Reg Z Prohibition on Financing Credit Insurance (12 CFR (i))

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1 Reg Z Prohibition on Financing Credit Insurance (12 CFR (i)) The Consumer Financial Protection Bureau s (CFPB) prohibition on financing credit insurance under Regulation Z goes into effect on January 10, The provision applies to closed-end consumer credit transactions secured by a dwelling and home equity lines of credit (HELOCs) secured by the consumer s principal dwelling. October 24, 2013 For the latest information please see CUNA s eguide to Federal Laws and Regulations Valerie Moss Regulatory Compliance CREDIT UNION NATIONAL ASSOCIATION

2 1 TABLE OF CONTENTS Background 2 Amended Section (i) and New Comment 2 CFPB Clarifies Prohibition on Financing Credit Insurance 2 What is financing under the rule? 5 What does it mean to be calculated and paid in full on a monthly basis? 5 What about accrued interest 9 CompBlog Post Update on Financing Credit Insurance Premiums (10/8/13) 11

3 2 Background Dodd-Frank Act Section 1414 added Truth in Lending Act Section 129C(d), which generally prohibits a creditor from financing premiums or fees for credit insurance in connection with a closed-end consumer credit transaction secured by a dwelling, or an extension of open-end consumer credit secured by the consumer s principal dwelling. The prohibition applies to credit life, credit disability, credit unemployment, credit property insurance, and other similar products, including debt cancellation and debt suspension contracts (defined collectively as credit insurance for purposes of this discussion). The same provision, however, excludes from the prohibition credit insurance premiums or fees that are calculated and paid in full on a monthly basis. In the 2013 loan originator compensation final rule, the Consumer Financial Protection Bureau (CFPB) adopted the statutory provision without substantive change in Regulation Z Section (i): prohibition on financing single premium credit insurance. The final rule provided an effective date of June 1, 2013 for Section (i) and clarified that the provision applied to transactions for which a creditor received an application on or after that date. In the preamble to the final rule (not in the regulation or commentary), the CFPB stated that adding a monthly charge for the insurance to the loan balance would amount to financing the premiums for credit insurance rather than paying them in full on a monthly basis, and doing so would fail to satisfy the conditions for the exclusion. CUNA and CUNA Mutual Group urged the CFPB to clarify the scope of the provision in light of the comments in the supplemental information to the final rule. It was clear that single premium credit insurance was prohibited. However, credit unions needed clarification regarding the application of the prohibition to monthly premium payments. Many credit unions data processing systems add the insurance premium amount to the loan balance on a monthly basis and as a result, it would be quite costly for changes to be made by June 1, Responding to these concerns, the CFPB delayed the June 1 effective date until January 10, 2014 and on September 13, 2013, clarified the scope of the prohibition on financing credit insurance premiums in connection with dwelling-secured consumer credit transactions. Amended Section (i) The amended Section (i) reads as follows: (i) Prohibition on financing credit insurance. (1) A creditor may not finance, directly or indirectly, any premiums or fees for credit insurance in connection with a consumer credit transaction secured by a dwelling (including a home equity line of credit secured by the consumer s principal dwelling). This prohibition does not apply to credit insurance for which premiums or fees are calculated and paid in full on a monthly basis. (2) For purposes of this paragraph (i):

4 3 (A) Credit insurance means credit life, credit disability, credit unemployment, or credit property insurance, or any other accident, loss-of-income, life, or health insurance, or any payments directly or indirectly for any debt cancellation or suspension agreement or contract. (B) The term credit insurance excludes credit unemployment insurance for which the unemployment insurance premiums are reasonable, the creditor receives no direct or indirect compensation in connection with the unemployment insurance premiums, and the unemployment insurance premiums are paid pursuant to a separate insurance contract and are not paid to an affiliate of the creditor. (ii) A creditor finances premiums or fees for credit insurance if it provides a consumer the right to defer payment of a credit insurance premium or fee owed by the consumer beyond the monthly period in which the premium or fee is due; and (iii) Credit insurance premiums or fees are calculated on a monthly basis if they are determined mathematically by multiplying a rate by the actual monthly outstanding balance. New Comment Comment 36(i) - Prohibition on financing credit insurance. Financing credit insurance premiums or fees. In the case of single-premium credit insurance, a creditor violates (i) by adding the credit insurance premium or fee to the amount owed by the consumer at closing. In the case of monthly-pay credit insurance, a creditor violates (i) if, upon the close of the monthly period in which the premium or fee is due, the creditor includes the premium or fee in the amount owed by the consumer. CFPB Clarifies Prohibition on Financing Credit Insurance Right away, you ll notice that the CFPB removed the term single premium from Section (i). Single premium credit insurance has generally been understood to mean a lump sum premium added to the consumer s loan balance at consummation. However, the CFPB clarified that Section (i) more broadly prohibits a creditor from financing credit insurance premiums directly or indirectly in connection with a covered consumer credit transaction secured by a dwelling. In other words, the rule generally prohibits a creditor from financing credit insurance premiums at any time. So, the prohibited financing of credit insurance premiums is not limited to the addition of a single, lump-sum premium to the loan amount by the creditor at consummation. What is financing under the rule? Under final Section (i)(2)(ii), financing occurs when a creditor treats a credit insurance premium as an amount owed and provides a consumer the right to defer payment of that obligation. According to the preamble to the rule, the CFPB believes this clarification best conforms the concept of financing in Section (i) with Regulation Z s concept of an extension of credit in Section (a)(14), which is defined as the right to defer payment of debt or to incur debt and defer its payment. The CFPB also

5 4 clarified that granting the consumer this right to defer payment only constitutes financing if it provides the consumer the right to defer payment of the premiums or fees beyond the period in which they are due. The CFPB also added comment 36(i)-1 to clarify how the prohibition applies to single-premium and monthly pay products. It clarifies that in the case of single-premium credit insurance, a creditor violates Section (i) by adding the credit insurance premium or fee to the amount owed by the consumer at closing. The comment states further that, in the case of monthly-pay credit insurance, a creditor violates the provision if, upon the close of the monthly period in which the premium or fee is due, the creditor includes the premium or fee in the amount owed by the consumer and thus treats it not as a monthly charge that could be cancelled prior to being due, but as a debt that is owed by the consumer to the creditor, which the consumer then would have a right to pay at some later date. What does it mean to be calculated and paid in full on a monthly basis? Credit insurance for which premiums or fees are calculated and paid in full on a monthly basis are excluded from the provision s general prohibition. Section (i)(2)(iii) states that that credit insurance premiums or fees are calculated on a monthly basis if they are determined mathematically by multiplying a rate by the monthly outstanding balance (e.g., the loan balance following the consumer s most recent monthly payment). According to the CFPB, a premium or fee that is calculated on a monthly basis is a premium or fee that declines as the consumer pays down the outstanding principal balance. Credit insurance with this feature is often referred to as a monthly outstanding balance, or M.O.B. credit insurance product. The CFPB stressed that a premium is not paid in full on a monthly basis merely because it is contractually required to be paid monthly. Levelized premiums refer to a flat monthly payment that is derived from a decreasing monthly premium payment arrangement and level premiums refer to premiums for which there is no decreasing monthly premium payment arrangement available. According to the CFPB, level or levelized premiums or fees that are calculated by multiplying a rate by the initial loan amount or by a fixed monthly principal and interest payment are not calculated on a monthly basis in any meaningful way because the factors in the calculation do not change monthly (in contrast to the M.O.B. credit insurance product). Nevertheless, the CFPB emphasized that a credit insurance product with a level or levelized premium is not prohibited by this final rule. For any credit insurance product that does not meet the conditions of the exclusion, this final rule s clarification on what constitutes a creditor s financing of credit insurance premiums or fees applies. What about accrued interest? Lastly, the CFPB addressed the issue of creditors adding credit insurance premiums to a consumer s principal balance before the premium is due from the consumer even though no funds are advanced on behalf of the consumer at that time. Interest then accrues on the increased principal until the consumer s subsequent payment is credited to the account. The CFPB stated that the accruing interest does not indicate that the creditor has financed the premium because the creditor doesn t advance any funds for the premium, and therefore, could not add to the consumer s debt until after the consumer s payment is actually due. Nevertheless, the Bureau believes that interest charged

6 5 under such practices raises potential consumer protection concerns and may not be appropriate --although the reason it may be inappropriate is not because it indicates the creditor is financing the premium. Rather, the potential concerns arise if the creditor is charging the consumer additional interest on the premium even though the creditor is not financing the premium. CUNA CompBlog Post: Update on Financing Credit Insurance Premiums (10/8/2013) A new final rule prohibiting the financing of credit insurance premiums By David K. Tomar, CUNA Mutual Group The Consumer Financial Protection Bureau (Bureau) delivered its final rule on September 13, 2013 prohibiting the financing of credit insurance premiums and debt protection fees (premiums). The rule can be found here. The rule is effective for loans whose applications are taken on or after January 10, The scope of the rule still applies only to closed-end loans secured by any dwelling or open-end loans secured by a principal dwelling. Thanks largely to the efforts of CUNA, credit unions, and CUNA Mutual, the Bureau agreed that adding a premium to the outstanding loan is not financing if the premium is posted and paid in the same monthly period, even if some interest accrues. That s the most common scenario and a huge relief for credit unions because credit unions do not need to make changes by January 10, Unfortunately, the Bureau also said that forbearances, modifications, and other delinquencies (including skip-apays) could cause a violation because it could amount to financing. That s so, says the Bureau, because it is a violation if credit unions, upon the close of the monthly period in which the premium is due, include the premium in the amount owed by the member. The Bureau suggested various solutions: offer a grace period to the member, suspend coverage, or cancel coverage immediately upon non-payment. While offering these suggestions, the Bureau did not address the rules, regulations and agreements of the underlying credit insurance or debt cancellation products, so some revisions to credit union practices might follow. Finally, the Bureau also said that, regardless of everything else, and while not a violation of the financing prohibition, the practice of charging interest was viewed as a potential violation of state or Federal law, though the Bureau cited no specific examples. The Bureau did, however, acknowledge it will monitor and may revisit these practices in the future. So what s that mean? It means the Bureau wants credit unions to either refund the additional interest or change the way their data processing systems account for the premiums (e.g., don't include the premiums in the loan balance). The Bureau did not put a timetable on when a change in practice needs to be in place. Rather, credit unions should begin planning a way to account for the premiums that is consistent with the Bureau s new rules and changes, while not required by January 10 th, should happen sooner rather than later (e.g., 2014 and not 2016). There is, obviously, much more to the story. But since this is a blog, we ve kept it brief. So, in the meantime, if you have questions or want more information, feel free to contact CUNA compliance staff at cucomply@cuna.com or myself at CUNA Mutual (david.tomar@cunamutual.com) if you have any questions.