Consumer Compliance Outlook: Fourth Quarter 2009

Compliance Alerts

The Board of Governors of the Federal Reserve System (Board) Announces a Final Rule to Protect Consumers Against Overdraft Fees

On November 12, 2009, the Board issued a final rule under Regulation E prohibiting institutions from charging fees for overdrafts on ATM and one-time debit card transactions, unless the institution:

  • provides the consumer with a notice, substantially similar to the Board's Model Form A9, segregated from other information;
  • provides a reasonable opportunity to affirmatively consent or opt in to the service;
  • obtains the consumer's affirmative consent or opt-in; and
  • provides the consumer with written confirmation of the consent.

The opt-in and notice requirements do not apply if an institution has a policy and practice of declining ATM or one-time debit card transactions when the institution has a reasonable belief that the consumer has insufficient funds to cover the transaction when authorization is requested. However, the institution still must obtain the consumer's opt-in if it wishes to impose a fee when an overdraft occurred despite the institution's policy and procedures.

The mandatory compliance deadline is July 1, 2010. For accounts opened before July 1, 2010, financial institutions cannot assess overdraft fees on or after August 15, 2010 for paying an ATM or one-time debit card transaction under an overdraft service unless the institution has complied with the opt-in and notice requirements and obtained the consumer's affirmative consent. For accounts opened on or after July 1, 2010, the financial institution must comply with the opt-in and notice requirements and obtain the consumer's affirmative consent before it can impose overdraft fees for paying an ATM or one-time debit card transaction under an overdraft service. The final rule also prohibits institutions from discriminating against consumers who do not opt in for an overdraft service.

The Board's December 2008 proposal also included a provision prohibiting financial institutions from imposing overdraft fees resulting solely from a hold placed on a debit card. This rule was not adopted because a more comprehensive approach involving financial institutions, card networks, and merchants may be needed to address this issue. The Board will continue to monitor this issue and determine whether additional action is necessary.

The Board' announcement and the final rule are available on the Board's website External Site.

Short-Term Balloon Loans and Regulation Z Repayment Ability Requirement for Higher-Priced Mortgage Loans

On November 9, 2009, the Board issued Consumer Affairs Letter1 09-12: Short-Term Balloon Loans and Regulation Z Repayment Ability Requirement for Higher-Priced Mortgage Loans (CA 09-12). The letter provides answers to frequently asked questions about Regulation Z's repayment ability rule for balloon mortgage loans with terms of less than seven years that qualify as higher-priced mortgage loans (HPML). The repayment ability rule became effective for mortgage loan applications received on or after October 1, 2009, and is part of the Board's final Regulation Z rule for home mortgage loans.

A creditor has a presumption of compliance with the repayment ability rule if the creditor follows certain procedures. However, the presumption does not apply when the "term of the loan is less than seven years and the regular periodic payments when aggregated do not fully amortize the outstanding principal balance." For example, balloon loans with terms of less than seven years (short-term balloon loans) would be excluded from the compliance presumption. Creditors making short-term balloon loans have sought guidance on this issue, and the Board has responded with a "Questions and Answers."

Q: Does the rule prohibit short-term balloon loans that are higher-priced mortgage loans?

A: No. However, the creditor must use prudent underwriting standards and, after considering consumers' income, employment, obligations, and assets other than the collateral, the creditor should determine that the value of the collateral (the home) is not the basis for repaying the obligation (including the balloon payment).

Q: Does that mean the creditor must verify that the consumer has assets and/or income at the time of consummation that would be sufficient to pay the balloon payment when it comes due?

A: No. Such a requirement would effectively ban short-term balloon loans. If the Board had intended to ban these products, it would have done so explicitly.

Q: What must the creditor do, then, to verify the borrower's ability to repay a short-term balloon loan?

A: In addition to verifying the consumer's ability to make regular monthly payments, a creditor should verify that the consumer would likely be able to satisfy the balloon payment obligation by refinancing the loan or through income or assets other than the collateral.

Q: How does the creditor verify, when it originates a short-term balloon loan, whether the consumer could qualify for a refinancing before the balloon payment is due?

A: The creditor has an affirmative duty to engage in prudent underwriting. Thus, the creditor should consider factors such as the loan-to-value ratio and the borrower's debt-to-income ratio or residual income — all as of the time of consummation. A borrower with a high debt-to-income ratio and/or with little or no equity in the property will be less likely to be able to refinance the loan before the balloon payment comes due than a borrower with lower debt-to-income and loan-to-value ratios. The creditor is not required to predict the consumer's future financial circumstances, interest rate environment, and home value.

CA 09-12 is available on the Board's website External Site.

The Board proposes rules to amend Regulation Z to implement the Credit Card Accountability Responsibility and Disclosure Act of 2009 (CARD Act)

On September 29, 2009, the Board proposed rules amending Regulation Z to implement the second phase of the CARD Act, which becomes effective on February 22, 2010. The rulemaking also includes changes to the Board's January 2009 final regulations under Regulations AA and Z to prohibit unfair and deceptive credit card practices and to improve consumer disclosures for open-end (not home-secured) credit, respectively. Amendments were necessary to the January 2009 regulations to conform them to the CARD Act.

The consumer protections under the implementing rules for the CARD Act proposal include:

  • Consideration of repayment ability: prohibits card issuers from opening a credit card account or increasing the credit limit unless the consumer's ability to make the required payments under the terms of the account is considered, and prohibits card issuers from issuing cards to consumers under the age of 21 who do not have income or assets unless certain requirements are satisfied, including a co-signer who is over the age of 21 and has the ability to repay the debts of the underage consumer.
  • Limitations on fees: prohibits card issuers from charging a card account with fees (excluding late fees, over-the-limit fees, and returned payment fees) during the first year after account opening that constitute more than 25 percent of the credit line at account opening, and prohibits creditors from imposing fees for making payment, except for expedited service with a service representative of the creditor.
  • Payment allocation rules: prohibits card issuers from using payment allocation methods that maximize interest charges by generally requiring that payments above the minimum be applied first to the balance with the highest rate.
  • Special rules for marketing open-end credit to college students: prohibits card issuers and creditors from offering tangible items to students on or near campus or at an event sponsored by an institution of higher learning to induce the student to open an open-end credit plan. While most of the rules in the CARD Act apply only to credit cards, this restriction applies to all open-end credit.
  • Limitations on increasing annual percentage rates, fees, and charges: prohibits card issuers from increasing rates, charges, and fees during the first year an account is opened and on existing credit card balances. The rule provides exceptions for temporary rates, variable rates, increases that apply only to new transactions, serious delinquencies, workouts, and increases when protections under the Servicemember Civil Relief Act expire.
  • Requirements for over-the-limit transactions: requires card issuers to obtain a consumer's consent before charging fees for exceeding the credit limit.
  • Limitations on the imposition of finance charges: prohibits card issuers from using the double-cycle billing method to impose interest charges. Also prohibits interest charges on amounts paid during a grace period.
  • Requirement to post credit card agreements on the Internet: requires card issuers to post their card agreements on their websites.

One important issue on which the Board is soliciting comment is whether to change the effective date of the January 2009 final rules for Regulations AA and Z from July 1, 2010 to February 22, 2010 to coincide with the effective date for the new implementing regulations for the CARD Act. In the alternative, the Board is considering retaining the July 1, 2010 date for certain disclosures requiring a tabular format because of operational burdens on card issuers.

Comments on this latest proposal were due by November 20, 2009. The Board's press release and the rulemaking proposal can be found on the Board's website External Site.

The Board will issue another rulemaking proposal at a later date to implement the final phase of the CARD Act that becomes effective on August 22, 2010.

Congress amends the CARD Act to limit scope of 21-day rule for periodic statements to credit cards

On November 6, 2009, President Obama signed into law H.R. 3606, the Credit CARD Technical Corrections Act of 2009, which amends §106(b) of the CARD Act. The original version of §106(b) required financial institutions offering open-end consumer credit plans, including home equity lines of credit (HELOCs), to establish procedures to ensure that periodic statements are mailed not later than 21 days before the payment due date. This requirement created operational challenges for financial institutions offering HELOCs and other non-credit-card open-end products. Congress responded by amending §106(b) to limit the rule to credit card accounts and not open-end credit in general. However, Congress left intact §106(b)'s requirement that periodic statements generally be mailed at least 21 days before the expiration of any time period within which the consumer may repay credit extended without incurring additional finance charges.

The change is not retroactive and became effective on November 6, 2009. The Board will be issuing a rulemaking proposal to amend §226.5(b)(2)(ii) of Regulation Z, where the 21-day rule is implemented, to conform to the CARD Act amendment. A copy of H.R. 3606 is available online External Site.

  • 1 Consumer Affairs letters address significant policy and procedural matters related to the Board's consumer compliance supervisory responsibilities. The letters are numbered sequentially by year. For example, the first letter issued in 2009 is numbered CA 09-1.