Tuesday, June 18, 2024

October 2007 Legal Briefs

D.O.D. Lending Regulation for Servicemembers

D.O.D. Lending Regulation for Servicemembers

As part of the 2007 Defense Authorization Act, Congress enacted the Talent Amendment, including provisions restricting permissible terms of consumer credit provided to servicemembers and their dependents.  The Department of Defense (DOD) has now issued a final regulation (32 C.F.R. Part 232), effective October 1, 2007. 

Banks will need to use a “covered borrower identification statement” to identify all servicemembers and dependents, in cases where three specific categories of loans are involved.  Only a small percentage of bank loans are affected, but the penalties are severe for not dealing properly with the fairly small number of loans that fit the definitions.

Although a bank’s interest-rate pricing may already be fully within the regulation’s guidelines, a bank will be required to provide additional disclosures, and may need to use slightly different loan documents for servicemembers and dependents.  (A bank’s standard documents may contain a prohibited “fine-print” clause of some kind (such as “arbitration”) that would violate the regulation and cause the entire loan to a servicemember or dependent to be void.) 

1. Background

The law restricts certain “predatory lending” practices—as identified by the U.S. Department of Defense (DOD).  DOD is concerned about servicemembers and their families who are falling prey to certain harmful loan provisions.  

  The focus of this regulation is on (1) payday loans (as defined), (2) lenders who take a security interest in the equity in a borrower’s already-owned vehicle, and (3) tax-refund loans.  The new law’s provisions impose limits on all of these practices in one way or another. The regulation leaves banks unaffected in most lending categories, but will create some new risks and pitfalls on at least a few loans that banks make.  

2. Regulated Categories of “Consumer Credit”

Section 232.2 restricts the terms of “consumer credit” extended to servicemembers and dependents, but within three categories only (as outlined in more detail below).  “Consumer credit” as used in this regulation is the same as in Regulation Z, except that it includes only “closed-end” credit.  Importantly for banks, the regulation’s scope is then narrowed further by applying the following limitations and exclusions:

(1) The regulation only applies to loans that fall within three “problem” loan categories (defined later):  payday loans, vehicle title loans, and refund anticipation loans. 

(2) A transaction that otherwise seems to fall within one of the three categories just listed will nevertheless be excluded from the regulation if it’s any of the following:

(i) a “residential mortgage”—any credit transaction secured by the borrower’s dwelling, including a purchase, construction, refinance, HELOC, or reverse mortgage;

(ii) a credit transaction financing the purchase or lease of a motor vehicle, if secured by that vehicle;

(iii) a credit transaction financing the purchase of any other type of personal property, if secured by that property;

(iv) credit secured by a qualified retirement account, as defined by the IRS; or

(v) credit that’s not “consumer”; or credit that’s not otherwise subject to Regulation Z disclosure requirements (for example, overdraft protection).

Understanding the above provisions is extremely important:  If a loan to a servicemember or dependent falls within any of the exclusions outlined above, nothing in the DOD regulation will apply to that loan.  However, if a loan to a servicemember or dependent is covered by the DOD regulation based on the guidelines set out above, all of the provisions of the regulation will apply to that loan.

3.  Three Loan Categories That Apply

(a) Payday Loans.  The regulation’s definition of “payday loan” has two parts, both of which must be satisfied:  (1) It is a closed-end credit transaction having a term of 91 days or less, with an amount financed that does not exceed $2,000.  In addition, (2) the borrower either (i) “contemporaneously provides a check or other payment instrument that the creditor agrees to hold,” or (ii) “contemporaneously authorizes the creditor to initiate a debit or debits to the covered borrower’s deposit account.”

In lending to servicemembers and their dependents, a bank should attempt to avoid the DOD regulation’s “payday loan” category by structuring the loan in a way that “flunks” at least one part of the above definition. Working first with the two alternatives under the second “half” of the “payday loan” definition, a bank probably never takes a post-dated check when the loan is originated, as the method of repayment—so this is not an issue.  Obviously, however, the other option is more common–setting up an automatic debit to a bank account, at the time of origination, as the method of repayment.

There are at least three simple ways to avoid the “payday loan” definition and the DOD regulation’s resulting restrictions: (1) If a bank’s proposed loan to a servicemember or dependent would have a term-to-maturity and dollar amount meeting the “payday loan” definition above, the bank can lengthen the loan’s maturity to not less than 92 days, while retaining an automatic debit (if desired) as the method of payment.  (Lengthening the loan does no harm, as the borrower is free to pay the loan off sooner.)

(2) Even if a loan has a maturity of 91 days or less, the lender can avoid setting up an automatic debit, and by that means can drop out of the “payday loan” category.

(3) If the loan is for “purchase money,” securing it with the personal property being purchased will drop the loan out of the definition.

Let’s consider briefly two categories of loan products, originated by banks, that could run afoul of the “payday loan” definition in the wrong circumstances:  The first example is a small loan made under provisions of Section 3-508B of Oklahoma’s Consumer Credit Code.  (Oklahoma law permits these loans to have an APR greater than 36%; but such terms may violate the DOD regulation (making the loan “void”) if (1) the borrower is a servicemember or dependent;  (2) the maturity is 91 days or less; and (3) repayment is by means of an automatic debit set up at the time of loan origination.)

Oklahoma’s 3-508B loans must be in an amount of $1,260 or less (automatically falling within the $2,000 amount stated in the DOD regulation).  But only those small loans with a maturity of 91 days or less will also meet the “payday loan” definition.  Oklahoma allows a 3-508B loan to have a maturity as short as 60 days (for loans over $125.96) or as long as 18 months.  In most cases, only a truly small 3-508B loan will have a maturity of 91 days or less—simply because a “small loan” borrower can’t afford to make monthly payments that are very large, and so usually can’t pay off a larger loan in three months.  But most banks also have a “minimum” loan amount, such as $500 (or larger), and even a “small loan” of this size is unlikely to be amortized with a maturity of 91 days or less.  Still, a bank that lends to servicemembers and dependents needs to understand the regulation very well in order to avoid the “stray” small loan that technically might fit the “payday loan” definition. 

A second example that could possibly be classified as a “payday loan” is a consumer-purpose “single-payment note” with a principal amount not more than $2,000 and a maturity of 91 days or less.  (A bank typically would not set up an automatic debit as the method of repayment on a single-pay note, and for that reason the loan would drop out of the “payday loan” definition.)  Instead, the single-pay borrower is normally looking toward some “lump-sum” future income source, and normally intends to pay by check when that income is received—which will not necessarily be on a predetermined date for which an EFT can be authorized.  

Some exceptions:  As explained by the DOD, a loan will not become a “payday loan” just because the borrower sets up an automatic debit provision at some time after the loan is originated.  (If the borrower calls when a payment is due and asks the bank to electronically debit his account for that amount, this payment does not turn the loan into a “payday loan.”  The “payday loan” definition is triggered only if the automatic debit is pre-authorized as part of the funding of the loan–not afterward.)

At Section 232.3(b)(1)(A)(ii), the regulation also clarifies that a statutory right of offset against funds on deposit in the event of the borrower’s delinquency or default on indebtedness is not an authorization to initiate an automatic debit to pay the loan within the regulation’s definition, and will not by itself turn a loan into a “payday loan.”

(b) Vehicle Title Loans.  This category includes any closed-end consumer loan with a term of 181 days or less that is secured by the title to a motor vehicle owned by the servicemember or dependent, if the purpose of the loan is not to finance the purchase of that vehicle.  In other words, these are vehicle-secured loans where a borrower’s already-owned vehicle is used as collateral for the loan.

Finance companies targeting servicemembers and dependents often require a security interest in the borrower’s existing vehicle.  This tactic gives the lender extra leverage by tying up one of the borrower’s “key assets”—which DOD views as potentially unfair.  (A security interest in, or cross-pledge of, an already-owned vehicle can lock a servicemember into a loan that’s structured on unfavorable terms.  The servicemember needs his vehicle, and so must continue to pay his loan. The situation is especially hard to escape if the amount of the loan leaves the borrower “underwater” in the vehicle.) 

Of course, a “normal” vehicle-secured loan usually does not a maturity of 181 days or less, as the definition requires.  DOD uses the pairing of two loan characteristics as a “rough guess” indicator of a loan that should require special restrictions, as set out in the regulation:  These are (1) a fairly short maturity (181 days or less) plus (2) taking a security interest in an already-owned vehicle (not a purchase of the new or used vehicle securing the loan).

Almost all bank loans secured by a vehicle will drop out of the DOD definition of “vehicle title loan” on one basis or another:  Any loan representing purchase money for a vehicle, new or used—if also secured by that vehicle—is excluded from the definition.  Automobile “dealer paper” will also drop out of the regulation.

However, most banks remain willing to make a consumer loan secured by equity in an already paid-off vehicle—assuming that the vehicle is not too old and has a reasonable resale value.  (This most often occurs when (1) the bank requires collateral on a loan, and equity in the borrower’s car is the most available, or (2) the borrower wants to get a better rate than is available for an unsecured loan.)  Oklahoma’s UCCC Section 3-515  prohibits taking an interest in a vehicle as security for any loan of $300 or less; but for loans above $300, taking a security interest in a paid-off vehicle is permissible.

However, even a loan secured by an already-owned vehicle drops out of the DOD regulation’s definition if it has a maturity of 182 days or more.  On this basis, very few bank-held consumer car loans will actually be covered by the regulation.  Still, it’s not safe to automatically assume there will be “none.”

(c) Tax Refund Anticipation Loans.  As defined in the regulation, these are closed-end loans in which (1) the servicemember or dependent expressly grants to the creditor the right to receive all or part of the borrower’s income tax refund (for example, a loan secured by the borrower’s anticipated refund, or a transaction where the borrower directly signs over to the creditor the right to receive the refund) or (2) the borrower at least agrees to repay the loan with the proceeds of a tax refund, although the loan may not be secured by that refund.

The DOD is attempting to restrict a common pattern of tax preparers, offering a “tax refund” loan or immediate advance, which gives the servicemember or dependent an “on the spot” check for the tax refund that is coming. The consumer “signs over” the right to a refund to the tax preparer—although that is not the only way to satisfy the DOD’s definition.  (Later, the tax preparer receives the refund electronically.)  What the consumer actually receives is an amount equal to (1) the tax refund to which he is entitled, minus (2) a “loan fee” that is deducted by the tax preparer.  The DOD says this fee is often in the range of $30 to $125; however, this arrangement gives the consumer his money only about 7 to 14 days faster than he could normally receive an electronic refund.  The DOD views this as a “triple digit APR” loan for an extremely short time period—a practice that can be abusive to the borrower, and is essentially unnecessary.  

By applying the regulation’s 36% maximum APR (discussed below) to this situation, the DOD will almost completely shut down tax preparers and finance companies from  making short-term “refund anticipation loans” to servicemembers or their dependents.

Unfortunately, the DOD’s definition of “tax refund anticipation loans” is not limited to the very short-term loans described above, but can also extend to tax refund loans originated by banks.  Many banks are willing to make a loan against an anticipated tax refund—but usually not for someone who is already at the point of filing a tax return electronically.  Instead, a bank tends to make a tax-refund loan to a consumer with a complicated tax return, who is “hung up” in filing it for some reason, and may have a couple of months’ delay before receiving a refund.  In many circumstances a consumer can make a very good estimate of his tax liability and the amount of his refund, although he is unable to file his tax return immediately.

The typical young servicemember in Iraq is not likely to be the same person who has a very complicated tax return and needs to obtain a bank loan secured by his future tax refund.  However, someone in the National Guard or Reserves, who owns his own business but is called up to active duty, may occasionally fall into these circumstances.

Although very few “refund anticipation” loans are actually made by the average bank to servicemembers or dependents, the bank still must thoroughly understand the regulation in order to recognize (and give appropriate disclosures for) the occasional loan falling within the DOD’s definition.

I see some ambiguity in the regulation (Section 232.3(b)(iii)) concerning what it takes for a loan to be considered a “tax refund anticipation loan.”  The definition applies to a borrower who “expressly agrees to repay the loan with the proceeds of the borrower’s refund.”  For example, if the borrower’s loan application lists “tax refund” as the source of repayment, I think it’s hard to argue that borrower is not indicating that he will repay the loan from this source.  Similarly, if the borrower verbally promises the loan officer that the tax refund will be applied to repay the loan, I would say the borrower has “expressly agreed” and that the loan has become a “tax refund anticipation loan,” even though the loan is not secured by the tax refund.  Even a loan secured by other collateral (which the borrower does not intend to sell) can meet the definition, if the tax refund is the promised source of repayment.

The DOD’s explanation of the regulation states, “The rule does not cover loans where borrowers merely note that a tax refund may be used to repay the advance.”  (Emphasis should be placed on the word “may.”)  Apparently if the borrower says, “I may repay this loan from my tax refund, or I may repay it from other funds” (and he actually has other potential sources of repayment), this is not a “tax refund anticipation loan,” because the borrower has not “expressly” agreed to use the tax refund—as opposed to other funds–to repay the loan.

One banker asked me if she could avoid having the loan treated as a “tax refund anticipation loan” by simply not using “tax refund” in the “source of repayment” box on any application.  (The bank thought it could ask the borrower to re-do the loan application, so as to put something other than “tax refund” as the source of repayment—and thereby avoid originating a “refund anticipation loan.”  To me, this just disguises reality.  If the transaction is actually viewed as a “tax refund” loan by both the lender and the borrower, I’m not in favor of “dummying up” the loan application to indicate otherwise.  If the loan clearly falls within the regulation, the bank’s position probably should be that it will comply with the regulation’s requirements!)

4. Need to Identify Every Covered Borrower

The threshold compliance issue raised by the DOD regulation is “how to identify accurately all persons to whom the regulation applies”—persons referred to in Section 232.3(c) of the regulation as “covered borrowers.”  In making any of the types of loans that might be covered, a lender is basically forced by the regulation to find out for certain  whether it is dealing with a “covered borrower.”

(The entire loan can become unenforceable—and there may even be a criminal violation—if the lender makes a loan (falling within one of the three categories outlined above) to a “covered borrower” without following the required compliance steps.)

From the surrounding circumstances, and as a result of normal income verification procedures, it may be fairly easy to identify most persons who are described as servicemembers in Section 232.3(c)(1)—which is quoted in full below.  But someone’s status as a “dependent” of a servicemember (also defined below) may not be so obvious to the lender.  If a dependent is unaware of the DOD regulation, or unaware that dependents are covered by it, there may be no particular reason for him or her to disclose the qualifying relationship with a servicemember.

 (For example, assume that a married person applies for credit individually, rather than jointly—and that person does not have joint debts.  If the one who applies is strong enough financially to be approved separately, the lender really can’t ask questions about the spouse, or the spouse’s employment, and so might not learn that the spouse is a servicemember on active duty.) 

5. “Covered Borrower Identification Statement”

To avoid “not recognizing who it is dealing with,” a lender is permitted by the DOD regulation to require a “covered borrower identification statement” from any consumer-purpose loan applicant.  If a lender obtains the completed statement from a loan applicant (and during the loan application process does not learn other information suggesting that the statement may be incorrect), the lender can rely on what is indicated in the statement, providing disclosures and loan documentation accordingly, without violating the regulation.  The loan applicant’s statement creates a “safe harbor.”  (If there is more than one loan applicant, all applicants must fill out a statement.)

Section 232.5 of the regulation sets out the specific language of the “covered borrower identification statement.”  (Software forms systems providers have probably already supplied the appropriate form to your bank.)  The DOD’s suggested form provides three alternative statements for a loan applicant to choose from—depending on which statement is correct.  The first statement says the loan applicant is a regular or reserve member of the Armed Forces on active duty; the second statement says the person is a dependent (as defined) of someone who is a regular or reserve member of the Armed Forces on active duty; and the third statement says the person is neither (1) a regular or reserve member of the Armed Forces on active duty, nor (2) a dependent.

(Federal Reserve Regulation B prohibits a lender from inquiring about the loan applicant’s marital status; but this form simply asks whether the individual is a “dependent,” without asking on what basis that person is a “dependent.”  The Federal Reserve has confirmed that this does not violate Regulation B.)

There’s an “exception” to the lender’s general ability to rely on a loan applicant’s response to this identification statement:  The lender must not know the statement to be false, and also must not have information suggesting that it is false.  A lender cannot say, for example, “I know you’re a servicemember on active duty, but I won’t make you a loan unless you state in this form that you are not a servicemember.”  In this example, the lender is attempting to evade the regulation, which will not be permitted.

Also, if the lender obtains documentation in the course of processing the loan application, indicating that the applicant’s identification statement may be false, the information statement will not create a “safe harbor” for the lender.  Where there seems to be conflicting information, the lender should attempt to resolve any inconsistency.  A lender is permitted, but not required, to verify whether an applicant is a covered borrower by going to https://www.dmdc.osd.mil/mla/owa/home and entering the individual’s full name, Social Security number, and date of birth.

A lender is also permitted (but not required) to verify an applicant’s status as a “covered borrower” by requesting a current (previous month) military leave and earning statement, or a military identification card (issued to both servicemembers and dependents).  Upon request, activated members of the National Guard or Reserves are required to provide a copy of military orders calling them to active duty.  

If a lender cannot resolve an apparent inconsistency between the applicant’s identification statement and other information available to the lender, the DOD suggests two ways of resolving this: (1) the lender can treat the applicant as a “covered borrower,” to avoid any risk of noncompliance, or (2) the lender can turn down the loan application based on inability to verify what the applicant has provided in the identification statement.

The “covered borrower identification statement” warns that making a false statement in a credit application, including this form, is a crime. (The responsibility for incorrect information falls entirely on the applicant, if the lender is otherwise unaware.)

Section 232.5(d) cuts some slack for the lender with respect to a renewal, extension, refinancing, or consolidation of consumer credit.  If the lender obtained a  “covered borrower identification statement” from each applicant at the time a loan was originated, and the statement(s) indicated that no applicant on the original loan was a “covered borrower,” the already-originated loan will not later become subject to the DOD regulation, even if the borrower’s status changes.  If the existing indebtedness is later reworked, amended, extended, renewed, consolidated, etc. (no new money), the lender does not need to obtain an updated “covered borrower identification statement,” but can continue to rely on the original identification statement and can prepare any documentation as if the DOD regulation continues not to apply.

However, this provision also seems to suggest an opposite scenario, which may be a trap for the unwary:  If a bank does an amendment, extension, renewal, consolidation, etc., after the October 1 effective date of the regulation, and no “covered borrower identification statement” was obtained when the original loan was made (for example, because the regulation did not yet exist), the borrower probably needs to obtain a “covered borrower identification statement” for any of the three categories of loans at the time of renewal, extension, consolidation, etc.

6.  Which Applicants Should Fill Out the Identification Statement?

From one perspective, the “covered borrower identification statement” is useful as a means of determining whether someone is a servicemember or dependent for purposes of the DOD regulation’s coverage.  From another viewpoint, this is “yet another piece of paper” for a lender to obtain from consumer loan applicants, from now on. 

Every bank has to choose which consumers will be asked to provide this information statement. The problem is to reliably identify all loan applicants to whom the new regulation applies–while also trying to avoid collecting unnecessary paperwork on consumer loans for which the regulation does not apply.

The most “bullet-proof” approach to full compliance, and the simplest from the standpoint of training, is to require every consumer applicant for a “closed-end” loan to fill out the “covered borrower identification statement”—regardless of the specific loan category involved.  Using this procedure, loan officers would review the completed form and send everything to the compliance officer (or a specially designated loan officer) in every case where the applicant’s statement indicates he or she is a servicemember or dependent. The compliance person (who understands the regulation fully) would determine whether the particular loan requested by the servicemember or dependent is actually covered by the DOD regulation, and what specific loan documentation and disclosures are required. 

(The vast majority of consumer loan applicants will indicate that they are not servicemembers or dependents, and for them the regular loan officer can simply process the loan application normally, without special documentation or disclosures.)

An alternative approach to compliance would be to train each loan officer to understand exactly what categories of loans are covered by the DOD regulation.  For this, every loan officer would need to understand what it takes for a specific consumer loan application to fall into the definition of (1) a payday loan, (2) a vehicle title loan, or (3) a tax refund anticipation loan.  If, in fact, every loan officer understands the regulation’s provisions accurately, it will only be necessary to obtain a “covered borrower identification statement” from those consumers whose requested loan fits within one of those three loan categories.  As explained earlier, very few bank loans will actually fit into any of these categories (once all of the exclusions are considered), so it would be possible to obtain identification statements from only a very few loan applicants.  The reduction in paperwork would be attractive, but this approach is risky if all loan officers do not recognize exactly when a consumer loan will fit in one of the three covered categories, because mistakes could create liability for noncompliance.

A “middle ground” might be to give loan officers a “simplified” (somewhat overly-inclusive) version of when the three loan categories apply.  Using this “rough outline” approach, loan officers would be instructed to always obtain an “information statement” in any of the following circumstances:  (1) whenever a consumer loan will have a term of 91 days or less and an amount of $2,000 or less; (2) whenever a consumer loan is secured by a vehicle title and the loan is not made to purchase the vehicle (new or used); and (3) whenever a consumer loan is for a term of 181 days or less and either (a) is secured by the borrower’s future tax refund, or (b) that tax refund is the promised source of repayment.  This could be used by loan officers as a checklist, to refer to as they are making loans.

Under this approach, for any loan application fitting roughly into any of these three general categories, the loan officer would request a “covered borrower identification statement.”  If an applicant then indicates that he is a servicemember or dependent, the loan officer can turn everything over to the compliance officer or other designated person, who will compare the loan application more closely to the regulation’s requirements, to determine whether special disclosure and documentation are required in the specific case.

7.  Special Provisions Applying to All Covered Loans

Everything discussed up to this point in this article relates to determining which loans fall out of the regulation’s coverage.   If you have determined that a specific loan is excluded from the regulation, nothing that is discussed below will apply.  On the other hand, if a loan does fall within the regulation’s coverage, then everything that follows will apply to that loan.
8. “Military APR” (MAPR); Other Required Disclosures

Section 232.3(h) contains a new definition–“military annual percentage rate” (MAPR).  Although this new calculation includes all items that are part of the “APR” as defined in Regulation Z, it is a broader term than Reg Z’s definition.  MAPR includes (i) all “interest, fees, credit service charges, credit renewal charges” (no Reg Z-type exclusions); (ii) “credit insurance premiums,” as well as fees for a “debt cancellation” contract; and (iii) “fees for credit-related ancillary products sold in connection with and either at or before consummation of the credit transaction” (for example, premiums for VSI).  

MAPR specifically excludes late charges, or default or delinquency charges. It also does not include “taxes or fees prescribed by law that actually are or will be paid to public officials for determining the existence of, or for perfecting, releasing, or satisfying a security interest.”

For extensions of credit to servicemembers and dependents (within the three specific categories outlined above), Section 232.6(a) will require additional disclosures (before consummation of the credit transaction) that do not apply to standard consumer loans:  (1)The lender must disclose the MAPR applicable to the extension of credit, as a percentage, as well as the total dollar amount of the charges.  (2) The lender also must provide a specific three-sentence statement (found in Section 232.6(a)(4)), informing servicemembers and dependents (a) that Federal law provides important protections for them, (b) that they may be able to obtain financial assistance from military relief societies, and (c) that they can request free legal advice concerning any credit application.

 In addition to the “new” disclosure items just described, a lender must provide “any disclosures required by Regulation Z,” including both “a clear description of the payment obligation” and a statement of the APR (stated separately from the MAPR even if both are the same percentage).

All of the above must be provided in writing, in a form the covered borrower can keep.  However, in addition to the written disclosures, the borrower must also orally provide (1) the MAPR (as a percentage, and total charges in dollars); (2) a clear description of the payment obligation (a payment schedule complying with Reg Z’s disclosure requirements); and (3) the three-sentence statement mentioned above, concerning important protections, financial assistance and free legal advice. 

Being required to give two different sets of disclosures (meeting both Reg Z and the DOD regulation’s requirements) is burdensome for lenders. Giving the regulation’s additional disclosures “orally” (as well as in writing) will take more time.  And the requirement to calculate and disclose the separate MAPR, in addition to the APR, will create still more opportunity for computation errors or other disclosure violations.

The best approach is for a bank to try to structure all of its consumer loans to servicemembers and dependents so that those loans will fall outside of the regulation’s coverage.  This is the most effective way to cut down on the disclosure requirements and to reduce liability for noncompliance.  (Earlier, I have already suggested ways to change a loan’s terms in order avoid the regulation’s coverage.) 

9.  “MAPR” Limited to 36%

For servicemembers and dependents, Section 232.4(b) prohibits a lender from charging a MAPR greater than 36% on consumer loans within the regulation’s three categories.  (Any more restrictive interest-rate limitations in state law will also apply.)

 If state law has more permissive rate or fee provisions (in other words, any otherwise legal combination of charges that could result in a MAPR calculation greater than 36%), that authority is pre-empted (Section 232.7(a)) for the three categories of loans falling within the regulation.  And the allowable 36% MAPR is not even “36% as we know it,” because certain fees charged in connection with a loan, excludable under Regulation Z, are included in MAPR, as explained above.

Oklahoma banks generally aren’t structuring consumer loans that would have a MAPR greater than 36%.  The obvious exception would be some “small loans” originated in compliance with Section 3-508B of Oklahoma’s UCCC.  (These loans are priced based on an “acquisition charge” plus a monthly “installment account handling charge,” instead of an annual interest rate.)To keep these small loans from being covered under the DOD regulation, a lender must either (a) make sure that the maturity on the loan is not less than 92 days, or (b) make sure the loan does not have an automatic debit authorized as the means of repayment.  With these changes, something that otherwise would be classified as a “payday loan” can avoid being limited to 36%.  Any small loan that also does not meet the definition of “vehicle title loan” or “tax refund anticipation loan” can still have an APR above 36% (in reliance on Section 3-508B), even for borrowers who are servicemembers and dependents.

The new 36% MAPR limitation will hit particularly hard at “payday lenders” located near military facilities, and that is intentional. 

10. No Renewal of Debt

Section 232.8(a)(1) of the regulation makes it unlawful to roll over, renew, repay, or refinance any consumer loan that was originated by that lender(in the three categories), or to consolidate one consumer loan from the same lender with another consumer loan from the same lender “unless the new transaction results in more favorable terms to the covered borrower, such as a lower MAPR.”  (If the original loan was not made to a “covered borrower”—for example, because the regulation was not yet in existence—the “more favorable terms” provision will not apply to a refinancing or renewal of the loan.)

It is common for payday lenders to roll over one payday loan into a second one with a higher balance, and so on.(The lender offers to extend the payday loan for an additional period, charging another loan fee that is also rolled into the balance owed.  A borrower quickly “digs the hole deeper and deeper,” instead of reducing the debt.)  The DOD strongly prefers that lenders structure loans to have a fully amortizing payment schedule with realistic payments, so that no extension or renewal is planned or necessary.

As already stated, the only exception to the general prohibition on renewal, extension, consolidation, etc., of a loan within the three categories is if the renewal, etc., is on “more favorable terms.”  A lower MAPR for a renewal note obviously constitutes “more favorable terms.” The DOD indicates that “factors other than a lower MAPR” can cause a renewal to be on “more favorable terms”—but this is left open-ended, with no examples given of other factors.

However, the mere fact that the renewal or other refinancing by the same lender will extend the maturity does not by itself amount to “more favorable terms.”  A smaller monthly payment (longer amortization) would be “more favorable.”

11.  Other Prohibited Practices

Section 232.8(a)(5) lists other “prohibited provisions” that cannot be part of a loan made to a servicemember or dependent within the three categories:

a. Requiring a Post-Dated Check. Section 232.8(a)(5) makes it unlawful for a lender to take a post-dated check from the borrower at the time of loan origination, as the means of repayment of a loan falling within any of the three categories.  This provision will strike particularly hard at “payday lenders.”

b. Other Methods of Access to a Borrower’s Account.  Except on “payday loans,” Section 232.8(a)(5) generally allows an EFT as the means of repaying a consumer credit transaction falling within the three categories.  (Based on Regulation E, such a provision must be voluntary, and can be cancelled at will).  A bank also may require direct deposit of the borrower’s salary, as a condition of eligibility for credit.  It is also permitted to take a security interest in funds deposited after the extension of credit, in an account established in connection with the consumer credit transaction. (For example, if the lender requires the borrower to open a deposit account as a condition of obtaining the loan, and secures the loan with that deposit account, the funds deposited to that account after the loan is made are permitted to secure the loan.)

The regulation seems to prohibit taking a security interest in a pre-existing deposit account—at least in that portion of deposit balances existing before the loan was made.  Banks making loans in the three categories should be particularly careful about “fine print” in their standard consumer loan forms that would automatically grant a security interest in all deposits held at the bank, as further collateral for the loan.  In a loan within the three categories, this provision may need to come out in order to avoid violating the regulation—because including it could make the loan “void.”

c. Prepayment Penalties.  Based on Section 232.8(a)(7), within the three categories the covered borrower is free to prepay the loan—and a prepayment penalty cannot be charged.  Oklahoma’s UCCC Section 3-209 already permits prepayment and prohibits prepayment penalties in these loan categories.

d. Arbitration. Section 232.8(a)(3) makes it unlawful (within the three categories of loans) to require a servicemember or dependent to submit to arbitration any dispute arising from the extension of consumer credit.  This provision overrides Oklahoma law, which does allow arbitration.

Many Oklahoma banks have a standard “arbitration” clause in the fine print of their loan documents.  Simply using the standard form can make the loan “void,” within the three categories.  As this example illustrates, a bank may have to use a somewhat modified set of loan documents in making loans that are covered by the DOD regulation.  This is certainly a messy approach, and a simpler way is to structure the loans’ provisions to avoid falling within one of the three categories.

12. Criminal Provision

The Act also creates a misdemeanor offense for putting prohibited provisions in a loan:  “A creditor who knowingly violates this section shall be fined [up to $100,000] as provided in title 18 [U.S.C.], or imprisoned for not more than one year, or both.”

Literally, the criminal provision will apply to both (1) a lender making thousands of loans to servicemembers at exorbitant rates and fees, and also (2) a lender who does not remove an arbitration clause from one consumer loan, or who renews one consumer loan (within the three categories) to a servicemember or dependent, on the same terms as before.  However, a federal District Attorney would probably not attempt to prosecute someone for trivial or accidental violations of this new regulation. 

13. What’s a “Covered Borrower”?

 Section 232.3(c) lists two categories of persons who are “covered borrowers”: 

“(1) A regular or reserve member of the Army, Navy, Marine Corps, Air Force, or Coast Guard, serving on active duty under a call or order that does not specify a period of 30 days or fewer, or such a member serving on Active Guard and Reserve duty” [call-up to active duty for Guards or Reserves for a period of at least 180 consecutive days]; or

“(2) The member’s spouse, the member’s child defined in 38 U.S.C. 101(4), or an individual for whom the member provided more than one-half of the individual’s support for 180 days immediately preceding an extension of consumer credit covered by this part.”  

The definition of “child” means any child under 18; any child under 23 (whether self-supporting or not) who is attending college; and any child (regardless of current age) who became permanently incapable of self-support (disabled) before age 18.  It includes a child by blood, an adopted child, a step-child, and an illegitimate child. 

This dependent test includes “anyone else,” more than half of whose support was provided over the last 180 days by a servicemember.  In a variety of situations (college attendance, major illness, job loss, etc.) someone would meet this “dependent” test if measured at certain points in time but not at other times a few months before or afterward.  The 180-day period is measured backward from the date when credit is extended. In some cases it would be time-consuming to document total income precisely enough to determine that someone is slightly above or below the 50% test.  Fortunately, a lender (not knowing facts to the contrary) can rely on whatever the borrower indicates in a “covered borrower identification statement,” without doing math calculations.