Compliance Blog

Posted by Steve Van Beek

This post is a continuation of the discussion of Section 101 of the Credit CARD Act.  Part 1 of Section 101 can be found here.

Restrictions on Raising APRs on Outstanding Balances
Section 101 adds Section 171 to TILA which provides a general prohibition on increasing the APR on the outstanding balance of a credit card account.  Again, this was a situation addressed in the UDAP regulations (see 12 C.F.R. 706.24 on pages 127-128) but Congress decided to strengthen and codify the restrictions. 

Let's be clear, even though the UDAP regulations addressed this issue - the Credit CARD Act is a law and governs if there are discrepancies between the law and the UDAP regulations.  For an example, I'm going to jump down to subsection (d) of Section 171 of TILA which defines "outstanding balance."  The law defines "outstanding balance" as the amount owed on a credit card account at the end of the 14th day after the date the credit union provides advance notice of the increased APR, fee, or finance charge.  The UDAP regulations had defined a "protected balance" as the balance on a credit card account at the end of the 7th day after advance notice.  Thus, the Credit CARD Act provision will prevail, meaning transactions that a member makes up to 14 days after the credit union provides advance notice of the increased APR must remain at the prior APR.  The UDAP regulations will need to be amended to reflect the language in the Credit CARD Act. 

Section 171 allows four exceptions to the general prohibition on increasing APRs on a credit card account's outstanding balance.  

(1) An increase in an APR after the expiration of a specified time period.  The credit union must have disclosed the length of the time period and the higher APR that will apply after the expiration of that time period.  For example, the credit union could advertise a credit card that will have a 9.99% APR for the first year, after which the APR will be increased to 11.99%.  Note: Another section of the Credit CARD Act, discussed below, requires that promotional periods be at least 6 months long.  

After the expiration of the first year promotional APR, the credit union would be able to increase the APR on the account to 11.99% on future purchases as well as on the outstanding balance on the account.  Think about it this way - the credit union has disclosed to the member that the promo 9.99% APR will apply for one year and then the rate will increase to 11.99%.  The member has one year to pay off the balance before the rate is increased to 11.99%.  Since it was disclosed upfront, the increased rate is not unfair or deceptive and could apply to the outstanding balance.  

Subparagraph (C) to Section 171(b)(1) indicates that the increased APR can not be applied to transactions that occurred prior to the commencement of the disclosed time period.  This would not restrict the example listed above.  Rather, this would prevent the credit union from offering a 12-month promotional period on an existing accout and after the 12-month period attempting to increase the APR on the entire outstanding balance.  This exception would only allow the credit union to increase the APR on transactions that occurred within the 12-month period, not those that occurred before that period.  Those must stay at the prior APR.  

(2) An increase in a variable APR due to the operation of an index.  If the credit union has variable rate accounts and the index (i.e. Wall Street Journal prime) changes on those accounts, the APR applicable to transactions occurring befor the index change can be raised to the new APR. 

(3) An increase due to the completion of a workout arrangement (or a failure to complete an arrangement).  After a workout period, the credit union would be able to increase the APR back to the contractual rate on the credit card account provided it has properly disclosed the conditions of the workout arrangement.  

(4) An increase due to the fact the member is 60 days late.  Remember, this is an exception that allows the credit union the ability to increase the APR on the outstanding balance of the credit card account.  The credit union would be allowed to increase the APR if: (1) the member is 60 days late; (2) the credit union provides 45-day advance notice of the increased APR; and (3) the notice includes the reason for the increase as well as the fact that the increased APR will terminate if the member makes their next 6 minimum payments on time.  The credit union would need to terminate the increased APR, and return to the prior APR, if the member makes the next 6 minimum payments on time.

Note: This section - especially subsection (4) - will most likely be addressed by the Federal Reserve in regulations that will clarify the requirements for financial institutions.  Remember, similar restrictions were included in the UDAP regulations (see pages 127-128) - which could give credit unions an idea of what the Fed's regulations will look like.  However, the Credit CARD Act restrictions and requirements are much stronger  For example, the "delinquency exception" under UDAP could be used if the member was 30 days late.  Under the Credit CARD Act, the exception can not be used until the member is 60 days late and the credit union provides 45-day advance notice.

Yesterday's post detailed the 45-day advance notice requirement.  There are 3 exceptions to the 45-day advance notice requirement - the first three subsections above: Sections 171(b)(1); 171(b)(2); and 171(b)(3).  Thus, if the credit union properly discloses a one-year promotional period after which the APR will increase, the credit union would not need to send the 45-day advance notice (nor the right to cancel) to the member.  However, Section 171(b)(4) does require a 45-day advance notice to be sent.  The effect is that the credit union would not be able to increase the APR on a delinquent member's account until 105 days after the member missed their payment (60 days late and the expiration of the 45-day advance notice).  In short, Congress severely limited financial institutions' ability to apportion risk in their credit card portfolios.

Repayment of Outstanding Balances
Subsection (c) of Section 171 requires that credit unions provide members sufficient time to repay "outstanding balances" as defined by subsection (d).  This requirement is identical to the repayment methods allowed under the UDAP regulations (see page 128 and especially pages 140-141 for the official staff commentary).  Obviously, the UDAP regulations are not effective - but they provide valuable insight as to what will be required of a credit union.  

Remember, if the member exercises his/her "right to cancel" the credit union must allow the member to repay their outstanding balance according to one of the methods under Section 171(c)(2) or a method that is no less beneficial to the member.     

The two repayment methods are as follows:

(A) an amortization period of not less than 5 years, beginning on the effective date of the 45-days advance notice; or

(B) a required minimum periodic payment that includes a percentage of the outstanding balance that is equal to not more than twice the percentage required before the effective date of the 45-day advance notice.

As indicated in yesterday's post, these repayment methods are designed to prevent financial institutions from requiring a consumer to repay their outstanding balance upon closing their account or within a short period thereafter.  The repayment methods prevent a financial institution from penalizing the consumer from rejecting the changes to their credit card account.  

Repayment method (B) is best explained using an example.  If the credit union currently charges a minimum payment calculated at 2% of the member's outstanding balance, you could not require more than 4% of the outstanding balance if the member closes their account or the balance falls under the definition of "outstanding balance" under subsection (d) of Section 171 (see above).

Also, the credit union may offer a repayment method that "is no less beneficial" to the member.  The easy example is for the credit union to decide to retain its standard calculation of the minimum payment (i.e. 2% of the outstanding balance) even after the member closes the account.  This repayment method is more beneficial as the member has more time to repay the outstanding balance and is not forced to quickly pay off the balance solely because he/she canceled the account.  

Limitation on APR Increases within the First Year
Section 101 also adds Section 172 to TILA.  Subsection (a) limits a credit union's ability to increase the APR on a member's account within the first year the account is open.  The section provides a general prohibition on increasing the APR in the first year.  However, there are 4 exceptions - the 4 subsections under Section 171(b) - that are detailed above.  Thus, if a credit union properly discloses a 6-month promotional period at account opening - it could increase the APR on the account after expiration of the 6-month period even though it was within the first year the account was open. Additionally, if the index tied to the account increases within the first year of the account - the credit union would be able to increase the corresponding APR on the account.

Promotional Rate Minimum Term
Subsection (b) of Section 172 mandates that promotional rates for credit card accounts be at least 6 months in length.  The Federal Reserve is required to define the term "promotional rate."  The Fed's recent amendments to Regulation Z included this definition of "promotional rate" under its advertising section:

"(i)  Promotional rate means any annual percentage rate applicable to one or more balances or transactions on an open-end (not home-secured) plan for a specified period of time that is lower than the annual percentage rate that will be in effect at the end of that period on such balances or transactions."  12 C.F.R. 226.16(g)(2)(i) - effective July 1, 2010.  These Reg Z changes also included requirements when advertising promotional rates that credit unions should be aware of.

Wow.  That is the end of Section 101.  On to Section 102 tomorrow - more of the same....

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Anthony and I will be giving a 4-hour compliance talk at a MACUMA event in Arlington, VA next Monday, June 29.  Believe it or not, the title - "What Keeps Us Up at Night: A Conversation with NAFCU's Compliance Team" - was coined before the Credit CARD Act.  Trust me, the Credit CARD Act has not helped me sleep at night.  We'd love to see you there.  This list covers most of the topics we will address.  Noticably absent is the Credit CARD Act - but, rest assured, we will be getting our hands (extremely) dirty in the Credit CARD Act provisions.  The event is open to both MACUMA members and non-members (as well as NAFCU-members and non-members).