Late Fees, Late fees, Late fees
By Reginald Watson, Regulatory Compliance Counsel, NAFCU
Greetings, I hope all is well out there in compliance land!
Over the past couple of weeks, we have received a few questions on different aspects of applying late fees for open-end credit transactions, including "pyramiding" of late fees. Back when NCUA had its own UDAP authority in the pre-Dodd-Frank era (old §706), the practice of pyramiding late fees was explicitly prohibited. Pyramiding of late fees is a situation where a member (who has been previously charged a late fee) pays the current amount due on a loan without the prior month’s late fee included, and the payment is applied to the late fee first, leaving an overdue balance on the current month payment, resulting in another late fee. While NCUA's UDAP rulemaking authority was repealed, the agency issued a Letter to Credit Unions stating the following:
“Due to the statutory repeal, the NCUA Board plans to repeal Part 706 at an open meeting later this year. However, the repeal of NCUA’s rules in Part 706 will not mean that the credit practices described in those rules are permissible. The FTC Act and the Dodd-Frank Act continue to prohibit unfair or deceptive acts or practices.
If a federal credit union engages in an unfair or deceptive practice described in the soon-to-be repealed credit practices rules, NCUA may determine a statutory violation exists, depending on the facts and circumstances of the particular case.”
We haven't heard much about the NCUA using this authority in exams, but it is something to keep in mind. These types of practices may also raise UDAAP type claims under state law or the CFPB's regulations. While NCUA’s rules preempt state laws purporting to affect the “amount, uniformity, and frequency of payments…,” the rules also state that the Board does not intend to preempt state laws affecting unfair credit practices or providing additional protection to consumers. See, 12 C.F.R. § 701.21(b)(1)(ii)(B), (b)(3). Meanwhile, the CFPB has changed its approach to UDAAP and enforcement under its new leadership.
But what about other regulations? Regulation Z treats the allocation of payments for open-end credit differently depending on the type of loan product.
Open-End, Home-Secured Credit
For open-end consumer credit plans secured by a home, Regulation Z does not appear to restrict the manner in which credit unions apply payments provided that payments are otherwise credited on the day they are received. See, 12 C.F.R. § 1026.10 (requiring prompt crediting of payments). Commentary to Section 1026.6(a)(1)(iii), which addresses the disclosure of finance charges imposed under HELOC plans, suggests that credit unions may structure payments to pay late fees or interest first:
2. Allocation of payments. Creditors may, but need not, explain how payments and other credits are allocated to outstanding balances. 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.)
Official Interpretations, § 1026.6(a)(1)(iii)-2
The credit union’s ability to structure payments in this manner may also be restricted by the loan contract. For example, if the loan contract specifies that payments will be credited in a specific manner – such as principal first, interest second, and late fees third, the credit union would be bound by the terms of its agreement with the member.
Open-End, Not Home-Secured Credit
Section 1026.52(b)(2)(ii) of Regulation Z has been interpreted as prohibiting the pyramiding of late fees for credit cards. Here is an excerpt:
(ii) Multiple fees based on a single event or transaction. A card issuer must not impose more than one fee for violating the terms or other requirements of a credit card account under an open-end (not home-secured) consumer credit plan based on a single event or transaction. A card issuer may, at its option, comply with this prohibition by imposing no more than one fee for violating the terms or other requirements of an account during a billing cycle.
The Official Interpretations to Regulation Z provide several examples of conduct that is impermissible under section 1026.52(b)(2)(ii) of Regulation Z, including various fee allocation issues. There are also rules on the "reasonableness" of late fees for credit card accounts, including a general safe harbor (for 2018, $27 for the first late fee, and $38 for additional late fees occurring within a six month period but the fee cannot exceed the minimum payment due). Overall, when addressing questions on late fees, the commentary may be worth reviewing for more information about these types of restrictions on credit card accounts.
In practice, our understanding is that not many credit unions structure payments in a manner that might result in pyramiding. This is in part because of the nature of credit unions being owned by members, and the resulting member-service focus – in fact, many NAFCU members reported waiving late fees in some cases. NCUA's pre-Dodd-Frank prohibition also impacted practices, as well as the fact that several states have laws prohibiting it. Overall, sometimes late payments happen, so understanding where regulations may impact fees is important.