
transactions where downpayments include cash and property used as a 
trade-in, and adopts several technical amendments.

DATES: This rule is effective March 31, 1999. Compliance is optional 
until March 31, 2000.

FOR FURTHER INFORMATION CONTACT: James H. Mann or Obrea O. Poindexter 
(open-end credit), or Michael E. Hentrel or Kathleen C. Ryan (closed-
end credit), Staff Attorneys; Division of Consumer and Community 
Affairs, Board of Governors of the Federal Reserve System, at (202) 
452-3667 or 452-2412; for users of Telecommunications Device for the 
Deaf (TDD) only, Diane Jenkins at (202) 452-3544.

SUPPLEMENTARY INFORMATION:

I. Background

    The purpose of the Truth in Lending Act (TILA; 15 U.S.C. 1601 et 
seq.) is to promote the informed use of consumer credit by providing 
for disclosures about its terms and cost. The act requires creditors to 
disclose the cost of credit as a dollar amount (the finance charge) and 
as an annual percentage rate (APR). Uniformity in creditors' 
disclosures is intended to assist consumers in comparison shopping. 
TILA requires additional disclosures for loans secured by a consumer's 
home and permits consumers to rescind certain transactions that involve 
their principal dwelling. In addition, the act regulates certain 
practices of creditors. The act is implemented by the Board's 
Regulation Z (12 CFR Part 226). The Board's official staff commentary 
(12 CFR Part 226 (Supp. I)) interprets the regulation, and provides 
guidance to creditors in applying the regulation to specific 
transactions. The commentary is a substitute for individual staff 
interpretations; it is updated periodically to address significant 
questions that arise.
    In December, the Board published proposed amendments to the 
commentary to Regulation Z (63 FR 67436, December 7, 1998). The Board 
received about 50 comments. Most of the comments were from financial 
institutions and other creditors; state attorneys general and consumer 
representatives also submitted comments. Overall, commenters generally 
supported the proposed amendments. Views were mixed on comments 
concerning multifunction cards that are or may be used as credit cards 
and credit sale transactions where downpayments involve cash payments 
and property used as a trade-in.
    Except as discussed below, the commentary is being adopted as 
proposed; some technical suggestions or concerns raised by commenters 
are addressed. In response to concerns about the uncertainty of 
computer readiness for the Year 2000 date change, the effective date 
for mandatory compliance with the commentary update is March 31, 2000.

II. Commentary Revisions

Subpart A--General

Section 226.2--Definitions and Rules of Construction

2(a) Definitions

2(a)(15) Credit Card
    Section 226.2(a)(15) defines a credit card to include any card or 
credit device that may be used from time to time to obtain credit. 
Comment 2(a)(15)-2 provides examples of cards and devices that are and 
are not credit cards. The comment is revised to include a new example 
of cards or devices that are credit cards, addressing recent programs 
where cards are marketed from the outset with both credit and non-
credit features. (Two additional examples were proposed. Some 
commenters suggested technical changes to ensure consistency in the new 
examples; the changes were made by merging them.)
2(a)(18) Downpayment
    Comment 2(a)(18)-3 provides guidance on how a creditor discloses 
the downpayment if a trade-in is

[[Page 16615]]

involved in a credit sale transaction and if the amount of an existing 
lien exceeds the value of the trade-in. Under Regulation Z, the term 
``downpayment'' refers to an amount, including the value of any 
property used as a trade-in, paid to a seller to reduce the ``cash 
price.'' If the amount of an existing lien exceeds the value of the 
property being used as a trade-in and no cash payment is involved, 
creditors must disclose zero as the downpayment and not a negative 
number. The proposed comment also added an example where the consumer 
makes a cash payment. In that example, creditors would apply the cash 
payment to the excess lien amount rather than reduce the price of the 
purchased item. In response to commenters' concerns, the comment has 
been revised to provide flexibility. At their option, creditors may 
first apply the cash payment to reduce the price of the purchased item.
    Many commenters opposed the proposal. Some believed that applying 
the cash payment to the excess lien amount would be confusing to 
consumers because the creditor's treatment of the cash payments might 
not be readily apparent. They argued that the comment should comport 
with consumers' general expectations--that cash payments would be 
disclosed as downpayments that reduce the cash price.
    Moreover, commenters stated that, where cash payments are made in 
credit sales involving a trade-in and a lien on the property that 
exceeds the value of the trade-in, many creditors currently apply the 
cash payment to any excess lien amount. These creditors disclose the 
cash payment as a downpayment. Many of these creditors, along with 
consumer advocates and state Attorneys General commenting on the issue, 
believe disclosing a downpayment equal to the cash payment is more 
helpful to consumers. They express concern about the potential for 
confusion under the proposal when, for example, a cash payment of $500 
is applied to an excess lien amount of $2,000 and the downpayment is 
disclosed as $0, even if the cash payment is disclosed elsewhere in the 
itemization of the amount financed. (See Sec. 226.18(c).) Some 
commenters also believed the proposal potentially conflicts with some 
state laws regarding the disclosure of downpayments.
    In response to comments received and upon further analysis, the 
proposed example has been revised. In disclosing a downpayment where 
cash payments are made in credit sales involving a trade-in and a lien 
on the property that exceeds the value of the trade-in, creditors may, 
but need not, apply the cash payment first to any excess lien amount.

Subpart B--Open-end Credit

Section 226.12--Special Credit Card Provisions

12(a) Issuance of Credit Cards
12(a)(1)
    Section 226.12(a) prohibits creditors from issuing credit cards 
except in response to a consumer's request or application for the card 
or as a renewal of, or substitute for, a previously accepted credit 
card. The prohibition, which parallels the statute, addresses various 
concerns including the potential for theft and fraud and the consumer 
inconvenience of refuting claims of liability. The law does not 
prohibit creditors from issuing unsolicited cards that have a non-
credit purpose--such as check-guarantee or purchase-price discount 
cards--so long as they cannot also be used to obtain credit. Consumers 
may later be able to convert these cards to credit cards if the issuer 
makes a credit feature available and the consumer requests the credit.
    Comment 12(a)(1)-7 provides guidance regarding a card that is 
issued to and accepted by the consumer as a non-credit device and that 
subsequently is converted for use as a credit device at the consumer's 
request. The revisions clarify the comment's applicability to recent 
programs where unsolicited cards are marketed from the outset as both 
stored-value cards and credit cards. The Board proposed revisions to 
the comment to reflect more clearly its intended purpose.
    Views were mixed on the proposal. Commenters that opposed the 
revisions cited a variety of reasons for their position. Some believed 
the concerns associated with the prohibition--theft, fraud, and the 
inconvenience of refuting claims of liability--were outdated, due to 
advances in technology and industry practice regarding fraud 
prevention, and TILA's $50 maximum potential loss for consumers. Others 
believed the proposal would inappropriately deter the development of 
multifunction cards. They discussed the convenience of such cards and 
urged that any rule be crafted narrowly so as to not affect the 
continuing development of multifunction cards. The prohibition is, 
however statutory.
    Comment 12(a)(1)-7 is revised in accord with the proposal, with 
some changes to address commenters' concerns. The fundamental import of 
the comment remains unchanged: Multifunction cards connected with 
credit plans when they are issued are credit cards, and they may not be 
sent without the consumer's prior request or application. New examples 
have been added to provide further guidance. The comment makes clear 
that card issuers do not violate the prohibition merely by sending a 
card imprinted with information that identifies the consumer, so long 
as the issuer does not propose to connect the card to a credit plan at 
the time the card is issued.
    To the extent that the interpretation of the TILA rule previously 
may have been unclear, the Board believes that liability should not 
attach to a card issuer's prior reliance on comment 12(a)(1)-7 in 
issuing multifunction cards that included a credit feature.

Section 226.14--Determination of Annual Percentage Rate

14(c) Annual Percentage Rate for Periodic Statements
    Comment 14(c)-10 addresses finance charges that are imposed during 
the current billing cycle but that relate to account activity that 
occurred during a prior billing cycle. The comment is revised to refer 
expressly to current-cycle or prior-cycle debits and current-cycle or 
prior-cycle credits.
Subpart C--Closed-end Credit
Section 226.18--Content of Disclosures
18(g) Payment Schedule
    The Homeowners Protection Act of 1998 limits the amount of private 
mortgage insurance (PMI) consumers can be required to purchase. 
Borrowers may request cancellation of PMI under some circumstances and 
lenders must terminate PMI automatically when certain conditions are 
met.
    Comment 18(g)-5 is added in response to creditors' requests for 
guidance on how the new statutory requirements affect TILA disclosures. 
PMI premiums are finance charges and are figured into disclosures such 
as the APR and payment schedule. TILA disclosures are based on the 
legal obligation between the parties, and the comment provides that the 
payment schedule disclosure should reflect all components of the 
finance charge, including PMI for the time period there is a legal 
obligation to maintain the insurance.
    Commenters generally supported the proposed guidance, although a 
few believed the guidance was unnecessary and others believed the 
guidance was not detailed enough. In response to comments received, the 
comment is revised to clarify that creditors may rely on assumptions 
used for variable-rate transactions and discounted and

[[Page 16616]]

premium variable-rate transactions in calculating payment schedules 
that involve PMI.
18(j) Total Sale Price
    Comment 18(j)-2 provides the formula for calculating the total sale 
price in a credit sale transaction; it is the sum of the cash price, 
certain other amounts financed, and the finance charge. In response to 
requests for guidance, the commentary is revised to address how the 
total sale price may be affected by downpayments involving both cash 
and property used as a trade-in with a lien exceeding the value of the 
trade-in. This guidance is provided in a new comment 18(j)-3.
    Under the proposal, creditors were to calculate the downpayment by 
applying cash payments first to reduce excess lien amounts. In response 
to commenters' concerns about the Board's proposed approach to 
disclosing the downpayment, the guidance has been revised. See comment 
2(a)(18)-3.
    The flexibility provided to creditors in disclosing a downpayment 
may result in disclosures of a total sale price that may differ among 
creditors. However, key disclosures such as the amount financed, 
finance charge, and APR remain uniform and will not be affected by the 
creditor's approach in disclosing the downpayment and total sale price.

Subpart E--Special Rules for Certain Home Mortgage Transactions

Section 226.32--Requirements for Certain Closed-end Home Mortgages

32(a) Coverage
32(a)(1)(ii)
    Creditors must follow the rules in Sec. 226.32 if the total points 
and fees payable by the consumer at or before loan closing exceed the 
greater of $400 or 8 percent of the total loan amount. The Board is 
required to adjust the $400 amount each year. The adjusted amount for 
1999 ($441), published on December 8, 1998 (63 FR 67575) is added to 
comment 32(a)(1)(ii)-2.

List of Subjects in 12 CFR Part 226

    Advertising, Banks, banking, Consumer protection, Credit, Federal 
Reserve System, Mortgages, Reporting and recordkeeping requirements, 
Truth in lending.
    For the reasons set forth in the preamble, the Board amends 12 CFR 
part 226 as follows:

PART 226--TRUTH IN LENDING (REGULATION Z)

    1. The authority citation for part 226 continues to read as 
follows:

    Authority: 12 U.S.C. 3806; 15 U.S.C. 1604 and 1637(c)(5).

    2. In Supplement I to Part 226, under Section 226.2--Definitions 
and Rules of Construction, the following amendments are made:
    a. Under Paragraph 2(a)(15) Credit card., paragraph 2. is revised; 
and
    b. Under Paragraph 2(a)(18) Downpayment., paragraph 3. is revised.
    The revisions read as follows:

Supplement I to Part 226--Official Staff Interpretations

* * * * *

Subpart A--General

* * * * *

Section 226.2--Definitions and Rules of Construction

2(a) Definitions.

* * * * *

2(a)(15) Credit card.

* * * * *
    2. Examples. i. Examples of credit cards include:
    A. A card that guarantees checks or similar instruments, if the 
asset account is also tied to an overdraft line or if the instrument 
directly accesses a line of credit.
    B. A card that accesses both a credit and an asset account (that 
is, a debit-credit card).
    C. An identification card that permits the consumer to defer 
payment on a purchase.
    D. An identification card indicating loan approval that is 
presented to a merchant or to a lender, whether or not the consumer 
signs a separate promissory note for each credit extension.
    E. A card or device that can be activated upon receipt to access 
credit, even if the card has a substantive use other than credit, such 
as a purchase-price discount card. Such a card or device is a credit 
card notwithstanding the fact that the recipient must first contact the 
card issuer to access or activate the credit feature.
    ii. In contrast, a credit card does not include, for example:
    A. A check-guarantee or debit card with no credit feature or 
agreement, even if the creditor occasionally honors an inadvertent 
overdraft.
    B. Any card, key, plate, or other device that is used in order to 
obtain petroleum products for business purposes from a wholesale 
distribution facility or to gain access to that facility, and that is 
required to be used without regard to payment terms.
* * * * *

2(a)(18) Downpayment.

* * * * *
    3. Effect of existing liens. i. No cash payment. In a credit sale, 
the ``downpayment'' may only be used to reduce the cash price. For 
example, when a trade-in is used as the downpayment and the existing 
lien on an automobile to be traded in exceeds the value of the 
automobile, creditors must disclose a zero on the downpayment line 
rather than a negative number. To illustrate, assume a consumer owes 
$10,000 on an existing automobile loan and that the trade-in value of 
the automobile is only $8,000, leaving a $2,000 deficit. The creditor 
should disclose a downpayment of $0, not -$2,000.
    ii. Cash payment. If the consumer makes a cash payment, creditors 
may, at their option, disclose the entire cash payment as the 
downpayment, or apply the cash payment first to any excess lien amount 
and disclose any remaining cash as the downpayment. In the above 
example:
    A. If the downpayment disclosed is equal to the cash payment, the 
$2,000 deficit must be reflected as an additional amount financed under 
Sec. 226.18(b)(2).
    B. If the consumer provides $1,500 in cash (which does not 
extinguish the $2,000 deficit), the creditor may disclose a downpayment 
of $1,500 or of $0.
    C. If the consumer provides $3,000 in cash, the creditor may 
disclose a downpayment of $3,000 or of $1,000.
* * * * *
    3. In Supplement I to Part 226, under Section 226.12--Special 
Credit Card Provisions, under Paragraph 12(a)(1), paragraph 7. is 
revised to read as follows:
* * * * *

Subpart B--Open-end Credit

* * * * *

Section 226.12--Special Credit Card Provisions

* * * * *
    12(a) Issuance of credit cards.
    Paragraph 12(a)(1)
* * * * *
    7. Issuance of non-credit cards. i. General. Under 
Sec. 226.12(a)(1), a credit card cannot be issued except in response to 
a request or an application. (See comment 2(a)(15)-2 for examples of 
cards or devices that are and are not credit cards.) A non-credit card 
may be sent on an unsolicited basis by an issuer that does not propose 
to connect the card to any credit plan; a credit feature

[[Page 16617]]

may be added to a previously issued non-credit card only upon the 
consumer's specific request.
    ii. Examples. A purchase-price discount card may be sent on an 
unsolicited basis by an issuer that does not propose to connect the 
card to any credit plan. An issuer demonstrates that it proposes to 
connect the card to a credit plan by, for example, including 
promotional materials about credit features or account agreements and 
disclosures required by Sec. 226.6. The issuer will violate the rule 
against unsolicited issuance if, for example, at the time the card is 
sent a credit plan can be accessed by the card or the recipient of the 
unsolicited card has been preapproved for credit that the recipient can 
access by contacting the issuer and activating the card.
* * * * *
    4. In Supplement I to Part 226, Section 226.14--Determination of 
Annual Percentage Rate, under Paragraph 14(c) Annual percentage rate 
for periodic statements., paragraph 10.ii. is republished and paragraph 
10.ii.B. is revised to read as follows:
* * * * *

Section 226.14--Determination of Annual Percentage Rate

* * * * *
    14(c) Annual percentage rate for periodic statements.
* * * * *
    10. Prior-cycle adjustments.
* * * * *
    ii. Finance charges relating to activity in prior cycles should be 
reflected on the periodic statement as follows:
* * * * *
    B. If a finance charge that is posted to the account relates to 
activity for which a finance charge was debited or credited to the 
account in a previous billing cycle (for example, if the finance charge 
relates to an adjustment such as the resolution of a billing error 
dispute, or an unintentional posting error, or a payment by check that 
was later returned unpaid for insufficient funds or other reasons), the 
creditor shall at its option:
    1. Calculate the annual percentage rate in accord with ii.A. of 
this paragraph, or
    2. Disclose the finance charge adjustment on the periodic statement 
and calculate the annual percentage rate for the current billing cycle 
without including the finance charge adjustment in the numerator and 
balances associated with the finance charge adjustment in the 
denominator.
* * * * *
    5. In Supplement I to Part 226, under Section 226.18--Content of 
Disclosures, the following amendments are made:
    a. Under 18(g) Payment schedule., a new paragraph 5. is added; and
    b. Under 18(j) Total sale price., a new paragraph 3. is added.
    The additions read as follows:
* * * * *

Subpart C--Closed-end Credit

* * * * *

Section 226.18--Content of Disclosures

* * * * *
    18(g) Payment schedule.
* * * * *
    5. Mortgage insurance. The payment schedule should reflect the 
consumer's mortgage insurance payments until the date on which the 
creditor must automatically terminate coverage under applicable law, 
even though the consumer may have a right to request that the insurance 
be cancelled earlier. (For assumptions in calculating a payment 
schedule that includes mortgage insurance that must be automatically 
terminated, see comments 17(c)(1)-8 and 17(c)(1)-10.)
* * * * *
    18(j) Total sale price.
* * * * *
    3. Effect of existing liens. When a credit sale transaction 
involves property that is being used as a trade-in (an automobile, for 
example) and that has a lien exceeding the value of the trade-in, the 
total sale price is affected by the amount of any cash provided. (See 
comment 2(a)(18)-3.) To illustrate, assume a consumer finances the 
purchase of an automobile with a cash price of $20,000. Another vehicle 
used as a trade-in has a value of $8,000 but has an existing lien of 
$10,000, leaving a $2,000 deficit that the consumer must finance.
    i. If the consumer pays $1,500 in cash, the creditor may apply the 
cash first to the lien, leaving a $500 deficit, and reflect a 
downpayment of $0. The total sale price would include the $20,000 cash 
price, an additional $500 financed under Sec. 226.18(b)(2), and the 
amount of the finance charge. Alternatively, the creditor may reflect a 
downpayment of $1,500 and finance the $2,000 deficit. In that case, the 
total sale price would include the sum of the $20,000 cash price, the 
$2,000 lien payoff amount as an additional amount financed, and the 
amount of the finance charge.
    ii. If the consumer pays $3,000 in cash, the creditor may apply the 
cash first to extinguish the lien and reflect the remainder as a 
downpayment of $1,000. The total sale price would reflect the $20,000 
cash price and the amount of the finance charge. (The cash payment 
extinguishes the trade-in deficit and no charges are added under 
Sec. 226.18(b)(2).) Alternatively, the creditor may elect to reflect a 
downpayment of $3,000 and finance the $2,000 deficit. In that case, the 
total sale price would include the sum of the $20,000 cash price, the 
$2,000 lien payoff amount as an additional amount financed, and the 
amount of the finance charge.
* * * * *
    6. In Supplement I to Part 226, Section 226.32--Requirements for 
Certain Closed-end Home Mortgages, under Paragraph 32(a)(1)(ii), 
paragraph 2.iv. is added to read as follows:
* * * * *

Subpart E--Special Rules For Certain Home Mortgage Transactions

* * * * *

Section 226.32--Requirements for Certain Closed-end Home Mortgages

* * * * *
    32(a) Coverage.
* * * * *
    Paragraph 32(a)(1)(ii).
* * * * *
    2. Annual adjustment of $400 amount.
* * * * *
    iv. For 1999, $441, reflecting a 1.4 percent increase in the CPI-U 
from June 1997 to June 1998, rounded to the nearest whole dollar.
* * * * *
    By order of the Board of Governors of the Federal Reserve 
System, acting through the Secretary of the Board under delegated 
authority, March 31, 1999.
Robert deV. Frierson,
Associate Secretary of the Board.
[FR Doc. 99-8413 Filed 4-5-99; 8:45 am]
BILLING CODE 6210-01-P